Bernanke v. Paul Title Bout: Pay Per View

"First of all, in private contracts: wherever the unjust is the partner of the just you will find that, when the partnership is dissolved, the unjust man has always more and the just less. Secondly, in their dealings with the State: when there is an income tax, the just man will pay more and the unjust less on the same amount of income; and when there is anything to be received the one gains nothing and the other much. Observe also what happens when they take an office; there is the just man neglecting his affairs and perhaps suffering other losses, and getting nothing out of the public, because he is just; moreover he is hated by his friends and acquaintance for refusing to serve them in unlawful ways. But all this is reversed in the case of the unjust man."

Plato's reply to Socrates, The Republic

I watched with ironic despondency as Representative Ron Paul (R-Texas) engaged, for what most commentators suggest is his farewell bout, with Federal Reserve Chairman Ben Bernanke (R - Banks & High Net Worth Investor Pals) on the cost of opacity in the Federal Reserve.  Characteristically, Chairman Bernanke knew that his philosophical battle with Rep. Paul has been a war of attrition and the last man standing will be proclaimed the victor.  To be clear, all Ben needed to do is be silent and he knew that the halls of Congress would serve as a cavernous acoustic curtain that would suck Ron's words into the void.   And, for the most part, he did what he needed to do.  The only place he lost his script of the silent treatment was in his unbelievable statement that, "To eliminate the exemption on monetary policy deliberations would effectively - at least to some extent - create a political influence, or a political dampening effect, on the Federal Reserve’s policy decisions."  Really, transparency would lead to political influence?  No wonder Socrates wound up drinking the hemlock!

This past week we have seen an expansion of unfathomable crimes being 'uncovered' long after their effects have wrought great damage on the General Public.  While I have, for years been commenting on the massive abuses in the municipal bond market - abuses which undermine every pension investor in the United States and many around the world - the U.S. Department of Justice has succeeded in getting 13 guilty pleas from muni riggers at Bank of America, JPMorgan, UBS, Wells Fargo, and General Electric resulting in a reported $700 million in restitution and penalties.  And now, this week the Justice Department announced an indictment for wire fraud and conspiring to defraud the United States against Bank of America's municipal derivatives desk former executive Phillip D. Murphy who allegedly played a key role in rigging the price of funds for things like building schools and roads.

Rep. Ron Paul's frustration with a system out of control and operating with impunity is justified.  Chairman Bernanke's reply to Rep. Paul suggests that he either never read or forgot what Congress actually authorized on that wonderful Christmas Eve eve session in 1913 at the passage of the Federal Reserve Act.  He overlooked the fact that Congress actually stated that "shareholders of every Federal Reserve bank shall be held individually responsible, equally and ratably, and not one for another, for all contracts, debts, and engagements of such bank…."  He also seemed to assume that We The People wouldn't go back and read the actual Act that put his position into effect and see that, "Nothing in this Act contained shall be construed as taking away any powers heretofore vested by law in the Secretary of the Treasury which relate to the supervision, management, and control of the Treasury Department and bureaus under such department, and wherever any power vested by this Act in the Federal Reserve Board or the Federal reserve agent appears to conflict with the powers of the Secretary of the Treasury, such powers shall be exercised subject to the supervision and control of the Secretary."  Oh, and did I mention that the Fed's salary cap was $12,000 annually?

This week's news highlighted one of the great cognitive ischemias of our time.  We're either supposed to listen to sound bites emanating from Congressional hearings and assume that one or more of the parties is actually telling the truth or we're supposed to be sufficiently anesthetized not to care (or both).  Without basic financial literacy, We the People are incapable of knowing when justice is being served and when it's being usurped.  While we've got a basic impulse that senses that injustice is at hand, we wait to see who is left in relative paucity and then conclude that the one that got away with all the wealth was the unjust.  While this logic is consistent with Plato's argument in The Republic, I am compelled to suggest that outing the bad guy is not overly constructive.  In fact, as Chairman Bernanke quite correctly said to Rep. Paul, "there's no constitutional reason why Congress couldn't just take over monetary policy," concluding that if Rep. Paul doesn't like the job the Fed is doing Congress can "take it back." 

This exchange was Chairman Bernanke's crowning achievement in the two days of testimony.  While guilty of grievous over-simplifications of the law authorizing his job, he quite correctly stated that the same Congress that passed the Federal Reserve Act in 1913 could repeal any or all of it.  And, this rather frontal retort should be a clarion call for citizens to join in the effort to reform or reconstitute a more transparent system.  In his defense, Chairman Bernanke is only as good as the ideas that he receives from his advisors and the public.  The lack of constructive solutions to monetary policies and the economy is, in large part, due to the lack of constructive input coming from citizens.  But, as Occupites across the globe have quite convincingly proven, disgruntled ignorance, regardless of its justification, is, in the end, as unhelpful as incumbent complacency. 

So, here's an idea.  This year, the U.S. Department of Justice is likely going to rake in record fines from banking institutions.  If the first two quarters are any indication (see their graph above), they could blow through last years $1 billion mark quite easily.  So why don't We the People petition for the Treasury (the recipient of these windfalls) to provision a Town-Hall-for-Financial-Literacy Campaign - funded by the temple robbers' levies - so that We the People actually know enough to form constructive critiques and, in so doing, actually create a More Perfect Union?  

