The press and the market continues to speculate about the negative impact of an exit of Greece from the Euro (expectations seems to be over 50%) and both the financial consequences of such an exit on the EZ (indeed everyone else) and, in particular, on the adverse contagion issues in respect of the other PIIGS and core EZ countries, for that matter. Yes it is true that the Greek party Syriza (comprising leftist anti bail out elements) came a surprising second in the last elections and, until recently, has lead in the polls. However, the most recent polls suggest that the Greeks may well be rethinking. New Democracy (23.1%) is narrowly back in the lead (with indications that its support is increasing), followed by Syriza and then Pasok some 10 points behind. If the next elections (due on 17th June) reflect recent polls, a coalition comprising New Democracy and Pasok will be able to form a working majority in Parliament, something which I believe the market has not picked up on as yet

Early days, but I for one believe that the trend away from Syriza will continue. Greeks, by an overwhelming majority (between 75% to 80%) want to remain in the Euro, as they realise that the reintroduction of the Drachma will result in an effective devaluation of at least 50%, by all accounts. The resultant hardship (the need to close the current account deficit to zero immediately) will make the current austerity plans seems like a mild dose of influenza, compared with the pneumonia that will follow an Euro exit. Yes the EZ will be negatively impacted, but the Greeks will make up their minds, based on the likely impact on themselves. This suggests to me that voters will swing away from Syriza and to New Democracy, in particular.

Whilst the Greeks want to remain in the Euro, they do not want to abide by the austerity measures, which their previous administration agreed to. Yes the austerity measures are tough, very likely too tough, but Greece needs to sort out the fiscal mess which it created for itself. The EU suggests that the Geeks will be offered some “sweeteners” if they chose to remain in the Euro, including some kind of growth measures (whatever they are) and possibly a watering down some aspects of the austerity measures. Will this be enough to persuade the Greek voters from following the nonsensical path proposed by the head of the Syriza, Mr Tsipras. Personally, I am beginning to believe that it may. Am I convinced - certainly not, but as days go by, I would not be surprised if the polls indicate that support for Syriza ebbs away and New Democracy’s lead increases.

If I’m right, markets should begin to recover. Personally, I just wish that Greece goes away. The gloom and doom scenario guys are overstating the impact of a Greek exit in my humble view. Yes, there will be huge losses for the EZ, but certainly not of the order of E1tr suggested by Mr Dallara of the IIF – do you think he has a vested interest – of course he does, as he acts for the small group of remaining private sector bondholders who will lose everything if Greece exit’s the Euro. He has every interest in exaggerating the size of the potential losses, in an attempt to get the EZ to offer more assistance to the EZ. Estimates of losses for the EZ (including banks etc) from a Geek exit, range from E150bn (too low in my opinion) to Mr Dallara’s E1tr (ludicrously high) – big numbers in any event. However, a Greek exit will force the ECB to act. Citi estimates that the ECB will have to provide some E800bn in liquidity to mitigate a run on EZ banks in the event of a Greek exit. In addition, the ECB will lower interest rates, buy Spanish and Italian bonds (quite possibly other country bonds) in size and introduce QE, etc, etc, something which is necessary. Draghi will have the perfect excuse to act. As a result, after the initial shock, I for one believe that the EZ will finally have begun to take the action necessary to start to resolve the crisis – there would be no alternative. Consequently, I really hope that Greek voters follow Syriza, but I fear that they wont.

Trying to predict anything involving the Greeks is virtually mission impossible. However, I am beginning to wonder whether the current excitement/panic is way overdone. I have closed all my shorts and remain hugely cashed up, but may well nibble away a bit more in coming weeks. However, it is impossible, in my humble view, to come up with an informed view at present and, as a result, extreme caution is the name of the game. There will be time.

As far as the EZ is concerned, Mrs Merkel remains the only serious player who wants Greece to remain in the Euro – the reason is that she just cannot get a handle on the financial and economic consequences of a Greek exit and is therefore concerned, given her inherent cautious nature. Most other players, including her Finance Minister, Mr Schaeuble are keen to kick Greece out. At present Mrs Merkel has won the argument, but I suspect her position is weakening.

There is a common misapprehension that the EZ cannot force an exit of Greece. Whilst technically true, it certainly can be engineered through the ECB. The ECB at present has stopped financing for Greek banks not because of an ECB policy decision, but technically because EU funds have not yet been used to recap 4 (insolvent) large Greek banks and, the ECB cannot provide funding to insolvent banks. Indeed, the EZ released E25bn to Greece’s recapitalisation agency as part of the new E174bn rescue on April 19, well ahead of the election on 6th May. The problem is on the Greek side (are you surprised) and involves continued negotiations between Athens and the 4 Greek banks as to how much control the government will have in exchange for the funding. Greek officials expected the money to be disbursed by the end of last week, but I have not seen any announcement as yet – typically Greek. When the EU funds are received by the Greek banks, the ECB is expected to continue with its funding operations to Greek banks, though there is an issue as to whether Greek banks have any eligible collateral left to access ECB funding.

However, Greek banks can tap the emergency liquidity assistance programme (“ELA” and which requires lower quality collateral), through their Central Bank, which they are doing at present. The consequences of this (especially as Greeks are withdrawing funds from their banks and Greek banks are, as a result,  increasingly turning to the ELA – estimated at approximately E60bn at the last count) is that the counter parties of the ELA, namely the EZ Central Banks (Germany, in particular, but also Finland, Holland and, I believe Austria and who are providing the funds for the ELA) are having to increase their exposure (and their risk), given the Target 2 arrangements. Not great news for these guys.

It is estimated (by Morgan Stanley) that Greek banks have some E130bn of eligible collateral left to use to access funds from the ELA. A haircut of 50% is considered necessary, which technically suggests that Greek banks can borrow a further E65bn from their Central Bank in accordance with the ELA arrangements. Unfortunately, there is scope to increase the collateral available to Greek banks, (a big Whoops), which will be acceptable for ELA. However, by a majority of 2/3rds, the ECB can stop a steep an unsustainable increase of lending under the Target 2 arrangements, which will require Greece to exit the Euro some time thereafter. As a result, there is a threat (indeed ever rising threat) that the ECB and the affected EZ Central Banks will cut off further lending through the ELA, especially if withdrawals from Greek banks continues to increase significantly. Interestingly, whilst some 20% to 25% of deposits at Greek banks have exited since 2009, the surprising issue is that approx 75% remains – indeed, some E170bn remained with banks at the end of March. This is a serious issue, though difficult to assess. Cutting off ELA funding to Greeks banks by the ECB will certainly focus the minds of Greek voters, though will really spook markets, and Spanish and Italian bond yields.

