Who's to Blame for Continuous Credit Crises? MBA Finance - Arrogance of Dogma and A Generation of Highly Paid Misfits

1. In 2003, when I was asked to teach finance and investments and given a selection of "highly respected textbooks" to choose from I told my supervisor and colleagues at a business school that EVERY MODEL in said textbooks were IMMEDIATELY and DEMONSTRABLY FALSE, and asked shouldn't we instead try to teach something closer to the truth and reality of the financial markets? I was told that I shouldn't worry so much, that it was such a bother to dig out the truth or discuss the realities, and that it would best for everyone if I just towed the line because if I did come up with something new, it would be even more bothersome for my colleagues to learn this new stuff. Besides feeling like I needed to wipe the poop off my face, I was a bit surprised by this attitude but I suppose this institutuonal attitude is replicated 10s of thousands of times throughout business schools which receive their own funding, and basically, operate completely enclosed and cut off from the rest of the humanities. Business Schools which have become independent are in effect suffering from the solipsism, moral hazard and adverse selection of dogmas which have been disproven empirically and yet they sit imperially at the top of the hierarchy of reproducing "untruths" for the sake of replicating power structures for the "sons, daughters and upstarts" of the moneyed oligarchy of bankers and financiers who manage and control the future cash flows of all individuals plugged into the global financial system.

2. What to do? To not feel like commiting philosophical murder, I would start my lectures on finance and investments by declaring that EVERY THEORY and MODEL they would study and learn are DEMONSTRABLY FALSE. If this is true, then they should understand WHY they would bother learning this stuff. So, a student would naturally ask "WHY THEN?" My answer is a bit Aristotelian. I would say, "Because this is the language and parts of the culture which you need to learn if you wish to communicate with those in finance and power." I justified my stance to myself as a matter of teaching anthropology. So, in fact, I would rehearse "how investment bankers would think through problems" and students would get high marks if they could do just that. Immitation of behaviours and beliefs is not the same as an examination of the truth. Also, to do some personal penance, I published notes on our internal learning management system on "corrections" to the major textbook we were using, which happened to be in its 11th edition. I think my students enjoyed my notes which happened to get longer and longer as we got deeper and deeper into the text. My longest "note" was 55 pages (!!) for a chapter that was 30 pages long. At the end of the lecture series, I had approximately 350 pages of corrections and when I told the publisher of the textbook in question that I had compiled so many corrections, she asked me for a copy. I then said, "Why? They are obvious errors that should have been corrected long ago and anyway, it's a good test of the teachers and students understanding to FIND the errors." Smiling.


3. So, who's to blame for the continuous credit crises? The morphism points to me. And think of all those 35 year old PhDs in finance making a buck. Do any of them have a way of thinking through these problems? I am quite sure that no PhD in Finance from any of the brand named schools has contributed anything except positively to increasing the potential problems inherent in the academic models which they have studied and believe so automatically.

4. What do I propose? A Platonic solution. One where elders above 55 years having no skin in the game ask simple questions to get to the truth. A little bit of wisdom is what we need.

Isomorphisms and Adjunctions in Corporate Finance Law - Some Speculations

1. In the summer, I usually read (skim read and fill in the margins with messy notes and doodles using a Pilot 0.4 black pen--if i feel artistic, sepia is preferred) a couple textbooks relating to corporate finance law and wonder, gritting my teeth, why these authors haven't studied Hohfeld and Category Theory. I think I know why. It's a sociology of knowledge problem, so a perfectly general field which may be very generally defined ("raising money for a company") is studied in terms of extremely local rules ("limited to the laws of England Wales" or "to the US Federal securities laws and the laws of the state of New York"). The authors will then disclaim except for some purpose of "comparison" any knowledge or relevance of other legal jurisdictions, and off we go looking at and commenting on the law of the land.

2. Here's a radically lazy thought: why not learn Hohfeld and Category Theory enough so that you can translate all of the laws relating to corporate finance law into a couple squiggles?

3. Right off the bat, you'll see intensional and extensional definitions of corporate finance law (the intensional definition asserts a feature common to the phenomena under study, and the extensional definition will list the elements composing the set of phenomena under study). Those who critique black letter law as being low brow scholarship are Intensionalists at heart. But the practitioner doesn't really trust the "impressionistic observations" of the Intensionalists as being of any use to his immediate needs of knowing the Extensionalist definitions of the laws. So, exactly how does the sky meet the tarmac and tarmac meet the sky?

