Snarky Behavior

Entries tagged as ‘dropping knowledge’

Who is Defaulting?

December 9, 2008 · 3 Comments

Somewhat dropping knowledge:

The news media is very good at shaping a collective narrative of what’s going on in our economy.  Times are tough, Americans are hurting, etc., etc.  And while this is true for many, it certainly is not true for all.  We need to stay diligent of how we provide assistance, and to whom.

My international capital markets professor, in a lecture about mortgage-backed securities, shared a VERY interesting study done by Fitch ratings agency.  The study randomly selected 45 case files of homeowners who had recently foreclosed on their homes due to “an inability to pay.”  What did those homeowners look like?

  • 66% fraudulently stated at the time of the loan that the home would be “owner occupied.”
  • 51% fraudulently overstated the value of the property, or the condition of the home at the time of the loan
  • 48% fraudulently stated they were first-time home-buyers, when a simple credit report showed past mortgage activity
  • 44% could not pay their structured debt due to “payment shock,” defined as greater than 100% increase (i.e.  balloon mortgage)
  • 44% questionably or fraudently stated income or employment
  • 22% had fraud alerts on their credit reports at the time of the loan
  • 18% had questionable ownership of accounts due to name or social security numbers not matching
  • 16% Strawbuyer/Flip scheme indicated based on evidence in servicing file
  • 16% Identity theft indicated
  • 10% Signature fraud indicated

So before we go running to help out these “struggling homeowners,” let’s be clear who we’re REALLY helping out.  Dumb, or oftentimes fraudulent, speculators.

Categories: graduate school
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Newt Gingrich is an Idiot

October 2, 2008 · Leave a Comment

I haven’t had a chance to follow the back and forth arguments going around right now about possible reforms for this financial crisis, but I can tell you with near certainty that Newt Gingrich’s proposal to suspend mark-to-market accounting practices is just about the dumbest thing I’ve ever heard.

I’m going to really over simplify this for “Dropping Knowledge” purposes:

In accounting, every company is required to file a “balance sheet” to show that its business is in good order.  It’s called a balance sheet because your assets should ALWAYS equal your liabilities.  Any difference between your assets and your liabilities is covered by shareholders (called owner’s equity).

ASSETS = LIABILITIES + OWNER’S EQUITY

If the value of your assets increase over the value of your liabilities, the value of each owner’s share of the company increases correspondingly.

↑ASSETS = LIABILITIES + OWNER’S EQUITY

If your liabilities are greater than your assets, you need to raise more capital by issuing more shares, decreasing the value of each share.

↓ASSETS = LIABILITIES + ↓OWNER’S EQUITY

The overall value of a company — or it’s “market capitalization” — can be calculated by multiplying all of the shares owned (shares outstanding) by the MARKET DETERMINED PRICE PER SHARE.

MARKET CAP = #SHARES OUTSTANDING x PRICE PER SHARE

If the market thinks you stink, the value of your company drops.  It’s pretty simple.

Right now, everybody knows the value of the liabilities.  That’s indisputable.  You owe what you owe.  But nobody knows the value of the assets; or, put more accurately, they know the value depends on the ability of of the underlying mortgages to be paid off.

For the last 18 months, companies have been busy “writing off” losses… basically devaluing their stated assets, so that their balance sheets actually balance.  Every time they recognize a loss, the perceived value of the company falls, the stock value drops, as does the market cap– the owner’s equity and asset values drops in correspondence with one another.

Now, financial institutions require capital to perform day-to-day operations.  Right now, because banks don’t know the value of their assets, they can’t sell them, and they can’t value the assets (or themselves) as a result.  Investors won’t invest, because they don’t believe the write-offs have finished.  And nobody will lend to them, because they’re worried the bank will go under at any moment.  The rating agencies downgrade their credit worthiness, and the cycle exacerbates.

Newt Gingrich says these liquidity issues rest at the feet of accounting practices requiring the banks to “mark” the price of their assets to their “market” value.  If only they could mark to “economic value”… or historical cost, they lending would continue and the crisis of “chasing a rabbit down the hill” could be averted.

Well, let me put it to you this way, Newt:

If I’m a chicken farmer, and all of my chickens die, I’m out inventory.  Nobody wants to buy my dead chickens.  My company isn’t going to become any more valuable if I’m suddenly allowed to mark my dead chickens at their historical price.

