A few years ago there was a discussion on the site about an esteemed Dailyspecer's paper:
"Modeling the Active versus Passive Debate

That article generated a considerable amount of hate mail from investment "professionals" who felt the piece threatened their buy-and-hold livelihood. I consoled myself with some rather unkind thoughts.

Roger Arnold writes:

This reminds me of the discussion we had here 15 years or so ago when Triumph of the Optimists was published.

When I discussed the subject of the outsized returns of equities versus other asset classes with the principal author, Elroy Dimson, he said that in his opinion the 20th century returns were unique and not likely to be repeated over the next century. I won't go into his reasoning here as we discussed it then and I'm not sure if It's been discussed during my absence from the list.

The gist of the conversation though was that everything that provided the positive drift to publicly traded equities has been exhausted.

The positive drift is what made passive management a plausible money management scenario.



The recently-opened Marine Corps Museum is impressive, especially for leathernecks. It's just off route 95 outside of Marine Corps Base Quantico, about 25 miles outside DC. And there's an old-fashioned tavern brewpub right in the museum!

Tun Tavern: Also located on the Second Deck, Tun Tavern is a recreation of the 18th century public tavern in Philadelphia, PA in which, according to legend, the first Colonial Marines were recruited in 1775 by Captain Samuel Nicholas. Open 11:00 to 5:00 p.m., Tun Tavern seats up to 30 and offers a full lunch menu and alcoholic beverage service.

Scott Brooks adds:

Marine Corps History: On November 10, 1775, the Continental Congress passed a resolution stating that "two battalions of Marines be raised" for service as landing forces with the fleet. This established the Continental Marines and marked the birth of the United States Marine Corps.

It's the 232rd birthday of the USMC!

I am grateful to the Marines and all those who fought for the freedoms that I enjoy today. Thought I have never been in the military nor had to fight in a war (which I consider one of the greatest blessings of my life), I honor those that have. To my friends who served and fought, I say thank you!



KB/MSClearly, it's not just the Martha Stewart brand that's succeeding right now in residential real estate. Branding by way of coming up with unique and repeatable ways of adding quality to residences is super hot. The building boom of recent years produced stamped-out and almost universally identical homes — McMansions. I spent part of today with a marble and granite wholesaler and his business is going gangbusters as renovators and home-sellers are trying to put unique touches on their properties that buyers won't get either through a development builder or from the neighbor trying to sell. New paint, carpeting, and stainless steel and granite in the kitchen doesn't cut it any longer. That's all assumed by buyers. What buyers want now are the custom touches, limestone walls and ceiling in the bathrooms with heated floors, floor to ceiling marble on the fireplace wall, heated garages, etc. — which development builders can't do because their designs, supply contracts and assembly line procedures and business models are not equipped for it. So everyone in the renovation business is experimenting, trying to find what works. The discounts available for buying superior building materials in bulk is substantial. Buyers are also no longer impressed by off-the-shelf upgrades they can easily do themselves, steamshowers, LCD TVs, fancy appliances. Buyers are beginning to show a strong preference for workmanship. The skill most in demand, I find, is stone masons, mostly for building or rebuilding real fireplaces. All of the true stone masons I have been privileged to meet were Italian. It is a vocation that has been beaten down for the past several decades. I hope it has a resurgence.



Today I attended a talk by David Hightower. The title was "The Inflation Spiral, Part 2". He's bullish on many commodity markets. In the next 6-12 months, he expects gold to reach $820 per ounce and crude oil to exceed $90 per barrel. He was careful to hedge his forecast by saying he was short-term bearish on energy (because of the end of the hurricane season) and agricultural commodities (because of the harvest).

Other key points from his talk:

- The emergence of China and India creates an increasing demand for natural resources, which will continue to result in cost-push inflation

- The emergence of not only the Euro, but also many formerly neglected currencies such as the Brazilian real, has created many alternatives to the U.S. dollar, which will probably continue to slide

- The Fed crossed an important threshold in September when, for the first time in 30 years, it cut rates despite a clear inflationary threat

- Despite a "shockingly large" corn crop this year, there is no glut

- There will be a "battle for acres" in agricultural markets going into 2008 that will link these markets together and make prices likely to go up

- When sugar exceeded 18 cents per pound last year, the Brazilian government diverted sugar supplies away from energy production in order to ease food inflation

- Stocks are going up in anticipation of an October rate cut. If anything happens to make a rate cut less likely (e.g., a strong employment report), stocks will decline

- The Fed was forced by the subprime crisis into reluctantly cutting the funds rate and will raise the funds rate as soon as the subprime crisis is over.

Roger Arnold replies:

I'm all for forward thinking and looking for where new and divergent patterns and trends begin or become apparent. It's a necessary process to go through so that your brain doesn't atrophy.

But, the number of guys, usually commodities, calling for a dollar crisis, with all of the attendant reflections in foreign flows, commodities, etc. is kind of spooky.

They never seem to provide the caveat that their prognostications for a dollar crisis — not just and end of dollar hegemony but a reversal of that hegemony — are without historical precedent and should be considered very very carefully before placing that bet.

And outside of opaque discussions of the rise of the Euro, the real, and even expectations for the yuan, they never ever take the logical next step in their argument and conclude with what currency or basket of such will replace the dollar.



TowelsI just got back from my gym, in the Washington D.C. suburbs. It is premium priced to dissuade the riffraff from joining. And the concept worked for a long time. Families could go and not worry about their wives or daughters being propositioned. The facilities were clean and the members always considerate of each other.

Recently the owners signed a contract with the federal government. Now, we have federal government employees at the gym, with their membership dues being paid for by tax dollars.

They have a sense of entitlement and no recognition of the costs associated with running the facility. They take four or five towels when one or two will suffice. And they all do it.

The locker rooms are filthy now and the staff has given up on attempting to get these people to act responsibly.

Their hygiene habits are disgusting. There was a woman in the hotub a few days ago wearing her underwear and was indignant when told she had to leave because it was a code violation.

This evening I was in the dry sauna and looked over at a woman using some kind of puff-pad to exfoliate her entire body. When finished contaminating the area she just walked out.

None of them shower before entering the pool area even though there is a very large sign stating such is required that they can't miss. And the staff don't bother even trying to enforce it.

Needless to say, the paying members are all leaving for other exclusive facilities so they don't have to deal with the riffraff.



Barney FrankIt is looking politically probable that the new GSE loan limits will be increased substantially above expectations for 2008 along with other changes, although below what Barney Frank has been suggesting he would like.

Probable changes for most areas:

1) Fannie and Freddie loan limits to $500,000 from $417,000
2) FHA / VA loan limits to $500,000 from ~$370,000
3) FHA / VA will allow for refinance into them.  Previously disallowed.

Limits for California, Hawaii, Alaska and the Virgin Islands will be ~50% greater.



… according to a new book by Ian Ayres, an econometrician and law professor at Yale, this is a microcosm of a powerful trend that will shape the economy for years to come: the replacement of expertise and intuition by objective, data-based decision making, made possible by a virtually inexhaustible supply of inexpensive information. Those who control and manipulate this data will be the masters of the new economic universe. Ayres calls them "Super Crunchers," which is also the title of his book, the latest attempt to siphon off a bit of the buzz that surrounds the hugely successful Freakonomics.[Abstract from Newsweek]

Intuition replaced by statistics. Should one therefore learn to ignore one's intuition or at least ascribe less value to it? And what about quick heuristics, rules of thumb, 'blink'-like judgments… and millions of years of instinctual bias?

Roger Arnold asks:

Are there computer systems that are being designed to handle macro issues as well? I would think that would be highly complex and beyond the scope of computers today.

Nigel Davies replies:

MasadaI can answer that for you - they don't have a hope. And I can tell you exactly why:

Despite huge resources' having been pumped into "solving" a tiny, limited game called chess, computers are just rubbish at the kind of creative synthesis of ideas at which the human brain excels. And it shows. They are totally unable to balance factors such as doubled pawns against the initiative. They just don't "think" like that.

Sure, they've made "progress," they can now beat human chess players by employing huge processing power, crunching a zillion variations a second and never getting tired. The Romans had a much better win when they took Masada.

Vincent Andres remarks:

You don't have to commit suicide! Computers are our allies — we just have to use them. Of course we have to learn to speak to them.

"I hate computers: they always do what I tell them, never what I want!"

Nigel Davies explains:

Deep Blue vs Kasparov 1997 Game 6There have been attempts to run tournaments with the players having assistance from computers — they call it "Advanced Chess." But in activities which enhance our experience of life, computers have no part. It's kind of like having computerized yoga.

The suicide has been the chess world's insistence on pitting man versus machine, which brought the computer manufacturers their Phyrric victory and allowed claims that computers were now showing "intelligence." But to me this is like claiming a Porsche is an athlete if it can beat a human in a marathon. Computers are still just number crunchers as far as I'm concerned.

I like computers; they are nice obedient slaves. But the claims they are showing any kind of intelligence is just bunk. All that has happened is that they're crunching faster.

Does fast crunching lead to consciousness and the human ability to reason? I don't think so. Humans crunch very slowly but are nonetheless able to deal with problems in which crunching is less effective. One demonstration is the miserable failure of computers in Go, which is still a closed game but "bigger" than chess. As for non-closed systems they will, therefore, be utterly hopeless.

There is another issues arising from the way that many humans are now assuming that computers have intelligence and assuming that computerized models are going to work. This viewpoint is not only wrong, the reliance on computerized models can lead to people's suspending their own intelligence or subjugating it to the computer's ideas. This is one of the main problems when human Grandmasters try to look at a chess position with a computer running in the background — they end up letting the computer take the lead.

These are very complex issues which the world will be addressing over the coming decades. But there are great dangers here, and I believe this effect was behind both LTCM and the current banking crisis.

Vincent Andres responds:

Brute force algorithms are used in chess. But they are so many other ways! Computers are doing many other things in so many and so far different ways than brute force. Chess was a challenge for number-crunching, but please don't reduce computer science to that.

Do not confound newspapers and computer scientists. We knew for years what the end of the chess story had to be. Nobody is surprised, nobody is overproud. It was a tedious job — but it had to be done. 10^30 computations had to be done, 10^31 were achieved.

In the computer science community there were few remaining people interested by the human/machine chess battle. Even the finances for the projects were questioned. A complete battle of the past, as far back as 1995 for many of us.



Washington Suburbs Lure Federal Work to Top New York's Wealth

Forget those swanky Connecticut addresses, lakeside Chicago suburbs and Silicon Valley millionaire enclaves. Loudoun and the next two wealthiest U.S. counties lie just outside Washington — the traditional home of government workers — and have median household incomes rising to almost $100,000, the latest Census Bureau figures show.

I have stated on the radio for years that if the taxpayers had any idea how disconnected government pay had become from the private sector pay, they would burn down Washington. It is not uncommon for two government workers to marry, each with a bachelors degree, and each attain a $100,000+ salary inside of five years and live in a million dollar home in the DC burbs. I live here and can tell you it is truly surreal.