I remain of the view that Greece is far too much of a problem and it’s ability to continue to create problems is way above it’s perceived threat. In addition, we all know that the Greeks will never comply – not a great precedent to the Irish, Portuguese Spanish and Italians. As a result, I feel that an exit by Greece in the next 12 months is a 75% certainty. As the EU/ECB considers the implications of a Greek exit (which clearly they are), plans will be drawn which will make a Greek exit more possible, though clearly will not be painless. At some stage, even Mrs Merkel is likely to change her mind.

It is near impossible to assess the possibilities at present, but my hunch (and that’s all it is – after think Greece, Turkey (totally intended) and Christmas) is that Greek voters will swing away from Syriza, which will be positive for markets. However, if Greeks start withdrawing funds in size from their banks (E1.2bn or 0.75% of deposits was withdrawn last Monday/Tuesday) and the ECB restricts ELA financing, as described above…….

Having said all that depositors seem (unsurprisingly) to be withdrawing deposits from the (perceived or actual) weaker EZ banks. For example, Santander is reported to have lost £200mn (just under 20bps of deposits) from it’s UK operations last week – indeed, I am asked about Santander UK virtually every day. Outflows continue at Spanish (Bankia, in particular) Belgium, French and Italian banks. The EZ must force the recap of it’s banks or this is going to be a serious problem. In any event, the recap of EZ banks is a prior requisite for a solution in the EZ.

Very tricky and I will remain excessively cashed up at present. Too dangerous (indeed not enough info to form a view), though given market sentiment and the current situation, shorts are likely to remain winners for a while longer.

There are rumours circulating today (from the UK’s Sunday Times) that the French Government may have to nationalise Caisse Centrale du Credit Immobilier de France, a French mortgage bank, with some E33bn of mortgages or roughly 4.0% of the market. Whoops. Welcome to the real world Monsieur Hollande.

Kiron Sarkar

21st May 2012

BBC Interview with Nassim Taleb on JPMorgan

Hat tip Jesse’s Cafe Americain

>

My Sunday Washington Post Business Section column is out. This morning, we look at the JPM debacle: Has the Economy been made safe from Wall Street? The short answer is not very.

The print version had the full headline Four short years after AIG, Wall Street is back to its old tricks (The online version is merely JPMorgan’s debacle, and its parallels to AIG).

Here’s an excerpt from the column:

“Finance has become a low-margin, high-leverage business. This is not surprising in an environment in which trading volumes are exceedingly low and interest rates even lower. In any other industry, a slowdown in economic activity sends management scurrying to cut costs, develop new products, become more productive. In short, to innovate. Companies can throw money at new products, marketing campaigns or discounted pricing, but a slowing economy brings down demand. What we have today is a deleveraging economy, and that is even more challenging — limiting the options that CEOs can take to increase their company revenue.

The world of finance refuses to accept that reality. Whenever Wall Street is confronted with a decrease in profits, we see the same response: Increase leverage. We usually don’t hear about it until some market wobble causes the excessive leverage to blow up in someone’s face. This time, the novelty cigar was smoked by Dimon, and the damage was inflicted on his reputation. The losses, we learned, were a “mere” $2 billion, described as manageable.

Consider any major finance disaster of the past 30 years, and what you will invariably see is the result of trying to spin dross into gold. The magic of finance is that this can work for a while. The reality of finance is simple mathematics. Eventually, the probabilities play themselves out and the dice come up snake eyes.”

I submitted this kinda late; there was not much they could do in terms of graphics for the dead tree version of the paper.
>
click for ginormous version of print edition

>

Source:
JPMorgan’s debacle, and its parallels to AIG
Barry Ritholtz
Washington Post, May 20 2012
http://www.washingtonpost.com/jpmorgans-debacle-and-its-parallels-to-aig/2012/05/18/gIQAPJxLbU_story.html

Washington Post,  May 20 2012(PDF)

The Financial Times - JPMorgan unit has $100bn of risky bonds
The unit at the centre of JPMorgan Chase’s $2bn trading loss has built up positions totalling more than $100bn in asset-backed securities and structured products – the complex, risky bonds at the centre of the financial crisis in 2008. These holdings are in addition to those in credit derivatives which led to the losses and have mired the bank in regulatory investigations and criticism. The unit, the chief investment office (CIO), has been the biggest buyer of European mortgage-backed bonds and other complex debt securities such as collateralised loan obligations in all markets for three years, more than a dozen senior traders and credit experts have told the Financial Times. The bank has said its derivative activities were intended primarily to help balance risks on its overall balance sheet, but the revelation that it has built up other large, risky positions is likely to raise further questions about the CIO’s remit.

The Wall Street Journal – Inside J.P. Morgan’s Blunder 
CEO Dimon Blessed the Concept Behind Disastrous Trades; ‘Blood in the Water’
On April 30, associates who were gathered in a conference room handed Mr. Dimon summaries and analyses of the losses. But there were no details about the trades themselves. “I want to see the positions!” he barked, throwing down the papers, according to attendees. “Now! I want to see everything!” When Mr. Dimon saw the numbers, these people say, he couldn’t breathe. Those trading positions have produced losses that could total as much as $5 billion, tarnishing the record of an executive who had thrived through the global financial crisis and who has long been known for paying close attention to the bank’s trading activity, its risk profile and the activities of its senior employees. J.P. Morgan, the nation’s largest financial firm by assets, is struggling to contain the damage, which already has shaved off more than $25 billion in shareholder value.

Comment

The press is finally figuring out J.P. Morgan’s position are still open and they are subject to more losses.  We noted this on Tuesday in a post titled “How Jamie Dimon Might Lose His Job This Summer“:

Four days after the announcement of the loss by J.P. Morgan and we get the sense that most still do not understand what happened.  The stories above are typical examples of this.  Until these losses are better understood, those that do not understand are going to be shocked in the months ahead by the continued “surprises” in this story and may eventually call for Dimon to be replaced.

So what exactly is being misunderstood in this story?  Namely, the positions that J.P. Morgan lost money on are still open and could grow many times over.  They are still open because they are so large J.P. Morgan cannot find counter-parties to close them.  Instead, the story above writes about these losses as if they are a one-time loss and the positions are already closed.