Categories: Opinion
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Dropping Knowledge: Financial Crisis

September 23, 2008 · 2 Comments

I’ve had a few requests for a “Dropping Knowledge” post so I’d like to share my understanding of “Black September” vis a vis my class on International Capital Markets.

A lot of the conversations you read about the crisis pick up at a point where you really need some fundamental background knowledge to understand what’s going on, so I’ll start from the beginning:

Have you ever heard someone say that financial markets “exist to efficiently allocate capital?”  Well that’s true… some people and entities have immediate needs for money (we’ll call them borrowers), and other people and entities have excess savings which they’d like to invest to earn a return (we’ll call them investors).

Borrowers look to borrow a lump sum of money up front in return for the promise to pay installments over the long-haul (basically an IOU, or “receivable”).  The IOU carries with it a small fee – an interest rate – for which the borrower agrees to pay over-time in exchange for the lump-sum up front.  The interest rate is determined by many things, the most important of which is determined by the borrower’s perceived ability to pay back the installments (or credit risk).  The higher the borrower’s credit risk, the higher the interest rate offered to them will be.  Obviously, the borrower would prefer to pay the lowest interest rate available to her.

On the flip side, Investors are looking to lend their money and capture the highest “return” on each dollar they lend.  Investors have a lot of opportunities available to them in terms of how they lend their money (to companies in the forms of equity/stocks, to individuals or groups of individuals, to government), but they typically have a preference for the highest available return at the lowest available risk of losing their investment.

Investment banks exist to find and research investment opportunities (i.e. finding borrowers in need of money, such as start-up companies, municipal governments installing a light-rail system, firms expanding their productive enterprise– “The Buy Side”), packing them up in some form (stock, bonds and securities), and selling them to investors (”The Sell Side”).  They make a hefty commission on this, because it involves a lot of work, and long hours.  In a global economy, money never sleeps! (i.e. there’s always an overnight demand for money or liquidity, and investors typically give their money over to managers to put it to use at all times).

Investment banks compete with each other in terms of the price and quality of the investment opportunities they make available to their customers.  Some investment banks (like JPMorgan, Bank of America) are also commerical deposit banks, meaning they have a broad deposit base from people like you and me who have checking and savings accounts with small amounts of money in them.  Other investment banks (like Lehman Brothers and Goldman Sachs) are “stand-alone,” meaning their only deposit base (i.e. “cash on hand”) comes from private investors (personal equity) and fund-managers (mutual, pension, hedge, or otherwise).

One of the many “packages” investment banks sell to investors are called securities.  Securities basically take a bunch (say 100 or so) of the individual IOUs from borrowers and package them together into a single “vehicle.”  The intuition behind a security is that it pools the risk of default of each individual IOU, so that collectively, the “vehicle”  has an overall expected return and performs with low rates of volatility.  That is, if a few people can’t pay back the IOU, that’s still OK, as long as everyone else still pays on time.

In terms of the current crisis, you had a situation where the IOUs “backing” these securities were American home mortgages.  People were borrowing money from small banks or places like CountryWide in exchange for IOUs to pay back both principal and interest over a period of 30 years or so.  Historically, preferred individual borrowers (i.e. people with good to great credit ratings) could borrow from banks at an interest rate called “Prime.”  The prime-rate is typically set variably 3% above the rate at which the banks themselves lend to each other over-night (the federal funds rate).  People with poor to fair credit ratings were required to pay “prime plus” some percentage amount, and also to place a large down-payment as collateral against their mortgage loan to off-set their risk of default.

Now, in the late 1990s and early 2000s, the American housing-market was booming; especially in places like Florida, Michigan, California and Arizona.  The boom was partly driven by consumer demand, but it was also driven by inflated prices caused by loose lending practices.

You see, as investment banks diversified their securities, they found that the mortgage-backed security “vehicles” were performing at a very attractive rate with an extremely low risk of default.  In fact, the agencies responsible for rating the risk of securities had given these vehicles AAA-ratings, which in financial terms means “money good” or “just as safe as a US treasury-note.”  Every investor wanted these security assets as a fundamental part of their investment portfolio.  And investment banks were buying individual mortgages off of the Country Wides of the world like crazy, so that they could turn around, package them up and sell them off to meet investor demand.  At a VERY handsome profit, by the way.