During the housing crunch of the 1930s, in many suburban and rural areas, where most of the banks failed, government employees moved in and bought up the land cheap from the taxpayers who had gone under. I kid you not.

I also advise reading Thomas Woods Jr.'s new book 33 Questions About American History You're Not Supposed To Ask, which is the follow-on to his previous book, The Politically Incorrect Guide to American History.

Mark Meredith remarks:

Wealthy DC suburbs are not the land of government workers, but of corporate lobbyists and consultants. Nearly every government worker I've known in DC made much more money when he left for the private sector.



 The pain in real estate land is increasing. Some of my developer cronies are hurting; taking 30 cents on the dollar loans against raw land they hold in reserve, with 90-day buy backs, to get cash to service ongoing projects because their credit lines are getting pulled. Brutal.

Many won't be able to meet the 90-day buy back unless, ironically, they come up with a development plan for that land that the hard money guys will fund. The scramble is on and the domino effect may begin soon as it did in the early 90s, the last time I saw this. Then I watched guys worth 100 million on their balance sheets go broke in 12 months.

Stefan Jovanovich adds:

The prices here in the Bay Area generally seem to have held up far better than they have in San Diego, Los Angeles and Orange County. What has slumped is the demand for home improvement services. The roofers, remodeling contractors, plumbers, and other local people in the building trades whom I know here in Contra Costa County have seen their backlogs disappear. They are still busy, but they no longer have pending projects beyond the job scheduled after the one they are currently working on.

Only a few months ago most they had half a year's work lined up; now they have three to four weeks’. It is now the best time since the early 90s to fix up a house in terms of cost, scheduling and improvement in building materials. Plywood has become expensive and crappy but resin board is now better and cheaper. HVAC equipment is vastly improved. Water heaters now have internal insulation and flameless ignition. Roofing underlayments have gone far beyond impregnated paper, and composite shingles now come in reflective "cool" shades that reduce heating loads by 30+%.

Tools have also improved. Nail guns, for example, are now much lighter yet actually stronger because of the use of composites. Building standards have also improved. Twenty years ago my friend George was considered "weird" because of his insistence on strapping tanks and adding plywood panels to house foundations for shear strength. Now earthquake reinforcement is taken for granted. What the people in the trades are wondering is whether people will take advantage of the opportunity. What the people in the trades themselves are doing is hiring each other to fix up their own primary and vacation homes. Whether that is a vote of confidence in the future or a sign that many intend to retire (most are in their late 40s or early 50s - which is "old" for the building trades) is the $64 question.

Dan Sturzenbecker writes:

I watched a recent episode of a popular reality TV show featuring investors who purchase fixer-uppers, make quick upgrades, and flip them back onto the market for purportedly large profits. A beach home was purchased in 2005 for $1.2 million. After $250,000 in repairs over a two week period, a "realtor" at the end of the show pronounced the home worth $2.4 million. The investors threw a party in the home and the episode faded to a close with much laughing and back-slapping in celebration of their investing genius. After a bit of research on the Internet, I discovered the home is still on the market with an asking price of $1.675 million.



 The Wimbledon Final between Federer and Nadal illustrates the importance of ever changing cycles in sport and the markets. Not only did each set alternate, but the break between the sets was key to a change of fortunes for the players. The first three games of the first set, which Federer won, were fatal for Nadal, as was his inferior stroke production, and how this tired him out in the end. I predict that Nadal will drop out of the top ten within the next two years as his athleticism regresses with old age.

The lessons from this match would all seem to have direct applicability to the markets:

Gravitation: If you looked through every world market as to its performance this year, you'd find the US below about 90% of them. This has been the case for the past three years, and could perhaps indicate that the hatred of the US that permeates the rest of the world carries over to investments, and leaves the US cheap relative to other countries. I hypothesize that there is a gravitational pull from all these other markets to the US.

Palindromic Lesson: People often ask me what I learned from the Palindrome during my 10 years of intimate association, aside from the value of using two cans of tennis balls in a match, being humble about your performance next year, and never admitting to a profit in the past. I would say that his idea that refuted hypotheses are the key to major market moves has much explanatory and predictive power. The most recent refuted hypothesis was that stocks couldn't go up when bonds are down. Last week bonds were down two points and stocks up 2%. Stocks are back to near their all time high, but are not there yet. I hypothesize that they need a refuted hypothesis to climb the last leg.

Death in the Woods: Much too little attention is paid to the death of companies and markets, as a prerequisite to renewed and bounteous growth in the future. A visit to Muir Woods, where fire and wind toppling a tree, leads to a profusion of new growth, from burls, roots, and stragglers, confirms the importance of this theory.

James Tar adds:

During yesterday's match coverage on NBC, there was a videotape comparison of the forehands of Borg and Federer. The strokes are frighteningly similar — the controlled loop backswing, the length and arc of the stroke, the extremely forward contact point, the angle of the racket at contact, and the follow-through just under the left shoulder. Their physiques, too, are almost identical. If you changed the hair and apparel of these players, you might have trouble identifying who was who. The real difference was the racket in each hand.

Borg's forehand was the most feared shot of its day, as is Federer's now. The point is that as technology changes, the foundations of competitive success remain constant. Nadal's strokes are completely different, even inferior. The power he generates is enhanced by the racket he uses. I recently tested the same racket. It does not favor smooth, traditional strokes. The balls flies — everywhere but into the court. Abbreviated, quick, jerky strokes, designed to create spin, must be used to harness the advanced technology in your hand. When the ability to make these incredibly timely movements diminish, so will the end result.

Barry Gitarts mentions:

One thing we can learn from Nadal is how far working harder then the next guy can take you.

Alfonso Sammassimo writes: 

Some points on the Wimbledon final:

1. Changing cycles. Just under thirty years ago one of the greatest ever baseliners won the title for the fifth consecutive occasion. Last Sunday one of the best ever all-court players in history did the same, playing predominantly baseline tennis. In between these two heroic feats, serve and volleyers have taken most of the spoils. Tennis, like markets, is a dynamic game where players discover new ways to counter present styles and tactics. It is a simple but perfect example of ever changing cycles. Greg Rusedski said it so well, "Tennis changes. If you look back in the past, they say it's too slow, then you have eras they say it's too quick. It always balances out."

2. Equipment best benefits those who best use it. While baseliners have benefited greatly from the power that comes with new racquets and strings, so too have the big servers. Nadal does indeed use a racquet that is very hard to control - the fact that he does so well is a testament to his talent, not the racquet. Roger Federer has his racquet strung at 50 pounds which is also extremely difficult to control and provides much power. They both have strings which can help generate a lot of spin. These are two superbly talented tennis players who maximize the benefits of available equipment. 'R' or a Bloomberg terminal doesn't help me trade any better unless I have the ability to utilize them expertly.

3. Speed and agility are often overlooked and under trained. From the first point the most obvious difference between this match and the lead up matches of the tournament was the speed of both players. They are in the right spot at the right time more than the other players. Not only better foot speed, but also better anticipation. Market analogy…

4. Never give up. Federer looked on the back foot for much of the match. Only one break point opportunity during the middle three sets, and down break points in two service games in the fifth. He hung in, and the opportunity came as nerves and possibly fatigue got to his opponent. He took it swiftly as a champion does.

5. Efficiency nurtures longevity. A style of compact strokes and taking the ball on the rise requires less physical effort, expends less energy, is less likely to lead to injury, and most of all can be continued for longer in a career. Agassi and Connors are examples. Fewer trades and less commission, and coming straight in after a decline might prolong my trading account. I would agree that Nadal will suffer as his athleticism regresses with age.

6. Have outs. Much advantage having an all-court game to fall back on, having something else available when you're in trouble. When he was down break points in the fifth Federer cranked out three aces in a row, so discouraging to an opponent who has to earn nearly all his points with longer rallies. It’s good to have mouse holes when in the market.

7. You have to work harder than anyone. Nadal's was an incredible effort, coming so close to winning the running double which has eluded previous champions who aspired for the Grand Slam. He is possibly the hardest worker on the tour and his obsessive and methodical approach to everything from training and practice to the placement of his water bottles might just help him maintain his place in the food chain for longer than might be expected. 



 What's more surprising, that the US deficit/GDP ratio is the best of this lot, or that Italy looks good next to Japan?

Roger Arnold adds:

If I recall properly, Japans sovereign debt to GDP is larger than any country has ever been able sustain without a collapse of their currency. The highest debt to GDP that a country has been able to work out of was the US post WW2 at about 140%.

It's interesting that every year or so, as we discuss here, the yen repatriation and associated carry trade unwinding is supposed to kill the dollar.

Buffet / Rogers et al jump on board and the media frenzy lasts about a week or so. None of them ever mention the dire situation Japan is in, which is compounded by their aging demographic and lack of an appropriate immigration policy to change it. And I think their personal savings rate has fallen to 8%, the lowest in Asia. Western Europe is in a similar-situation although their savings rates are still roughly-14%.

How does the dollar collapse in that environment? Where would the capital go? Why would the capital go? What benefit may be achieved by either area taking their savings home from the US?

Rhetorical questions. 

Stefan Jovanovich writes:

The War of the Spanish Succession - the first European World War - left Britain, France, Austria, Spain, Netherlands, Sweden, and Russia with debts that, compared to their governments' actual cash incomes, were far greater than those owed by Japan, the United States or any of the countries of Europe. At the height of the crisis, in 1719, the costs of debt service alone for the British crown were 60% of the government's income. Yet, somehow, the Brits, alone among all the other European nations, successfully refinanced their debt and began their journey towards Empire.

You can read an introduction to the story of their financial triumph, which paid for Marlborough, Nelson, and Wellington's victories. 

From Alex  Forshaw:

Inflation was very high after WW2 ended, correct? So the real value of America's debt would have been significantly reduced. Considering that inflation was a widespread phenomenon among recovering economies, America's currency did not suffer a relative collapse, but Americans holding government debt were screwed.

In this case, Japan's currency seems destined for a relative collapse. I believe that debt service costs the Japanese government about one-third of its income.

In the British instance, didn't a group of private bankers step forward and essentially assume lots of the crown's obligations, because it faced bankruptcy after the Glorious Revolution? (As I understand it, that was when the Bank of England was founded.)

Charles Sorkin writes: 

US Inflation fell precipitously immediately after the war. There was another spike in the late 50s, but there were also two periods of deflation in the immediate decade (or so) into the post-war period. For the most part, inflation was rather benign, by today's standards, until the late 1960s. 

Alex Forshaw writes: 

Hmm, I simply can't reconcile US debt/GDP falling from about 135% at the end of WWII to, what, 20% by 1960? How could economic growth have been that high? Yeah, taxes were high (top marginal rate was about 91% and top effective rate approx. 57%) and Eisenhower was extremely frugal, but Korea would have ratcheted up the national debt again. So I have a hard time getting those figures to add up without brief but intense bursts of inflation at some point in the 1945-60 time frame. 

