When in Doubt - Politicians Agree, Blame Greed!

Palestinian father denies son a terrorist just a bad driver. (See 1 and 1a below.)

Durham Ellis decries going to the government for a bail-out. What is the better alternative if done intelligently? Ellis is correct we never learn from history but I would remind Durham, the patient is dying. Another short take by James de Long (See 2 and 2a below.)

More European umbilical oil connections. Reminds me of when American scrap dealers sold their metals to Japan prior to Pearl Harbour. Buy from the enemy and he will destroy you with your own purchases. (See 3 below.)

Tom Sowell and I agree again - when in doubt emotional politicians will agree, greed is the culprit. (See 4 below.)

Dick

1)'My son's no terrorist, it was a car accident'


The family of a Palestinian shot dead after his car plowed into pedestrians at a busy Jerusalem intersection challenged on Tuesday Israeli police allegations that he had carried out a deliberate terror attack.

But police spokesman Micky Rosenfeld said authorities were convinced the attack was politically motivated. "We're 100 percent sure ... he deliberately drove into people," Rosenfeld said.

Israeli police on Tuesday beefed up patrols around Jerusalem, hours after
More than a dozen soldiers, on a late-night excursion to the city ahead of the Jewish New Year next week, were injured in Monday's incident. No Palestinian group has made a credible claim of responsibility.

Police, including undercover agents, were out on Jerusalem's streets in larger numbers, on the lookout for suspicious activity and conducting spot checks of Palestinian pedestrians and vehicles, Rosenfeld said.
Officers were also patrolling Arab neighborhoods of the city, including village of Jabel Mukaber, where the driver had lived.

Police announced Monday night that the incident was a terrorist attack, the third of its kind using vehicles against Israelis in the city since July and involving Palestinians from East Jerusalem and have wide freedom of movement.

The driver of the black BMW was identified as Qassem Mughrabi, 19. Mahmoud Mughrabi, 49, his father, said his son did not have a driving licence and apparently lost control of the car. "My son was murdered, they killed him. He did not carry out a terrorist attack. This was a car accident."

Mughrabi, owner of a trucking business, said at his home where police had barred him from setting up a traditional Muslim mourning tent.

Mughrabi said he wished the soldiers a speedy recovery, a remark not typical of parents of Palestinian militants killed by Israeli forces.

IDF Lieutenant Elad Amar, who shot and killed Qassem Mughrabi, said Tuesday that he fired a hail of bullets into the BMW after it hit a wall, because he feared that the driver would restart the car and strike more passers-by.

Amar told Israel Radio that the driver pointed the car directly at the group of soldiers and "floored it. I didn't see his face, just the car as it neared us."

"He ran into them, they flew into the air, some landing on the hood, people you were laughing with, joking with, just a moment before," Amar said. "They're my friends and I love them."

Army Radio said the Palestinian terrorist was shot 11 times.

This is the third time a vehicle has been used in a terror attack in Jerusalem in as many months. In July, two East Jerusalem residents carried out separate attacks with vehicles used in ongoing construction work in the city, killing three people and wounding many others.

1a) ANALYSIS / Another attack in Jerusalem, get ready for more
By Amos Harel

At midnight Monday the police and Shin Bet security service were still piecing together the first details on the Palestinian who drove into pedestrians on the Green Line in Jerusalem.

Eyewitnesses described the incident as a terrorist attack, but this was a private car and not a bulldozer as in previous incidents, so the police want to be sure it was not a traffic accident.

The attack - the sixth in Jerusalem since the beginning of the year 
undermines the personal sense of security in the capital after a few years of relative quiet.

The difficulty in fighting this new kind of terror in Jerusalem is clear: They are relatively easy to imitate and almost impossible to prevent. Perhaps getting a gun is harder without attracting attention, but a bulldozer is more accessible and no less lethal.

The freedom with which East Jerusalem residents, who have blue Israeli ID
cards, move about the western part of the city also makes foiling this kind of attack more difficult.

Defense Minister Ehud Barak urged Monday that legal obstacles be removed so that terrorists' homes in Jerusalem can be demolished. But outgoing prime minister Ehud Olmert's observation after the previous attack in the capital in July is also noteworthy. Anyone who thinks Israel's occupation in East Jerusalem must continue will have to take into account more bulldozer attacks, he said.