J.P. Morgan’s stock performed poorly again yesterday presumably because this position continues to move against them:

Zero Hedge (blog) – It’s Not Over Yet For JPM
IG9 10Y spreads re-surged today and were very choppy into the close as they broke back above 155bps (at 155.5/157.5bps now) for the first time since Mid-December with a 31% rip in the last two weeks. This fits perfectly with our ongoing thesis of this being a tail-risk hedge (not a simple ‘spread’ as other ignorant commentators presume) whose risk management has exploded in their face. While the skew (the difference between the index and its portfolio fair-value) has collapsed and arbs will be happy and likely exiting – the same correlation shifts (that we discussed earlier) that drove the big bank to sell more and more protection into a spread compressing market are now back-firing as systemic risk re-surges and the correlation shift is forcing them to buy back more and more protection into a spread decompressing market. Oh the fun of negative convexity – especially when you ARE the market and there is no-one to unwind the actual tranches to. While we among others expected the selling to slow as the skew collapsed, the secondary effect of the actual rise in systemic risk is now taking over and forces the bank to buy protection back into a rising spread market…

Source: Bianco Research

Comment or Read More at The Big Picture

Bugatti Veyron Super Sport

˜˜˜

Gumpert Apollo

˜˜˜

Hennessey Venom GT

˜˜˜

More after jump

Koenigsegg CCX

˜˜˜

Koenigsegg Agera R

˜˜˜

Saleen S7 Twin Turbo

˜˜˜

SSC Ultimate Aero

˜˜˜

McLaren F1

˜˜˜

Zenvo ST1

˜˜˜

Noble M600

Source: Market Watch

Good morning. Its time for some reads to start your Sunday:

• The Market Is Starting To Recognize Reality (Comstock Partners, Inc)
• Greece’s predicament: Lessons from Argentina (VOX EU)
• What Money Can’t Buy: The Moral Limits of Markets (B&N Review)
• 11 Brilliant Insights From Wall Street Legend Barton Biggs (Business Insider)
• Lessons From Trades Big and Bad (NYT)
• Dental Abuse Seen Driven by Private Equity Investments (Bloomberg)
• Sure Facebook has 900 million users, but its engagement is smoked by these other sites (Social Media)
• Bitter Frenemies (Foreign Affairs)
• An Enduring Condition: On War Time (The Nation)
• Every CNN Transcript Collection (2000-2012) (April 25, 2012) (Internet Archive)

What are you reading?

>
Global business barometer

Source: The Economist

Indian consumer prices rose by +10.36% in April YoY, as food prices increased, and higher than the +9.38% in March. Headline WPI rose to 7.2% in April, up from 6.9% in March. However, lower oil prices (particularly if sustained) will help materially in coming months;

The Bank of Spain reported that bad loans increased by 1/3rd over the last year to E148bn (over 3 months late). In March, bad loans rose to 8.37% of banks portfolio, the highest level since the property market collapsed and the highest since August 1994, up from a restated 8.30% in February. Some analysts suggest that bad loans may increase to 15% of the banks portfolio. Bank deposits rose slightly in March from February, but fell to E1.16tr or down -4.0% in the year to March 2012;

Spanish newspapers (El Mundo) report that Spain’s 2011 budget deficit will be even higher than previously reported (increased to 8.91% of GDP), from the previous 8.5% (which itself was far in excess of the 6.0% target), as several regions, including Madrid (though also Valencia, Andalusia and Castille-Leon), reported higher deficits – according to information from the Spanish Ministry of Finance. Here we go again. Spain claims that they will meet the target of 5.3% of GDP this year and 3.0% next. However, the EU forecast that Spain’s budget deficit will amount to 6.4% this year and 6.3% in 2013;

April’s ECB data reveals that lending to Spanish banks rose by 16% or E36bn to a record E264bn, accounting for 69% of total ECB lending to EZ banks. In contrast Spanish banks deposits at the ECB declined by 40% or approximately E35bn to approximately E53bn, well lower than the record of near E89bn, following the 2nd LTRO;

LCH Clearnet has raised the margin requirements on trading Spanish bonds. The news from Spain just gets worse and worse;

Just 1 more on Spain. Mr Hollande, the recently elected French President states that Spain will be able to use the EFSF/ESM to recap its banks. The rules need to be changed to allow this. However earlier in the day, Mr Ollie Rehn denied that Spain would require financial assistance from the EFSF/ESM in respect of it’s banks. Same old confusion. However, at the end of the day, Spain will require funding from the EFSF/ESM for it’s banks and itself;

Deutsche bank state that Irish banks may need more capital to cover as much as E4bn of additional bad loans than that assumed in last years stress tests. This will involve the Irish government requiring a further bail out. The Irish government has injected some E63bbn into it’s banking sector to date. The 10 largest Irish financial institutions have lost some E118bn in bad loans in the 4 years to last December. The Irish government claims that it’s banks have adequate capital, including appropriate buffers and will not need another bail out.
Most recent polls suggest that over 60% of the Irish population will vote in favour of the fiscal compact – I agree they will vote in favour. To do otherwise would mean that the Irish get no further access to funding;

The EU trade Commissioner stated that the EU is working on contingency plans in case of an exit by Greece from the Euro. Well great, but it would be better if Mr Karel De Gaucht just shut up. One of the big problems with the EU/EZ is too many people unnecessarily opening their mouths and just making the situation worse. Other EU sources denied the comments;

The BoE’s Adam Posen has become more dovish, stating that he was premature in stating that further stimulus was unnecessary. More QE is likely in the UK, but buying more gilts is futile, as the BoE already owns over 30% of the gilt market. Targeted purchases of mortgages would be far more useful, though the governor of the BoE, Mr Mervyn King, has expressed concern that such a course of action could involve the BoE taking unacceptable credit risks. I hope he changes his mind. Having said all that Paul Fisher, the BoE’s exec director for markets and on the Monetary Policy Committee stated that the BoE had concluded that the existing £325bn programme was sufficient, unless there were any “economic storms”;

Bloomberg and the WSJ reports that JPM’s losses on its huge derivatives and other instruments may rise to US$5bn. A definite whoops. The problem however is that these positions remain open (some say it will take till the end of the year to close) given their size and, as a result, the final bill will remain unknown for quite some time. In addition, hedge funds are likely to trade against these positions as they smell “blood in the water”. Regulators are scrutinising these trades far more carefully and I fear that more bad news is likely;

Employment rose in 32 US states in April lead by Indiana and Texas, whilst unemployment declined in 37 states, suggesting that the US labour market continues to improve. In addition, housing starts increased, with mortgage delinquencies lower, retail sales data was roughly as expected, industrial production and capacity utilisation higher, jobless claims slightly weaker and divergent (though suggests a slowing) Philly and Empire State data, though generally indicating some weakness. Overall, the data suggests continuing modest growth in the US;