Charles Sorkin writes:

US Inflation fell precipitously immediately after the war. There was another spike in the late 50s, but there were also two periods of deflation in the immediate decade (or so) into the post-war period. For the most part, inflation was rather benign, by today's standards, until the late 1960s.

Stefan Jovanovich comments:

I think Charles takes the point. There was also a brief spurt of energy price inflation with the start of the Korean War, but that was entirely the product of the Truman Administration's imposition of Jimmy Carter controls. When those were repealed (with the Republican's taking control of Congress), the gas lines disappeared and Exxon was offering to put a tiger in your tank and give you free dishware with every fill-up. The consensus forecast of most expert opinion in 1945 was that the country would experience a deflationary collapse. Sewell Avery, the Chairman of Montgomery Ward, decided to hold cash. The radicals at Sears (!) chose to expand. If Mr. Avery and others holding bonds were "screwed", as Alex puts it, it was not by any precipitous decline in the value of the dollar but by having failed to participate in what John Brooks described as Seven Fat Years.

As for the bankruptcy of the Glorious Revolution, that was entirely a function of the unwillingness of Parliament to pay the King's bills, not any crushing burden of debt. The Duke of Marlborough (hero of the War of Spanish Succession) started his career as a young go-fer to the Stuart crown; he - and most of the other smart money - changed sides when the Dutch indicated a willingness to make a white knight takeover bid.

"Bankruptcy" was the cover story; the real issue was the unwillingness of the city merchants to accept even a hint of the restoration of full civil rights to the Catholics. And so, for another hundred plus years, no one who wanted to hear the mass in Latin could attend Oxford or Cambridge. That did not, of course, prevent Marlborough's forces from being the allies of the Austrians (still among Europe's most fervent Catholics) against the comparatively agnostic French.

Alex Forshaw writes:

Hmm, I simply can't reconcile US debt/GDP falling from about 135% at the end of WWII to, what, 20% by 1960? How could economic growth have been that high? Yeah, taxes were high (top marginal rate was about 91% and top effective rate approx. 57%) and Eisenhower was extremely frugal, but Korea would have ratcheted up the national debt again. So I have a hard time getting those figures to add up without brief but intense bursts of inflation at some point in the 1945-60 time frame. 



A newly-opened Italian restaurant in my town has their staff park in the best parking spaces out front and then hires people to walk in and out of the restaurant. It's hilarious once you are there and you figure out what's happening.

Last time I was there, we commented that it must really be catching on because the place looked busy from the outside. When we got inside, there was not one person eating in the restaurant's main dining area. The whopping ten or so people were all outside on the patio. I have no idea how many of them were hired hands, but I wouldn't be surprised if we were the only paying customers.

We are treated very well and the food is excellent. Watching the marketing performance is a fun freebie!



 A Look At U.S. Home Price Performance in 20 Markets charts the historical year-over-year monthly percent change in the actual home-price figures for the 20 cities that S&P/Case Shiller tracks.

Sam Humbert writes: 

The key phrase is "severity of the declines in home price appreciation" — not "declines in home prices." By that logic, if home prices are unchanged year-to-year, it's a "severe decline."

Reminds me of Washington budgeting — all discussions of "cutting" the federal budget revolve around declining second, third, and fourth derivatives of dollars/time, not reducing the actual dollars.

George Zachar replies:

Yes, in fact, there's a tutorial being conducted by the press on how to selectively report and present data to drive down economic confidence. So far polling data indicate it's working.

Roger Arnold counters: 

A rose by any other name…

Most markets are now showing negative price appreciation. No matter how you count it that is a price reduction even before adjusting for inflation. Bottom line is that in both nominal and real terms home prices are falling, late pays/defaults/foreclosures are rising, underwriting guidelines are tightening, and availability of credit as a result is decreasing.

All indicators are that pro-cyclical real estate and credit contraction is accelerating. The question is whether or not it has reached a stage of self-reinforcing, i.e., tipped over the fulcrum.

To date the trend has been slow, steady, and transparent, much more so than I was counting on at this point. However, the events unfolding in the subprime space today may very well be the precursors to and immediate catalyst for MBS ratings downgrades to sub investment grade.

There has been enormous pressure placed on the ratings agencies to act more concurrent with market conditions. It is debatable as to whether or not that is their function but Allied Capital, a large buyer of the lowest grade subprime tranches, liquidated their portfolio in such months before that market began its sudden consolidation earlier this year.

A good argument has been made that the rating agencies should have seen what was coming regardless of what the capital markets were doing. With the movements today, those rating agencies now have their own potential legal liability issues to contend with should they not act soon.



 Necessity is the mother of invention. The S&L debacle gave rise to commercial conduit financing for real estate, which in turn was the catalyst for the virtuous cycle of real estate value increases concurrent with new financing options and increased home ownership globally.

The real estate business is now going through a transition phase again, like a snake shedding the skin it has outgrown. The new systems being created are far more robust and inclusive of market segments that were not afforded the opportunity to participate in the most recent virtuous cycle.

The bottom line is that although there are very real concerns about localized markets around the world, the rapidly evolving systems being developed are taking this into account preemptively. The coming changes are not small; they are gargantuan. Stay tuned.



 A striking feature of recent stock market moves is the weakness of the housing sector. For example, the S&P 400 Homebuilding Index, which is a cap-weighted index with six members (NVR, Toll Brothers, Ryland, MDC, Beazer and Hovnanian), with a base of 100 as of year end 1990, hit a high of 725 in July 2005, and now stands at 373, down from 450 as of three months ago.

Needless to say, this decline has been heralded as indicative of coming woes in the overall stock market. But as with most things widely disseminated by the media, shouted from their posts in Trinity Church by chronic bears (where they wait to hook a lunch from a member who's not broke from listening to them), such views are false and lead to the public's losing much more money then they have to.

Practical Speculation has a chapter on the relation between real estate prices and stock prices, following in the footsteps of Henry George. Studies show that boom/bust cycles in the economy and stocks are started when real estate prices get out of line with underlying economic activity. When real estate is too high, retailers can't make a profit and they downsize. When real estate falls, retailers and others who use property make more profit because their costs of real estate is lower. Henry George and others, such as Homer Hoyt, documented this phenomenon for many economic cycles up to the 1930s. David Ricardo first elucidated the theory.

Laurel and I documented that the cycles had continued vis a vis REIT prices, with declines in quarterly REIT prices forecasting gains in the overall market in the next quarter of about twice the normal rate, 7% versus the normal 3%. We recently updated the study to look at what happens to the overall market after changes in the S&P 400 Homebuilding index and found a highly negative predictive correlation of -20%. After quarterly declines in the Homebuilding index, such as we've just witnessed, the average gain in stock prices in the next quarter is 5%, with about a 75% chance of a rise. Once again, a commonly held fallacy leading the pubic to sell when they should buy bites the dust.

Kim Zussman writes: 

Here is a quick check of HMI this month change vs next month change in SP500 index (12/85-3/07):

Pearson correlation of HMI chg and nxt mo rt = -0.085
P-Value = 0.167

Regression Analysis: nxt mo rt versus HMI chg

The regression equation is nxt mo rt = 0.00889 - 0.0535 HMI chg

Predictor      Coef       SE Coef        T        P
Constant    0.00889    0.00260     3.42   0.001
HMI chg    -0.05353    0.03859   -1.39   0.167

S = 0.0424313   R-Sq = 0.7%   R-Sq(adj) = 0.3%

Negatively correlated, but not quite significant, on monthly frequency.

James Tar remarks:

Shorting real estate and housing is difficult. You can't go out in the housing market and get a borrow on a few million homes that you can then go out and short. So everyone in the market who wants to be short housing/real estate is crowded into the homebuilders and select REIT issues. REITs have high dividends, so you can imagine how expensive it to carry your bearish disposition. A few buddies of mine running fairly large funds are feeling the pinch.

A good way to make sense of it all is to step back and take a look at what is really going on. I believe inflation, just like alpha in the stock market, is a finite quantity. There is only so much inflation that can go around. My studies indicate that the deflation we are seeing in housing/select REITs/mortgage banks is just about the same amount in dollar terms as the inflation we are seeing in energy, precious metals and agriculturals. So there is an inflation/deflation cycle constantly at work in the marketplace. As some assets inflate, others deflate.

To make sense of a confusing cycle, look for smaller, more easily identifiable components within this difficult game. I am looking at firms such as Georgia Gulf Corporation. Till the middle of last week the market believed it was headed for Chapter 11. But now this key supplier to the housing market has a much different story unfolding, perhaps indicating the imbalances in the housing market are declining.

From Alan Millhone:

On a very local note, I was talking to a neighbor the other night who was chatting with a man we both know who wants to build a new home. My neighbor said the fellow had scheduled several appointments to meet several builders and none of them ever showed. He asked me if I wanted to meet with this person and I told him no.

Houses are hard to figure due to rising material costs and the volatile changes in prices, sometimes on a daily basis. Also, I am now figuring mileage for my employees into my jobs X-number of days I project we will be on a particular job. I am confident giant home builders are having a tough time getting a firm handle on material prices to 'lock in' their hard costs of building homes in vast subdivisions. At present I would want little to do with building stocks of any type. 

Roger Arnold writes:

The real estate pros who stepped out in 2005 are prepping to get back in and with big ideas about restructuring the entire industry. Gargantuan funds are prepping to get into the real estate game.



I went to buy pool supplies today and found that the chlorine/shock I usually use has gone up in price by almost 100% since last year. So I logged on to Leslie's Pool Supplies and bought from them but they said their prices were up by about 50%, too. Of course the clerk had no idea why. Has anybody else run into this or know why this is happening? Twenty-five pounds of chlorine/shock for $94.99. I kid you not!

Gordon Haave replies:

The pool at my new house is a salt pool. You put in salt, and a little box zaps it and turns it into chlorine. The end result is a clear pool that is very slightly chlorinated and very slightly salty. Very refreshing.

Joyce Shulman adds:

I don't know if it is cost-effective for large pools, but we have a spa in our backyard and purify it with an ozone generator. The water is sparkling clean and clear and has never had a drop of chlorine or bromine in it. We heard that ozone generators were used in the pool in the Atlanta Olympics at the insistence of the Europeans, then returned to chlorine later. I wonder why? Ozone is wonderful. 



There is still an enormous number of subprime and stated income loan programs available for people with low credit scores and few assets. Only the programs for the most marginal borrowers have been taken from the market. And new creative programs have been introduced to fill the temporary void at startling speed. It has truly been a marvel to behold.

Far from being the contagion I was expecting, the mortgage markets and residential real estate markets have not only absorbed this shock but are exhibiting signs of even greater confidence and liquidity now that the underlying concerns about fraud and irrational underwriting in the mortgage markets and loose appraisals of collateral have been acknowledged.

