We teach what we cannot learn.

A "friendly experiencer" in the markets, makes his decisions amidst the deluge of sights, soundbits, and combating opinions from other experiencers market-wide. Often times our convictions are proved wrong, and when we get burned, we learn not to touch the fire. But if we're all future-blind, how are we to know the incendiary agent? We may prepare ourselves against fire, only to be scalded by a bursting steampipe. Worse, in our blindness, we may mistake the scald for a burn and learn nothing.

And so we often learn the wrong lessons, mistaking causality or blaming our own tactics. But the most malicious lesson, is the one we make when we have been burned so many times that our nerves have been seared off. We cease to be able to feel. In our numbness, we abdicate our responsibility to prepare for the next conflagration.

Today the stock market fell back 11 years in time, briefly touching a number near which Alan Greenspan gave his infamous "irrational exuberance" speech. In 1997, Greenspan was worried about the excessive valuations in the stock market. He decided to raise interest rates. The market fell 7% and then roared back. Greenspan writes, "It recouped all of its losses and gained 10 percent more, so that by mid-June, it was nearing 7,800. In effect, investors were teaching the Fed a lesson. Bob Rubin was right: you can't tell when a market is overvalued, and you can't fight market forces."

This was precisely the wrong lesson to learn. Lets review what Greenspan said in his infamous speech:

"As we move into the 21st century... one factor will continue to complicate [the] task of pinning down the notion of what constitutes a stable general price level... Where do we draw the line on what prices matter? Certainly prices of goods and services now being produced - our basic measure of inflation - matter. But what about futures prices? Or more importantly, prices of claims on future goods and services, like equities, real estate, or other earning assets? Is stability of these prices essential to the stability of the economy... How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions... and how do we factor that assessment into monetary policy?... We should not underestimate, or become complacent about, the complexity of the interactions of asset markets and the economy."

And so after Greenspan's puny stand against asset prices (he raised interest rates 0.25%) he threw his hands in the air and abdicated all responsibility for counter-cyclical tightening, with grave consequences for us and the stability of the world economy.

He will be remembered for illustrating what he could not perform.

And for teaching what he could not learn.

Make-A-Wish Foundation Rings Opening Bell, Tanks Stocks. Seismic Collapse in Bond Market Yields Benefits Non-Profits Everywhere. Quantitative Easing!

The Make-A-Wish foundation destroyed the stock market today. Charity is even more out of style than clowns and Kiss.

This is ironic because a properly run foundation should have the majority of their investments in bonds. Well lets hope they do because the entire yield curve collapsed to below the rates where the Treasury has ever issued bonds. Assuming Make-A-Wish is properly run, they racked up massive gains today as the collapse in Treasury rates make their bond holdings extremely profitable.

As the market moves to price in quantitative easing, banks are aggressively hedging their exposure to the bond swap market, in which they have guaranteed long term rates for borrowers. This has kept swap rates below the bonds they're linked to... previously considered to be a mathematical impossibility. This is because banks normally charge a premium over the market rate on bonds to compensate them for the long term risk they're taking on.

Let's review the Bernanke playbook for conducting monetary policy in a zero Federal Funds rate environment which we spoke about a week and a half ago.

1) Take the Federal Funds rate to zero. Check.

2) Lower the rates on long term (5-30 year) bonds, by either promising to keep short term rates low for a number of years or commit to make unlimited purchases of long term bonds until their interest rate falls. Check.

3) Push down interest rates on private securities by buying them as well. Check for Commercial Paper (short term debt) Not much impact on long term corporate bonds, unfortunately.

4) Intervene in the Foreign Exchange market to weaken the dollar and raise the price of imports. No action yet.

5) Coordinated easing of both monetary and fiscal policy, for example tax cuts financed by issuing money so there is no increase in government debt. Check, sort of.

So it appears the majority of their gunpowder remains only in Foreign Exchange intervention. This is an extremely politically sensitive measure and is unlikely to be implemented except as a last resort.

But what is truly shocking about this whole thing is that the Fed has not come out to announce these courses of action. Very strange for a Fed that prides themselves on transparency.