2) Here We Go Again
By Durham Ellis

Once again, we have a financial crisis, and once again, the American lemmings are rushing off the cliff to our destruction, running to our nanny government for help. With some combination of the media, creative historians, misinformed voters, our government monopoly schools, and opportunistic politicians, we just never seem to benefit from the lessons of history.

We all know that there was a financial crisis starting in 1929. We know that President Franklin Delano Roosevelt cared about the people and used the Federal government to try to end their problems, and we all know that the Great Depression ended many years later in the 1940's. Unfortunately, only a few economists and their students know just how counter-productive FDR's actions were and how much his intervention prolonged the misery of the American people.

Also, few of us seem to notice or care that we have been caught for decades in the expensive quagmires of the Wars on Poverty, Drugs, and Illiteracy. We have no exit plans, victory is not at the end of any tunnel, and our efforts are producing as many negative consequences as positive ones. But, government is still considered by many to be the best of all possible solutions to any situation. Many are convinced that our only problem is that we need a lot more government regulations in all areas--that is, we need an even higher level of fascism than we already have.

So, now we face some serious financial problems and our only plan is to call them crises so we can invoke the "wonderful" problem-solving capabilities of the Federal government. To get a perspective on how this "crisis" could end, we only need to go back two decades to the Savings & Loan debacle. For years prior to 1986, our elected representatives to the Federal government used tax incentives to buy votes and encourage investment in real estate held for rental purposes. The tax breaks resulted in artificially inflated prices on all investment real estate. Then, in 1986 these tax incentives were eliminated after first being reclassified as tax loopholes for the "evil" rich. In the absence of the incentives/loopholes, the artificial part of prices on all investment real estate disappeared immediately. That is, the value of this type of collateral being held by the S&Ls dropped by 25%-30% instantly upon passage of the 1986 tax law.

That was the coup de grâce for the S&Ls. They had been buffeted by so many government regulations for so many years that many of them were already struggling to stay solvent. When the real estate investors walked from their devalued investments after 1986 and returned the devalued collateral to the lenders, almost everyone lost. The taxpayers and anyone interested in freedom took a hit, the "evil, greedy" owners of the S&Ls got blamed and punished, but the Senators and Congressmen who "solved" the problems they caused got re-elected--with raises.

Today, we have some more financial problems. Once again, the Marxists among us will maintain that these problems are just one more proof that capitalism does not work and that we need more government regulation. Millions of Americans have already agreed with Senator Obama or Senator McCain when they stated their versions of the American fascist slogan, "There ought to be a law..." The fallacy is that we do not have capitalism, and today's problems prove once again that socialism and fascism do not work. Almost all of our schools are socialist (businesses owned by the government), and our "privately owned" businesses suffer from so many regulations that the ownership is only nominal and the over-regulation amounts to fascism.

Our country's founders mandated that the best way "to promote the general welfare" is through a severely limited republic. When will we ever insist that our government get involved only in the areas permitted to it by our not-a-living-document Constitution? When will we ever learn from history so we can stop
repeating it?

2a) Avoiding National Suicide out of Schadenfreude
By James V. DeLong

Let us stipulate that saving the financial system will indeed have the effect of saving many of the financial institutions and their operators. In the current mood of the nation and the press, this is regarded as a bad thing. Satisfaction will be attained only when every one of these people has been bankrupted, and 6,000 investment bankers crucified along I-95.

This reaction is a bit like protesting against patching the hole in an ocean liner because doing so will save those who made the crucial navigational errors. Watching the navigator sink beneath the waves might be fun, but one's pleasure will be short and gurgly. So let's get real. While some unjustified enrichment is possible, for the most part, if the financial institutions survive and prosper it will not be because they have been "bailed out" but because the system has been saved. So take a deep breath and say "This is good." In the Midwesternism of my youth, "Don't cut off your nose to spite your face."

Another reason for rational restraint is that there are fewer villains in this tale than the news and the political campaigns would lead one to believe. Three basically good things - the securitization of consumer credit, the extension of credit down the economic ladder, and the invention of derivatives - have combined, and the resulting mix turned out to be explosive. Well, live and learn, and do better next time. But first, ensure there is a next time.