There will still be more headlines but those unscrupulous players not already knocked out are quickly being isolated from participating by the mbs markets. Underwriting to exact specifications for each loan program has returned following the sloppy underwriting that was at the heart of the real problem in the mbs market.

This tension release and resulting rapid tightening up of the industry appears to have worked amazingly well and amazingly quickly.

Charles Sorkin writes: 

Just throwing this notion out there, but is it accurate to say that "home-ownership for all Americans" is a stable economic regime? For instance, jobs for all Americans (i.e. 0% unemployment) is widely considered unstable, and would lead to sporadic regional labor shortages and is associated with inflation pressure.

Is there a NAIRH (non accelerating instability rate of homeownership) associated with the American economy, much like the much-debated NAIRU concept?

An insightful reference to housing stock, homeownership, and the means of financing it, are referenced in Paul McCulley's monthly commentary on the Pimco website.

Ken Smith writes: 

The next step in America will be to follow Britian which in the period 1979 through 1997 converted municipal housing to ownership housing. Well over a million former tenants became homeowners.

This was the era of privatization. In 1979 British government institutions owned much or all of coal, steel, gas, electricity, water, railways, airlines, telecommunications, nuclear power and shipbuilding, and had a significant stake in oil, banking, shipping and road haulage.

The agencies responsible for these changes were called Next Step Agencies. So the next step in America is conversion of municipal housing to private ownership by individuals or corporations.

The Bush Administration has voiced, many times, the goal of home ownership for all Americans. It appears the goal is to implement this program without regard to ability to pay. I can see a way to profit from this. Get the loan without ability to pay, peddle the property for an appreciated value, pay off the loan and keep the difference. Do another flip, and another.

So what happens when everything falls apart? When jobs are lost, as in Illinois, Ohio, and other hard hit states? Nothing bad happens. Since anyone can get a property without income then anyone can pay up for the property being flipped. So another person steps in, without income, to purchase property that has been appreciated by an appraiser willing to be part of the game, for compensation, of course.

Is this magical thinking? Is this reason? Is this logic? Is this traditional? Is this paradise? Is this the new economy? Is this a bubble?



I recently opened a business line of credit with Advanta and thought I would share with the members here that my experience with them has been far and away superior to any other business lending institution I have ever worked with.

If you are a business owner I highly recommend them. Their people are classy as are their written communications. Moreover, their website for managing the account is superb.



 I haven't shaved for weeks. The result is my manly Viking beard. You see, most men have difficulty growing nice beards — they are spotty on the chin. Not mine. Mine is a mixture of red, blond, and light brown. And it was even better back in 1997-2000, when my beard was soaked with sun, salt from the wind, seawater, and rum.

Most people don't like beards in the business world, maybe because most people can't grow good ones, and their inferiority complex leads them to marginalize beard growers.

Roger Arnold advises:

W-2? A shave is due.
1099? You look just fine.



 My partner and I recently listed the names of every entrepreneur we had worked with in three decades of doing business in California and then tried to decide whether or not any had provided income documentation for a business, auto, or home loan with "stated income" that varied significantly from what we knew their actual income was. The answer was that less than a quarter of our law clients and business associates had been "completely honest" when it came to filling out lenders' paperwork. That may be a damning commentary on our choice of associates, but there is an alternate explanation.

Credit scoring and credit documentation, at least as we have directly experienced it here in California, is based on the assumption that people work for government, the educational-industrial complex (by far the State's largest employer group), or a large corporation. Failures such as losing a job, having a business go under, or surrendering assets in a divorce can be excused, but only if one has reformed, i.e., worked for at least five years as a W-2 employee for a bureaucracy or company that cannot possibly go out of business. Having substantial assets but no current income, the common fate of entrepreneurs, is not seen not as the natural result of making one's living from deals. On the contrary, it is taken as a clear sign of having a questionable character.

People who work for themselves repeatedly go through these inquisitions. Being nothing if not resourceful, they soon learn how to "pass" as upstanding citizens. They form corporations that can "verify" their own personal incomes as employees. They learn how to provide copies of tax returns that "restated" their income appropriately. We do not know but strongly suspect that the decision of the Sandlers and CFC and WM (each of which we bought last week) to offer "no income verification" loans in California was a sensible response to the fact that income verification had become a bigger genre of show business than either CSI spinoffs or reality shows.

It has been a number of years since we have been involved with a start-up, and the entrepreneurs on our list and we are now all respectably successful. A few people we know have done time - one for drug dealing, another for securities fraud, but none has defaulted on their mortgages. We know nothing about the credit market other than the little we have gleaned from George Zachar's considerable wisdom. But the recent "discovery" of dishonesty on the part of sub-prime borrowers and their mortgage brokers seems to have at least some echoes of Claude Raines' expression of "shock" at discovering that there was gambling going on at Rick's.

Roger Arnold adds:

I concur with the assessment concerning the sensible response to an irrational marketplace by World, WAMU, and the other original members of the 11th district of federal home loan bank system (before most of them were bought by WAMU) to offer no income verification loans to self employed borrowers in California and then spreading that same offer throughout the US. They exploited a massive irrationality in the system.

Previously, it was incredibly difficult for these people to get loans. For some bizarre reason the banking system always looked at them with suspicion and underwrote their loans to much more strenuous standards than wage earners with far less assets. So, underwriting to two of the three c's of credit, character, and collateral, and negating the necessity to prove the 3rd c, capacity, with tax returns, and financial statements, was brilliant. But, then to extend that offer to wage earners in an attempt to maintain their own growth rates was imprudent, especially for World and the Sandlers.

If it had stayed that way it probably would have been OK too; but it didn't. The Sandlers and WAMU began to cannibalize their own track records. They began to monetize their good will and trade on their historical track record of prudence in underwriting by gaming the system they created. As they increasingly went out on the risk curve by offering no income verification loans to increasingly dubious borrowers they simply increased the margins on their loans to make up for it.

And then countrywide, in conjunction with the MBS, packagers created similar loan products and sold the idea and the bonds to investors using the historical track record of performance established by World and WAMU. The problem is that that track record was based on borrowers that are no longer reflective of the profiles of the borrowers that the track record was based on.

From 1990 to 2000 or so, World was ranked by Fortune and Forbes magazines as the best financial firm in the US. In the last five years or so, they gamed that reputation and WAMU and Countrywide did too by extension. Their balance sheets ballooned along with their earnings and last year the Sandlers cashed out at the top by selling World to Wachovia for 25 billion dollars.

But now, the traditional clientele World had, the high-end self-employed borrower, has left them because World abandoned them by raising rates to what are today close to subprime. Today, world savings is where borrowers needing no income verification loans go to get loans they can't get from WAMU or Countrywide. And if they fail to get a loan at World the next step is subprime.

That's a long way down from the prudent underwriting that the Sandlers grew World with. Just as GM had to put one billion into rescap don't be surprised if before too long Wachovia is asking the Sandlers for some money back, too.

George Zachar writes:

Everything I know about "liar loans" and the real-life history of no docs I learned on this list from Roger Arnold.

There's a huge discontinuity in knowledge between the ground troops originating loans, and the Air Force strategic forces playing with highly abstract tranched securities. At the latter level, it's all (pseudo?) quantified risk profiles and lots of comparative history on the trajectories of various securities under "Monte Carlo-ed" simulations.

The securities geeks don't believe they need to know, let alone care, about such origination details as W2s, FICO scores, etc. Once the tranches emerge from the sausage machine, it's just a matter of getting the AAA pieces to favored accounts, seducing options kids to assume convexity, and finding the dummies to take the dreck. The marketing material will map out how (supposedly) each slice "should" behave along various rate and default paths. Then it's old fashioned caveat emptor.

As I understand it the fatalities thus far have been among folks holding the hot potato raw products before they could pass through the Street's cuisinart.

Yes, the down-credit tranches and related derivatives have widened out, but nothing like parallel historic events. And the rest of the capital structure has hung in so well that even the cynical pros are scratching their heads.

There's an interesting pattern to how sophisticated folks are reading all this. Those close to the ground, watching the paperwork and hearing the horror stories, understandably fret about an economic disaster. Folks who pass their days in front of screens watching the relationships between securities, see a speed bump. Politicians and lawyers see the next three years of legislation and litigation.

A Rashomon economy.



 Brothel Discounts 'Matinee s-x' for Pensioners

Mar 14, 2007 11:57 AM Reuters News Agency

BERLIN — A brothel in Germany hopes to capitalise on the growing number of pensioners interested in "matinee" s-x by offering them a 50 percent discount during the afternoon hours.

The "Pascha" in the western city of Cologne has introduced reduced rates for s-x sessions for clients aged 66 and above — provided they can prove they are old enough.

"All clients need to do is show us some proof of age," said a spokesman for the brothel's managing director Armin Lobscheid. "A 'normal session' costs 50 euros with us — and we're now paying 50 percent of that for these older guests."

"Life begins at 66!" it says in an advert for its "senior citizens afternoon" next to a picture of a motorcycle rider.

Brothels have Managing Directors? Wow, I bet those MDs at Morgan Stanley feel super-special now.

Gordon Haave replies:

And I'd bet the "talent" are all vice-presidents.

Roger Arnold queries:

How does this get accounted for in GDP? Is it a deflationary indicator or indicative of an increase in productivity? Are there any hedonic adjusters that need to be accounted for? Looks like free market animal spirits are beginning to reawaken in Europe!

George Zachar responds:

Simplistically, I'd say it would show up as a decline in productivity, as seniors will simply shift their s-x purchases to the earlier time slot, with the establishments earning only half their prior revenue per session. GDP would similarly take a hit, and assuming quality remains constant, this would show up as a price decline.

So look for Trichet, at his next press conference, to be asked about stag-de-flation.

Marion Dreyfus explains:

George's explanation is a wrong take entirely. The early bird special is income that would be extra, since these are men who would not be coming in at all, short of lowered price per assignation. These are men who are thus providing income in the slow early afternoon hours when nothing much else is happening. Since the wear and tear on the females is supposedly less (I don't know from experience what the difference is in men from 20s, 30s, to 70s, etc.) than from the younger males that give them a harsher workout, maybe the lower price is fair, since they are not working as hard for the money.

Thus it seems like a win-win, actually. Management is selling product in normally slow hours, and the clientele will be doubly pleased at low-priced but professional action and can get a workout without having to be especially nice to their wives. Or if single, they can feel manly again, despite not being able to date perhaps, at their age or with a paucity of date-objects around. And likely as not, some of the men will use the opportunity to simply talk, as a surrogate for therapy, and bloviate on topics they can't share comfortably with their wives or friends without censorious responses.

I think the whole thing a fit subject for a PhD, actually, when one considers all the ramifications.

Adi Schnytzer adds:

I agree entirely. This is very definitely a topic for a PhD in sexual economics, a field I will be delighted to pioneer if anyone wants me as a supervisor and who isn't scared of fieldwork. Marion's gritty microanalysis makes a lot of sense and an econometric analysis of the wear and tear caused by different age males on working females is long overdue. 