In spite of stimulus measures, Brazil’s economic output declined by -0.35% in March MoM as opposed to a forecast of growth of +0.4% to +0.5%, making Brazil’s growth the 2nd slowest (after Argentina) in South America. Real GDP rose by just +1.1% in the 1st Q on an YoY basis, though slightly higher than the +1.0% in the 4th Q of 2011. Remember talk of the BRIC’s growth  “decoupling” from developed markets – just wonder where that’s gone !!!. It was and remains total rubbish;

Copper prices have turned negative for the year – not a good sign, as copper is a leading global economic indicator. In addition, various bullish trades by the Chinese may reverse – the Chinese have been using copper inventories as a source of financing given difficulties in accessing financing elsewhere, whilst ignoring the impact of a potential decline in prices. This could well be a definite whoops, as prices decline further;

Facebook’s IPO seems to have been a bit of a damp squib. The shares, priced at US$38 had to be supported by underwriters and closed at US$38.23, just +0.6% above the IPO price. Sure to attract the shorts. The weak performance adversely impacted markets/sentiment on Friday;

The CFTC reported last Friday that Hedge Funds and other money managers had reduced their long positions significantly in oil – to just 3.2 to 1 from 6.2 to 1 the previous week, the lowest since October 2011 and the equivalent of 54mn barrels – the largest decline since June 2006. However, the COT also reports that a category of investor defined as “other reportables” had increased their long positions and now have larger gross long and short positions and a larger net position in the market than hedge funds, CTA’s and other money managers. Who are the mysterious “other reportables”. I have my suspicions, but need to check out first. This issue could well prove to be important – watch it carefully (Source FT);

Outlook

Declines in energy, food and commodity prices will materially lower inflation in coming months – good news. A decline in inflation will provide Central Banks (FED, BOE, BoJ, ECB) the opportunity to consider further monetary easing measures, including addition QE by the FED and the BoE – the BoJ may also step up easing. The ECB is very likely to cut interest rates in the near future, though may wait until the outcome of the Greek elections is known ie a cut (25bps minimum, though possibly 50 bps) in July?, though it may be brought forward to June, if there is more bad news from Greece, later in the event of good news from Greece. However, I for one don’t believe that that will be sufficient and a resumption of bond purchases of, inter alia, Spanish and Italian debt by the ECB is very likely, particularly if Spanish yields rise to closer to 7.0%.

Portugal will need and will get another bailout – to be announced ahead of September (being 1 year ahead of the redemption of a large sovereign bond in September 2013) ie August at the latest, but most likely in June/July, to fulfill IMF requirements that a country must be able to finance itself 1 year hence – clearly impossible for Portugal. It would be great if at that time the EZ restructures Portuguese debt to sustainable levels. There is also a growing possibility of Ireland requiring a further bail out, even though the data (ex the banks) is improving.

All of the above, together with the total mess in the EZ, should weaken the Euro further in my humble view, in spite of my expectation that the FED will introduce another (version of a) QE programme.

Markets were weaker, yet again, last week. Whilst  I expect markets to open lower on Monday, I expect some stabilisation in the early part of the coming week. However, amongst other things, HSBC flash May Chinese PMI is due on Thursday – the odds are that it will disappoint (weaker A$ likely?), which may well put pressure on markets later in the week. Then you have the EZ……

Initial comments coming out of the G8 meeting are the same old hot air wishy washy claptrap that these meetings normally generate.

ECB policy will focus more on EZ countries ex Germany and, in particular, the peripherals, especially given Schaeuble’s comments that Germany would “accept” inflation within a “corridor” of 2.0% to 3.0%, something which I believe remains hugely significant, but (amazingly) seems to have been ignored by the markets to date.

Have a great weekend.

Kiron Sarkar

19th May 2012

Given the insane hype surrounding the Facebook IPO, it should really have come as no surprise to anyone that it’s being perceived as a massive flop. (A search at the NY Times website turns up no articles about Cisco Systems 1990 Initial Public Offering (Feb 16, 1990 at a split-adjusted price of $0.06); it does turn up a story that references Cisco’s Restaurant, Bakery and Bar in Austin, TX). In fact, it has been widely reported that the underwriters had to step in to prevent the stock from falling below its $38 issue price, which would have truly been an unmitigated disaster. While investors stood to make a bit of money from the Facebook IPO (if they timed their sale right), it clearly did not live up to the breathless media coverage of the last several weeks. It was all too reminiscent of the “Countdown to PALM” we were treated to a dozen years ago on CNBC (who remembers that?). And while the contrarian in me wants desperately to get long FB when I see “Experts Say Now’s Not the Time to Buy Facebook,” my gut tends to agree.

The wildcard in the FB offering, to me, was the fact that no one could quantify the brand name recognition and what its potential impact would be on investors’ appetites. With [fill in the blank] hundreds of millions of “users” (however you choose to define them), how many of them would want in? (20/20 hindsight answer: Apparently not enough.)

In the end, the age-old Wall St. adage proved true yet again: Retail investors should be circumspect (to put it politely) of any offering they’re able to get their hands on. If you can get it, chances are you don’t want it.

How does the syndicate process generally work on the retail side? Herewith, a primer.

Every office has a designated syndicate coordinator whose job it is to work as a liaison with the syndicate desk that handles the allocations to the branch offices. Once upon a time it was the coordinator’s job to poll his advisor colleagues for their interest (Indications of Interest, or IOIs, in street jargon) in each deal on the calendar and subsequently “indicate” for X shares of stock from the desk. Back in the day, the institutional/retail split was fairly equitable, and the coordinator could, with some exceptions, be fairly confident that he’d get the number of shares from the desk for which he’d indicated. The system worked for everyone.

Over the years, notably throughout the internet/technology bubble, Day One “pops” – huge gains from the issue price – became fairly common place, producing outsized profits for IPO recipients. Consequently, firms began to use IPO shares as carrots to their institutional accounts (to do additional business) and the institutional/retail split became absurdly lopsided in favor of the institutional side. Except, of course, when it came to REITS or companies that arguably should not have been going public in the first place (read: dogs that would open flat, trade down from there and never recover) – there was, is, and always will be plenty of those for the retail side of the house.

Although coordinators generally did a fair and equitable job of handing out the allocations they got from the desk, some squeaky wheels (every business has more than its share), decided they weren’t getting their due, or that coordinators were playing favorites to the whiners’ detriment, or that there was no clearly defined process (there wasn’t, really) or some such. Complaints and perhaps a lawsuit or two ensued, and a process was established for syndicate participation. But that’s another (fascinating) story.