(Side note:  it is at this point where AIG becomes involved.  AIG agreed to insure each one of these assets at a tiny, tiny premium.  They were, after-all, rated AAA.  That’s how a company with market value of $150 billion drops to $5 billion in the span of a year).

(Second side note:  This is where the shit really hits the fan.  Once the institutional investors (i.e. banks, funds, etc.) realized how well these investments were performing, they started borrowing money themselves in order to purchase the securities, and at astonishing rates.  Some funds were “leveraged” at ratios as high as 30:1, meaning for every $30 borrowed, they only had $1 on hand to back it up.  This creates a dangerous situation of musical chairs… once the music stops, the scientific term is “absolute shit storm.”)

Meanwhile, the Country Wides and other small banks were in a bind:  as intermediaries, they could not possibly find traditional mortgages fast enough to sell on to the Investment Banks.  But the Investment Banks were telling them “risk is fine.  We’ll diversify (i.e. pool and mix) the risk.  You just get us the mortages.”

And so the banks started to loosen up their lending practices.  Prime rate went out the window (enter: Sub-Prime lending).  Mortgages were offered without down-payment.  Then without proof of any assets.  Then without any proof of any job or income (NINJA loans – No Income No Job or Assets). When you offer to lend money to someone without running a credit check or requiring them to have any equity-stake whatsover in their home… you can pretty much guarantee that their risk of default is 100%, no matter how low you make the interest payment.

Simply put:  banks preditorily lent money to people to purchase homes that they could not afford.

Why would they do this?  Why would anyone with any sense take an investors money and give it to a borrower, when they knew with near-certainty that the borrower would/could never afford the payments?

Well, for one thing, they were relying on “finely tuned instruments” to monitor the performance of the securities.  Even when some people defaulted, the banks assumed the asset of the house, and could turn around and sell it at the current market price, for a profit.  It was win-win.

Until it became lose-lose, around August 2007.  Times thirty.

Once the housing market bubble bursts, those security vehicles stop performing so well.  And it’s a downward cycle (hence:  “toxic” assets).  If someone defaults on their mortgage, the bank now has to assume and sell the home.  If the bottom of the housing market has fallen out, the banks sells the home for a HUGE loss (which translates to a small drop in the value of the asset it is partially-backing).  Suddenly the supply of available housing vastly exceeds demand.  Everyone is trying to get out of the house they couldn’t afford in the first place.  Consumer spending drops, because everyone’s trying to pay down their house.  The economy tanks.  People get laid off, and can’t afford to pay their mortgages.  And the cycle exacerbates.

The thing is, on Wall Street, nearly everybody has these assets on their books.  As the value of these assets drop, so do the value of their companies, and so does the value of their stock.  Investors see where the economy is headed, and so they withdraw their funds, or stop buying the securities the Investment Banks are trying to sell (er… get rid of).  Who’s going to buy toxic assets?  Nobody knows the values of these assets. There is literally no market for them.  Lehman Brothers, Bear Sterns and Merryl Lynch were scrambling to get rid of them, but they finally had to admit that they just couldn’t do it.  The money was gone.  The wealth was destroyed.

Well, scratch that last part.  Part of the wealth COULD be recouped, but it would require financial backing from someone bigger than Lehman Brothers or Bear Stearns.  In fact, it would require the financial backing of the US Treasury.  If the US taxpayers buy the assets from these companies, then the banks have the required liquidity to perform their normal operations, without having to worry about the perfomance of the toxic assets.  Now they have a fixed interest rate to pay-back the Treasury, which is easier to manage around.

Bernake’s hope is that over-time, that the $700 billion dollars “worth” (I use that word in quotations since nobody knows the “worth” of the assets due to the absence of a market) will be a wise investment.  How?  Well, if the underlying mortgages start getting paid off (i.e. the housing market swings back upward)… that’s how.  The stronger our economy performs in terms of quality job and wealth creation, the greater the return on those assets.

Of course, there’s just as large of a risk that those assets severely underperform, and our economy goes into a recession, if not a depression.  And then as tax-payers, we’re out $700 billion.