For over a year, people have been wrong-footed in their assessments because the fundamental subprime mortgage problem is simply not that large. As of March 2008, S&P estimated writedowns in mortage backed securities of $285 billion, a respectable sum, but not terribly significant in the context of total home mortgages outstanding of $10.6 trillion against home real estate values of $19.7 trillion, the $16 trillion net worth of non-financial corporations, or the massive resources of the financial system. AIG alone, back in the palmy days of 2007, had a market cap of $190 billion and a book value of $95 billion. TIAA/CREF had $446 billion under management. http://www.federalreserve.gov/releases/z1/Current/z1r-5.pdf (S&P upped its estimate by $100 billion the other day, indicating its fear of a downward spiral.)

So sensible people ignored the innumerate and panic-mongering press and waited for the professionals of Wall Street to sort it out, assuming that the financial institutions would eventually stop planting scare stories to pressure the Fed into inflating away their problems, eat their losses, and got back to business.

Over the past two weeks, though, as Lord Melbourne once said, "What all the wise men promised has not happened, and what all the damned fools predicted has come to pass." Instead of being contained, the mortgage problem spilled over into the derivatives world. And then, the risk foreseen six years ago by the wisest of all came home: "Derivatives also create a daisy-chain risk . . . . A participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not dangerous. . . . [But] history teaches us that a crisis often causes problems to correlate in a manner undreamed of in more tranquil times." [Warren Buffet, Berkshire Hathaway Shareholders Letter. 2002 p. 14]

Three separate things at work, and, while most commentary blends them into one big bundle of confusion, it is worth separating them.

The first element in the crisis is the rise of the asset-backed securities industry. Basically, ASBs are instruments for reducing the risks from mortgages and other credit instruments. Defaults are usually the result of some individual misfortune, such as job loss or health crisis. These are individually uncertain, but statistically predictable. So if enough individual contracts are aggregated, the package becomes reasonably stable. Smoothing out the risks expanded the pool of capital available for home purchases, which is generally thought to be a good thing, if that is how people want to spend their money.

The industry also developed the concept of dividing the payments into tranches. To simplify, a bundle of mortgages can be divided into two sub-bundles, with the first 90% of the payments received going to sub-bundle #1 and the remaining 10% going to sub-bundle #2. Sub-bundle #1 is insulated until the loss reaches 10%, which was regarded as unlikely. (Note, by the way, that in this system the existence of sub-bundle #2 serves the same function as a down-payment in an ordinary mortgage system.) Sub-bundle #1 can then be sold to highly risk averse institutions, which are protected by the double layer of sub-bundle #2 plus ordinary down payments and other credit checks.

To say the purchasers of these instruments were recklessly assuming that housing prices would never decline is a bit disingenuous. Anyone looking at a trend line could see that the increases in prices would probably level off at some point. But a decline of the magnitude necessary to seriously jeopardize all the sub-bundles #1 was, and remains, improbable, barring economic meltdown.

The second element of the crisis was the extension of this system into the subprime market. The basic impulse behind this was not bad. If one accepts the national mania for home ownership (which is highly problematical, but that is another story), then trying to extend it down the economic ladder is a worthy goal. And the creators of the system really thought that by spreading the risks and decreasing the volatility they could indeed make it work.

The mistake was that no one was policing the system. To some degree, this is indeed a tale of greed, folly, and gambling. Politicians pushed for loans to the un-creditworthy, Freddy and Fannie built their empires, Wall Street saw a way to make money out of it, and principal-agent problems allowed originators and aggregators to gamble with OPM. The home buyers themselves realized that the system was giving them free Put options; if real estate prices rose, then the buyers kept the gain. If prices fell, then the loans were either non-recourse or uncollectible and the buyers walked away. By 2006, average down payments were about 3%.Eventually, the system did crack. The real estate bubble burst and the riskiest tranches incurred losses. Institutions that had over-leveraged saw their capital wiped out. It is a familiar story.

But this time it truly is different, because the bursting bubble and the subprime mess interacted with the development of the derivatives industry, which is the third component of the explosive mix.