Eventually, as the balance between institutional and retail allocations became more and more lopsided, the coordinator’s aggregate IOI to the desk became largely symbolic, as there became no chance retail would be handed enough stock to satisfy demand in even a lukewarm deal. I’ve heard of innumerable offerings where large retail offices (100+ advisors) get allocations of 500 or 1,000 shares total to divvy up among all those advisors. The notion of going to a high or ultra-high net worth client with 50 shares of a deal priced at $30 – a $1,500 principal investment – is beyond laughable. But that became the norm. Like Mom used to say at mealtime: “You have two choices for dinner: take it or leave it.”

Fast forward to Facebook. For weeks, perhaps months, every communique from syndicate desks street-wide cautioned retail offices that allocations would be very small and that clients’ expectations needed to be managed – standard language for any deal that has a decent chance for an opening day pop. It’s situations like those that are the syndicate coordinator’s worst nightmare – not nearly enough stock and way too many mouths to feed. This was the case right through last Thursday, when allocations were expected to go out to the offices.

And then came the stock. A flood of it. More than anyone, anywhere, expected. Advisors who’d indicated for stock got more than they’d asked for. Those who didn’t even indicate – or didn’t rank highly enough on the process-driven totem pole to get stock – suddenly found themselves awash in stock they never expected to get, and that they had told clients to forget about. The unconfirmed word was that FB had instructed its underwriters to broaden retail participation (but even that would not account for what was unleashed on retail).

And then the fun began. Given all the regulatory changes of the past few years, clients now need to certify their eligibility to participate in the IPO market. Yes, really, they do. A copy of the form they need to sign and submit can be found here. Well, guess what? Since retail syndicate has more or less become a running joke, no one had these forms on file. Hilarity ensued, as brokers emailed these forms to clients, who signed them and got them back (via fax or scan/email). They then had to be signed off on at both a local level and in document control, which was quickly overwhelmed to the point of multi-hour delays in processing. To all participants’ great credit, however, I hear any and all available resources were thrown at the problem and that, in the end, no one who wanted to participate was unable to do so.

In the end, no harm no foul, I suppose. Morgan Stanley and the syndicate stepped in to support the stock at $38, so no one who’d gotten IPO shares has (yet) taken a loss. Anyone who did not participate in the IPO had the opportunity, late in the day, to buy all they wanted at the IPO price. Who really comes out of this looking the worst, in my very humble opinion, is the media, which just can’t help itself these days. If it had not been all Facebook, all the time, 24/7, for the past month, perhaps this would not now be viewed as such a huge disappointment which, truth be told, it’s not. A new, different type of company (i.e. “social media”) went public – just like CSCO did in 1990. It is, as Zuckerberg said, a milestone, but by no means an end in and of itself. Absent the record-setting hype that surrounded this deal, things worked more or less the way they’re supposed to. It was the ridiculous doubles and triples of the late 90s early 2000s that were the anomalies.

Dr. Frankenstein’s Europe
By John Mauldin
May 19, 2012

“Had I right, for my own benefit, to inflict this curse upon everlasting generations? I had before been moved by the sophisms of the being I had created; I had been struck senseless by his fiendish threats; but now, for the first time, the wickedness of my promise burst upon me; I shuddered to think that future ages might curse me as their pest, whose selfishness had not hesitated to buy its own peace at the price, perhaps, of the existence of the whole human race.”

– The musings of Dr. Frankenstein about his creation of a monster, in Mary Shelley’s 1818 novel, Frankenstein

And later the monster answers:

“Shall each man,” cried he, “find a wife for his bosom, and each beast have his mate, and I be alone? I had feelings of affection, and they were requited by detestation and scorn. Man! You may hate, but beware! Your hours will pass in dread and misery, and soon the bolt will fall which must ravish from you your happiness forever. Are you to be happy while I grovel in the intensity of my wretchedness? You can blast my other passions, but revenge remains – revenge, henceforth dearer than light or food! I may die, but first you, my tyrant and tormentor, shall curse the sun that gazes on your misery. Beware, for I am fearless and therefore powerful. I will watch with the wiliness of a snake, that I may sting with its venom. Man, you shall repent of the injuries you inflict.”

In the classic novel by Mary Shelley (written when she was just 19!), she writes about a young doctor (the Frankenstein of the title) who defies nature and creates an ungainly monster, piecing together parts that were not designed to fit each other. Even though he gives the creature life, it eventually turns on him and his family. The unhappy monster, which develops into quite the rationalizing being, demands that Dr. Frankenstein create a female version of himself so they can flee civilization and find happiness. When Dr. Frankenstein decides not to follow through on his initial promise to do so (thus the first quote), the monster seeks revenge. It does not end happily.

The European Monetary Union was a triumph of hope over reason, pieced together from very dissimilar countries which, while sharing common borders, have very different cultures and economies. That it would eventually face an existential crisis was foretold by numerous critics at the time of its creation. The euro has never been a real currency. It was and still is an experiment, fashioned and shaped by a generation with noble ideas and vision, but tied together by an unworkable structure. Can its foundation be reworked into a solid structure? Or will natural centrifugal forces pull it apart? The difficulties that are faced are somewhat akin to fixing the engine of a jet plane while it is flying at 30,000 feet.

In today’s letter we explore the options that the eurozone faces in order to stay together, and what it all means for some of the countries involved. While I have written for a very long time about the probability of Greece exiting the eurozone, the actuality is fraught with risk, not just for Europe but for the world economy. What happens in the next few months will impact us all for a very long time. Indeed, this is one of those years, as Lenin noted, when decades happen. There is a lot to cover, and in future weeks we will go into more detail, but today let’s just step back and see if we can get the larger picture.

There Is No Easy Grexit

The term du jour for the possible exit of Greece from the eurozone is “Grexit.” It is a rather ugly sounding word for what will be an ugly process if it happens. A Grexit has several serious implications. (I wonder how the Chinese translators will render Grexit.)

The first is the risk of contagion. When Bear Stearns went bankrupt, the immediate question by the market was not how much did we lose, but who is next? As it turned out, it was Lehman. The rest is history. But it was a recent lesson that is still quite vivid in the memory of traders and investors.

Grexit calls into question the very existence of the European Monetary Union. Is it a union from which there may be no exit, an “all for one and one for all” union, or is it a club that one can choose to belong to or to leave? Certainly, it’s a club that offers very distinct privileges, but also one that imposes very high costs on both the member who leaves and the members who stay, who must pick up the bar tab of the fleeing member.