Categories: graduate school
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Dropping Knowledge: Online Banking

June 26, 2008 · 1 Comment

Earlier this week Ben Bernake made it known that the Federal Reserve was severely worried about rising inflation rate of the US dollar.

Normally this rate is about 3.5% annually.  But because the Federal Reserve has increased the money supply to combat a recession, the expected inflation rate going forward is expected to be much higher.

In an environment of rising inflation, it is important that you not have your money “under a mattress,” as they say.  Every day your dollars are not earning a return, they are losing value, through inflation.  If you are not investing your money in anything, the real rate of return for “holding” dollars is equal to the rate of inflation.  That is to say, by standing still, you’re losing value over time.

Now, if you are paying money for a checking account, stop whatever it is you’re doing right now, and call to either a.) demand a fee-waiver or b.) cancel the account.  There is absolutely no reason to pay anyone to hold your money for you in today’s day and age.

Once you have a free checking account linked to paper checks (with no minimum balance required), find out how to access and manage this account online.  Any bank worth a damn will have this option, and you should be taking advantage of it.

NOW the gravy train…

Either through ING Direct or HSBC Direct, set up an online checking account (1.74% or 2.25% returns, respectively).  I personally use ING Direct for convenience; let me know if you’re interested and we’ll both get referral bonuses. Be sure to link your paper-check account to this one.  For a more in-depth comparison between the two, go here.

Additionally, sign up with a savings account with one of these sites (3% or 3.5% returns, respectively), and be sure to link your savings to both checking accounts.

The ONLY downside of online checking that I can see is that transfers usually require a short processing timeframe of 2-3 business days.  However, your checking account can include an overdraft amount of up to $500, so this isn’t a tremendous concern if you’re diligent.

Keep on track of all of your accounts in one place such as Mint.com, Microsoft Money, or Quicken.

SUMMARY

You may not think this is worth your time, but think of it this way.

Say  you tend to keep an average balance of $1500 in your checking account (enough to pay the rent and withdraw cash if you need it).

If you only open an online checking account, at a 1.74% return you will earn an additional $26 for the year.

If you open an online savings account and set up an automatic transfer schedule before your rent is due, you will earn an additional $45 for the year assuming a 3% return.

Considering these accounts take about 10 minutes to set-up, the Fed will probably soon raise interest rates (meaning higher returns), these accounts may very well be worth your time.

Categories: Neato
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Dropping Knowledge: The Economics and Ethics of Carbon Abatement

May 20, 2008 · Leave a Comment

This past semester I took an interesting (albeit frustrating) class on the “Risks of Globalization,” taught by an economist who was involved in the incipient development of the Kyoto protocol. 

Fundamentally, the risks of climate change are as follows:

1.      Overwhelming scientific evidence shows that the earth is becoming progressively warmer, and that this trend is accelerating.  People who still argue this fact are known in most circles as “dumb fucks.”

2.      Significant evidence suggests that this warming is anthropogenic, primarily due to Carbon emissions (CFC, CO2, and CH4).  People who argue this fact are known as Republicans.

3.      The atmosphere is treated as a global public good.  That means it is non-rival and non-exclusive (everyone enjoys it for free without diminishing anyone else’s right to enjoy it).  Also important to note is that gases disperse evenly throughout the atmosphere.  Hence the “global” part.

4.      Because the atmosphere is treated as free for everyone, it is subjected to what is known as “the tragedy of the commons.”  In economic terms, this means that because no single person (or nation) can reap the benefits of a clean atmosphere, no single entity will incur the costs to do so.  Another way to think of this is: a public toilet that everyone uses but nobody cleans up.    

5.      Generally, when dealing with the market of public good provision, we would say that the sum of everybody’s preference for clean air (instead of carbon-based energy consumption) should equal the rate at which we as a society choose that tradeoff.  That is another way of saying, if you want to reduce your individual carbon footprint, and I want to reduce my individual carbon footprint, and so on for every person in the world, the total amount we reduce carbon emissions will be equal to the global rate of change between a public good (clean air) and a private good (energy production).   

6.      The problem here is that there is significant reason to believe that we cannot afford to make that tradeoff at its current rate, because it results in insufficient abatement. 

This is where the majority of people who think about solutions to this problem begin to diverge significantly.  The consensus is that we either need some mechanism to increase the individual incentives to abate (i.e. a carbon market), or to decrease the benefits of polluting (i.e. a carbon tax).