4. Isomorphism for Disclosures of a Prospectus and Adjunction for Universality in Comparative Law. What the Intensionalists and Extensionalists must agree on is the conception of disclosure as being a hard-datum phenomenon under study as well as some normative value and goal of overall corporate finance theory. But what is disclosure per se? Having wandered around various disciplines to bottom out this question, I guess the best and most satisfying answer comes from a confluence of theories including Ramsey's Law, Shannon's Information Theory and some bits (pun intended) from quantum information theory. The short way to get underneath the hood, is to define disclosure in terms of a PHYSICAL TRANSFERENCE in a MUTUALITY transaction. In category theory terms, this looks like: (1) an isomorphism of f:A->B, g:B->A; and ideally, (2) a naturality transformation where we have an adjunction which is really an isomorphism amongst functors. (1) gets you simple disclosures which MUST meet and satisfy Akerloffian boundaries against asymmetric information. (2) gets you to the level of comparative law systems where transactions MUST meet and satisfy the bounds imposed by UNIVERSALITY (as in universal bankruptcy theories) and HARMONISATION by deference (as in EU normative treaties or in conflict of law laws under the old common law). (1) can be illustrated by disentangling a prospectus published under US Securities law or under EU law and asking, "How can we be assured that the materiality of disclosure test has been met?" The positive answer should (and logically must) be that the isomorphism in (1) has been met. (2) is much more open to research. I can see the steps one would need to undertake to make the argument plausible and I'm pretty sure if one could do it, that it would prove to be a big contribution to comparative law theory.

False Dichotomies: Intensionalists versus Extensionalists in the US Debt Default Theatre

1. One of the problems in philosophy which I have thought about for 41 years and have not got any closer to solving or resolving is the question of the one versus the many. Is reality one or many? Is it a false dichotomy? Is it a question at the heart of all mathematical theories, namely, number theory? Is it translated into the opposing camps of nominalists versus realists? Is it translated again amongst set theorists as intuitionists like Bouwer versus extensionalists like Zermelo-Frankel? And yet again amongst legal theorists as an opposition between monist-universalists versus cultural-pluralists? And the list of debates goes on and on, as if reflected and refracted on many pieces of broken glass and mirrors.

2. I suggest that if one wishes to develop theory then the optimal way is via Aristotle-Descates. This way is best for those who find it impossible to not question belief.

3. For true believers, the best is to find a way to complete the meaning of one's own religion.

4. How do (2) and (3) have anything to do with the US Debt Crisis? Well, an extreme view of either (2) or (3) leads to very similar conclusions. Using either, one will move towards the same goal of self-survival.

5. Now, consider the doubter of (2) and the believer of (3). The doubter cannot believe the US government will commit suicide and genocide by acts of incompetence. The believer believes a golden rabbit will be pulled out of the government's empty hat. So, what's the deal?

6. Anyone who has ever traded knows there is a second book that the auditors and compliance people can't quite put their fingers on. Applied to the US government, the US Treasury and the Fed have a lot more power than what they are saying to the hoi polloi. They can manufacture on my estimate at least another trillion dollars out of thin air by booking profits, monetizing gold reserves and accounting on an accrued-pull-cash-flow forward basis. These are tricks legitimated in practice and acceptable de iure. For a discussion of these techniques, see: http://www.zerohedge.com/news/stop-presses-fed-can-fund-treasury-over-half-trillion-emergency-capital.

7. So, do we have an answer to the false dichotomies? Does it matter if we don't get an optimal answer by August 2nd?

n-Financial Science Fiction: Pre- to Post-Credit Default

Some quick notes drawn from an alien planet spying on Earth's financial economic activities:

1.  If the US government, and specifically, the US Department of the Treasury cannot pay on its obligations when due then it is technically, insolvent, and it is declared in default as per the conditions set by bilateral legal agreements called financial contracts including straight bonds, futures, options, CDS and thousands of different kinds of interest-related over-the-counter derivatives. As of this moment in time, Thursday, July 28, 2011, neither the President of the United States nor congressmen or senators of the US have come up with a plan that meets even a modicum of credibility to the financial markets. As of July 27, major funds are positioning their books to take on the inconceivable--a default of US government obligations. On August 7th, 2007, we had a seizure of the very short-term money markets, in effect, the liquidity of the Western world, shrank from $600 billion per day in trading volume to notjhing, nada, zilch! The former Goldman Sach's CEO, and chief discretionary trader of the US at that time, Hank Paulson, one year later diverted $750 billion to save four big entities on Wall Street, which entities would continue to receive life support subsidises in the form QE1 and QE2, and by the grace of the Fed window, be able to trade "dead mice" (RMBS) for an astounding $14+ trillion in combined subsidies over 3 years. This profligacy of overt moral hazard can be compared to Nero playing the fiddle while Rome burned. Gold has zoomed above $1630 per ounce whence it was $500 per ounce 5 years ago. The charade of "panem et circenses" has come to a dreaded faltering halt by the US Fed as of May 6th when it announced no more QEn. That announcement has been completely discounted and manipulated by the ALGO traders on stock markets at low volumes at the close of trading (the so-called "compression trade"). The compression trade disappeared last Monday, July 25th. And yesterday, someone swallowed a very bitter pill and sold 65,000 futures contracts on US T-Bills! If this sort of trade occurs pre-default, only a sic fi writer of first rank can imagine what will happen as August 2nd comes and goes.

2. The markets are factoring between a 35 and 85 basis point hit in the US treasuries. The knock on tsunamic effect will be difficult to contain. Here are some headline inevitabilities:

(1) All sovereigns will be rated downwards except for the oil producers. The cost of capital will be driven prohibitively high for non-oil producing states. This means most of Europe except Gernany which enjoys a trade surplus will temporarily destroyed with extraordinary risk premia.

(2) Pension Funds and Insurers will be forced to move to safer bonds whatever that means in a sea of utter volatility. These moves are mandated by US Federal laws requiring that such funds hold AAA securities. So the law will have the unintended consequence market euthanasia.

(3) For similar reasons, the shadow banking sector, i.e., Money Market Funds (MMFs), will lead the pack, by complying with Rule 2(a)7 and immediately withdraw support for non-AAA bonds. This can cause genuine global illiqudity since without the MMFs 3 to 4 trillion dollars of very short term money suddenly goes into deposit and no bank, no corporate, no government can move any money since collateral lines will be totally frozen.

(4) Municipal bonds are downrated in relation to the US downgrade. This will make completely naked the 38 states in the US that are trading insolvent.

(5) if (3) or (4) occur then expect the US Fed and Treasury to pump another trillion dollars to prop up the failing Wall Street banks--obviously, Bank of America is getting near the threshold of the dead zone abyss and Citi will not be a beneficiary of any short-term chaos. Good luck if you want to play the river for a pair of aces.

We can list at least a hundred different effects a US default will cause, but all of these can be understood under a theory of Default Invariance. See my previous blogs. By the way, one the beneficiaries of the coming US de facto default is textbook publishing because ALL TEXTBOOKS ON FINANCE will need to scuppered and re-written. The ENTIRETY OF FINANCIAL DOGMA since the 1950s has proved itself to be less worthy than astrology.

n-Unintended Direct Consequences of Not being Able to Fix US Debt Crisis; Direct Evidence of d:B->I Behaviour

1. Should have seen this coming. The CME is raising haircuts across the board on all sovereigns.

Source: http://www.cmegroup.com/tools-information/lookups/advisories/clearing/files/Chadv11-262.pdf

What does this mean? As Zerohedge points out, the exchange is doing what the rating agencies are hesitating to do, which is to down rate US government debt. See: http://www.zerohedge.com/news/cme-celebrates-americas-ever-nearer-date-insolvency-raising-collateral-haircut-treasurys#comments

2. For those non-initiated to the rites and rituals of the financial markets, you might consider that the EXCHANGE MODEL is the way almost all financial practitioners think of a completely controlled environment, with requirements that its trading members put up initial and variation margins, which in effect create a pool of assets buffeting the exchange as a whole from catastrophic collapse. So, when the exchange, in this case the CME, (where a huge volume of sovereign debt is traded and cleared) says that on this THURSDAY all sovereign margins are going up (and on US T-Bills, by an INFINITE RATE, from ex nihil 0% to 1%), this means an all endearing shift in Market Premise has occurred from pure academic unreal world theory to burning rubber on the tarmac.