 Sarkozy appears on track to win the French elections in April. This is something I have been tracking for the past three years, since Sarkozy distanced himself from Chirac and started vocally turning away from the traditional European socialist model of political economy and towards free markets etc.

Could the French electorate finally be willing to push back against socialism? Will they finally begin to sell off state-controlled companies? Is there concern for Airbus's continued state support in Europe? Is this an indicator of a broader trend in Europe?

The questions and potential ramifications of a Sarkozy win in France are staggering and endless.

George Zachar responds:

Sarkozy has made lots of recent statements that leave him firmly in the "democratic socialist" part of the political spectrum. He's not overtly hard-left like Royal, but his election would hardly be a mandate for what Americans would term free markets.

Roger Arnold replies:

Relative to US standards you're right. But he's also running for office and needs consensus. The fact that he is even in the running, let alone in the lead, is an indication of a change in sentiment in France by the electorate with respect to the trajectory their current policies have them on.

The fact that his lead is increasing is an indication of his migration to the middle as the election approaches.

Bruno Ombreux writes:

I am watching this by necessity since I am in France. Sarkozy has not won yet. I think it will be a very close call.

The guy has courage. He is running his campaign on the theme the "party is over, time to get back to work." Problem is that the French people have had their minds washed by the leftist media and school system since 1968. So a big part of the electorate might not be prepared to give up socialism.

And Sarkozy, like all French politicians, remains a statist. I support him, however, because he is the less worse choice. And if he is elected and can get the country back to work, even a bit, that would be great.

The biggest change could be seen abroad, not domestically — in foreign policy, since Sarkozy is pro-USA and pro-Israel.



 I have no response that could place this within any kind of rational frame of reference.

Very little of what is occurring in the capital markets today makes sense to me and I understand it less every day. Twenty percent on the SPX in the last seven months…VIX and spreads are at all-time lows…talk of a permanently flat yield curve…infinite capital?

Maybe it really is different this time, no more recessions, no more business cycle, and we all live happily ever after. Except me - I am still here with my tinfoil dunce cap on, waiting for the sky to fall.

Bud Conrad writes:

This is one of the best summaries of the changes in the new Financial Engineered Credit markets I have ever seen laid out. Thanks very much. If you have some sources on the bigger credit picture, such as where are the numbers on percentage of loans from outside the banking system, that would be of great interest. 



I was fortunate enough last night to see Eastwood's two films on the Battle of Iwo Jima back to back at the Jacob Burns Film Center in Pleasantville, NY. As an aside to anyone in that area, the Film Center is a fantastic resource for independent, art house, foreign, and classic movies.

It was a very interesting experience watching the two movies back to back. It was great being able to compare the second with the first so fresh in my mind. I enjoyed both movies greatly, and found them both incredibly moving. I found Letters from Iwo Jima, which tells the story of the battle from the Japanese perspective (and is entirely in the Japanese language) to be one of the most powerful anti-war pictures (in my opinion) that I've ever seen. It was also the better movie of the two in my opinion, although the emotional impact of Flags ran much deeper for me.

I suspect that was due to two reasons. The obvious first one is that I'm an American, and we tend to sympathize with our own countrymen. The second is that my deceased grandfather who I was very close to, was a fighter pilot in the European theater of WW II, and the movie brought back memories of him, and imaginings of the incredible sacrifices that must have been required of all during that time.

Anyways back to the movies … I found them to be two very different films for the most part. One thing they do have in common is an examination of the theme that war literally is hell, and that actions on the battlefield are often brutal, and amoral no matter which side claims the moral imperative.

'Flags' which purports to tell the story behind the famous picture of the flag raising over Iwo Jima will inevitably be compared to 'Saving Private Ryan' for its battle sequences. Eastwood manages to capture the randomness and chaos of war vividly in the battle scenes. In particular, the opening assault on the beach near Mount Suribachi (where the flag would eventually be planted) is very impressive.

'Flags' is shot as a series of flashbacks between the battle itself, the present day, and the war bond drive immediately after the battle where the three survivors of the flag raising captured in the photograph are trotted out by the US government to raise money for a near bankrupt US. The movie raises a lot of questions over what it means to be a hero, the reasons behind actions on the battlefield, and their often unthinkable nature, and shines an uncomfortable spotlight on the war propaganda machine. One can't help to have some thoughts of the current situation in Iraq, and Bush's infamous picture on the carrier with 'Mission Accomplished' overhead when watching the spin during the bond drive portions of the film.

Some reviews have complained about the way 'Flags' cuts back and forth between past and present, but it didn't bother me at all. I'm not sure it necessarily adds a great deal to an already powerful film though.

The acting in 'Flags' is generally very good, but I thought the actor who plays one of the flag raisers, a Native American named Ira Hayes, steals the show. His performance is heart wrenching. He is a soldier that has seen and done unthinkable things in the battle. He is literally dragged into the spotlight unwillingly and trotted out as a hero for the flag raising during a series of appearances with the other two survivors during the bond drive.

'Letters' begins in 1944 before the battle, during the early Japanese preparations on the desolate island of Iwo Jima (Sulfur Island in Japanese). Ken Watanabe does an incredible acting job as the general in command of the operation, Tadamichi Kuribayashi.

Kuribayashi had spent time in America before the war, and was against it but was obviously overruled. He knew that the industrial output of the US at the time was unmatched, and would likely be unbeatable. He certainly knew that he and his 20,000 troops were doomed going into battle, but he strategized for maximum impact on the American invasion. He turned a lot of traditional Japanese battle planning on its head, which led to dissension in the ranks of his underlings both before and during the battle, and definitely contributed in some cases to a quicker death for some Japanese units. By the end of the battle, there were around 1000 Japanese left between battle casualties and suicides to avoid surrender.

Watanabe captures a man torn between duty to family and country, and between his love of homeland versus a friendly view towards Americans in general.

The other star of the show is the actor who plays a simple baker with no interest in war, and is forcibly conscripted into the Japanese war effort and sent to Iwo Jima while his pregnant wife watches powerlessly. His performance, at times comedic, always powerful, is very well done.

'Letters' is clearly an anti-war picture. Its emotional impact is different in some ways because you know from the beginning that most if not all of the characters are going to be dead by the end of the film, and they all know it themselves. The island is inhospitable, and hot. There is little food or water, and dysentery everywhere. Yet, they manage to build a series of tunnels and reinforced positions that go so deep, they are eventually immune to American air bombing campaigns. Despite the brilliant strategy of Kuribayashi, the Japanese are far outnumbered, outmatched, and have been essentially abandoned by the Japanese mainland in terms of reinforcements. It is a very difficult movie to watch knowing the ultimate outcome.

It manages to humanize the face of the enemy like few war pictures have done. I would be interested to see the reaction to it in Japan.

Anyways, I would strongly recommend seeing both movies. As movies, they are both very well done, but I feel like 'Letters' is a crowning achievement for Eastwood, while 'Flags' is not quite at that same level. They will definitely give you many things to think about as we begin a new year.

Stefan Jovanovich comments:

I don't do war movies any more so I can't comment on the films that Dylan saw. The last uniform, splatter film I saw was "Saving Private Ryan." Compared to the memoirs and documentary photography made by the people who fought on D-Day and in the weeks after the landings, Spielberg's epic was so completely meretricious that it cured me permanently of any curiosity about what contemporary filmmakers have to say about WW II or any other war.

What I would like to question is the presumption that Americans were destined to win the war because of our material superiority or, as Dylan puts it, "the industrial output of the US at the time was unmatched and would likely be unbeatable." In the actual combat against the Japanese army and navy in the Pacific, the weight of numbers and equipment was rarely a decisive factor for the Americans who did the fighting. The reason for this is painfully simple: until the summer of 1945, the Pacific theater always had last priority. Supplies and reinforcements were first sent to Britain and North Africa and then - after 1944 - the European continent. Even Lend Lease to Russia usually had a greater priority than the Pacific theater.

It is only at the very end of the war, with the arrival of the B-29 and the invasion fleet for Okinawa that material superiority became a significant factor; and that was countered to a large degree by the Japanese use of kamikaze tactics. (The U.S. Navy lost more sailors in one month, off the island of Okinawa, than it had in its entire history before that time.)

The triumph of the Americans over the Japanese Empire came far more from intelligence and courage than it did from having more equipment. That eventual victory began with the neutralization of Japanese naval superiority at the Battle of Midway in 1942. 12 bombs destroyed 4 aircraft carriers and - far more important - the elite cadre of Japanese aviators on those ships.

Both Japanese and American scholars agree that, at Midway, the Japanese had more and better aircraft, ships and torpedoes. Their pilots and sailors had greater technical skills and far greater combat experience. Nevertheless, they lost - because of luck and the willingness of the American commanders, Nimitz and Spruance, to go against the odds. Even after the Japanese lost their absolute air superiority at Midway, they still retained the tactical advantages of being on defense. They assumed - not without cause - that the vast distances of the Pacific would make it impossible for the Americans to defeat them. What destroyed that assumption was the success of the American submarine forces in literally choking off supplies of fuel and other materials to the Japanese.

Like the United States Navy, the Army and Marines were able to capture territory for the establishment of forward bases in the mid and Western Pacific, and the submarine forces were able to reach the shipping lanes that converged in the seas around Luzon. The submariners were able to use the information, which the U.S. Naval Intelligence had gathered by successfully breaking the Japanese Naval cipher, to hunt down the Japanese merchant fleet. (The Japanese naval command cooperated by requiring each merchant ship to report to its position daily.)

By 1945 the naval blockade had been so successful that the only targets left were lighters and other coastal vessels; the entire oceangoing Japanese merchant marine - all 5 million tons - had been sunk.

When the battle of Iwo Jima began, the fuel supply to the entire home islands and the military was 10% of what the fuel requirements for the Japanese Navy alone had been in 1942. To suggest that the Japanese troops on Iwo Jima were "abandoned by the Japanese mainland in terms of reinforcements" is to fail utterly to understand how desperate the situation was for the Japanese. It is also to imply - yet again - that the Americans could have been expected to win because of their material advantage. Iwo Jima was - even more than Okinawa - considered part of Japan itself; and Japan's soldiers, sailors and airmen had sworn to protect the homeland at the cost of their lives. Defeating them required a sacrifice equal to their own.

What should also be remembered is the price paid for American submariners: 52 subs and 3,505 officers and crewmen. One last quibble: if, as the filmmakers imply, the U.S. was "near bankrupt" after the Battle of Iwo Jima, it must have been as part of a previously unreported planetary repo out of the pages of Douglas Adams. The near fatal hubris of post-WW II Federal Reserve and Treasury policy had its origins in 1945 - a time when the U.S. dollar was considered not only as good as gold but better. For the next 2 decades everyone in the world would take our checks without ever asking for ID.