In theory, a market (which allocates property rights or permits to emit, which are then priced and traded for competitively) provides certainty for the outcome of the tradeoff (since emissions are capped), without providing certainty for the costs.  A tax provides near certainty in costs (by internalizing the cost of the tax), without providing certainty for emissions (since there is no cap).

What makes these options trickier is the underlying game theory.  Since the policies are directly tied to energy consumption, which is directly tied to domestic output, self-imposed “carbon constraints” in a global economy put early adopters at a competitive disadvantage.  Carbon markets that aren’t global essentially introduce a “black” market in non-participating nations, who continue to treat the air as free.

Even if we can get beyond the competitive issue with present rivals, the issue becomes even more complex when we consider future generations.  As this article from Scientific America highlights, there is a fundamental ethical question surrounding inter-temporal dynamics:      

The costs of mitigating climate change are the sacrifices the present generation will have to make to reduce greenhouse gases.  The benefits are the better lives that future people will lead: they will not suffer so much from the spread of deserts, from the loss of their homes to the rising sea, or from floods, famines and the general impoverishment of nature.

I think that this way of framing the problem (sacrificing today for the benefit of tomorrow) complicates the issue unnecessarily. 

First of all, if we indeed create the incentives to reduce current consumption, we should compensate ourselves by treating this reduction as an immediate increase in investment.  As such, we (current generation) should be entitled to a return from future beneficiaries—through financing for alternative energy sources today.   

Future generations will expect a cleaner and energy independent future, and will pay for it by an increased debt burden.  This is a fair and just expectation, unlike the expectations to bear the costs of the reckless and unjust invasion of Iraq.

The problem after all isn’t energy consumption per se… it’s carbon emissions.  If we can invest in and/or subsidize immediate alternatives to coal/oil/natural gas, then we can consume all of the energy we want (hypothetically speaking).    

Second, I believe that the idea of sacrifice for future beneficiaries undervalues the costs we are currently facing from not only climate change, but fluctuating commodities.  As long as coal and oil are the most cost competitive sources for energy, we will use them, and build our infrastructure around them.  Clearly these are not viable long term investments, so the risks to the investments, and therefore the incentives to remain committed to those inputs of production, increase.

 

If you take oil off the table, there is no longer speculation on what the future holds or when it will get here.  It is not a matter of reducing current consumption.  It is a matter of leveraging the future.

Categories: Uncategorized
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Dropping Knowledge: On Guilty Liberals

December 9, 2007 · Leave a Comment

I found this gem while researching my paper on Globalization.  From “In Defense of Globalization,” by Jagdish Bhagwati:

I also think that an altogether new factor on the scene that
propels the young into anti-capitalist attitudes comes from a different,
technological source in a rather curious fashion. This is the dissonance
that now exists between empathy for others elsewhere for their misery
and the inadequate intellectual grasp of what can be done to ameliorate
that distress. The resulting tension spills over into unhappiness with the
capitalist system (in varying forms) within which they live and hence
anger at it for its apparent callousness.


Today, thanks to television, we have what I call the paradox of inversion
of the philosopher David Hume’s concentric circles of reducing
loyalty and empathy. Each of us feels diminishing empathy as we go from
our nuclear family to the extended family, to our local community, to
our state or county (say, Lancashire or Louisiana), to our nation, to our
geographical region (say, Europe or the Americas), and then to the world.
This idea of concentric circles of empathy can be traced back to the Stoics’
doctrine of oikeiosis—that human affection radiates outward from
oneself, diminishing as distance grows from oneself and increasing as
proximity increases to oneself. In the same vein, Hume famously argued
that “it is not contrary to reason to prefer the destruction of the whole
world to the scratching of my finger” and that “sympathy with persons
remote from us is much fainter than with persons near and contiguous.”

What the Internet and CNN have done is to take Hume’s outermost
circle and turn it into the innermost. No longer can we snore while the
other half of humanity suffers plague and pestilence and the continuing
misery of extreme poverty. Television has disturbed our sleep, perhaps
short of a fitful fever but certainly arousing our finest instincts.  Indeed,
this is what the Stoics, chiefly Hierocles, having observed the concentric
circles of vanishing empathy, had urged by way of morality: that “it is the
task of a well tempered man, in his proper treatment of each group, to
draw circles together somehow towards the centre, and to keep zealously
transferring those from the enclosing circles into the enclosed ones.”