There are those who argue that there is no treaty provision that allows for the exit of a member of the eurozone. Therefore, under the rules, you simply can’t leave. That is a nice concept in theory, but each member of the eurozone still thinks of itself as a sovereign country with full rights of self-determination, including the right to be self-destructive.

It is kind of like telling South Carolina in 1861 that there is no provision in the US Constitution for a state to secede from the Union. South Carolina and ten other states soon decided they did indeed have that right, and the bloodiest war in US history was fought over that question. People who think they are part of a sovereign country tend to be jealous of that idea and resist any suggestion that there may be limits on their sovereignty. And while no one thinks that the rest of the eurozone would resort to any sort of coercive action, the manner in which Greece is allowed to leave (or pushed out the door) is of the utmost importance.

The “Troika” (the European Commission [EC], the International Monetary Fund [IMF], and the European Central Bank [ECB]) has set up budgetary expectations for Greece as a condition of getting loans to pay their current operating expenses. These conditions require Greece to reduce its deficit and balance its budget by cutting government spending and raising taxes, and by actually collecting the taxes that have not been paid. This idea of not spending more than you take in taxes is called austerity by its critics and simple common sense by its proponents.

But the program has resulted in 25% unemployment (50% among youth) and a deep five-year recession, with the likelihood of another 7% dip just this year alone. (Question: How long does a recession have to last until it becomes a depression? Recessions typically last at most two years in developed countries.) Government workers are losing their jobs, and profits are severely down, as are tax receipts.

Greeks recently voted overwhelmingly for parties that want to reject the austerity program in one way or another. It was an almost complete reversal of the margins that the two previously dominant parties tended to get. Those parties agreed on the need to accept the austerity measures, in order to be able to continue selling bonds to European governmental institutions (and the IMF), since the private bond market for Greece had simply ceased to exist, except for relatively small trades by speculators buying bonds that others were forced to sell.

And the government entities represented by the Troika wanted some assurance that Greece would not continue to run huge deficits, but would at some point in the future be able to return to the private bond market. That meant that there had to be a balanced budget. Otherwise, Europe would be funding Greece for decades, which would not sit well with European voters.

Even so, because of the very real pain caused by the austerity measures, Greek voters pushed back and resoundingly voted out the parties that had agreed to the measures. Because so many small parties with such different views garnered votes, there was no way to form a majority government, and so there will be another election June 17. The recent vote notwithstanding, opinion polls show more than 75 percent of Greek voters want to stay in the euro.

There is no way to know what will happen next month; the polls change every few days. And the Greek economy may be in much worse shape by June 17. The government is running out of money to pay its day-to-day bills. We are not talking just your basic police, fire, military, and other government-worker salaries, though those are very much at risk.

The austerity deal requires that Greece actually collect taxes that are owed. One of these is the property tax, which evidently almost no one paid. And some bureaucrat got the “bright” idea (pardon the pun) to collect the tax by adding it to people’s electric bills. People tended to pay their electric bills – the power was shut off if you didn’t. However, that didn’t work out so well. This from the Financial Times:

“The government had hoped to raise €1.7bn-€2bn from the levy in the fourth quarter of last year. But a massive unions-led civil disobedience movement against this ‘injustice’ scuppered that and a ruling that it was illegal to disconnect people’s electricity supply for non-payment sent the collection rate even lower. However, the memorandum of understanding with the IMF-EU signed in March demands that Athens collects a range of back taxes, such as the property tax from 2009 which was essentially never collected. So it will be interesting to see how the Troika reacts to these most recent developments. Ironically, the scale of non-payment means that the PPC itself (the power company) has run out of money. Last month it needed a €250m liquidity injection from the government so as to avert a nation-wide energy supply meltdown. So even less of the already-too-small pot of tax revenues is going to the government. The PPC has until end of June to find new sources of funding. It seems unlikely that people who stopped paying power bills last year are suddenly going to start now. While EU-IMF funding is still forthcoming, the overwhelming support for the anti-bailout parties as Greece heads for new elections next month puts an obvious question mark over future assistance. But the PCC experience suggests we really could be moving towards the IOU stage of this crisis as liquidity issues bite.”

So let’s get this straight. Now the government is running out of money and the power company can’t collect enough to pay its bills because Greeks simply aren’t made to pay, so the government has to subsidize the power company with money it doesn’t have.

The party that leads in various polls is called Syriza. A youngish firebrand has convinced many Greeks that the austerity program must stop but that Europe should and will continue funding them. Let’s take this straight from the Wall Street Journal:

“ATHENS—The head of Greece’s radical left party says there is little chance that Europe will cut off funding to the country, and if it does, Greece will repudiate its debts.

“In an interview, Alexis Tsipras, the 37-year-old head of the Coalition of the Radical Left, also known as Syriza, warns that financial collapse in Greece would drag down the rest of the euro zone. Instead, he says, Europe must consider a more growth-oriented policy to arrest Greece’s spiraling recession and address what he calls a growing ‘humanitarian crisis’ facing the country.

” ‘Our first choice is to convince our European partners that, in their own interest, financing must not be stopped,’ Tsipras said in an interview with The Wall Street Journal Thursday. ‘If we can’t convince them—because we don’t have the intention to take unilateral action—but if they proceed with unilateral action on their side, in other words they cut off our funding, then we will be forced to stop paying our creditors, to go to a suspension in payments to our creditors.’

“According to recent opinion polls, Tsipras’ party is poised to win the most votes in repeat elections next month, bettering its surprise, second-place finish in an inconclusive May 6 vote that left no party or coalition with enough seats in parliament to form a government.”

Call me skeptical, but I fail to see how a young man who has never been at a negotiating table with any of the Troika (and who has apparently never talked with a German banker) can think he can hold Europe hostage.

“Tsipras says that, if push comes to shove, Greece can manage on its own. By not paying its debts, the country will have enough cash to pay its workers and retirees. He also proposes cuts in defense spending, cracking down on waste and corruption, and tackling widespread tax evasion by the rich.”

While such a platform might qualify him to run for US president, I somehow don’t see it convincing anyone that Greece is on a path to a balanced budget. Especially when he wants to quash the austerity programs that were agreed to, in order to secure the last round of funding.

A Rational Bank Run

The entire issue is made worse by the fact that there is a very real run on Greek banks. The FT reports that €5 billion has left Greek banks in just the last two weeks, some 3% of the total remaining deposits, by my calculation. As Mervyn King, the governor of the Bank of England noted during the Northern Rock crisis, “Once a bank run has started, it is rational to join in.”