Dylan Distasio responds:

Thanks to Stefan for the informative analysis. The above section in particular got me thinking about the validity of the statements in the movie. I happen to have a copy of Milton Friedman's A Monetary History of the US 1867-1960, which is an interesting tome in its own right. I'll quote some of the section in it on WW II deficits below (with the caveat that access to internal Fed documents from 1940 onwards during the war was apparently limited when Friedman was writing his book).

From A Monetary History:

Period of Wartime Deficits, December 1941-January 1946

…By early 1941, however, the deficit had begun to rise sharply. For calendar 1941, cash operating outgo exceeded cash operating income by $10 billion or nearly half of total expenditures. Pearl Harbor brought a sharp intensification of these tendencies. Government expenditures nearly tripled from calendar 1941 to calendar 1942, and rose a further 50 per cent from 1942 to 1943, reaching a peak of $95 billion in 1944. Tax receipts also rose but more slowly and in no greater ratio. As a result, the cash deficit rose to levels without precedent, either in absolute amount or as a percentage of national income; to nearly $40 billion in calendar 1942, over $50 billion in 1943, over $45 billion in 1944, and over $35 billion in 1945—sums averaging nearly 30 per cent of the contemporary net national product.

From the Atlanta Fed's website, here's another tidbit:

The war whipped Reserve Bank operations out of the doldrums of the late 1930s in a spectacular manner. A great deal of the war financing bypassed the old and suddenly cumbersome system of supplying credit through the Federal Reserve System by allowing member banks to rediscount eligible loans. In stark contrast to World War I and its postwar years, rediscounts dwindled and finally disappeared during World War II. The Atlanta Bank's portfolio of earning assets at the end of 1944, for example, consisted almost entirely of Treasury securities distributed from the System's account. There were no discounted loans from member banks. The Reserve Banks became almost exclusively holders of government debt. Commercial banks financed $95 billion of the $380 billion war debt, as the Fed augmented their asset capacity by supplying ample reserves. The money supply more than tripled between June 1940 and the end of 1945, and U.S. government debt increased from one-fourth to two-thirds of all U.S. debt. Thus a large portion of the banking resources of the nation, which had seemed so plentiful and so neglected in 1938, fueled the war effort, and both the activity as well as the assets of the Atlanta Fed soared.

It's also interesting to note that commercial banks were disallowed from most of the bond drives resulting in banks attempting to buy them from individuals on the black market.

Jim Sogi adds:

Stephan, have you read Embracing Defeat: Japan in the Wake of World War II (Hardcover) by John W. Dower?

It is an amazing, but quite depressing description of utter devastation to the cities, the economy, the industry, and the people and society of Japan during WWII. The fire bombs in Tokyo and in other industrial cities had an even greater capacity to kill and destroy than even those nuclear bombs, which destroyed over 40-80% of all residences and major industrial areas. Japan lost 1/3 of its net worth, and it suffered a 35% decline in urban living standards, and a 65% decline in rural living standards. It also lost 4/5th of all its ships. Furthermore, the feudal system ended. 4% of the entire population of 74 million was killed. In addition, 1/3 of the population of Okinawa was killed.

MacArthur's occupation force of 245,000 would have had great lessons for Iraq. Bremmer totally destroyed any hope and chance of stabilizing the Iraqi government by dismissing the entire bureaucracy and army in Iraq in three days with ill conceived and poorly planned action. In Japan, they kept the bureaucracy with tremendous efficacy.

It's quite amazing how prosperous they became. Now the Nikkei is 17245, which shows that it doubled in the last three years.

Stefan Jovanovich comments:

I share James Sogi's appreciation of Dower's book, Embracing Defeat; it is an extraordinary story. What the people of Japan have accomplished in 60 years is without historical parallel. To understand the extent of the devastation to Japan from the B-25 and B-29 raids at the end of WW II, you would have to take the recent hurricane devastation of Louisiana and Mississippi and multiply it 50-fold. You would then have to kill 3 million people from blast, disease and outright starvation, and leave the country with no fuel or food. Sadaharu Oh, the great baseball player, remembers sheltering with his mother in the canal near their home during one of the firestorms. They considered themselves lucky that the fires from the surrounding homes were not so intense that they raised the water temperature beyond the point of endurance. Others were not so fortunate; their bodies were found boiled to death. Oh was 5 years old at the time.

The blame for the failure of U.S. - Japanese relations in the 20th century has to be placed at the feet of Teddy Roosevelt, Woodrow Wilson and their fellow Social Darwinists (authors of that wonderful contribution to American jurisprudence - Plessey v. Ferguson). Their racism was eventually matched and exceeded by the members of the Kodaha and Tosei-Ha, but the Americans went first. In 1914, Japan was a more genuine democracy than the German Empire. The Emperor's political authority was far closer to that of George V than William II. Nevertheless, none of the Western allies - not the Americans, French, British or Italians - thought that their Japanese counterparts had the right to claim equal status at the conference table at Versailles. When that humiliation was followed by the Asian Exclusion Act of 1920 and the ending of the Anglo-Japanese alliance in 1922, the Socialist and Social Democratic parties in Japan and their policies of "Westernization" were deeply weakened. They might yet have prevailed, but the devastation of the Tokyo Earthquake and Fire created the same loss of faith and desire for a new, "strong" Japan that the Depression did in Germany.

I share James' scorn for the use of a civilian pro-consul instead of a military one in Iraq. Tommy Franks and the U.S. Army would have been a much better choice than Bremer and the State Department. But I think the historical analogy with Vietnam is the more appropriate one with regard to whether the Baathist bureaucracy and military in Iraq should have been left in place. In 1945 the Japanese forces in Indo-China had removed the French from all positions of military and civil authority just as the Germans had taken over in Italy in 1944. Roosevelt had wanted to require the Japanese forces there to formally surrender, as the Germans did in Italy; but he was persuaded to allow the Japanese to continue to govern the country until the French colonial authority could be reestablished. In the eyes of the Vietnamese, the French never overcame the double shame of defeat, followed by outright collaboration with a hated enemy. If the U.S. forces had allowed the Baathists to remain in power, the situation in Iraq would have been a second Indo-China War. I would offer instead the Philippines after the Spanish-American War as a historical comparison. The Spanish authorities were clearly discredited. Rather than leave them in place, the Americans established a joint military and civil authority. To T. Roosevelt's deep frustration, William Howard Taft, who was the pro-consul, committed the United States to granting the country political independence. (One of Roosevelt's strongest motivations for his later 3rd party run for President as a "Bull Moose" was his disdain for Taft's willingness to disestablish the fledging American Empire. He also thought Taft's fondness for baseball and his willingness to be seen throwing out the first pitch at an opening game was "common".) The U.S. Army and the Marines had to battle both the Moro and the Aguinaldo insurgents for nearly a decade after Dewey's dramatic success in Manila Bay. The chapters of General Pershing's memoirs dealing with his negotiations with village chiefs in the Philippine islands are being written again by successor American officers in the field in Afghanistan and the Western Provinces today.

From Roger Arnold: 

 I finally watched Flags of Our Fathers on Saturday at home with my 13-year-old daughter. As the movie was playing I was explaining the background of the story and of the men's lives to her. I knew some of the story because I was a Marine. The non-public parts of the story were told to me by James Bradley, even before he wrote the book. He had a passion for this story and for getting it told. This wasn't just a movie, made from a book, authored by a chop-shop writer.

Jim willed this movie into existence. Without his singular determination to tell the story it would have been lost to history. And that story too is worth hearing. As far as I can tell the movie relates the story pretty much as Jim told it to me 10 years ago, especially as pertains to Ira.

There were some peculiarities and omissions that raise questions for me. But as they pertain to private issues that readers and viewers would otherwise not be aware of, I will not relate them here.



The Hawaiian polymath James Sogi recommends Coercive Family Processes by Gerald R. Patterson. The book discusses how to measure and study aggressive behavior, and has already lead to great controversy in my family, as it recommends an authoritarian approach to raising children by removing what kids value, e.g. attention, when they are bad. Don't give them attention when they cry. Removing the attention is called negative reinforcement. The whole subject of how we behave when faced with stimuli of various kinds, with selling and buying being the behavior, and the environment, e.g. an economic announcement, a vivid change in a related market, or a backdrop of staged conditioning by the Fed Commissioners, would seem to call out for study and testing. This introduction to operant conditioning provides a nice summary of the kinds of things that behavioral psychologists study and might open up some fruitful lines of inquiry. A good reference to Patterson's work can be found here. In examining the diverse bodies of stimulus and response schedules covered by behavioral psychologists, one comes away with the impression that the grass is always greener on the other side and that if instead of following the promiscuous theories of cognitive psychology, that have a hypothesis for any seemingly irrational behavior, (albeit most of them are completely rational and based on rules of thumb that people in real life as opposed to college students for a buck an hour would choose), the often validated and completely specified studies of operant conditioning would be a much more fruitful line of inquiry for market people. One feels he is one the right track here as "Operant Conditioning" and "Stock Market " is almost a Google whack at 337 mentions but "Operant Conditioning" "Cognitive Psychology" has a promiscuous 38,700 mentions. It would be good to take the basic two by two table of operant conditioning and classify it by fixed ratio, fixed interval, variable ratio, variable interval, and see how these relate to predictive patterns. For example: bonds up/ stocks down, a positive reinforcer when it occurs at a steady rate with little variation (fixed interval) versus when it occurs with great variability (variable ratio). But bonds up/ stocks down, if it occurs at an unsteady state, it is an example of a positive punishment variable ratio. All the predictions of operant conditioning could be tested in the real world of humans with prices in markets, instead of on rats.

Reinforcement (behavior increases) Punishment (behavior decreases)
Positive (something added) Positive Reinforcement: Something added increases behavior Positive Punishment: Something added decreases behavior
Negative (something removed) Negative Reinforcement: Something removed increases behavior Negative Punishment: Something removed decreases behavior

Source: "An Animal Trainer's Introduction To Operant and Classical Conditioning"

Alston Mabry Replies:

As I understand it, in animal learning trials, if you put the rat in the cage with the little lever, eventually, in the process of exploring the cage, the rat pushes on the lever, and there is some possibility that a bit of food plops out. The process repeats, and the rat learns to associate pushing the lever with getting food. Interestingly, if what you want is for the rat to push the lever a lot, you provide the food reward only intermittently and randomly. If the food is provided each time the rat pushes the lever, the rat will push the lever only when it is hungry. However, if the food appears only occasionally when the lever is pressed, the rat will press the lever over and over, brimming with anticipation. Now let's assume the Mistress is a master trainer, to her own benefit. She places the rat (trader) in it's cage (home office with high-speed internet access, TradeStation account, etc.) and waits until the rat discovers the plastic keys on the keyboard and starts tapping them. Then she provides the rat with a food pellet (profitable trade). If the Mistress wants the trader/rat to trade as often as possible, she will reward the trader/rat with a profit (food pellet) only intermittently and randomly. If the trader/rat could get profit/food any time it pleased just by tapping the keys on the keyboard, then it would tap the keys only when it needed money. But because it is actually the Mistress who is in control, and she wants to maximize trading behavior from each rat, she keeps the rewards as random and unexpected as possible. In fact, "unexpectedness" is one of her most important tools. By the Rescorla-Wagner model of conditioning, the greater the unexpectedness of the reward, the higher the associative strength of the learning. This is why it is so effective for the Mistress, after a rat has tapped the keys many, many times with no reward at all and become convinced in bleak despair that no further reward is possible, to toss a nice food pellet into the cage and provoke the rat to even greater efforts.