At the same time, the technology of the Internet and CNN, as Robert
Putnam has told us, has accelerated our move to “bowling alone,”
gluing us to our TV sets and shifting us steadily out of civic participation,
so that the innermost circle has become the outermost one.
So the young see and are anguished by the poverty and the civil wars
and the famines in remote areas of the world but often have no intellectual
training to cope with their anguish and follow it through rationally
in terms of appropriate action.

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Dropping Knowledge: Stating the Obvious

November 26, 2007 · 1 Comment

oil map of world

One thing I’ve learned studying IR Theory is that most decisions at their core are based on the theory of structural realism. That is to say, at a minimum all states make decisions to ensure their survival, and that states with greater capacities will seek to increase their capabilities (also known as “power maximization”). Great powers constrain each others’ maximization pursuits, resulting in what is known as a “balance of power.”

In today’s world, the key to power is oil. This point tends to get vastly understated in the discussions we have about current affairs. For example:

1. When we talk about the rising cost of oil (which is now flirting with $100 per barrel), we tend to neglect two important facts: first, that the price elasticity of demand for oil is extremely inelastic. That is to say, it doesn’t matter how much oil prices drop or rise, the quantity demanded remains the same. As President Bush said in this years’ State of the Union Address: “Our nation has an oil addiction.” And it’s not just our country, although we’ve got it the worst. It’s a global addiction.

Second, addiction by its very definition implies lack of control. Which brings us back full circle to the original point: whomever controls oil, controls the world. From the perspective of industry, this is because the factors of production of almost every sector include components that are sensitive to oil prices. These price sensitivities can have a direct impact on cost, as in manufacturing, or an indirect impact (via transportation costs), as in technology. And every sector has varying degrees of energy costs. So the more sensitive an industry is to oil prices, the more power whomever controls the oil supply has over that industry.

From the perspective of the consumer, rising oil prices are also felt directly (at the pump and airport), and indirectly, by both a constrained budget set (more money spent on gas means less for movies, clothes, etc.) and by the increased prices for consumer goods (the costs of which are passed along by producers). You know what they call the combination of rising prices, low interests rates, and decreased purchasing power? Inflation.

2. If I lost you above, I shouldn’t have. Go back and read it again. I’m just stating the obvious here. The first point was meant to establish just how important of a position the global control of oil is to whomever can secure it. Take a look at the map above. You see how little oil Europe has? China? The US? India? The less oil a country has, the more it is willing to give up to get oil. The more globally integrated oil is within consumption and factors of production, the more dependent consumers and producers become on oil.

Now take a look at this map. Notice how many US military bases are in the Middle East? You think that’s a coincidence?

3. The logical “next steps” everyone seems to recognize, especially given the environmental considerations of oil, is the pursuit of “alternative” sources of energy. There is of course some game theory to this though. Even if there were a cost-effective substitute for oil (and there most certainly is not, at least yet), the transition costs of adopting that alternative source across sectors would be enormous. And the countries that undertook such an enterprise would be buried by the “cheaters” who continued to use oil (and at an even lesser price due to drop-out of demand). No, oil is a fixed commodity, and unless we find some form of global governance to ration it (highly unlikely), it seems the race is on to squeeze the orange and horde the juice before its all gone in the next 25 years or so.

In the meantime, there is evidence to believe that the financial markets are grossly distorting the price of oil by placing a premium on the political risks associated with its extraction. Based on global supply and demand, it is argued that the price should not be any higher than $60 per barrel. Speculative trading creates a self-fulfilling prophecy, where oil rises to $100 because traders spread unsubstantiated rumors that China and India are insatiable, or Nigeria/Venezuela/Iran are unstable. The consumer ultimately suffers here for the reasons mentioned previously, including inflationary risks, and even risks of recession.

All of this information is extremely relevant when we consider the following foreign policy “debates.”

1.)  Iran and Nuclear Energy– Notice how much oil Iran has?  Notice how much they consume?  It would be economically advantageous if they were to consume nuclear energy and maximize foreign oil sales.  When hawks argue about Iran “obtaining nuclear weapons,” they’re really pushing an agenda that says “Iran holds the potential to leverage and balance the oil oligarchy, and once they obtain nukes we can’t foment a regime change.”