The derivatives industry is new, one of the many children of the information processing revolution, since it would have been unthinkable before the computer. Because of the newness, there is no standardization and no centralized reporting. Buffett's description of it in 2002 was sobering, but mostly because of the opacity. He identified real questions, but there was no way of knowing whether he was describing outliers or the mainstream. If the government and the financial industry were able to analyze the existing contracts and their exposures, the fright factor might diminish markedly.

As with ABSs, derivatives were born primarily out of financiers' desire to limit risk, not to take it. McCain's comment that Wall Street became a casino is true, but not in the sense that he means it - most finance professionals want to be the House, not the player, collecting a steady 1% off a stream of money flowing through. High rollers have their place because they make markets, but they are not the center of the system.

In particular, the big clients are not gamblers. They are insurance companies and pension funds in need of predictable cash flows and the certainty that obligations can be met, and eager for instruments that squeeze out an extra percent or so. Also, different investors want to be at different places on the risk/reward trade-off, and derivatives offered a way to match these desires and, on the whole, make capital work more efficiently.

From these desires, which are laudatory rather than corrupt, developed a remarkable number of types of contracts, especially default insurance. These were applied to all sorts of obligations, such as good old corporate bonds, but they were also applied to ABSs and to the obligations of firms involved with them. An estimate of $62 trillion in notional value is thrown around, or maybe its $43 trillion - the uncertainty is high - which means that every real-world transaction was generating multiples of itself in derivatives.

By definition, and perhaps paradoxically, risk averse strategies require high leverage to be profitable. And, of course, the financiers basked in the security that this time their quant models really were accurate, so the level of leverage was not a risk.

When the ABS/subprime combination came together with the derivatives system, the subprime losses went multiplying through the system. Financial Times columnist Anatole Kaletsky wrote recently that the crisis has so far had little impact on the real economy because:

[B]efore the arrival of "hyper-finance", if a family wanted a £100,000 mortgage they would go to the Halifax and simply borrow £100,000. Now consider what would have happened in the new financial world. The family would have borrowed £100,000 from Northern Rock, which would sell £100,000 of bonds to hedge funds, which would buy these bonds with £100,000 borrowed from Bear Stearns, their prime broker, which would raise this money by selling £100,000 of commercial paper to Citibank, which would then borrow £100,000 through the inter-bank market from Halifax. The original borrower is still the same household and the ultimate lender is still Haliax, but now a £100,000 mortgage has created £500,000 of new debt.

In theory, this entire chain of transactions could be squeezed, like a concertina, back to the original £100,000 loan between the homeowner and Halifax and the total credit in the banking system could be reduced by 80 per cent, with very little effect on the real economy.

There is another side to this. In the simpler age, if the mortgage got written down 10%, then Halifax took the hit and that ended it, unless the bank failed and the FDIC stepped in, which ended it there. Now, each player in the chain takes a hit, and the loss is multiplied into a notional $50,000, and if any of the firms is weak or over-leveraged, it fails. And then, since each has many counterparties in many transactions, the whole structure topples.

So what should the government do, bearing in mind that most of the major players are by no means gamblers. They are risk-averse fiduciaries who use derivatives to smooth out risk, not take it, and they must get out of any weak institutions. One news story last week said that the whole money market system almost melted down last week.

One would prefer to let the losses from the ABS/subprime mess lie where they fall, but given the "daisy chain" effect on derivatives, that is not wise.

There are only three things to do, actually. No one knows if they will work, but they are what we've got.

The first is to reverse the Lehman decision and avoid its repetition. Knowledgeable derivatives experts regard it as insane to let Lehman go into uncontrolled bankruptcy (http://seekingalpha.com/article/95696-lehman-s-bankruptcy-creates-systemic-risk). It has a trillion dollars in derivatives contracts outstanding, and leaving the counterparties at the mercy of the bankruptcy processes, which were not made for systemic national crises, is folly. The feds should take it over and unwind it in orderly fashion.

Because of the opacity of the derivatives system, no one can be certain, but one possibility is that the financial system is seizing up because the buyers of default protection are mostly unleveraged hedge funds while the sellers are mostly leveraged financial institutions. Since the latter are also taking the hit on the subprime crisis, the basically sound corporate credit default insurance market is getting contaminated. So, by ensuring that the leveraged institutions do not go into free fall, the contamination can be contained.