3. Relation to Joe's Theory of the Invariance of Default. In terms of the Great Cycles of Default, we are deeply in phase 3 where governments are moving from Bailout [B] to Bailout [B]. In categorical notation, d:[B]->[B], where d is the universal morphism of default. We really don't need the brackets since in the end only the arrows count. So, d:B->B, is a more elegant way of describing the structure. But now consider the CME's act of raising the haircuts on sovereigns across the board. This action is not the signature of a bailout. In fact, it is just the sort of action that the private markets would consider realistic of themselves. The act of the haircut is an idempotent endomap of what we have earlier defined as part of the world of Financial Innovation or [I].

4. Thus, the CME haircut action is indicative of phase 4 behaviour. In category theory notation, d:[B]->[I] or simply, d:B->I. In words, the object-domain of bailout behaviour is being translated into private innovative market behaviour. We are now getting clarification on the meaning of the structure of phase 4. It will mean massive private market reaction. To put it mildly, bailouts cannot continue to be maintained.

A Couple Predictable Unintended Consequences from a US Debt Downgrade and Default

1. Money Market Funds will have to move out of any AA US treasuries and bonds. The will move en mass. Their combined action will seize up the short term markets. Very bad.

2. The GSEs, Fannie MAE and Freedie Mac will need to fold into receivership from their current conservatorship. Now that will set off pure liquidation and cause all related debt markets to seize up. Very very bad.

3. Meanwhile the jokers in Congress and the President who's sided with Wall Street and has condoned about $7.5 trillion in bailouts to four banks over 3 years, are arguing about $50 to $100 billion.

Source: http://www.zerohedge.com/sites/default/files/images/user5/imageroot/draghi/Debt%20Plan%20Summary_0.jpg

n-Systemic Risk of the US Fed: Can the Orderly Liquidation Authority be used to Limit the Power of the US Fed

1. Sometimes the medicine is worse than the disease. Under the Orderly Liquidation Authority (OLA) of the Dodd Frank Act, any company posing a systemic risk to the US economy may be taken over by the FDIC and properly dismembered into a "good company" and a "bad company" such that the latter retains the bad (underwater or non-performing) assets and the former retains the good (profitable or performing) assets. Nothing in the OLA prohibits or prevents the FDIC from going after the US Fed itself, although one might argue that sort of action was not explicitly contemplated by the statute. Supposing the OLA could be applied to any private company having 85% of its tradable assets or balance sheet in financial instruments, which the Fed unquestionably has, then the question is "What actions or activities has the Fed engaged in which have posed systemic risk on the US economy?"

2. Evidence abounds. This blog is not the place to itemise the evidence. But a good summary is as follows:

"The Last Remission:

According to the official figures put out by the US government, the economic "recovery" in the US celebrated its second anniversary on June 30, 2011. The "fuel" burned in this "recovery" is immense. Mr Obama's presidency has ushered in the era of $US 1 TRILLION plus annual deficits riding on top of 0.00 percent controlling interest rates from the Fed. It has also ushered in the era in which almost nothing is traded on the paper markets which is not - explicitly or implicitly - guaranteed by the government.

The fuel to keep the global financial system functioning does not stop at the borders of the US. The "Dodd-Frank Wall Street Reform and Consumer Protection Act" has just produced the first ever "audit" of the US central bank. It reveals that in the period between December 2007 and July 2010, the Fed parcelled out $US 16.1 TRILLION in emergency loans to financial entities all over the world. Almost half of this - a total of $US 7.75 TRILLION - was loaned to four US banks. They were Citigroup, Morgan Stanley, Merrill Lynch and the Bank of America. In July 2010 (the cut off date for this "audit"), total US stock market capitalisation was $US 15 TRILLION. The Fed provided about half of that."

Source: http://www.the-privateer.com/front.html

3. If these figures are to be believed then the US Fed is the main culprit for insidiously halting the private markets and propping up at least four major banking entities for an amount which is around one-half of the total national debt! Crazy, what a public entity can do to its people while vainly saying that its policies are meant to avoid depression.

4. And who is to blame for this systemic fiasco? Shall we blame Obama, the puppet, or his major contributors ("his masters") on Wall Street? Why blame anyone at all when the rules of the game are fixed to ensure the continuation of the power, privilege, immunities and rights of the few against disabilities, duties, liabilities and no rights of the many?