2.)  “Democratizing the Middle East”– The so called “Bush Doctrine” is a fanciful liberal justification for a realist policy.  Oil rich countries really only have two options:  1) illiberal autocracies (Saudi Arabia) or 2.)  illiberal democracies (Venezuela).  The distribution of wealth obtained from a natural resource is complicated in state systems because the citizens of the state feel entitled to the financial windfalls in some form or another.  Elites must either find their power base internally (by implementing fiscally irresponsible, short-term, socialist programs) or externally (by charging rent to the United States in return for a strong military presence or other forms of foreign “aid”).

3.)  Iraq — With the above point in mind, the US objective has become to contain the sectarian violence within the confines of Baghdad.  Let politics play out on a political stage, but keep the pipelines flowing in the fringe regions.  A true power-sharing constitutional government isn’t possible as long as the US is present: because the emergent elites are reliant on the US for security provision, they will never have popular support, and vice versa.  Not to say the US prefers a disorganized central government, only that it benefits from one.  Our presence is justified for as long as there is insecurity.

So that was my Thanksgiving dinner conversation with my parents to justify my expensive Ivy education.  No solutions provided, only a survey analysis.  My stepmother thinks that Hillary will have solutions to these problems.  I introduced her to Mark Penn, the next Karl Rove.  She’s no longer so optimistic.

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More On: Oil Distortions

November 4, 2007 · Leave a Comment

For those interested in the idea behind rentier states , how difficult governance is in sole-resource economies, and the megalomaniacal appeal of Hugo Chavez, check out this article.  Not exactly well written, but certainly very interesting.  Thanks to Faraj for the heads up.

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Dropping Knowledge: Rentier States

October 15, 2007 · 2 Comments

“Dropping Knowledge”… where I laymenize an important aspect of social science.

A rentier state is a government that derives all or a significant portion of its national revenue from the rent of its indigenous resources to external clients.  It is a term most commonly applied to oil rich countries (such as Saudi Arabia), which grant access and management of its petroleum deposits to the United States (or the UK, Russia, etc.) in return for a “rent.”

Rentier states are inherently undemocratic.  You see, the geo-political distribution of natural resources makes certain areas extremely profitable, by random chance.  If the states themselves lack the privately developed technology and infrastructure to efficiently extract and distribute their resources, they must (or are otherwise coerced to) outsource such activities.

The thing is, democratic societies detest foreign management of domestic resources (see: Venezuela, Bolivia), and will take steps to “socialize” their industries, directly tax the exports instead of charging rent to foreign entities, and redistribute the wealth domestically, for a much bigger return.  But democratic management of a single resource economy naturally entails a heck of a lot of fighting over “who gets what, and why.”  And government industries are never as efficient as private industries in terms of production, so global trade organizations (OPEC) get antsy when a member state isn’t hitting its productive capacity.

The most efficient governmental arrangement for single-resource economies is therefore the rentier model… small, authoritarian leaderships (Saudi royal family) that placate domestic population by subsidizing EVERYTHING (except, generally, higher education, since educated elites tend to challenge authority).  The tax costs “flow” through the rent charged to Americans for pumping out oil and establishing military bases in the region for security purposes, and no taxes are levied domestically.  The royal family invests the majority of its staggering financial resources back into US securities, which solidifies the dollar and keeps oil demand and prices high.

This brings up a couple important issues:

1)  Some “experts” like to state that Islam is incompatible with democracy.  Bush is actually right when he says this is false (just look at Indonesia).  It’s actually more likely that democracy cannot exist without a diversified economy.  The less access there is to economic opportunity, the less people are involved in the management of the economy.

2)  Democracy is about sovereignty, about the population making decisions based on the Wilsonian principles of self-determination.  If you look at Iraq, you have two major obstacles:  the first is the introduction of a political power struggle between rival populations (Sunni and Shia).  Sunnis are keenly aware of their minority position in Iraq and refuse to participate in a political framework that is illegitimately stacked against their interests.   Shias are a minority within the greater Muslim world and subscribe to a cultural narrative based on resistance to oppression and illegitimate authority.  Even if Shia leadership wanted to achieve stability under the watchful eyes (and guns) of the US, they would continue to be undermined by Iran, which has no interest in seeing a successful secular Shia-dominated democracy as a neighbor, because that would intensify domestic pressures for reform.

