Behavorial Finance, meet Technical Analysis

What does it mean for stocks to "test the lows" or "test the highs"? Well, most people are delusional cheapskates and Monday morning quarterbacks. As they follow a stock, they privately imagine that they were the geniuses who traded the highs and lows. "Look at the chart -- it's so easy -- you just buy it here and sell it there!" But when it comes time to make a decision, while the stock is making new lows, of say, 13, 12, 11, and 10, these clowns sit on the sidelines, too terrified to buy. However, once it turns around from 10, and goes to say, 11, 12, 13 -- they tell themselves, "gee, I was so close to buying that stock at 10, but I'm not such a fool that I will pay 13"! But once the stock returns to its downward trajectory, these people support the price at the previous low, because they imagine that they would have bought it at the earlier price, and now that it returns to that price, they feel like less of a chump when they pay it. And that, Virginia, is why stocks tend to bounce off their lows and highs.

Classic Bailout

If the TARP directly intervenes in markets and artificially supports inflated price levels, one delicious side effect is that CDSes on CDOs will settle at lower prices. Since some folks estimate the CDS:CDO ratio to be four or five to one, this would also reduce the economic fallout for the authors of CDSes.

When to hold 'em, when to fold 'em

Last week, I was worried that a gambler like McCain would continue doubling down, using increasingly high-risk bets to keep himself in contention for the Presidency. However, with yesterday's change in tone in the campaign, the gambler is folding his hand.

If McCain continues playing the long odds and antagonizes the future President, he would be condemned to an irrelevant future as a United States Senator of the minority party. However, if he can Dole it up, he will still go down as a class act losing to an inevitable force, with the chance to be part of a bipartisan governing coalition.

After preposterous faux-statistics on the upside, welcome to the astonishing world of bizarre downside statistics. The WHOLE POINT of the market is that it steadfastly refuses to repeat itself -- the existence of the expectation of repetition short-circuits repetition. So, responsible organs of journalism are now using their expertise -- which, as far as I can tell by reading the article, consists of looking at the graph included in the article -- to encourage people sell companies whose ROC : 5 Year Prime Rate ratios are three and four to one, just because they are expected to go down, based on historical analogies. After the markets settle down and we are in for grueling multi-year period of sideways stocks, slow growth, low volatility and low interest rates, people will start appreciating how hard a stock has to work in order to get back the ten percent that people threw away in their panic selling, and they'll look back on their investments and kick themselves.

But here's an idea. To encourage Buy and Hold, online brokerage firms should have an option that shows people the difference between the price where they sold a stock and where it is now, and add it together as money that was left on the table.

Boundless anxiety

What if the European Union falls, and the different countries go back to their own currencies?

What if a bank in the Cayman Islands or the Bahamas has lent wildly in excess of its reserves?

What does it take for an unregulated tropical bank to fail?

What if hedge funds with loans from undercapitalized, underregulated banks are counterparties embedded throughout the financial system?

As it turns out, the G7 cannot agree to draw a circle of safety around its own banks, so the next phase of the crisis -- collapsing tropical banks that are providing leverage inside the system -- won't unfold next week.

Things will get worse if they get better

Right now, the Fed is furiously pouring money in the economy to counteract the deflationary pressure of the collapsed stock and housing prices. Fighting deflation hurts people with savings, but it removes the incentive to invest or lend money inside the system, so it makes sense to have an anti-deflationary social policy. But if share prices recover, that extra money in the economy will create inflationary pressures, and the federal reserve policy that counteracts those inflationary pressures will reduce the speed of the recovery.

Remember the Seventies (part 2)

It cracks me up when twentysomething financial journalists ask whether the despair at the bottom of the recent sell-off means that the bear market is over. Hardly. When people are so sick of stocks that nobody wonders whether the bear market is over, when the thought of owning a stock sends people running to the toilet in nauseated revulsion -- that's when it will be over.

"ha ha" funny, or "it makes me want to put a gun to my head" funny?

Wouldn't it be funny if Paulson's desire to rid Goldman of a competitor was behind the collapse of the international financial system?

Every man a Philosopher King?

Most cultural production is just a distraction that keeps people from thinking about the conditions of their existence. From the perspective of Plato's cave, audiences are stuck there, bored, and staring at a wall: diversion keeps them sane.

The difference between "art" and "cultural production" is that "art" leads to transcendence -- a shimmering appreciation of the beauty of the universe -- while "cultural production" can be a pleasant way for a brain exhausted by a long workday to pass some time. From a phenomenological perspective, "art" breaks the structural intellectual habits of one's historical era while "cultural production" reinforces those habits.

The passage of time can turn "cultural production" into "art", because the historicity of a work creates a counterpoint to the Zeitgeist of the current time, and the tension between the two systems of interpretation can undermine one's commitment to the current system of interpretation. In recent years, the marketplace has enhanced the value of cultural production by representing it as art, but cultural production that reinforces the preconceptions of its own historical era will only become art after that historical era has passed.

By telling people that contemporary books and movies are "art", our civilization has stripped real art of its power to counterbalance the cultural production of our civilization. Twenty years ago, people said that Film Studies Courses or teaching comic books at universities marked the end of our civilization -- and that is true insofar as the saving grace of our civilization is our ability to transcend our civilization -- but the real effect of putting contemporary culture on the same level as art is to reinforce our civilization rather than subvert it.

Social criticism -- pointing the relationship between cultural production and power structures -- draws attention to the moment of cultural production, but not the deeper reality masked by cultural production. Social critics can be so consumed by jealousy that they can't conceptualize an alternate reality. Their only truth is that other people are hiding the truth.

