The New Blackbox: Comic Interlude

I was in a Bunuel-esque moment this weekend. Getting a car tire replace they issued a 88% refund on the original price. I was repeatedly told 88% of $197 was $157.  Just because the cash register says so. The "impenetrable mysteries" of arithmetic have now been replaced by the "blackbox" of the cash register!

I'm right back to the theme of my first post!

Inviting Asst. US Treasury Secretary to MBA Estimation Class

Every semester I teach my Smith MBA students basic estimation techniques -- with back of the envelope math -- to build intuition and problem-solving skills. Estimating market size for a new product, the ridership of the DC metro, the size of the IT budget at a firm, etc.

Neel Kashkari, Asst. Treasury Secretary to Hank Paulson during the financial crisis, had the ultimate in high-profile estimation moments in 2008:

Mr Kashkari admitted that he plucked “a number out of the air” when deciding with Mr Paulson how much funding to request from Congress for the Tarp.  He told The Washington Post that he used his BlackBerry to calculate the bailout figures: “We have $11 trillion residential mortgages, $3 trillion commercial mortgages. Total $14 trillion. Five per cent of that is $700 billion. A nice round number.”

[Complete article]

To my former (and future) students -- Good estimation approaches show clarity, numerical fluency, appropriate nuance and complexity, and well substantiated assumptions. The approach for the bailout calculations leaves a lot to be desired (even if Congress approved $700B of taxpayer dollars) - so lets write up a better solution at the next estimation lecture!

Of State Budget Gaps, Elections, and Unemployment

The CBO has a new report out : Policies for Increasing Economic Growth and Employment

18 states are projected to have budget gaps >20% and 3 (including California, the largest economy in the US) have gaps >40%. See the nice chart above for the detailed, depressing forecasts.

The report finds that most states are near-maxing out their borrowing capabilities (the positive impact of monetary policy is nearly tapped out).  Is there aid forthcoming to states with the Republicans winning their 41st Senate seat? More likely its local tax increases and lots of service cuts!

Gridlock at the Federal level with Republican votes to filibuster may bring us to budget balance sooner that otherwise, but that will be poor consolation at ~20% unemployment.

My Reading Recommendations

Thanks for the comments and suggestions across the last days for additional posts. Given multiple requests and my passion for book recommendations -- I'm starting with my must-read list (see disclosure below).

Fiction
The Shadow of the Wind - favorite in last 5 years.
The Book of Embraces (Norton Paperback) - Galeano will make you laugh and cry with his 1 page vignettes and poignant images from the far corners of Latin America
Samarkand (Interlink World Fiction) - Maalouf's historical fiction takes us on a 1000 year journey across the Middle East and Europe with poetry and forceful characters.
Sea of Poppies - Historical fiction in India


Non-Fiction (Business/Economics/Management)

Ascent of Money -- central to understanding the current financial environment

The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance - my current reading. Downright eerie how many elements of the current financial crisis have been seen in history. Follows the history of JPMorgan Co. -- and the Fed/US Govt that played along with JPM.

Drive: The Surprising Truth About What Motivates Us -- must read for managers

The Craftsman - Scale and specialization drove productivity for the last 200 years. We seem poised for another era where the individual and his/her craft will be the source of productivity. Sennett's historical take inspires some forward-looking thought.

Predictably Irrational: The Hidden Forces That Shape Our Decisions - we're not as rational as neo-classical economic models. Great stories and experiments on the predictable biases in our decisions and actions.

Non-Fiction (Philosophy, General)

Mans Search for Meaning - Title says it all!
Siddharth - Hesse's classic. Good companion to previous title.
In Light of India - India seen from the eyes of a latin-american, catholic, western philosopher. Octavio Paz analyzes the difference in perception of time, motivation, goals from his time as Mexican ambassador to India.
A People's History of the United States: 1492 to Present (P.S.) - Zinn is wonderful. Perfect reading for current political times.

Full Disclosure:  If you enter Amazon through my site and purchase a recommendation, I get a small commission, and their price does not change at all. A win-win situation for me and my readers.  Such a deal. But, buy only what you plan to read -- I don’t want my readers to waste their money just to reward me.

More Mortgage Pain: Moody's revises sub-prime losses downward

Research Recap reports:

Ratings agency now expecting significantly higher losses than previously projected as foreclosures take their toll.

Moody’s has revised its loss projections for US subprime residential mortgage backed securities (RMBS) issued between 2005 and 2007. On average, Moody’s is now projecting cumulative losses of 18.7% for 2005 securitizations, 38.4% for 2006, and 48.1% for 2007, as a percentage of the original balance. As a result of the revision, Moody’s has now placed 5,698 tranches of subprime RMBS with an original balance of $584 billion and outstanding balance of $319 billion, on review for possible downgrade.

Moody’s last revised its loss projections in March 2009, to 13%, 30%, and 36% of original balances on 2005, 2006 and 2007 vintages, respectively.

Nearly 50% of original balances loss projections for the 2007 vintage. And Moody's consistently (still) underestimating the losses.  The raters (as expected) are slow and coy about  projecting anything but the most optimistic scenarios.

Should we still keep believing those who say that banks who hold real-estate instruments (and of course, also the Fed) will not see further losses?