Anecdotal High Crimes

Andrea Priest, spokeswoman for the New York Federal Reserve gets my quote-of-the-week award when she stated that the Fed had, "received occasional anecdotal reports from Barclays of problems with LIBOR."  To be clear, the ERROR value in the LIBOR reporting scandal is likely to be in the vicinity of $900 billion each year placing the LIBOR ERROR as the world's 19^th largest economy - coming in just ahead of Taiwan and just behind Australia and the Islamic Republic of Iran.  Since its inception, the current LIBOR oops that we know about allowed just over $4 trillion to change hands with no one watching.  Associated to the public sector involvement I pointed out in my last blog post, this number has an uncanny resemblance to the value of wealth transfers that were sponsored by government-backed interventions with banks, insurers and other investors during the G-20's financial crisis response.  So the timing of the Barclay's "discovery" seems to be remarkable given the fact that Tim Geithner seemed to at least know of the reporting risk as early as 2007.  So we treat a $4 trillion heist as just an 'anecdotal' event until we've monetized the theft of global taxpayers and then we decide to take it seriously???  SERIOUSLY????

In related news, one of the shareholders who has greatly benefited from the opaque wealth transfers of the last several years is now advocating for another business that, if enacted, will pick pensioners pockets again.  Steve Gluckstern, chairman of San Francisco based Mortgage Resolution Partners is suggesting that one way to address the country's real estate economic woes is to allow governments to use eminent domain to seize real estate with underwater mortgages and have private investors repurchase the properties for "fair value".  Under an Obama-esque acronym CARES (which stands for Community Action to Restore Equity and Stability - think the 2008 election slogan HOPE which probably really stood for Helping Oligarchs Purloin an Empire), Mortgage Resolution Partners is proposing that jurisdictions like San Bernardino County use their ability to seize property and summarily revalue the same sticking the losses to every pension holder in the U.S. thereby "assisting communities".  For their service to the country the firm would collect a fee on every loan modified.  That's right, a private group of investors would receive an incentive payment for a municipality 'legally' erasing mortgage obligations.  

We live in interesting times.  The audacity of the public-sector crimes enabled against the citizens of countries - all of them measured in billions or trillions of dollars of value - seem to live comfortably under the sleepy eye of the lethargic judicial system that can see anecdotal trillions of dollars go missing without leaping into action.  During the same time we see politicians get in front of cameras across Capitol Hill and perjure themselves by stating that Bush-era tax cuts are necessary to grow employment and the economy.  These statements are being made despite the fact that, since the Bush tax cuts, unemployment has nearly doubled and the permanently unemployed has nearly tripled.  By keeping more money via the "tax cuts" and stealing money via government bailouts and LIBOR scandals (just to name a few), the employment scene has gotten more bleak and the global economy has become more fragile for the majority of people.

And all of this has another pillar of structural weakness that I've tried to illuminate for many years.  As we see Kodak collapse and we see other stalwart employers slip into the annals of a history not to be repeated, the Pension Benefit Guaranty Corporation (PBGC), a member of the credit committee for the Kodak bankruptcy made the statement back in January that the Kodak pension was "reasonably well funded" with $4.9 billion in assets and a mere $5.6 billion in obligations.  Now, on the surface, the fallacy of their statement is self-evident.  A company in bankruptcy is going to magically come up with $700 million (assuming that the $4.9 billion is correct).  When approached recently about whether they wanted independent corroboration on the value of Kodak's assets, the PBGC responded by saying that they "did not need" any additional help.

So let's see these stories all come together.  LIBOR price-fixing has been undermining true notional value of credit instruments for 5 years or more.  Private investors are seeking to use eminent domain to gut fixed income products (including investments held by and managed by PBGC).  We've got prima facie evidence that our tax and bailout indebtedness has NOT been a stimulus.  And the PBGC doesn't require additional visibility to understand its actuarial exposure.  Get it?  In a world where We the People fail to become informed and understand the interconnections between colluding parties, We the People place ourselves in the cross-hairs for being hijacked.

This past week, a few thousand of you cared enough to share the LIBOR blog post with your friends.  Well done and many thanks.  This week, your activism and awareness needs to spread more like a wildfire racing up a canyon driven by hot winds.  We the People need to have hundreds of thousands or millions talking about this - not just a few thousand.  This coming week, bidders will put a nail in the coffin of Kodak as they seek to scavenge the innovation carcass of what was one of America's leading companies.  This week, illiquid municipalities will seriously consider confiscating property and turning eminent domain into a financial arbitrage to transfer CMO value from pension accounts for the private benefit of a small group of investors.  And this week, if you read this and get frustrated, nothing will happen.  Dig deeper.  Put the puzzle together.  And above all, get the word out that We the People are not helpless against those who seek to pillage the masses.  It can only get better if you and all those you know become educated and involved.    

Conclusion: Collusion

Why is there a "Lie" in LIBOR? 

Several months ago I had the good fortune of sitting down with some of the senior team at the U.S. Department of Justice's Anti Trust Division in Washington D.C.  For several months, we had been meeting with U.S. Attorneys to educate them on their own anti-competitiveness laws with respect to a growing illegal practice of building 'blind patent pools' for the purpose of extorting money from legally operating businesses.  As momentum built from a number of U.S. Attorneys who, when presented with the evidence we provided insisted we meet with the DOJ in Washington D.C., we were somewhat disheartened by a statement made by one of the senior officials when he said, "Well, we need something more than extortion to build a case.  We need to prove that the extortionists are also colluding."  No sooner than the words had come out of his mouth than he looked as us rather dryly and said, "I guess that sounds bad, doesn't it?"  Fortunately, this week the collusion piece was announced in a press release so, hopefully the DOJ was actually paying attention to the now multi-billion dollar violation of not only the Sherman Act and Clayton Act but now the Racketeer Influenced and Corrupt Organizations Act of 1961.