The last two weeks have been like a moment in a play where the house lights come on and the actors break character. The show is gripping, but the theatrical spell is broken. Previously solid truths have all the substance of shadows on the wall. Narrative is no longer following its expected path, and nobody knows what will happen next.

We are at a fork in the allegory: Will an enraged lynch mob fall on the performers? Will we find a better show with an even more compelling story? Or will we accept this moment of freedom as a gift and head towards the exit of the cave?

After Daryl Gates

"But also never neglect the psychological, cultural, political, and human dimensions of trading, which is inevitably tragic, inefficient, and uncertain. Be skeptical of systems analysis, computer models, game theories, or doctrines that suggest otherwise. Look askance at idealized, triumphalist, or ethnocentric notions of future strategies that aspire to upend the immutable principles of risk: where the money is made but capital is unjeopardized. Where markets can be cowed, shocked, or awed into profitability instead of being processed, execution by execution, scalp by scalp, trade by grueling trade."

wouldn't it be funny

if this were the bottom for banks and brokerage firms, and the short sale ban on financials forced the shorts to the sidelines, rather than letting them provide liquidity to the longs...

Everyone brings up Japan as an example of deflation and low interest rates for a multi-year period, but Japan's economy is predicated on trade surpluses.

alternate dimension

In a universe where Goldman hadn't unwound their LEH trades, Paulson would have bailed Lehman out, and the whole crisis would have emerged after Obama's inauguration.

Brace yourself

For a massive Reverend Wright television barrage in the week of October 26th. McCain and Palin aren't discussing Reverend Wright in order to keep their powder dry for the final assault. No matter what is happening in the economy, the News of the week before the election will be dominated by McCain bringing up Wright and Obama either responding or ignoring.

Turnaround is fair play?

For the longest time, people on the right used the corrupt and -- dare I say -- Russian Soviet Union to refute ideal visions of Socialism. So what's wrong with people on the left claiming that the collapse of the Government supported housing market shows the dangers of unfettered capitalism?

The real danger is a socialism with a capitalist face -- where clever capitalists arbitrage inefficiencies created by government and then use their wealth and alpha status to ask the government to continue to help them.

The case for deflation

Sunday's post discussed the chemical conditions for hyperinflation, but deflation is probably quite likely. We have an asset-backed economy rather than a gold-backed economy, so when stocks and real estate fall by 30%, it is like removing a third of the gold in a gold-backed economy. The problem is that the monetary tools available to fight deflation could trigger hyperinflation.

Where are the Nazis when we need them?

That America slid into a recession in 1938 is no longer a Pointdexterian piece of trivia: it is a warning that solving our problems is even more difficult than the monumental task of reviving the New Deal.

Time to face Realty

Now that 700B has entered the consciousness in a single congressional bill, people no longer think that Bill Gates or Warren Buffett are particularly rich.

700B is an almost inconceivable amount of money, but it gives us handle on thinking about the 11T national debt. Eleven trillion dollars could buy HALF of all publicly traded companies in the world. Eleven trillion dollars could buy ALL the real estate in the united states (at current prices). Eleven trillion dollars could feed, clothe and shelter EVERY PERSON ON EARTH for five years.

If interest rates are nearly zero, the debt is not a large problem. However, every point increase in rates will cost 110B per year -- so if the cost of money returns to its late seventies level, we would be looking at an extra trillion dollars a year of interest expense.

In short, the system might be subject to the same instability that hit LEH -- or Argentina. After a threshold, every increase in interest rates decreases the creditworthyness of the debtor, forcing them to pay more to borrow money (which is another increase in interest rates) which further decreases the debtor's credit rating, driven from AAA to zero in a few days.

The good news about this gloomy scenario is that -- because there are gloomy scenarios all over the world -- the cost of money might well remain cheap, and we will never spiral into hyper-inflation.

Watch the libor rate

Let's hope that the deliciously loony conspiracy theories of DRJ and the Chief are true, and that -- having gotten their ransom -- the banks now allow things to settle down. If the bailout "works" and heals the TED spread, the bailout will be viewed as a necessary capitulation to a simple act of blackmail.

And the meek shall inheirit the debts

This article shows why the too-big-to-fail banks are the ones that are failing. Es Viva the Second Tier!

So, remind me, why does anyone think the "rescue plan" will address the deeper economic issues? Will the "rescue plan" support housing prices? Now that the inability of House leaders to control their members has damaged faith in our political-economic system will it restore public faith when we pass a flawed plan? And won't artificially supported housing prices increase rents and divert economic resources that might be spent on public works programs?

Hamilton's beats Jefferson!

With today's manufacturing numbers, it looks like the credit freeze is a stop, breath, and think response to changing reality and not something as easily addressed as a panic. So why assume that international banks, once their balance sheets are generously shored up, will jeopardize their second chance at life with shaky loans to companies doing business in the United States?

The solution is obvious: rather than giving money to banks in the hope that they will lend money to United States consumers and industry, the TARP should lend money directly to consumers and domestic industries. The original Paulson plan would have allowed this, but the modified Paulson plan will be an ineffective solution to an already ever-expanding problem. In two short months, the Chinese and Russian State capitalist systems have gone from historical curiosities to role models: the American gift has always been assimilation and improvement, so let's hope we can out-do them!

Welcome to the Seventies

Urban mansions have not lost value as quickly as other real estate investments because the re-Urbanization of the elites has protected them from the downward trend in property values. But if we are really heading into a major recession, the superrich will once again retreat into their enclaves rather than expose themselves and their children to hordes of unwashed, unemployed, unpleasant drug addicts. Population density amplifies the general mood, and when that moves shifts into recession or depression, the superrich will buffer themselves from the Zeitgeist rather than vampically feed upon it, so watch for the ebb and flow of our urban centers to repeat the cycle of the Seventies.