The more that Greek citizens feel it is possible that Greece will leave the euro, the more likely they are to pull their money from Greek banks and send it abroad. Everyone in Greece is reading about the bank run, and the lines at the banks next week will be longer than the ones this week. And in today’s world there is no need to stand in line. The bank run can be entirely executed by computer. You simply open an account in another country and wire the money out.

That means the very cash that is needed by businesses small and large is fleeing the country. There is little investment in equipment or services, beyond what is absolutely necessary. Forget about getting a small-business loan at a bank. The ECB has already said it cannot continue to fund four Greek banks (talk about yelling fire in a crowded theater!), although those banks can get funded by the Greek central bank, which can get money from the ECB.

The primary resource that is needed to create growth is confidence, and that is in short supply in Greece. And if you’re in another country and thinking about investing in Greece, it makes sense to wait and see what will happen. Maybe prices of things you want to buy will be much more attractive if the banking system collapses. A few months after the collapse, someone will get around to selling the assets and loans of the banks, which may be in drachmas at the time, so your euros or dollars will go a LOT farther. Distressed loans and a currency revaluation? That smells like opportunity.

When Argentina collapsed, last decade, those who went in with cash were able to get some very good properties and deals. I could go down a list of such potential opportunities, but they will be there. At least Greek beaches are not going to be taken away. While it has been 25 years since I was there, I still remember how beautiful they were. There is a reason tourism in Greece is 20% of the economy. And that will be there no matter what currency Greece uses.

I said it was important how Europe deals with Greece, whether it stays in the euro or leaves. If Europe gives in to the demands for more money without a real plan for a path to a balanced budget, then they are sending a message to the voters of Spain, Portugal, Italy, and Ireland. Ireland goes to the polls in a few weeks. Spain already has Greek-like 25% unemployment. The frustration that Spain and the other countries feel with their own austerities is very real and getting worse, and the Troika knows it.

That is the reality that Greece faces. If they vote to stop the austerity, it is likely that Europe will simply not fund their loans. If Greece is not going to pay anyway, why not just pay off the loans or write them off? The thinking will be, “Why give them more money to spend when they are not living up to the agreements? These things can’t be negotiated with every new government. There has to be some continuity.”

But staying in the euro does not solve Greece’s most significant problem. Greece has a serious trade deficit. Its workers are not as productive as those in the core of Europe, and relative wages need to come down. And while that is easy to say in the abstract economic world, it is hard to do in the real world. What Greek worker thinks he is overpaid by 30% relative to a German worker? Try and sell that in Athens.

But that is the judgment of the market. And until the trade imbalance is solved, there will be no lasting solution to the Greek crisis. The imbalance will either be solved by a swift change of currency and a revaluation of the new drachma or a slow, tortuous process that could result in more than a decade of recessions and slow growth, with chronic high unemployment.

Greek Fatigue

Europe is visibly getting weary of dealing with Greece. Just as Hank Paulson eventually gave up trying to convince Dick Fuld to accept a rescue of Lehman Brothers on realistic terms, Europe may grow tired of being only one election away from yet another Greek crisis. And while Greeks may be tired of austerity, and they are, they have not yet come to the realization that the rest of Europe may not be willing to let them live as they want.

Greece will not be kicked out of the euro, but it is entirely possible and even likely that their funding will dry up without a continued austerity program. And that will eventually push voters to demand a government that promises them a return to their own currency. “How could it be worse?” they will think. But for a year or so it will get worse. Then it will get better. But the changes will be severe.

The Alligator of Bank Runs

If and when Greece exits the euro, the ECB must be prepared to step in with massive funding of peripheral-country banks and sovereign debt. That is not within their charter today; but when the euro is at total risk, that is the only way to save it.

As the joke goes, it is hard to remember that the original project was to drain the swamp when you are up to your neck in alligators. The “alligator” that will immediately face Europe after a Greek exit is bank runs in Spain and Italy. There must be the creation of a European-wide institution to insure deposits, in order to stop bank runs. Inexplicably, Europe does not have the equivalent of an FDIC, but if they are to survive they’d better get one.

Further, a Greek exit will mean even more defaults and losses, not only on Greek government debt but on their private debt as well. I know, the law says the contracts are in euros, not drachmas. But the Greek government will pass a law that says all debt owed by Greek citizens will be paid in drachmas, or something to that effect. And Greek citizens have to obey the law, don’t they? Exactly who are you going to send to repossess my property (car, home, equipment, etc.)? As we kids used to say when someone wanted to make us do something, “Yeah? You and what army?”

Businesses will get very concerned about doing business with citizens of a country that might leave the euro. If Greece is allowed to set a precedent by leaving, there must be clear rules for the reconciliation of contracts.

And there must be a massive show of support for Spanish and Italian sovereign debt, to convince the market that Germany and the other core countries are serious. We are talking multiple trillions of euros will be needed, if the interest rates on Spanish and Italian debt are not kept in check. That may mean the ECB will have to monetize debt for a time. Or they can change the rules and allow the European Stability Mechanism (ESM) to function as a bank, which would essentially allow the ESM to borrow from the ECB a relatively unlimited amount of capital (just 20 times leverage of €400 billion is a LOT of euros). That should buy all the time needed.

And then they have to deal with the whole fiscal union concept. As so many people said at the beginning of the euro experiment, you can’t have a real monetary union without a fiscal union. But that is a story for another letter.

So, let’s sum up. Greece will either have to continue with austerity to get any more money or leave the euro. The latter is more likely at some point, because sooner or later the voters will elect a government that will make that choice. And it may happen quite soon.

Right now, it would be difficult for the eurozone to guarantee Spanish bank deposits, for instance, and not guarantee Greek deposits. I suppose they could cook up a reason, but it would not be seen as the right thing to do in polite circles. And if a run on Spanish banks happens while waiting for Greece to make up its mind? What then? That will be a crisis on steroids.

Europe is going to either have to abandon the idea of a complete monetary union and let some nations go, or it is going to have to print massive amounts of money. Most likely it would be the ECB that turns on the presses, although making the ESM a bank could be an option if things get really bad. It all depends on how badly the Germans want to keep the euro together and what they will pay for doing so. Right now, the polls say they will do whatever it takes, even if they don’t like it. If inflation gets to 4-5%, then let’s ask the question again.