The current administration has its hands full with Attorney General Eric Holder's civil and criminal contempt of Congress issues - a matter made more distressing by President Obama's frequent assurances that his administration was going to actually break from the Bush Administration's tradition of thumbing its nose at the Constitution.  So it's going to be interesting to see how the Law-Enforcer-In-Chief gets in front of what could very easily be a trans-Atlantic scandal that is erupting as I'm writing this blog post.  Collusion!

A little history is important.  LIBOR or the London Interbank Offered Rate is an inextricable warp in the fabric of our global economy.  The magic carpet woven on that warp includes momentarily values for currencies, short term credit and over $800 trillion in financial products such as derivatives, swap agreements and a host of other debt instruments (according to the Economist while the Washington Post reports the LIBOR linked instruments to $360 trillion).  The LIBOR is supposed to reflect the liquidity of market acceptance for money, the credit risk associated with financial institutions and their primary constituents, and the nature of currency confidence reasonably expected to support monetary instruments.  If you have ANY investment, any money, or any debt, this story not only directly impacts you - your pocket has been picked and you didn't even know it! 

By definition, LIBOR is an agreement between parties.  So when Barclays Plc was assessed a record setting £290 million fine ($455 million if you believe that a dollar is actually worth a dollar) I'm sure that the regulators were hoping that nobody actually paused to think about the "I" in LIBOR.  You see, if the "Inter" is in the name, that means that there is more than one party involved.  And the more Robert Diamond and Jerry Del Missier open their mouths to investigators, the more trouble is likely to unfold.  As we see, Barclays was not alone in this racket.  According to recently released information, Bank of England deputy governor Paul Tucker not only was aware that this was going on but was consuming advice on how to appropriately fix the fix.  Ah, for those nostalgic days when the rule of law actually meant…, oh, that's right, it must be the heat getting to me - those days have NEVER existed!  The Financial Services Authority, the U.S. Department of Justice, and regulators and law enforcers will seek to put several hapless CEO's and mid-level minders into the stocks for public ridicule and rotten vegetable hurling - now being considered for an Olympic sport in London (don't I wish).

But, I want to get out in front of the story that will one day be the real story.  This LIBOR fixing nonsense is only a week old but there are now at least 20 banks that are reportedly under some form of inquiry.  And this number is going to grow.  But here's the tricky part.  It's not just banks that should be under the Klieg lights.  Thomson Reuters proudly states that it is the "official calculator of more than 120 benchmark fixings" on their website.  In other words, what Thomson has told the world is 'calculated' by them is either not, or they, like their rating agency brethren are implicated.  Someone at Thomson should e-mail their webmaster and tell him or her to pull down this page really fast.  Because one thing that this scandal will show is that the arbiter of calculated just got shown to be a rather naked king!  If they were actually measuring things and calculating things they should have easily detected the same anomalies that I detected in 2006 at the Arlington Institute giving me the ability to see the 2008 collapse two years before it happened!  But it gets worse.  Oh yes, much worse. 

As has been the case in public scandals in which the public is legally robbed by government-sanctioned holders of Letters of Marque (legalized piracy), the inquiries are going to run into a much bigger problem that neither side of the Atlantic can politically stomach.  You see the financial institutions implicated in this LIBOR scandal were doing a public relations service for the governments who give them favor.  Had the banks, in October 2008, actually reported the condition of credit and currency, a politically unacceptable reality would have surfaced.  The public would have realized that there is much deeper problems facing the economy than anyone had previously been willing to confront.  So, in classic fashion, they kicked the can down the road.  Bad news here is the road is a cul-de-sac and there are some really big bullies at the end.

What we'll find (as we are already seeing) is that public officials desperate to see their political fortunes surf the tsunami of financial illusions made the very predictable mistake of inquiring of banks how to manipulate public confidence.  "How do we get credit flowing…?" will be in some e-mail to which a bank executive will reply, "In exchange for some government guarantees, we can tax the public a few pence or pennies at a time through subtle manipulation of LIBOR and, voila, problem solved," to which the response was, "I don't know what that means but if it works, do it and we'll back you up."  Credit guarantee schemes - those wonderful manipulations that pass public funds to private investors - have been, and will continue to be the lubricant in a debt-based currency system until we invert the alchemy!

Which leads me to the following.  You've been robbed.  To be sure, there will be no public dividend slated for the massive fines that the FSA and DOJ assess against those they publicly decide to scapegoat.  And, if YouTube videos of kids with toothaches and KONY2012 can go viral to millions, than do yourself a favor and let your neighbors, your friends, and your colleagues know that adding public racketeering to collusion is dangerously close to treason - only this time, it's the sovereign acting against the people!  Maybe Eric Holder's Justice Department will wake up but it will only happen if enough of you who read this decide to stop the bank robbers!  Send this blog post to as many of your acquaintances as you can and let's see if the people's voices can actually propel the investigation past the banking executives all the way to the place where the Buck Stops!