One can see why the shareholders of the leveraged institutions need to be wiped out as a penalty, and one can even argue that the bondholders should have been more careful, but to impose on all derivatives counter-parties a duty to police financial soundness (beyond, perhaps, checking a rating) is libertarian theory run amok. The financial system runs on standardization and quick decisions; to kill this is to return to the souk.

Indeed, the feds may already have realized their mistake on Lehman, judging by the AIG decision. The risk posed by AIG was from its role in the derivatives market and the chaos that would result from the company's failure. The fiduciaries need to know that they can keep dealing with other investment banks and institutions without getting sued themselves, and as of last Wednesday the feds faced a possibility of a system-wide run on everything and had to act.

Yes, throw the navigators a life preserver! The government can always insist that they pay for it, in any case, so driving a hard bargain, as with AIG, is a reasonable risk of the taxpayers' money. The government will probably make a profit.

The second action is to freeze the losses where they are now. If people know that there will not be a death spiral, there will not be one. Some $300 or $400 billion in mortgage losses will still have to be allocated somehow, but that can be looked at a bit more carefully, and at least we can avoid turning it into some multiple of the basic writedowns as it flows through the system. If the real estate market declines further, the loss should fall where it belongs, on the owners.

In any event, the cost will not be $700 billion because the government will own the real estate, and can over time liquidate it back into the market.

The third action is to increase transparency. Suggestions are floating around for a clearinghouse for derivatives, which would standardize deals and net out cross transactions. This is a fine idea, but we do not have it now, and for the short-term the feds need to get a handle on what exists.

It should be possible to get an emergency reporting system in place pronto so that we can know what we are dealing with. John McCain's recent criticism of Chris Cox was unfair, since Cox has headed the SEC for only a year, but it was a fair comment on the SEC as an institution, which has made no move to address the opacity problem in the years since Buffett's warning. But it had plenty of help in its slumber from every other institution of government, including the Congress, and from Wall Street.

Will these three things be enough? Probably. There are a lot of devils in the details, but the economy is strong, basically. If the financial system goes down, it will be because we are so intent on punishing the guilty, even if we must invent them, that we cannot put in place the mechanisms of survival. Committing national suicide out of self-righteous Schadenfreude would be a bad way to go.

3) Austria antes up
By DIANA GREGOR

'Austria is a small world within the bigger world which challenges it," German dramatist Friedrich Hebbel once said. This quote rings true, especially today. Although it is true that the former empire is in many ways a veritable Garden of Eden - from a political, economic, ecological and cultural point of view it is one of the safest places on earth - a dark stain continues to stretch over Austria's history like an invisible shade.

It impossible to ignore the opportunism which plagues Austria's diplomatic history. In the maze of international events, Austria always manages to appear forced into a corner in order to be able to close its eyes and ears unobserved. This was the case with Austria's work on reconciliation during 1938-1945, and it is still true to this day. It would be foolish, though, to assume that this attitude is a result of a real inability to act, whether politically or economically. Austria antes up so as not to be thrown out of the world powers' poker game, but in fact it plays its hand quite skillfully and aggressively.

CONSIDER THE round of a new game that started in April 2007. Nobody thought that Austria would have been one of the two players to sign an energy deal with Iran worth 22 billion euros. Moreover, Austria won the jackpot. Representatives of Austria's OMV, which is 30 percent government owned, and the Iranian National Oil Company signed the biggest gas deal that a European company has ever concluded with Iran.

The agreement found support among all parties in the Austrian parliament - despite Iran's non-compliance with UN resolutions regarding its controversial nuclear program. Despite the Iranian regime's pronouncement that Israel, a UN member state, ought to be wiped off the map. Despite the fact that there are more children and teenagers being sentenced to death in Iran than in any other country. And despite the fact that the President Mahmoud Ahmadinejad has repeatedly referred to the Holocaust as "the myth about the massacre of the Jews."

The war of words in the debate about the Iranian nuclear program has sharpened in tone. It is beyond question that a major offensive is going to happen eventually. "A nuclear Iran is intolerable," said Ephraim Sneh, Israel's former deputy defense minister, during his recent visit in Vienna. "If one helps the regime economically, that equals encouraging its nuclear ambitions."