Russell Sears responds:

This is of course the opposite of what is recommended for a baby totally dependent on the parent. I find this one of the greatest challenges of parenting, determining when to use negative reinforcement to cut off the dependency. And looking around to family and friends, especially with young adults, it seems many have never truthfully acknowledged this.

Steve Leslie adds:

This is exactly the foundation of slot machines. Intermittent rewards promote more activity on behalf of the participant. The theory is that if one gets rewarded on equal installments the activity is seen as work, whereas if one receives an intermittent reward then it is seen more as recreation. This is also how companies motivate their salesmen and saleswomen. They conduct sales contests but they do it randomly. It is one way that the company keeps the salespersons attention. Brokerage firms were famous for offering sales contests during the summer months, typically the slowest months for commissions to keep the brokers working and keep the revenue flowing. Here is a sidebar to this discussion. In Las Vegas, if a casino advertises that they give a 99% payout on their slots, then they must pay out on average the machines that they have posted to pay out that amount. This does not mean that every slot machine in the casino pays out 99%. It applies only to the bank of machines that are listed as paying out this amount and the patron has to look long and hard inside the facility to find those. What this does mean is that if you took a large enough sample size for example a $1 slot machine and played this machine forever and each individual were to put $100 in and no more, taken collectively they would receive back $99 on average. Now statisticians will tell you that everyone who plays slots will eventually go broke. The reason for this is that people continually take their reward and plow it back into the machine until eventually they have spent their full bankroll. Therefore the machine will collect everything, it just takes longer if the payouts are higher. This applies to all other games as well including roulette baccarat and dice. Even though you can approach almost even money odds such as betting the color on a roulette wheel, the player only on the baccarat table, and the line on the craps table, if you keep playing them long enough you will lose your entire bankroll.

Jay Pasch replies:

Markets are authoritarian, nature is authoritarian, society is authoritarian, the world they're going to live in is authoritarian, "ya gotta serve somebody" as Dylan would say. Of course there is great benefit to self and others in going against at times, i.e. Thoreau's Civil Disobedience, the rebel call, et al. But on the battlefield of child-rearing, relieving one's self of authority is like dropping one's arms on the field, and pants, and waiting to take one between the… eyes. What works best for the young warriors is that they have 'contracted' to decency and respect with all of the ensuing benefits and luxuries given their meritorious behavior; but break the contract and it is they that surrender their benefits, rather than the mindset that some sort of entitlement has been 'taken away'. Under this arrangement the kids have buy-in, they feel important, creative, their ideas beneficial, because they were asked to help create their world in the first place. They see clearly the reality of their own behavior, understanding it was they that surrendered their privileges rather than the big bad general removing their stripes…

Daniel Flam replies:

It would seem to me that all education revolves around pain. So you say we can't "flik" the kids? Ok let's give them a mental pain Like take away something they like, put them in the corner, its like the way the intelligence interrogators in the western world operate under the democratic laws, we just find a better way of inflicting pain in confines of the law… I find the same with the market… which bring an old adage… "No pain, no gain" How would we go about studying pain in the market?

Steve Leslie replies:

First let me say that "No Pain No Gain" is a very dangerous statement. Physical pain while training is an indication that one is approaching a physical limit. By going too far, one can instill permanent damage. Only a fool would feel a muscle tearing during a set of lifting weights and continue to lift weights. Now there are minor aches and pains that an athlete must endure however there are limits that the body can withstand. An athlete who is in touch with their body is well aware of the difference. I am sure my good friends Dr. Goulston and Dr. Dorn are much more qualified than myself to comment on this subject matter and I hope that they do weigh in. However, there are three distinct subjects here.

Giving a child an iPod for excellent grades is positive reinforcement. Withholding a reward from a child or taking away privileges would be negative reinforcement. Yelling and/or corporal punishment would be forms of punishment They are very different. The problem with punishment is that it has a very short term result. And repeated punishment eventually will result in no positive result whatsoever. Please forgive me for probably misrepresenting this study but here goes: There was a famous study performed where an electric grid was installed in an enclosed box. Mice were placed in the box and half of the box was shocked. The mice went over to the other side away from the pain. Then a barrier was installed so they could not move from one side of the box to the other. Then the mice were shocked. They initially tried to escape to the other side. However the barrier would not allow them to move over. After repeated shocking, the barrier was removed. The mice were shocked yet they did not move over to the safe side. In effect, they were conditioned to just sit and take the pain. Think about this: When your dog runs away and you beat it. That is punishment. If the dog runs away and you beat it again it will be trained to stay away. If you beat a dog long enough eventually it will just lie there and allow itself to be beaten. This is shown dramatically in abused wives. They become beaten physically and/or mentally and that if this occurs long enough that eventually they just sit there and continue to be beaten. And should someone come along and offer them sanctuary, the abused wife will chose to stay with the abuser. Someone once said you train animals but you teach children. If you really want to go into deeper understanding of this, I recommend an exceptional person Dr. James Dobson either in his numerous books on this subject most notably Love Must Be Tough. He also hosts an extremely informative radio show entitled Focus on the Family. My church radio station broadcasts this as do many Christian radio stations around the corner. He is seen very regularly on Fox shows such as Hannity and Colmes.

Daniel Flam adds:

Having spoiled brats that everyone in the room hates to be around because you don't want to put them in their spot, Will just delay the point in time where someone that is not a family member will put him in place in a most unpleasant way. Bringing up Children is like painting a work of art. You must use all the colors of the spectrum, although some colors should be used a very small dose, or you might get an ugly result. I see additional factors to the one suggested:

Today we find names for anyone who doesn't behave like a sedated rabbit. This reminds me of that shirt "I hate it when people think I have ADD! Oh look, a chicken!"

James Sogi replies:

Rather than 'greed' and 'fear', counting, like behaviorism, is more scientific. Quantify to predict. The market trains everyone to do the wrong thing. When one is trained to go long, the market goes south. When one is trained to play the range, it breaks out. Of course it trains one in the just the most intermittent and thus most powerful manner, like slots, to go the wrong way. It is called variable reinforcement. Counting gives the clue that the training is in play and not to follow the masses and to stay a step ahead of the market. Be the trainer not the trainee. Who is in control here after all. Little babies train their parents. It is the brat in public that has the haggard parent running around like a chicken. Both are miserable. Proper training involves the use of love attention and affection. It is not the rats-in-a-box syndrome. The natural reaction is to run to the crying baby. That merely reinforces the crying. The natural crying pattern has variations. When there is a break in the first few moments of crying, use that moment variation to sooth the child. The reinforces the calm not the cry. Inconsistent parents give mixed signals can cause confused children, unhappiness. Consistency give certainty and clearness to the child. I tried to see how many days we could et my kids without crying. How many times per day would they cry? Why did they cry, what were the operant conditions? Quantify the responses. Forget the mumbo cognitive jive. In the market, the public rushes to the upsurge, but is this the correct response? When the market tanks, the public trained panics. Again, scientists, is this the right response? Quantify one's own responses to get an idea of what works, what doesn't. consistency brings profit.

J. T. Holley reminisces:

My PaPa would espouse to me "the grass might be greener on the other side but someone has to mow and rake it too" whenever I would act like those cognitive psychologists! I think the operant conditioning like B. F. Skinner is appropriate for those dealing with the markets. The classic philosophy (shortened and brief) is that Plato felt to "know the good was to do the good", whereas Aristotle had a more operant conditioning belief in that "to do the good was to know the good".

Russell Sears suggests exercise:

What the kid needs is an outlet for his energy. Have the kid run a few lapse, go a few miles on his bike, or even shoot some hoops. I would suggest, that what Lackey encourages his kids to do has more to do with his kids well adjusted behavior . Lackey little league, and coaching wouldn't see these kids. Kids with no competitive outlet, takes it out on the adults. Exercise generally works better than any drug for mild depression. But what Doctor will prescribe 2-3 miles run everyday for 2 months to a single Mom for her kid. Its called "child abuse". But giving him mind altering drugs, to a developing growing brain, is called "therapeutic care."

Pamela Van Giessen laments:

This seems to be part of a larger issue where every single moment of childrens' days are being structured and moderated by adults. There is school, soccer practice, swim lessons, judo, music lessons, play dates, etc. It's kind of like jail. Even worse because at every turn there are adults loitering, supervising, and otherwise keeping a watchful eye. I call them helicopter parents. They mean well, but I can't help but be eternally grateful for my parent's lack of vigilance. I read an excerpt from John Dickerson's book about his mother, Nancy (first female TV news star), where he noted how absent his parents were and that he and his siblings were often left to their own devices, and how, in the long run, that turned out to not be an entirely bad thing. My American nephews are supervised 24/7 and while they are smart and adorable children, I notice that they are more prone to temper tantrums and the like. My Dutch nephews roam free; they rarely have a baby spell. And, honestly, the Dutch kids seem more creative and amusingly naughty. I like children who stick carrots up their nose at the dinner table, provided they are stealthy and quiet about it. Kids don't put up with other kid's temper tantrums and so children who hang out with children stop behaving like brats — at least if they want to have friends. At the age of seven, I was biking a mile to go get candy. I rarely see children about my 'hood without adults. Can't they even go to the bodega without Mom? At what point will they not be supervised and watched over? I've also noticed that the young women (oh, how I hate saying that) that work for me seem to approach their jobs, careers, and even daily to-do list like a school exam that they must ace. They miss the larger point about spontaneity, about creating, about doing as you go and it all becomes about getting an A and moving on to the next "test." They also seem to structure their lives accordingly. From x-time to y-time is work time, from z-time to a-time is not work time. One hopes that romance isn't scheduled so rigidly. When I think of all the wonderful experiences and successes (and even some failures) I've had by being spontaneous, by looking in rooms I wasn't due to be in, by not scheduling my life with much structure it makes me sad to see us creating a society of automatons.