To Form a More Perfect Union, we must return to economic systems which are built upon transparency, productivity and bounded scale.  We don't need more scandals to prove that the Creature from Jekyll Island - uncannily the island governed in the 16th century by Ponce de Leon (seeker of the Fountain of Youth) - is ready for the Museum of Unnatural History with other lumbering reptiles that had voracious appetites and very small brains devoid of cortices.  LIBOR's ubiquity gives We the People an opportunity to efficiently unwind what hasn't worked and lay down the warp threads for a new, publicly accountable system of value exchange. 

A Pirate By Any Other Name

Today’s announcement that Apple paid $60 million to settle the case with Shenzhen Proview Technology for the name “iPad” was more than great theater.  Evidencing a callous disregard for “slavishly copying” a Chinese firm’s intellectual property (the dramatic assertion used in the argument made by Apple against Samsung for which Judge Lucy Koh just granted Apple an injunction), Apple has proven that it’s respect for intellectual property and its commitment to ethical standards is quite simple:  if it’s good for Apple, then IP is good; if it’s someone else’s IP that Apple wants to take, IP is bad.  Worst of all, Apple is allowed to act with impunity knowing that it has friendly judges in the U.S. who will allow it to skate on thin ice when it comes to respecting the law. 

Apple lovers around the world will shake their head in disapproval for what appears to be a case of trademark cyber-squatting.  This disdain for the rights of others around the world is unfounded and portends great risk in the future.  Apple didn’t own “iPad” any more than it owns “slide-to-unlock.”  And the double standard of seeking court injunctions to support their illusion merely makes the IP bubble inflate which, as we all know, will one day lead to the great deflation.

In a world where millions of patents and trademarks are issued to enclose ideas that are neither original or inventive, our cultural, linguistic, and hegemonic ignorance will cost us far more than Apple’s $60 million settlement.  This is a phenomenon that I addressed with the Bush Administration years ago and, below, you will find a letter that I wrote for then Commerce Secretary Donald Evans' senior staff before he went over to China to castigate them for not respect IP – including the misrepresented innovation of one Apple corporation.

The Letter of Marque – An Intellectual Property Paradox

January 15, 2005

Dr. David E. Martin

CEO, M∙CAM Inc

Fellow, Batten Institute, Darden Graduate School of Business Administration

University of Virginia

In the dawn of the 19^th century, considerable international commerce fueled the expanding markets of Europe and the newly independent United States of America.  Caravans followed centuries old paths overland to bring goods from the East to markets in Europe.  However, with growing populations eager for the exotic and with the need to more rapidly move goods from manufacture to market, the seas became the corridors for trade.  Ships plying the trade routes were frequently exposed to piracy – a splendid business in which others bothered to retrieve goods which, with relative swiftness and aided by cannon, musket and sword, could be repatriated for the benefit of the opportunistic and strong.  Napoleonic fervor fueled the court of Britain to create a class of civilized piracy to undermine the economy of France and its allies creating a designation of ships with the “Letter of Marque”.  Thusly empowered, these ships could “take prizes” (a terribly civilized term for piracy) with impunity surprising their quarry under false colors and in disguise.  In other words, piracy was what others did – defense of economic interest was what Letter of Marque ships did.

This Wednesday, outgoing Secretary of Commerce, Don Evans, excoriated the Chinese for their failure to reign in intellectual property piracy.  Suggesting that the Chinese should imprison those guilty of violating patent, copyright, and trademark laws, Secretary Evans’ issued a clarion call for the defense of U.S. sovereign intellectual property rights.  By suggesting imprisonment as a remedy for what in the U.S. calls for financial sanctions only when infringed parties have sufficient liquidity to seek remedy in the courts, his suggestions seem ironic in light of a historical position on human rights and due process criticisms of China.  Was Secretary Evans representing a U.S. position which holds all intellectual property rights (IPR) as requiring united national defense or was he, like others, representing a minority of vocal business interests who defend a policy of the Letter of Marque?  Namely, when others do it, it’s piracy, when the U.S. does it, its called innovation.

Presaged at the World Trade Organization gatherings in Doha and Cancun, the duplicitous U.S. policy on IPR may be unraveling.  We don’t want our creative works annexed by others but we fail to address two fundamental inconsistencies.  First, we deny the well-established reality that our IPR granting systems are ineffectual in ensuring that only legitimate rights are granted.  The same Commerce Department, which oversees the United States Patent & Trademark Office, fails to defend international interests against U.S., European, and Japanese commercial entities who engage in the expatriation of the one resource that emerging economies have in excess – namely, biodiversity and traditional knowledge regarding its beneficial uses.

Attributing to malevolence that which is ignorance is unjustified.  In meetings with senior Commerce Department officials, we are aware that many of them are unaware of the depth of dysfunction in the IPR granting institutions whose products they wish to defend.  Therefore, one can argue that Secretary Evans is merely guilty of an industry-advocated farsightedness in which the real IPR violations of others can be seen more clearly than the same activity at home.  It is ironic that a number of European states are beginning to realize the need for national defense of IPR held by small and large business interests within their borders while in the U.S., enforcement is only available to those with liquidity to access the courts.

Where was Secretary Evans call for jail time when Columbia University sought to double-patent its co-transformation technology licensed to Amgen, Genetech, Abbott, and others?  Who is serving time for applying for, granting, or enforcing patents on indigenous cultivars of China, Brazil, and India?  