AUSTRIA IS caught right in the middle. Not only has OMV signed a multibillion-euro deal with Iran, but it also is one of the major sponsors of the "Gas Export Conference," which will take place in Teheran on October 4 and 5. How can such behavior possibly be reconciled with the sense of responsibility that Austria bears for the Holocaust and for Israel's right to exist? Not at all.

Instead, Austria is looking for arguments and excuses that legitimate its actual ambitions. The fact is that Austria has become one of the leading strategic partners of the mullah-dictatorship - and not only because of the oil giant OMV. During the past six years Austrian exports to Iran have almost doubled; future exports are being secured by government guarantees.

Aside from the moral dubiousness, the bilateral relationship should also be mistrusted on an economic level. If Austrian investors cannot take ethical dimensions into account, they should at least consider the financial risk of dealing with an unstable region. Iran is a powder keg. In the near future the country will face a military strike. Anyone unimpressed by sanctions and resolutions should at least avoid investing in a tinderbox. But as Cicero once said: "There are many ways that lead to wealth, and most of them are dirty."

4) A Political "Solution": Part II
By Thomas Sowell

Estimates of how much money a government program will cost are notoriously unreliable. Estimates of the cost of the current bailout in the financial markets run into the hundreds of billions of dollars, and some say it may reach or exceed a trillion.

Many people have trouble even forming some notion of what such numbers as billion and trillion mean. One way to get some idea of the magnitude of a trillion is to ask: How long ago was a trillion seconds?

A trillion seconds ago, no one on this planet could read and write. Neither the Roman Empire nor the ancient Chinese dynasties had yet come into existence. None of the founders of the world's great religions today had yet been born.

That's what a trillion means. Put a dollar sign in front of it and that's what the current bailout may cost.

Will that money be spent wisely? It is theoretically possible. But don't bet the rent money on it or you could end up among the homeless.

Whenever there is a lot of the taxpayers' money around, politicians are going to find ways to spend it that will increase their chances of getting re-elected by giving goodies to voters.

The longer it takes Congress to pass the bailout bill, the more of those goodies are going to find their way into the legislation. Speed is important, not just to protect the financial markets but to protect the taxpayers from having more of their hard-earned money squandered by politicians.

Regardless of what Barack Obama or John McCain may say they are going to do as president, after a trillion dollars has been taken off the top there is going to be a lot less left in the federal treasury for them to do anything with.

Already Senator Christopher Dodd is talking about extending the bailout from the financial firms to homeowners facing mortgage foreclosures-- as if the point of all this is to play Santa Claus.

The huge federal debts that we already have are the ghosts of Christmas past.

Financial institutions are not being bailed out as a favor to them or their stockholders. In fact, stockholders have come out worse off after some bailouts.

The real point is to avoid a major contraction of credit that could cause major downturns in output and employment, ruining millions of people, far beyond the financial institutions involved. If it was just a question of the financial institutions themselves, they could be left to sink or swim. But it is not.

We do not need a replay of the Great Depression of the 1930s, when the failure of thousands of banks meant a drastic reduction of credit-- and therefore a drastic reduction of the demand needed to keep production going and millions of people employed.

But bailing out people who made ill-advised mortgages makes no more sense that bailing out people who lost their life savings in Las Vegas casinos. It makes political sense only to people like Senator Dodd, who are among the reasons for the financial mess in the first place.

People usually stop making ill-advised decisions when they are forced to face the consequences of those decisions, not when politicians come to their rescue and make the taxpayers pay for decisions that the taxpayers had nothing to do with.

The Wall Street Journal, which has for years been sounding the alarm about the riskiness of Fannie Mae and Freddie Mac, recently cited Senator Christopher Dodd along with Senator Charles Schumer and Congressman Barney Frank among those on Capitol Hill who have been "shilling" for these financial institutions, downplaying the risks and opposing attempts to restrict their free-wheeling role in the mortgage market.

As recently as July of this year, Senator Dodd declared Fannie Mae and Freddie "fundamentally strong" and said there is no need for "panicking" about them. But now that the chickens have come home to roost, Senator Dodd wants to be sure to get some goodies from the rescue legislation to pass out to people likely to vote for him.

Don't make any bets on how this situation is going to turn out-- except that we can predict that politicians will blame the "greed" of other people. You can bet the rent money on that.