Nat Stewart adds:

One of the most worrisome trends in my view is the "bans" on student organized, spontaneous recess games, which for me were always the highlight of the day in the early grades. The spontaneity and sense of it being "ours" and not a teacher/instructor lead activity also increased the value and fun of these activities. I think for many kids this type of vigorous exercise is almost a need or requirement, It certainly was for me. Kids who are naturally curious, such as this kid in the article who is a "gifted reader" need independent outlets to exercise their own curiosity, and opportunities for individual study and thought. I think many of these kids are just bored stiff! The extreme bureaucratic environment is not a good learning environment for many children. Kid can use logic, and I believe many start to rebel and have trouble when they are repeatedly asked to do things that they do not find logical. "Johnny has a problem…" Well, maybe he is mad that so much of his day is wasted in useless, pointless, mind numbing activities? Maybe he would rather be off on his own, reading a book. Kids can be sensitive to injustice, and little things over time poison can poison ones attitude to the entire process or system, which is unfortunate. All kids are different. Labeling children with 1000 different Disorders is only a smokescreen that hides our severely dysfunctional system.

Professor Gordon Haave replies:

I would suggest that what is wrong with the children is nothing… except a total lack of discipline and their learning at 5 when taken to a psychiatrist that being crazy is normal and they can do whatever they want because they are not being bad, they are "sick". Another good thing about Oklahoma: I don't know anyone who sends their kid to a psychiatrist. Kids get discipline, hard work, and an ass-whupping if they do something particularly egregious.

November 11, 2006 Troubled Children What's Wrong With a Child? Psychiatrists Often Disagree By Benedict Carey

Paul Williams, 13, has had almost as many psychiatric diagnoses as birthdays.

The first psychiatrist he saw, at age 7, decided after a 20-minute visit that the boy was suffering from depression.

A grave looking child, quiet and instinctively suspicious of others, he looked depressed, said his mother, Kasan Williams. Yet it soon became clear that the boy was too restless, too explosive, to be suffering from chronic depression.

Paul was a gifted reader, curious, independent. But in fourth grade, after a screaming match with a school counselor, he walked out of the building and disappeared, riding the F train for most of the night through Brooklyn, alone, while his family searched frantically.

It was the second time in two years that he had disappeared for the night, and his mother was determined to find some answers, some guidance.

Sam Humbert responds:

The long-time sense of the word "discipline" was to instruct, educate, train. It somehow became twisted (as has the word "liberal") to mean, in common usage, Prof. H's "ass-whupping." What does an "ass-whupping" instruct or educate? Well, it teaches that if you're frustrated, angry, tired or stressed, and have the advantage of being bigger and stronger than the other guy, then it's OK to indicate your frustration with verbal or physical violence. Is this the what a parent wants to teach? "Discipline", in the bastardized sense of the word, means the parent has failed. Failed to authentically instruct, educate, train. And is now lashing out, motivated by frustration, not by a desire to educate or improve the child. The parent's reptile brain is in charge. And what becomes of kids who are beaten into submission for 12, 14 years.. But then become teenagers? How will they conduct themselves "out of eyeshot" of their parents, when their parents are around to "control" them with "discipline"? What actually does work in parenting — since "discipline" doesn't — is spending time with kids, and most especially, meeting them at their level, not at your own. Becoming engaged in their lives, their interests, their hopes, fears, dreams. Really hearing them, rather than lecturing them. My kids have never been "disciplined", and many parents in our town have commented to us that there are — far from being "undisciplined" — among the kindest, most thoughtful little boys they've met. The proof is in the pudding.

Professor Gordon Haave replies:

Although, as I have said, I don't believe in Ass whupping, I don't think what you are stating is correct. In its simplest form, it is the most crude way of stating "actions have consequences". Most of this on this list know that there are better ways of teaching that then ass-whupping, therefore they don't do it. Around here in Oklahoma, it is probably not very common, but was even just 15 or 20 years ago. Now, what goes on in NYC is simply the opposite message, that actions don't have consequences, that nothing is your fault, that if you look out the window during class or talk back to your mother you have a problem that needs to be medicated. Mr. Wiz suggests that those who receive an ass-whupping grow up having learned the wrong lessons, etc. I submit that it is better than the weirdos who grow up thinking that actions don't have consequences. They are more prone to destroying families and societies, in my opinion. So, I will restate: Ass-whupping is preferable to the NYC psychobabble approach, even if it is crude in its own right.

Stefan Jovanovich responds:

The "ass-whupping" meme seems to me more than a bit overdone. Striking a small child is like beating a cat. Children are small creatures compared to us adults, and they spend most of the years up to the age of puberty navigating around us comparative giants. Simply restraining them physically - holding them still - is enough physical punishment for "acting out". What was notable in the article about poor Paul Williams is that his father - the person most likely to have the physical strength to be able to hold him still - is nowhere mentioned. You can step on a cat's tail, and she will instantly forgive you even though the pain was excruciating. Intentionally strike the same animal with one-tenth the same force, and she will view you as an enemy until the day one of you dies. I agree with Gordon's skepticism about psychiatric diagnoses. Since they almost always have no clinical basis in blood chemistry or any other quantifiable physical symptom, they are usually like visits before the parole board. The patient - i.e. prisoner - has to reassure everyone that he is "sorry" and will make a sincere effort towards "rehabilitation" - i.e. sitting still in school. My Dad's theory was that compulsory education was invented so that the adults could find somewhere to warehouse the children during working hours. In his darker moments he also speculated that it was an expression of society's underlying belief that poverty was a crime. Since almost all children were destitute, society was simply doing what it did with other criminals - locking them up and then pretending that incarceration had some useful purpose.

GM Nigel Davies responds:

I agree. And given that one of the tenets of libertarianism is to remove physical force and coercion from human affairs, this seems to be given quite the wrong message. I strongly suspect that kids who get beaten will tend towards an authoritarian attitude to life. There are more creative ways to instill discipline, such as gaining a child's attention by showing them something that actualky interests them and using a system of reward and punishment based on what they like to do. If good behaviour is rewarded it represents a trade and fosters an attitude to life based on exchange rather than force.

The President of the Old Speculators Club:

I recently read an article with a darker view — suggesting that Americans who send their children to public schools are allowing the "state" to "kidnap" their children for 8 hours a day. Hours in which they are taught what it is believed they should be taught, and shielded from those things that might make them less than docile, cooperative citizens. The goal is to produce individuals who will view governments the provider of all solutions.

Roger Arnold replies:

When I was a boy, getting a butt tannin from time to time was a part of growing up, as it was for everyone else I knew. I can still hear the sound of my father's belt as it is pulled through his belt loops. My mother would send me and my brother to our room with a pronouncement of "wait til your father gets home", and we would sit in there laughing and joking until we heard the front door open — and oh my god that's when the terror began. Nowadays we joke about it at family get togethers and, although I have never raised a hand to my own child, I can understand the utility of the spanking as a tool of nurturing.

Jim Sogi adds:

The characterization as 'authoritarian' places the wrong emphasis. The reason is that firstly operant conditioning is not necessarily controlled by parents as the authoritarian and that secondly rewards are more powerful than punishments. Everyone is subject to operant conditioning regimes, some of which they may be aware, but also by many others of which they are not aware. There are in fact random conditioning regimes that wreak havoc on the unsuspecting. The result is superstitious behavior and the development of personal "issues" and psychotic behavior due to the various random influences at work creating random patterns in people without their knowledge. We see this in the markets daily. When one is not aware of the theories of social learning, feedback loops can be created that are destructive and create bad habits. When one is aware of feedback patterns in social situations one can control the bad influences and foster the good. A human cannot opt out of conditioning regimes. They exist everywhere in the family, in society, at work, and also as random elements in daily life. The question is not whether social learning takes place, the question is which regime is going to dominate your development? The random crying of a baby? The whims of a teenager? The random flow of traffic? Or the structured goal oriented regime of successful adults in the pursuit of happiness. To believe one is not conditioned every minute is denial. The question is who is doing the conditioning and to what ends? In the delightful and hilarious book, Taxonomy of Barnacles by Galt Niederhoffer, read during the last vacation, the issue posed by the author was whether nature or nurture were the determining factors in the success of a person. This issue has been a great debate in our family and I agree with the author that nature is the predominant influence, and that we in fact are subject to many of the same traits our grandfather's displayed to a remarkable degree, and that conditioning might try to guild refined gold or paint the lily, but the mold is cast genetically to a much greater degree than most are willing to admit.

Steve Leslie offers:

Jim, you have nailed what I find one of the most difficult aspects of trading. If I open a trade and the price goes the direction I want, I feel rewarded; if it goes the other way, I feel punished, but these feelings have little to do with actual success. Success is trading when, and only when, one has an edge. Individual trades may not be profitable because of variance or because the hypothesized edge is illusory or has fallen prey to changing cycles. Success is managing risk so that, after the inevitable setbacks, one lives to fight another day.



Can the Da Vinci code help us unlock the secrets of the markets? I'm not talking about the content of the book, more its popularity. The world loves conspiracy theories and it is a huge business. Why do they love them? Because the human mind wants to embellish and create storylines around random events. Is this starting to sound familiar?

The problem with most bullish thinking is that it lacks a conspiratorial element. How much more interesting it is to consider that what we see is just a facade and that there are agents of various different types undermining the fabric of civilisation. The spec-list has been presented with a few conspiracy theories in its time such as the deliberate manipulation of government economic numbers or undermining of the moral fabric of civilisation by assorted minority groups.

In this light, Abelson and his ilk might be seen as conspiracy theorists, titillating the public with thoughts that something in the woodwork is rotten. And our minds seem all too willing to go along with it.

Roger Arnold replies:

The equity bulls have an entire economic system that caters to bullish conspiracy theories and realities. Capitalism as an economic system may be considered a conspiracy theory; i.e. Gordon Gekko's "Greed is Good". The Greenspan/Bernanke Put may be viewed as a bullish conspiracy to steal from future generations a la moral hazard. The drift the Chair speaks of so fondly may be considered to be the reflection of that moral hazard. How many bears to do you see in the media? In a capitalist system the collective voice must be bullish and even Pollyana-ish by design. Advertisers do not pay for reality, they pay for promotion. That's why the bears have so few outlets are left frustrated; the bulls have conspired against them and reality itself. A big deal was made last week about the Dow record. But nobody mentioned that that was only in nominal terms. In real terms the Dow is now 17% below its record high — but that doesn't sell. And speaking of that upward drift in real terms, and keeping survivorship bias in mind, equities have for the most part kept up with inflation / dollar depreciation for most of the past 100 years, but not much better. So, by and large being invested broadly in US equities ensures that your wealth grows with the cost of living. But that's about it. But that's ok! Because the cost of not investing is that you sink like a rock! So, the key to wealth is not simply to save and invest; at best all that can do is keep you afloat. You must specialize and excel. That's the key to the capitalist system.



I just received this from a US expatriate businessman in Nicaragua:

You might want to spread the word; this place is going to Boom here after the election. HSBC just bought a bank call Banismo and now has a branch here, and it is just a matter of time before an American bank gets wind of the opportunity. My friends and I are meeting with all the presidential candidates on Fri. and will get a feel of how things are going to go. The down side to the election would be if Ortega wins, though it won't make much difference as far as the economy is concerned, just perception to Americans.


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