IPR theft is wrong in any context.  Secretary Evans’ passion is admirable.  However, under the rule of law, precedent serves as a cruel master.  Should the U.S. seek global respect for its commercial deployment of IPR, it should insure that it grants only that which is statutorily valid serving the Constitutional social benefit incumbent thereon and, once granted, advocate for equal enforcement regardless of venue.  A Letter of Marque IPR policy is unsustainable and one day may be used against us. 

Objects in the Mirror May Be Closer Than They Appear

While I was not a huge fan of the movie Jurassic Park, there's no doubt that one of the best pieces of cinematographic humor is the fleeting shot of the rearview mirror during a near death escape from a rogue Tyrannosaurus Rex.  With his yawning terrifying dentifrice taking up the whole of the mirror, the camera focuses on the words: "Caution: Objects In The Mirror May Be Closer Than They Appear."  While I'm applying a bit of Moore's Law to an analogy, allow me to remind you of the observation of Charles Mackay's timeless commentary on John Law's shenanigans in 1720:

"The regent, who knew nothing whatever of the philosophy of finance, thought that a system which had produced such good effects could never be carried to excess. If five hundred millions of paper had been of such advantage, five hundred millions additional would be of still greater advantage. This was the grand error of the regent, and which Law did not attempt to dispel. The extraordinary avidity of the people kept up the delusion; and the higher the price of Indian and Mississippi stock, the more billets de banque were issued to keep pace with it. The edifice thus reared might not unaptly be compared to the gorgeous palace erected by Potemkin, that princely barbarian of Russia, to surprise and please his imperial mistress: huge blocks of ice were piled one upon another; ionic pillars, of chastest workmanship, in ice, formed a noble portico; and a dome, of the same material, shone in the sun, which had just strength enough to gild, but not to melt it. It glittered afar, like a palace of crystals and diamonds; but there came one warm breeze from the south, and the stately building dissolved away, till none were able even to gather up the fragments. So with Law and his paper system. No sooner did the breath of popular mistrust blow steadily upon it, than it fell to ruins, and none could raise it up again." 

- From Memoirs of Extraordinary Popular Delusions and the Madness of Crowds (1852)

Now our T-Rex in J-Park spanned a bit greater an epochal reach showing up in the mirror of an SUV but his toothy menace should give us considerable pause as we look at the financial news coming from the U.S. and Europe.  Like the ill-fated impulse to see if you could reintroduce giant paleontological behemoths into a theme park, manipulation of things we don't fully understand, regardless of the novelty of the rationale for it, usually ends with something as elegant as the digestive track of a raging lizard.  I have frequently reminded Inverted Alchemists that our obsession with reductionist statistical models - an impulse borne of the celebrated "scientific method" - is central to our societal undoing.  Nothing could be more germane to the moment than the announcement that leading rating agencies have downgraded many of the world's largest banks.

To fully understand the contempt with which I hold this news, we may recall the forbearers of our economic 'innovations' that date back to the very regent co-conspirators of the infamous John Law.  To support the popular delusions of fiat economies (both then and now), it is imperative for an alleged group of observers to provide 'empirical support' for the risk-free nature of the sovereign.  This concept, which should have long found its way into the Museum of Unnatural History, is as alive and well today as the virtual T-Rex was in the park.  To see how little things have changed in 300 years, I commend to your reading at least the first section of Mackay's Memoirs.  However, it's important to note that rating agencies - operating under the SEC and government's modern NSRSO oligopoly blessing - are, at their core, marketing agencies.  Their 'risk assessment' neither correlates to, nor is derived from, verifiable, reproducible data.  That said, they never were supposed to do so.  From the life insurance mandate for long-duration investments leading up to the 1913 creation of what is our current Federal Reserve system to the present, when the economy gets tough, rating agencies must manufacture 'investment grade' rationale for people (and, more importantly, their fiduciary intermediaries) to invest. 

Whimsically, Moody's, S&P, and Fitch - the arbiters of independent risk rating - actually had a rather ironic proclivity to see their risk ratings actually correlate to the world's 60 largest banks' need for government bailouts in 2008!  The better you scored in risk, the more unsound you were.  However, given my aversion to ALL correlative logic for the fallacies upon which it is built, I only offer the preceding observation to kick sand in the face of the proverbial laggard.  The point is that the 15 bank downgrade of this past week actually had very little - if anything - to do with the banks.  Rather it had to do with a recursive error built into the rating process itself - an error that was wired in from day one and is setting us all up for a big, toothy shock.

Now, for a moment I'm going to pick on Moody's - not because of a greater contempt but, to their credit - for their published Bank Financial Strength Ratings (or BFSRs) which go further in describing their process than either S&P or Fitch have the courage to disclose.  I love their dog-ate-my-homework / get-out-of-jail-free disclaimer that stated in 2007, "barring systemic stress and provided that there is reasonable client confidence…" prior to describing how they navigated the markets into the rocks of the sirens!  In other words, "If we actually did measure what the public actually thinks we do, we'd be extinct but, since we don't, business is booming."  According to Moody's, their inputs include: 1) Franchise Value; 2) Regulatory Positioning; 3) Regulatory Environment; 4) Operating Environment; and, 5) Financial Fundamentals.   They go on to state their explicit bias stating that financial fundamentals contribute to 50% of the risk score in "developed markets" and only 30% of the risk score in "emerging markets".  After all, a financial stability rating should have a minority of quantitative inputs coming from financial data, right?!