Opening Bell

Last Friday, clowns from the "Big Apple Circus" rang the opening bell. The Dow fell 403 points.

Today, Gene "The Street Giveth, and the Street Taketh Away" Simmons rang the opening bell. The Dow fell 517 points.

Tomorrow, the Make-A-Wish foundation will ring the bell. Frankly, this is getting a bit ridiculous.

Oddly disconcerting clips:
Clowns

Kiss

The (un)Thinkable is happening. Panic now. Thankfully we have the Bernanke Experimental Economics Playbook

Vol. 1: "Soft Landings..."

Dr. Ben Bernanke, in a speech on November 21, 2002 laid out a playbook of options for the Federal Reserve to run should it ever lose control of monetary policy in the face of massive deflation. Intended primarily as a thought experiment, this graph shows the Fed losing control as we speak. Witness the (relative) stability of the federal funds rate until the bankruptcy of Lehman Brothers and the reverse take-under of A.I.G.. Up until today, the effective federal funds rate has never approached its zero limit... never-ever.

We are truly balancing on the edge of economic science and there is no chart for where we are going. This is a Ph.d level, alchemy lab improvisation called "Quantitative Easing." The Federal Reserve is synthesizing a powerful medicine, but they don't know if they're missing an ingredient, and they have no idea what size dose to give. To much and the patient will OD chasing the inflation dragon. To little and he'll go into cardiac arrest.














Click here to understand what I'm talking about.

And here to read "The Unthinkable Has Happened" by Tracy Alloway, Ftalphaville.ft.com

And here to read "Obama Can Be a Roosevelt, Not a Carter" by David Blake, Ft.com

Go Long, Karl Popper

Reading a biography of Karl Popper today I was struck by this quote:

"Popper regarded democracy as the only political system capable of institutionalizing knowledge and freedom, and since he regarded the latter as a condition for the former, it may be said - though he might not say it - that history had proved him right. The fallibility of the democracies had turned out to be a strength; the infallibility of dictators had revealed their weakness. Totalitarian systems created an illusion of frictionless cohesion and inflexible unanimity, but - by damning all dissent as treachery - such regimes lost any prospect of improvement or self-correction through constructive criticism."

Applying this concept to the stock market, I think this is the strongest argument in favor of allowing short selling I've ever heard.

The Gaussian Fallacy and Other Epistomological Failings in the Age of the (Aging) Bullshit Baby-Boomer

I've typically been skeptical of adherents to Nassim Taleb's "Black Swan" club. The events that have unfolded since the collapse of the Chrysler deal in late July 2007, are not black swan outcomes. [No one posited the existence of black swans. All swans were white, until they weren't.]

These outcomes are the wholly predictable results (in framework, if not in detail) of the moral bankruptcy of the Baby-Boomers and Generation X coupled with an unsustainable and untenable financial system. I believe there were extremely few people in the world who believed we could save nothing and borrow money at 0% forever without the bill ever coming due.

However, I think that this very lucid post on Ultimi Barbarorum (a Spinozist blog about finance) is an excellent summary of the ways in which financial innovation abetted the stability of the system for the first half of this decade until it didn't.

The only thing I would add, is that retail investors were also tricked by a Gaussian Fallacy. They were told that stock returns followed a Gaussian distribution... as long as you diversified, never paniced, and invested in low cost stock index funds, you could expect 10% a year and retire happy. This shiny ordure was sold to our parents by men under fifty who had begun their careers after 1980 and had never seen anything but a stock bull market. The ideological laziness and lack of intellectual curiosity on the part of our parents and their financial advisers is inexcusable. The "this time its different" argument, used to explain why it is not important to study the past, is the direct consequence of the self-indulgence, egoism, and narcissism of the Baby-Boomers and Generation X, both of whom were raised or came to believe that they were "special" and somehow their history would be as well.

With compassion for their sins, I nevertheless look forward to the rottenness being purged from the system. As a child I used to think a good name for my generation would be "Generation Why" but more and more as I become an adult I believe in Generation MGMT.