AIG - What should have been done...

The facts and figures are all but familiar to those who haven't been living under a rock: $165 million paid to an estimated 400 AIG executives, HR1586 passing with flying colors (328-93) with the promise to return 90% of all post-January 2009 retention payments to the tax base, and an outraged public. Sure enough, it doesn't require a Harvard mathematician to figure out that the average bonus handed out per executive was $165million/400 = $412,500 – an amount more than what 90% of American households make in a given year. Some reporters of the Associated Press have even reported what they think is a more accurate figure of the amount handed: $218 million.
Regardless of what the real amount was, for the purposes of my mini-analysis, it will suffice to say that this recent action (both on the part of those handing out the bonuses and those accepting them) was unwarranted. By unwarranted we mean unethical, or simply put as violating an implicit social contract meant to enhance the aggregate benefit to society. We need not get into a meta-ethical debate as to the exact definitions of ethics and actions which qualify as ethical or unethical. Most, if not all, would agree that distribution and acceptance of $165million retention payments given in the current temporal context was unethical.
We move on to the essence of the analysis. My thesis: HR1586 will be almost completely ineffective in eradicating prospective corrupt usage of American tax dollars by bailed-out corporations. It might effectively collect 90% of the $165million handed out to AIG executives. However, it still keeps open possible instances of future scandals of the sort. Why? Suppose you are an executive in a non-AIG firm receiving bailouts with overwhelming influence on the preparation and distribution of bonus payments. Your line of reasoning – given that you capably carry sound judgment – will go as follows:

AIG execs got away with 10% of their distributed bonuses; therefore even in a worst case where 90% of my bonuses were taxed, I can still creep away with 10% of the money which was not even mine to begin with. Not bad, I think giving this a shot can help me more than it can hurt me. And even if some Draconian move on Congress's part took away 100% of my bonuses, my firm will in essence have lost only a fraction of the bailout originally received, which will hardly make a dent in my firm's current operations and cash flows. Therefore, I have myself a win-break even situation; where I win in a best case, and break even in a worst (and even unprecedented) case.

Simply put, the lack of punitive action on the part of both the House and Senate will not necessarily avoid (and even possibly give leeway to) similar instances of corruption and greed in the future. Then what solution, if any, do I have to offer? Abstractly speaking, an ideal solution will be one that perpetuates AIG's business transactions (as the company is indeed “too big to fail”) while having the scandal-inducing executives and decision-makers serve both punitive and compensatory sentences. By this I do not mean jail-time, as putting managers behind bars is inconsistent with a firm's operational perpetuation. The compensatory sentence is simple, a 100% tax on the bonuses will suffice. The punitive sentence will undoubtedly become the heat of more controversy: income and asset redistribution of up to 50% of all executives willing to receive American tax dollars in the form of retention payments. A loss of 50% of a given year's annual income and all personal assets will still keep executives' continued work in the firm as personally more beneficial than quitting altogether. This is only a ballpark estimation of the sort of punitive action that must be carried out to effectively eradicate the problem from its root. The redistribution may be slightly higher or lower than 50%, however it must be substantial to remain effective. And that is ultimately what we need – namely continued operations of these firms with gargantuan disincentives of future scandals of the sort.

Yielding our Consumptive Zen

“Any whiffs of growth this year are likely to herald a false dawn.”

A simpler articulation of this proposition will render: “the economy will most likely not grow for the remainder of the year.”

Simplified even further, we're left with “we're screwed.” Or at least that's what Stephen Roach, CEO of Morgan Stanley Asia, and Niall Ferguson, a financial historian at Harvard University, think. And sure enough, it seems that any whiffs heralding any more falsehood would bound us to never see light again. Hearing about a 6.2% annual contraction rate, AIG's $30 Billion additional bailout fund, a loss of 650,000 jobs in a month's time, and the Dow's 1997-level pricing doesn't lend argumentative credence to the hopeful side. Many, myself inclusive, may find a tonal conflict with President Obama's somewhat optimistic address to Congress couple weeks back. Truthfully, though – mood aside – no such conflicts exist. Both support a strong likelihood of economic deterioration on every level (falling housing values, employment, real income) for a sustained period lasting up to three years.

But there is actually a sign of hope.

If we all took a moment to dim the lights, take a toadstool position, quiet our minds, light our incense, and find our true inner nerdy economist, the answer may indeed “dawn.” The sign of hope which may reveal itself is one currently narrowly discussed in prevailing economic literature: the yield curve. Any 'Investment for Dummies' books will reveal that the yield curve is the spread between interest rates on the 10-year Treasury note and the 3-month Treasury bill. People such as myself wonder why one of the most powerful indicators (if not, the most useful leading indicator) has gone almost completely unreported. It raises the question of whether or not most forecasting reporters fails to live up to the intellectual standards of a dummy. And what relevance does this value have to any hope?