So, what we've got are a group of soothsayers publishing their contempt for actual risk modeling with impunity who are desperately trying to put lipstick on pigs.  Why?  Well, a huge number of investors, by law or by charter, must buy investment grade assets.  In other words, we require an inventory of good investments be manufactured whether they're good or not!  Pension, life insurance and other insurance companies, banks, etc. are all required to buy fixed income products which are deemed 'safe' so that their public fiduciary obligations can be met.  Now, we've got a T-Rex sized problem which we're trying to cover up with a fig leaf.  Government debt - once the stuff of "risk-free" capital designations - is seeing public confidence collapse like the hanging brick in Hitchhiker's Guide to the Galaxy (if you don't get it, look it up).   Investors the world over have been willing to buy as much corporate and municipal debt as they can get their hands on and the inventory is not what the demand requires.  The European summer and the U.S. Fall (and I do mean over the cliff) all suggest that government debt is going to continue smelling like a Greek fishing village on a hot afternoon with no breeze.  To stay in business, rating agencies who only exist at the pleasure of their sovereign authorizers, have to preemptively make government debt appear more desirable relative to other investment products.  Lest you think this is my commentary, make sure you read all rating agency disclaimers which explicitly state that they're ratings of relative risk - not quantitative risk.  However, this short-term fix is a long-term madness.  By undermining the investment quality of the financial sector, the financial sector, in the short term will be forced by regulatory capital mandates to become bigger consumers of (you guessed it) government debt.  And they'll have to buy it up at the same time that the government debt becomes lower quality which, as you can readily discern, will degrade financial institutions even more.

What's the point?  Well, to keep my streak going, what I'm stating is that the bank downgrade was not about bank risk but rather an impending down-grade in government confidence.  It's the opening act of a comic tragedy that will end with most of the actors with knives in their backs or hemlock in their goblets.  It wasn’t an accident that the bank rating cuts punctuated a week when several governments were debating a unified European debt issuance.  After all, what better a time to have the few productive economies of the EU prop up the majority who are illiquid?  By forcing fixed income buyers and reserve managers into a debt demand for which there is no quality supply, suddenly what is economically suicidal appears to have momentary expediency.  And, as with John Law in the run up to 1720 no one dare question that, in the end, the sovereign knows best.

By this point we're both frustrated.  Many of you faithfully read my blog and share with me your critique that I don't deliver messages in a clear and concise (accessible) manner.  This is not for lack of trying.  When I see the T-Rex in the rearview mirror, I'm not prone to sugar coat the fact that we're about to experience the prey side of the food-chain.  However, in a world where we have Twitter-fed economic literacy, the transparency of the problem hides the treasonous acts in plain sight with virtually no one taking note.  So I'm going to attempt to deliver a punchline that is accessible.

This week's move by the rating agencies was no more about bank risk than the events of 2008 were about real-estate.  You're being fed propaganda and it tastes of carrion.  It was about creating an illusion to cover an up-coming junk debt fabrication and subsequent sale by governments.  If you have any life insurance or long-duration investments (like a pension) you'll be having your money used to fuel the Madness of Crowds.  By downgrading banks, they simultaneously:

a.         Decreased the appetite for investors to support bank equity;

b.         Increased the demand by banks to buy government-issued debt;

c.         Created the illusion that government debt was 'better' than other options (the same phenomenon that has propped up the U.S. Treasuries for the past several months as a relatively safe alternative to Europe because we're deferring addressing our problems until the election which thankfully happens in November);

d.         Failed to measure quantitative risk; and,

e.         Failed to restore credibility in themselves or their models.

What this means to you is that, far from being over, we're about to see a deepening collapse of the heralded 'recovery'.  Going into the next few months, public sentiment is going to be encouraged to falter and, We the People, are going to be invited into the despair that primes the pump for another irrationally unjustified paternalistic intervention. 

So, what can you do?  Well, for starters - DON'T DESPAIR.  These events are the inevitable and timely fruit of a tree planted in an aspirational Eden called Bretton Woods.  If you listen to the snakes and eat from the fruit of the tree…, well, I think you know how that story played out.  This is a time to build productive, essential enterprises at scale.  While intervention-minded policy makers will scamper about trying to tell you to live in fear, explicitly live in a manner that seeks to build value within your communities of proximity and diversity.  Rely on your ability to steward the resources you influence - your abilities to build the context for value and its exchange.  Rather than looking to remote 'solution providers', realize that the 'problems' are not essentially real.  They are but the illusions projected from a master delusion and the less you respond to them, the less power they'll wield.  In short - Live Fully and realize that this past week, we just passed another signpost of the end of a system that did not work for most of the world.  That's good.  Rather than fearing what's looming in the rearview mirror, its time that we look down the road ahead of us and start driving with our eyes on the road through the wind shield.  Between here and there, we'll have a few bug splats and some pterodactyl poop but, that's why we've got wiper blades!

