An inverted Ponzi scheme?

The WSJ has a wonderful piece on a particular type of CDOs and how they concentrated the risk which is creating problems for the US economy. Remember the lesson of diversification? Well, if you follow their graphic, you'll see that these CDOs actually served to concentrate risk that was diversified in the Mortgage Backed Securities (which purchase individual mortgages and pools them into one instrument). You see, the CDOs would buy pieces of these securities that were all subject to similar default risks, thereby eliminating the advantage of diversification. Geniuses!

The reasons they were doing this was to generate transaction fees, and with the sorry state of the rating agency industry, information on the true nature of the risk was lacking. As these instruments were repackaged and resold, all based on the same underlying securities, you can start to see a analogy to a classic Ponzi scheme, where incoming investors pay the returns of existing investors, without any growth in the underlying security. Kinda like a bubble...

So the current crisis smells of a "reverse" Ponzi, where new investment instruments are created and sold based on existing instruments, all of which share the same underlying asset, and the same risk. The incoming instruments are paying for the returns of the previous instruments (not strictly though).

If it smells fishy, it probably is a big, rotten fish, or a big pile of shit!

Three sources on the risks to the US Economy

Read these three:

Martin Wolf - Why the credit squeeze is a turning point for the world

Paul Krugman - After the Money is Gone

Nouriel Roubini - Coordinated Central Banks Liquidity Injections: Too Little Too Late To Address the Fundamental Problems of the Financial System

I don't think people really get how serious the problems are. The recent decision by the Fed to make available $40 billion is amazing. When Brazil still had its hard peg currency system, it pointed to reserves of $41 billion as their insurance that they would weather a crisis. That wasn't enough.

Part of me blames what can only be seen as a desperate attempt to shore up the system on politics. If a recession hits, there is no saving the Republican party in the coming elections. I would bet that whips are being cracked in Washington, but I agree with Roubini that this will get a lot worse.

Economist's View: "Productivity vs. Employment Growth: A Zero-Sum Game?"

Economist's View: "Productivity vs. Employment Growth: A Zero-Sum Game?"

I've had arguments about my dad about "productivity". I think the term is often used as an instrument, when it is actually a goal (productivity being output/worker over a period of time). Want to boost productivity, then you have to increase the output/worker ratio. When you hear news that "productivity is up 3.3%", you have to ask if the workers are working harder/smarter, or there is some new technology involved (hi Solow!). I think it is obvious than in any optimized production system (where marginal returns to labor at at their peaks), an increase in employment will decrease productivity and vice-versa, unless there is also a technological or administrative change. This is why I find it curious that economists laud productivity gains at the same time that we see employment (and compensation) losses without looking at the overall effect (and the distributional problem).

It's one of these discussions that I like to have over some beers.

Logistics Performance Index

From the World Bank's Logistics Performance Index:
Latin America needs better logistics for commerce


Correlation (not causality) of income and logistic performance:

Chavez

At my previous job, I once told someone that I thought that Chavez would lose once he overreached. Thankfully, it seems that Venezuelans thought that trying to be an emperor was overreaching, and voted to reject his reforms. I'm still dismayed that it was this close.

Topics

Some things I will be working on:
-A newsletter for CEPAL identifying the major topics/risks for commercial activity in Latin America
-The role of commerce on growth and development
-Take a look at cascading tariff structures and their impact on protection rates
-Innovation and commerce. I would love to have enough data to work on product space dynamics in Latin America
-Better visual presentations for the division

Personal update

In the last two months, a lot has changed in my personal and professional lives. I changed jobs, from being a country risk economist at the US Exim Bank, to being an economist with CEPAL - ECLAC in Chile, and doing commerce and integration work. This change will allow me to work in topics that are more germane to "development", as I look at the interaction of commerce and social indicators of development. But this will be an uphill battle.

Some observations on my first month here: Chile is a "westernized" country (at least the capital is). I haven't found any good restaurants yet. Despite its modernized facade, the bureaucracy is immense and stifling. Competition seems to exist mainly in the marketing side of commerce, not in actual value.

CEPAL can improve how it presents information. The culture of PowerPoint is deeply ingrained here, and a lot of the workload involves created these presentations, instead of conducting original and rigorous research. Part of this seems related to lack of funding for some projects, and the need to constantly hire consultants as opposed to using the existing staff. This is particularly acute given the influx of new hires in the last year or so, and the need for a more dynamic management of their duties.

But the people here are brilliant and dedicated. I'm going to like it here.

Thoughts on regulation

In his recent Oped at the NY times, Krugman makes the point that the lack of sufficient regulations in the face of agressive "financial innovation" has allowed for the current confusion in financial markets. I agree entirely with his point. But before anyone accuses me of defending excessive regulation, let me clarify my position on the topic. I believe that regulation exists to enable the flow of information to market players. I don't think that government should be telling the markets what to do (beyond a limited role as a social agent). To the extent that markets can create conditions whereby information is not available, the system will lead to situations like the current "subprime crisis".

Enron, the current (housing) crisis, the Great Depression, etc all have roots on a similar dynamic: the lack of available information created a misalignment between expectated risk/return and the revealed risk/returns. You can argue for caveat investor, but that is just a recepie for volatility.