Putting questions of integrity aside, let us shortly get back to our mini-tutorial. Simply put, the yield spread is a leading indicator highly correlated with upcoming recessions. Its predictive power can range anywhere from 2-6 quarters. Historical trends indicate that a little over six out of seven recessions have been preceded by a negative yield spread. Since the yield curve can be represented mathematically as the 10-year note minus the 3-month note, this would mean that about six of seven recessions have been preceded by (within 2-6 quarters) a higher 3-month note value relative to the 10-month note value.

But we haven't yet answered our own question: how does this tie in to our current situation? A current look at yield spread data released daily by the U.S. Treasury department will show hopeful results: an average yield spread of 2.68% over the past week.

By taking this average value and finding its corresponding probabilistic assessment of upcoming recessions, we feel some relief as we see a 6/7 (85.7%) probability for recessionary recovery four quarters from the present.

That's almost a 90% chance of good news, you fools!

Nevertheless, one may make the argument that our indicators grossly mislead, or that an unexpected or unforeseen factor determines an entirely different outcome than the one indicated above. However, in the face of the current mishap, we can know definitively that the trends above force us to conclude at least one of three things: either our luck has it that our happy indicator does not exhibit its causal efficacy in this case (unlikely), the macro-psyche is undergoing a breakdown at an amplified rate with respect to actual real-world occurrences (meaning consumer confidence is unnecessarily low), or consumer confidence properly corresponds adequately to the severity of the current mishap, yet the rate of recovery is fast enough to avoid a recession extending beyond four more quarters.

What consumers need to do is exactly what I indicated earlier: go home, dim the lights, light a candle, and quiet the mind. Although I will not go into details here, it can easily be argued that a great deal of underpricing today is attributable to low consumer confidence, and not particularly to any non-psyche related business shenanigans.

Path to Socialism

I’m not a journalist, therefore I feel compelled to give my own input on this matter. But as a human being who feels compelled to give each argument a fair evaluation regardless of possible personal affiliations that may fall into contradiction, I will first mention exactly what happened.

Recently, Hugo Chavez, the newly reelected Venezuelan president called for a socialist revolution in the United States. A reporting on this incident can be found here:
http://www.bloomberg.com/apps/news?pid=20601086&sid=aB6yw1ihGZ2k&refer=latin_america
This post is simple in nature. I will offer an argument (in the purest philosophically-styled format) against the practicality of socialism. What exactly do I mean by practicality? I will define an economic transaction as practical if and only if it achieves a statistically significant level of efficiency.

Argument Against the Practicality of Socialism
Premise 1: An industry is efficient only if it entails a profit motive.
Premise 2: Any socialized industry will necessarily eliminate any profit motive.
Conclusion: Therefore, any socialized industry will not be performing efficiently.

The argument above is transitively valid. It consists of the form:
A --> B
C --> ~B
Therefore, C --> ~A. by Law of Contraposition we know this inference to be truth-preserving.
If one wants to refute the argument above, they will have to attack either Premise 1 or Premise 2. Any economist will affirm the truth of the first premise. The second premise may be most commonly inspected on grounds of suspicion. Therefore, let me make its argument. Socialism, by definition, is the theory or system of social organization that advocates the vesting of the ownership and control of the means of production and distribution, of capital, land, and labor in the community as a whole. However, each community member is, by human nature, concerned with his or her own best interest and not with the community's at large. Therefore, each individual will work to maximize his or her own benefit at the expense of the aggregate. What you are left with is a loss of profit incentive and consequent systematic disorder and chaos. If one wants to contest this further, I would strongly suggest one first read an economic-philosophical paradox which is said to have instantiated capitalism into existence: The Tragedy of the Commons.
What Friedman suggested at one point with respect to socialism, is where anyone will find the angels willing to work without any profit incentive. Sure enough, on paper the theory works well. In practice, however, failure or extreme inefficiencies will result. And if the inefficiencies do not show up immediately in the industry per se, they will necessarily surface in the aggregate economy in one form or another through the payment of unnecessarily high taxes and resulting deadweight loss – such as chronic high unemployment, high inflation, wage rigidity, and many other negative features attributed to socialist endorsing nation-states. We can see such instances in countries such as France and Germany whose natural level of unemployment gravitates at around 8-12%.

Sorry Hugo, but socialism just doesn’t work in the non-imaginative world, beyond its oversimplifying theoretical limitations.