P.S.  I cannot let today pass without calling your attention to the elections in Papua New Guinea today, the elections in Mongolia this week, and the recent statements by President Evo Morales in Bolivia.  These contemporaneous stories all are a referendum on whether the world is going to allow the holders of modern legalized piracy - the colonial equivalent of Letters of Marque - to continue to use colonial business models to take billions from countries while leaving people in financial and social poverty.  Glencore, the latest company to appeal to the tired, pathetic whining about "fairness" - like Rio Tinto in Mongolia and countless others - need to know, that together with artifacts of inhumanity like slavery, racism, and colonialism, they need to exterminate their tactics of entitlement and lead by engaging in true resource development partnerships.  In PNG, Mongolia, Bolivia and scores of other countries, there's enough to go around.  Failure to lead with ethical governance will lead to tired reprisals.  If you want a different outcome, initiate more conscious leadership!  While Rio Tinto seeks to white-wash its reputation by sponsoring human-rights events around the Olympics, I trust that all readers take these democratic events seriously and increase the scrutiny on those operators who have profited far too long at the expense of millions suffering in their shadows.

It's the Heteroscedasticity, stupid!

Let's assume that somebody knows what to do when it comes to the U.S. and European economic and banking situation.  And let's assume that they'll come back from their extended vacation (or coma, as the case may be) at some point in the next few months and put things in order.  Further, let's assume that all the destructive decisions that were cemented into the foundation of our current crisis in the fourth quarter of 2001 can be jack-hammered into tiny bits and used as aggregate for paving the path out of the mess we're in.  Assuming all of this (aided by some mythical unicorn tears, pixie dust, and the whisker of a saber tooth tiger - yes, it's one of those potions) and you don't need to know what heteroscedasticity is and you can just return to your nostalgic Father's Day festivities.  However, assuming that any of the aforementioned fail to materialize, read on.

As with most of the statistics we use to make sense out of our world, a plethora of assumptions - both implicit and explicit - undergird our consensus 'knowledge'.  I have yet to meet any individual expert or group of scientists in any field who have the academic or social integrity to actually state the assumptions that they have opted to deploy untested and have the further decency to critique their own conclusions based on the failure for those assumptions to hold.  I marveled at the digital tautology infused in the papers presented at a conference from which I recently returned.  The scientific method, if invoked, meant that whatever statement or conclusion was to follow must enjoy some hegemonic priority in the minds of the listeners.  Let there be statistical significance in a regressed set of variables and, voilà, we've got truth.  InvertedAlchemy readers are acutely aware of my critique of our untested assumptions in general and their tragic behavioral and policy consequences.  However, it's worth noting that the current economic interventions being proposed in the G-20 are actually doing grave damage to our ability to even sustain our statistical myth.  And that, is the subject of this week's observations.

Now some of you are more familiar - because you were unwilling to sit through one of my statistics lectures at the University - with the concept of dispersion than you are with the term heteroscedasticity (and yes, I'll forgive that indiscretion).  And, for you, allow me to explain the following.  Let's assume that you make a series of observations that seem to work most of the time.  For example, let's say that we survey the world's middle class and find that, with additional money, we find that people report a better quality of life.  Using regression, we conclude that, with more money, quality of life increases.  However, when we extrapolate that observation to the whole population, we find that the relationship not only doesn't hold but we find that some people at very high levels of monetary wealth are miserable and some people at very low levels of monetary wealth are quite self-actualized.  Rather than rejecting our correlation 'truth', we explain the information that challenges the correctness of our hypothesis as 'outliers' or 'unexplained' rather than holding the possibility that we had the wrong hypothesis for which we applied the wrong metrics to confirm an imposed outcome.  And we do this because, in the name of convenience, we need to understand the world efficiently.  I don't want to ask everyone from every culture to respond to my attempt to understand the world.  I want to ask a few people a few questions and draw sweeping conclusions therefrom.

And here's the problem.  When the variables I think I'm assessing or measuring have dispersions creating heteroscedasticity (frequently a function of metrics at the measurement extremes of data), to gain confidence in my observations and the resultant conclusions, I limit the data that I gather to insure: a) self-fulfilling hypothesis retention; and, b) consensus among my scientifically-minded colleagues who, like me, want reductionism over complexity.  Ironically, the most damaging effect of heteroscedastic variables is not in their essence per se but rather in the 'error' or 'unexplained variance' that they represent to the generalizability of the model and its conclusions.

Now, take a deep breath, grab a nutritious snack (possibly some nerve conducting friendly egg yolks for your brain) and strap in for the reason why I've used James Carville's 1992 presidential campaign slogan for this post.  The world - sorry to all of you intelligent designers out there - is heteroscedastic.  And that's the case for the part we think we understand.  That's bad news for all you adherents to the method advanced in the 10th century by Ibn al-Haytham and modernized in the 16th century by the likes of Galileo and Kepler.  Most of what we confidently know that we know, we don't know.  But here's what's worse.  What's happening in Washington, Brussels, and capitals across the G-20 is that we are adding scale to variables we do not understand in the first place.  We already don't know how monetary supply behaves in manipulated interventions so we put MORE money in.  We don't know how real property deflation (a risk of currency inflation) will impact our long-standing social obligations so we create currency supply bubbles of gargantuan proportions.  We know that 'sovereign debt' has the full faith and confidence of governments at a time when no one has faith and confidence in governments so we develop schemes to issue more sovereign debt!  In other words, we are increasing the dispersion in a variable set that we've already evidenced a complete absence of mastery around and we somehow wait to see it show up in a model that was wrong in its creation.  At the apex of this irony is the fact that the most wealthy - yes the uber-1% - are clamoring for returns to invest their ill-gotten spoils and they're stuck with, you guessed it, currency and sovereign debt.  It must be a bummer to steal all the jewels only to find out that the jewels are just paving stones!