The second obstacle to self-determination is that clearly, the preferred interest of Iraqis is American withdrawal, if not now (in the short-term), certainly in the medium- and long-terms.  Iraqis are well aware that the Persian Gulf war resulted in the construction of permanent bases in Saudi Arabia.  And Secretary of Defense Gates has stated publicly that the US “has historically had a strong presence in the region, and we will continue to have a strong presence in the region, and it’s important for our friends, and those who might consider themselves our adversaries, to recognize that.”

The US would prefer for the political outcomes of Iraqi democratic elections to be friendly governments that actively engage in rentier relationships to assuage the masses and ensure their positions of power.   But the Iraqi population will never recognize a pro-US business government as legitimate.  We live in an Age of Information where covert regime changes or puppet governments are really, really hard to achieve.  In the meantime, as instability and civil war rage on in Iraq, the US is quietly consolidating four major bases around the strategic oil regions in the country.

3)  That last point is the most telling.  For all of the gum flapping that goes on about “the principals of liberal democracy” and “freedom,” we tend to get distracted from the realist perspective — that control of Iraq means control over the second largest oil reserve in the world.  Always keep in mind that oil is a finite resource whose price rises with scarcity.  It’s one thing for Saudi Arabia to sell oil at (relatively) competitive prices now… it’s another thing entirely for the US to be rationing the last drops of oil in 20 years, at monopoly prices (don’t forget about Alaska!).  That means the potential for wealth and global power… power over everyone who is addicted to oil… is assured to whomever controls Iraq and the Persian Gulf.

I hate to be the bearer of bad news to some, but that means the business and military pressures are too great on the executive branch of the US government to expect a withdrawal anytime soon, unless Dennis Kucinich and Ron Paul magically win their primaries.  The US army/state department did not spend billions of dollars on bases and the world’s largest embassy to come home any time soon.

4)  With all of this in perspective, it’s important to recognize why Al Gore won the Nobel Peace Prize.  The real “Inconvenient Truth” isn’t necessarily that global warming is a real threat per se… I mean, that was already pretty obvious.  It’s that oil consumption is behind global warming, and that oil demand makes actions like the war in Iraq profitable.  By raising awareness about an ancillary (but still primary concern) of global climate change, Gore is indirectly calling for the necessity to research and develop alternative sources of sustainable energy that would compete with coal, oil and natural gas, making those resources’ price demands more flexible, and reducing the profit incentive of military control and domination of them.  Hence the “Peace” rationale in the Nobel Peace Prize.

The thing is, alternative energy sources are nowhere nearly as profitable as oil, even given the tremendous extraneous costs of financing strategic military bases around the world to protect the investments.  And the transition costs to adopting alternative energy sources would be tremendous in every sector, so oil companies can continue to pass the costs incurred from political instability and deeper, harder to get to reserves (i.e. the melting North Pole) onto the consumers.  I’ve read somewhere that the McKinsey Global Institute did an analysis of gasoline consumption in America, and found that demand wouldn’t significantly falter until the price went past $5.00 per gallon.  (I’m couldn’t find the exact report via a Google search, but hey, it’s midterms… give me a break).

The key of course is then electing leaders who are seriously committed to implementing policies of consumer regulation that prevent us from letting our aggregate demand get the better of us.  Individual conscience in the US is (generally) against empire, against war, against destruction of the environment, against global injustice.  But we speak with our wallets, we make demands through our purchases and consumption, and global suppliers react accordingly, even if the outcomes violate our individual consciences.

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Dropping Knowledge: Rashid Khalidi

October 14, 2007 · 2 Comments

Yes, I know I promised a hiatus.  But this will be short.

All of my Conceptual Foundations of International Politics lectures are being hosted on YouTube.  Please enjoy for free the education that costs me a fortune.

It’s no Charlie Rose, and it can get a bit bland.  But Khalidi is provocative.   And he spit hot fire at the neo-cons when everyone else was buying what they were selling in 2003.  The lecture is framed through “Alternative Views of American Primacy” and was accompanied by the reading of Khalidi’s book, “Resurrecting Empire,” which I highly recommend.

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