And I know some of you are thinking, how can he be talking trillions? Easy. Greece’s commitments alone to various European entities (the ECB, their portion of the ESM, EIB, etc.) run to about €500 billion. Add to that what private contract losses would be. Then realize that Greece is quite small compared to Spain or Italy. Yes, I know, Italy and Spain are not Greece; but the bond market is getting nervous. Spanish yields spiked to 6.5% at one point this week. The eurozone must commit to keeping peripheral interest rates low while countries struggle to get their budgets under control. That will not happen overnight, nor will it be cheap. It may cost Europe trillions. As in, more money than anyone can wrap their head around.

(Sidebar: I’m thinking the ECB is going to cut rates shortly.)

And the rest of the world had better hope they get it right. European banks are almost three times larger than US banks and finance much of world trade. A weakened European banking system is not good for anyone. Yes, emerging-market banks, private banks (hedge funds and sovereign funds), and even US banks can step in and, over time, make up the difference. Bu the operative words are “over time.” Building up the institutional infrastructure to finance global trade has taken decades. It wouldn’t take that long to do it again, but it would not be just a year. There could be large disruptions.

And that is not to mention European consumers and their imports, which would suffer in a prolonged European recession. Which would of course affects world trade and global GDP.

European leaders have given us an experiment called the euro. Will it be like Frankenstein’s monster and turn on them? Have they defied the natural order of Europe, or tamed the beast that raged for a thousand years? Have they created something that mankind will dearly wish they hadn’t, and suffer for their hubris?

Or will the euro yet become a Hercules, capable of performing astounding feats for the greater good? We are at the critical moment of the experiment, when the results are not yet clear but everyone can see that we won’t have to wait much longer.

Who Gets the Old Maid?

A popular card game for children is called Old Maid, which is played with a deck with an extra queen. The cards are dealt and the players trying to match their cards (a 3 with another 3, or a king with another king, for instance) until they can play all their cards. And of course you must trade cards with other players. When one person has no cards left, whoever has the Old Maid (the solitary queen) loses. There is some strategy involved, as if you have the Old Maid early, you might not pass it until close to the end, so it cannot come back to you.

Which brings to mind the balance sheet of the ECB, and leads to some rather dark thoughts. If Greece leaves, then at best the ECB will only get drachmas in return for the euros on the Greek account. IF Greece decides to pay anything at all. (My bet is that if they do pay, there will be strings attached that say the ECB must hold the drachmas for a very long time, so as not to hurt the currency.)

OK, but that increases every remaining eurozone member’s commitment by around 2.5% of the remaining balance. And then what if Portugal or Spain leaves? Or, heaven forbid, Italy? Your commitment just grew by a rather large amount. Not to mention your portion of the ESM, EFSF, EIB, etc.

On the way to a Nash equilibrium, the players all try and anticipate the moves and rationale of the other players, plus what their levels of pain tolerance will be. And then they adjust their own positions.

At what point does it occur to the voters of a country that they are taking on more debt than they can bear? How much European solidarity is really there? Is there an unlimited amount of pain that can be tolerated? I rather think there is a limit; we just don’t know what it is, or even if we could ever conceivably get there.

At what point does a country decide it does not want to be stuck with the Old Maid? Will Greece be allowed to walk away from its commitments? And if it tries, what will be the consequences? I know there is no mechanism for any of this, but someone had better be doing some serious planning around it, because you can bet a lot of investors are privately calculating how things will play out. This can all be handled, if you decide to deal with the issues openly.

So what am I worried about? We all know that developed countries do not default on their sovereign debts: the banking regulators of Europe have told us so. And if you can’t trust a banking regulator to know what he’s doing, then who can you trust?

Atlanta, New York, Philadelphia, Italy, and Singapore

I leave for Atlanta Tuesday and get back Thursday morning. I am then home for a whole ten days before I take off to New York for a meeting and then on to Philadelphia for the CMG Advisor Forum with my good friend Steve Blumenthal. He has assembled an outstanding group of speakers. Details to follow, but if you are an investment advisor you should consider coming. You can call CMG at 610-989-9090.

I have a few other events on the calendar, but the next big trip will our third-annual vacation to Tuscany. I do love Tuscany and am looking forward to seeing friends and relaxing a little bit. Then in July I will be going to Singapore for a speaking engagement, and will try and see more of that country. I really liked it when I went earlier this year.

And speaking of Frankenstein, I think Mary Shelley wrote the first true science-fiction novel, creating a whole new genre of literature. She took what was known as science (or at least scientific lore) and extrapolated into the realm of “what if,” giving us a tale that called into open discussion the nature of life and existence. And to do that while still a teenager? When today our students write papers in English classes that leave us wondering about what we allow to pass for literacy in our educational system?

This has come to mind while watching a YouTube video about my friend David Brin’s new book which, almost 200 years after Mary Shelley, deals with the very same issues, but with a very modern twist and cutting-edge science. The book is titled simply Existence, and it will be out in June. A Science Fiction Hall of Fame writer, David weaves a great story while making us think about the purpose of life. You can see the video (about 4 minutes) at http://youtu.be/cn6GqxeOvn4

It is once again time to hit the send button. It is early Saturday morning and I need to get some rest to prepare for another action-packed week of trying to figure out the ontological meaning of the existential angst in Europe that is caused by the dilemma of Greece. Or, in layman’s terms, “What the hell are they thinking?”

Have a great week.

Your happy to be existing at very this moment in time analyst,

John Mauldin

John@FrontlineThoughts.com

Why Foxes Are Better Forecasters Than Hedgehogs from The Long Now Foundation on FORA.tv

>

From his perspective as a pyschology researcher, Philip Tetlock watched political advisors on the left and the right make bizarre rationalizations about their wrong predictions at the time of the rise of Gorbachev in the 1980s and the eventual collapse of the Soviet Union. (Liberals were sure that Reagan was a dangerous idiot; conservatives were sure that the USSR was permanent.) The whole exercise struck Tetlock as what used to be called an “outcome-irrelevant learning structure.” No feedback, no correction.

He observes the same thing is going on with expert opinion about the Iraq War. Instead of saying, “I evidently had the wrong theory,” the experts declare, “It almost went my way,” or “It was the right mistake to make under the circumstances,” or “I’ll be proved right later,” or “The evilness of the enemy is still the main event here.”

Tetlock’s summary: “Partisans across the opinion spectrum are vulnerable to occasional bouts of ideologically induced insanity.” He determined to figure out a way to keep score on expert political forecasts, even though it is a notoriously subjective domain (compared to, say, medical advice), and “there are no control groups in history.” – The Long Now Foundation