2010 Predictions: Political

In the past I've not ventured into political arena predictions. The events of 2009 make it too tempting to stay out. So here are a rookie's predictions on some political themes-

1. US Government Gridlock in Dec 2010: "Yes,we can" voters increasingly acknowledge that this slogan only applies to lobby groups and withdraw from the electoral process. Nov 2010 will leave the US government in deadlock -- the preferred outcome of an electorate that increasingly cannot distinguish one party from the other. Even as the use of web2.0 tools for campaigning and fundraising will reach unprecedented levels, real engagement will remain limited.

2. Early 2010 will result in political pork of unprecedented proportions: Current appointed and elected officials can already predict the outcome of Nov 2010. They have limited time to cash-in their votes for future gain. Appointed officials (particularly Fed, Treasury) will make "brave, even if unpopular" choices to prop up systemic failures.  Expect more FUD (Fear, uncertainty, doubt) regarding the housing market, terrorism, and credit.
3. China, India, Brazil, and South Africa (World Cup 2010 host) -- will opportunistically seize the global bully pulpit. Realizing that "Victors, not the vanquished, write history" is a reflexive thought, they will engage in establishing a winning narrative for 2020.
4. China will face increasing rebellion, especially in the interior. A combination of carrots and sticks will allow the central government to delay change for another year.

5. India will be forced to deal with domestic separatist challenges in 2010. The dangerous policy of creating new states within the union will fuel further movements for splintering. The positive momentum of the economy will largely roll forward.
6. China will risk trade war with the US, India will wait it out.  The battle for economic supremacy is entering an interesting stretch. China is (or soon will overtake Japan to be) the second largest economy in the world with a much faster growth rate than the largest economy (the US).  The currency battles of recent month and trade skirmishes will threaten to escalate into a full trade war. 2010 will see sharper saber-rattling than ever before, but we likely have to wait till 2011 and beyond to actually see full trade war.  India will meantime -- for once -- sit out this round not force the issue.

What Makes Good Information Design?

Excellent post at  http://www.informationisbeautiful.net/2009/interesting-easy-beautiful-true/
David's new visualization work is very compelling.

2010 Predictions: Financial

1. Global Markets will continue to resemble casinos, more than mechanisms to allocate capital and manage inter-temporal savings and consumption.
2. Non-market forces will continue to be the biggest determinants of market outcomes for the first 3 quarters of 2010.
3. 2010 will be a stock-pickers market. Global markets will rise and fall 20+% in 2010. US (and other) markets will see an unprecedented number of +-2% days. Many equity markets will close lower in 2010 than 2009.  The critical question for the average person is how significant the role of inside information will be in getting returns -- and can you find such a stock picker?

4. Gold will hit $1400 in 2010. It will also hit $900. These 2 events will happen in successive quarters.

5. Don't be greedy about yield: With rates for savers at historical lows the temptation is to chase a few points of yield -- don't yield to that temptation (unless you have a high risk tolerance, insider information, or are too big to fail).
6. Continuing (near-term) high-correlations across asset classes.  The US Federal Reserve's balance sheet is a horrible mix of risk classes (MBS, Maiden Lane, Treasuries) masquerading as a risk-free rating (remember the real estate market!). In such an environment high-correlations are likely to remain across asset classes.  However, diversification remains a valuable strategy, even if buy-and-hold will increasingly be under attack.

2010 Predictions: Economy

1. Global Economic Growth Stalls -- Emerging Market bright spots (China, India, Brazil) will remain, but overall growth sputters as worldwide stimulus fades. Ex-stimulus growth rates in most of the developed economies will be < 2%.

2. The Mythical Consumption Re-balancing assumption of the IMF will not be seen in 2010. China's growth continues to be driven by production and asset purchases, not consumption. Chinese policy has, and will continue to be, driven by a different objective function than the western "Washington consensus".
3. (Measured) Inflation remains tame -- continued technology absorption, excess capacity, outsourcing, and growth in the global work-force will keep downward pressures on prices. CPI (ex-energy) will continue to be tame. Asset price inflation (from global liquidity) will continue to put pressure on broader measures of inflation, but will continue to be ignored by policy makers in official decision statements.

4. US Unemployment to remain ~20% (U6).  The census will add ~800,000 workers as will other parts of the US government. However, the average employer will remain conservative on hiring. Corrections in global stock markets by the second half of 2010 will further reduce risk appetite for real (i.e. non-financial asset) decisions.

5. Acceleration in US banking failures as the impact of the real estate bubble finally hits the balance sheets. The prospect of further (big and small) banking bailouts in 2009 will be one of the fascinating political stories of the year. Can massive rent-seeking continue even in an election year?

6. Service Sector innovation will flourish -- increasing self-employment and free agent behaviors will lead to service sector productivity gains. Emerging markets with abundant labor will lead introduction of new in kind service sector models.

7. The Global Rollup of Excess Capacity Industries gains momentum -- from steel to auto to durable goods manufacturing. As global demand recedes inventory and excess capacity management will be the critical capabilities.

8. Excess capacity in non-tradeable sectors, such as real estate, will remain unresolved. Pricing mechanisms will continue to be distorted sending (small) expansionary signals for capacity. Expect both rent-seeking and innovative behaviors in the non-tradeables sector.

Restart Button

After a fiction-writing hiatus I'm back to blogging. Consolidating the blogs that proliferated across 2008/9 to this primary blog.  I'm starting the year with some predictions for 2010 -- economic, financial, political, and technology related.

Look forward to engaging with you -- online and offline.