So here comes the punchline.  What we need is to shrink.  We actually need to have the courage to strive for a more elegant less.  Now the cool reality is that we'll get there one way or another.  We can either take the elixir of living within our suitable means or we can be served the ipecac from less charitable hands.  Starting with a deflation of our egoic, dominion-infused certainty of control, we need to accept that, in our finest moments, we describe, not explain (and certainly never predict).  Rather than seeking to control, we are more suited to steward that with which we are entrusted.  This does not suggest an aversion to accretive impulses.  It does, however suggest that we need to increase the heterogeneity of the variables we measure while decreasing the expectation of successful imposition of conclusions on disregarded populations.  Realizing that unexplained variance is more likely a reflection of the sum of our projected social monotony plus observational sloth rather than an unfathomable mystery, we need to confront the reality that more input into a broken model actually speeds the propagation of the problem rather than introducing any remedy.  Heteroscedasticity is not our enemy but our ill-conceived piling into its maelstrom will be our undoing.

In Integral Accounting parlance, we can seek phase and state coherence where all of the utility we desire from a system is achieved leaving the system with as much retained optionality as possible.  Simply put, we must engage in a process of removing ourselves from the end of consumption and see ourselves in participation with a cycling and recycling of matter and energy.  In a bizarre paradox, we may find ourselves DOING MORE with LESS.

An Inquiry into Human Nature and the Cost of the Wealth of Nations

Adam Smith would be far less popular today were it not for his indolent generalizations about the march of progress in America and his contempt for Asia.  Nearly 240 years later, as we watch as the economies built on his perfunctory musings crumble despite the most impassioned interventions, it is ironic that we still blindly follow our Hobbesian Narcissism to his Echo.  Wealth is Power, we hear in the romantic distance and gaze longingly into the pool of our reflection puzzling over the beauty of our own projection.  Like the woodland nymphs of antiquity, European leaders intervene in Spain this weekend while the U.S. Congress and the sparring presidential campaigns blissfully ignore the 'fiscal cliff' looming at year's end.

In his Wealth of Nations, Adam Smith writes:

Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniencies, and amusements of human life. But after the division of labour has once thoroughly taken place, it is but a very small part of these with which a man's own labour can supply him. The far greater part of them he must derive from the labour of other people, and he must be rich or poor according to the quantity of that labour which he can command, or which he can afford to purchase. The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour therefore, is the real measure of the exchangeable value of all commodities.

It is ironic that this Spring and Summer of European discontent is emanating from economies that have long shunned the very labor celebrated by their economic demigod.  Far more insidious is the abject failure with which U.S. economists and their operators adequately price the cost of our economic dependency built on our militarized extreme of the "command" of labor.  Our "fiscal cliff" is looming larger than all estimates given the fruit borne of our unconsidered resolution to violent control of commodities which, having yet again lurched into military campaigns in Iraq and Afghanistan from which we will have no quantifiable gain, we will seek to repatriate our soldiers and repurpose our industrial complex only to find that we've built nothing of transferrable value.  While at the end of the Great Wars we were able to forge a civilian manufacturing base, exactly how do you repurpose unwitting mercenaries and nation-building consultants who failed to build what they were handsomely paid to build?  Bringing our soldiers home to unemployment and having austerity hit our defense budget in January leaves the U.S. in the unenviable position of adding violence to austerity.  And we thought that with our wealth came power.  Hobbes didn't see that with violent power comes moral poverty. 

The fallacy of historicism so richly imbued in Smith's view and so warmly embraced by his protégés is built upon a linear regression that suggests that:

Free Natural Resources + Commanded Labor = Colonial Wealth.

Now we clearly don't wish to think of ourselves as still living in the bigotry of colonialist models.  However, as I pointed out in last week's post, the shareholders of Rio Tinto's Bougainville Copper Limited celebrate surrogated cannibalism when they turn a blind eye towards the death of 20,000 people so their company can enforce a mining concession granted by the U.N.-sanctioned colonial administration of Bougainville by Australia!  When Smith's 'command of labor' is taken to the militarized extreme, we find ourselves building an entirely unsustainable order of affairs which is sure to collapse - most probably in the most inelegant of ways.

In my presentation tomorrow (the manuscript will be published in the Proceedings and is available upon request), I will be suggesting that wealth needs to be redefined and liberated from its dominion-based, colonial empowered moral bankruptcy.  In an argument suggesting that sustainability is a function of the ability to enjoy non-destructive utility of matter and energy while preserving as much essential optionality as possible, I propose that:

wealth = utility x retained optionality^∞

where ∞ = ∫ of all users across all value dimensions

When one considers this formula, one can readily see that the greatest wealth is experienced when the maximum benefit can be derived (in number of participants) from the least phase and state alteration (for more on this, take a look at my previous postings on Phase and State Coherence).  And the more value (in terms of integral accounting) dimensions can be simultaneously appreciated by the more participants, the greater the momentary and residual wealth.

In future posts, we will broaden the inquiry into this expansion of Buckminister Fuller's view of wealth which he described as the, "organized capability to cope effectively with the environment in sustaining our healthy regeneration and decreasing both the physical and metaphysical restrictions of the forward days of our lives."  By liberating this definition from its linearity, one can see that a Common Wealth can emerge, be characterized, and, in application, be the basis for a More Perfect Union.