Video: Michael Burry 2012 UCLA Commencement Address

Video: Niall Ferguson's China: Triumph and Turmoil

Link to video here. (Non UK-based viewers will need to use a proxy.)

For more on the subject of China and the West here is Standpoint's recent interview with Niall and Dambisa Moyo.

Recapping The PolyCapitalist's 2011 Predictions

For those keeping score three topics I made 2011 forecasts on were:

1. Rise of Android
2. China's bubble
3. U.S. Housing

On Android, the verdict is in:

The U.S. housing market officially double dipped in May and then continued to fall, so that call looks correct as well.

The China prediction is a bit murkier, but here are some points worth noting:

• The Hang Seng and Shanghai stock markets are in a bear market and down roughly 20% for the year, or 30% since May. From its peak in 2008 Shanghai is off 60%.
• Housing prices are softening quickly; in Beijing new home prices dropped 35% in November alone.
• Coastal cities such as Wenzhou and Ordos appear to be experiencing a credit crisis with reports of businessmen leaping off rooftops.
• Hot money appears to be flowing out of the country: China's $3.2 trillion in foreign reserves have been falling for three months despite a trade surplus.

Things aren't shaping up too well for China or trade relations with the U.S. in 2012 either. For more on this see here, here, here and here.

Overall, does 2.5 out of 3 predictions sound about right?

Two more quick ones: bullishness on gold has been a steady theme since starting this blog in May 2010. And how did gold do in 2011? Despite the autumn selloff gold priced in U.S. dollars has returned around 10%. Not too shabby given that the S&P500 is flat YTD. I also managed a correct mid-year bearish call on the euro.

Check back later for The PolyCapitalist's 2012 predictions.

Steve Keen on How He Saw "It" Coming and Why We're in a Depression

A must watch interview with Economist Steven Keen, the first part of which is embedded below (remaining parts can be found here).

Video: Kyle Bass' Full BBC Hardtalk Interview

"Capitalism without bankruptcy is like Christianity without Hell" and other choice comments from the hedge fund manager profiled in Michael Lewis' most recent book, Boomerang.

h/t Zerohedge

Recommended links

1. Is there a shadowy plot behind gold? (FT)

2. Ray Dalio video interview (Charlie Rose). Ray doesn't have the most compelling television presence, but as the world's largest hedge fund manager he's clearly doing something right. Here is an interesting earlier read from the New Yorker on him and his firm, Bridgewater.

3. Eurozone summit - despair and backbiting in the corridors of power (Telegraph)

4. Steve Jobs Was Willing To 'Rip Off' Everyone Else... But Was Pissed About Android Copying iPhone? (TechDirt)

5. Michael Pettis Talks China (Infectious Greed)

6. €1.5bn Dexia loans used to buy shares in...Dexia (FT)

7. Generation X Doesn’t Want to Hear It (Emptypage)

Video: Jim Chanos - China Real Estate Meltdown in the Early Innings

Video after the jump:

Michael Lewis on Bankrupt California

It's Michael Lewis week here at the PolyCapitalist.

His latest in a series of financial disaster pieces he's been penning for Vanity Fair is about his home state of California. The whole article is a must-read (here's a link to the full article) but below are a some of the highlights:

But when you look below the surface, he adds, the system is actually very good at giving Californians what they want. “What all the polls show,” says Paul, “is that people want services and not to pay for them. And that’s exactly what they have now got.” As much as they claimed to despise their government, the citizens of California shared its defining trait: a need for debt. The average Californian, in 2011, had debts of $78,000 against an income of $43,000. The behavior was unsustainable, but, in its way, for the people, it works brilliantly.

On the fiscal nightmare that is the City of San Jose...

The ex-Governator

The relationship between the people and their money in California is such that you can pluck almost any city at random and enter a crisis. San Jose has the highest per capita income of any city in the United States, after New York. It has the highest credit rating of any city in California with a population over 250,000. It is one of the few cities in America with a triple-A rating from Moody’s and Standard & Poor’s, but only because its bondholders have the power to compel the city to levy a tax on property owners to pay off the bonds. The city itself is not all that far from being bankrupt. 

By 2014, Reed had calculated, a city of a million people, the 10th-largest city in the United States, would be serviced by 1,600 public workers. “There is no way to run a city with that level of staffing,” he said. “You start to ask: What is a city? Why do we bother to live together? But that’s just the start.” The problem was going to grow worse until, as he put it, “you get to one.” A single employee to service the entire city, presumably with a focus on paying pensions. “I don’t know how far out you have to go until you get to one,” said Reed, “but it isn’t all that far.” At that point, if not before, the city would be nothing more than a vehicle to pay the retirement costs of its former workers. The only clear solution was if former city workers up and died, soon. But former city workers were, blessedly, living longer than ever. 

This wasn’t a hypothetical scary situation, said Reed. “It’s a mathematical inevitability.” In spirit it reminded me of Bernard Madoff’s investment business. Anyone who looked at Madoff’s returns and understood them could see he was running a Ponzi scheme; only one person who had understood them both­ered to blow the whistle, and no one listened to him. (See No One Would Listen: A True Financial Thriller, by Harry Markopolos.) 

“How on earth did this happen?” I ask him. 

“I think we’ve suffered from a series of mass delusions,” he says. 

I didn’t completely understand what he meant, and said so. 

“We’re all going to be rich,” he says. “We’re all going to live forever. All the forces in the state are lined up to preserve the status quo. To preserve the delusion. And here—this place—is where the reality hits.” 

...and the bankrupt hell that is the City of Vallejo:

On the way back to the elevators I chat with two of Mayor Reed’s aides. He’d mentioned to me that, as bad as they might think they have it in San Jose, a lot of other American cities have it worse. “I count my blessings when I talk to the mayors of other cities,” he’d said. 

“Which city do you pity most?” I ask just before the elevator doors close.

They laugh and in unison say, “Vallejo!” 

I notice on his shelf a copy of Fortune magazine, with Meredith Whitney on the cover. And as he talked about the bankrupting of Vallejo, I realized that I had heard this story before, or a private-sector version of it. The people who had power in the society, and were charged with saving it from itself, had instead bled the society to death. The problem with police officers and firefighters isn’t a public-sector problem; it isn’t a problem with government; it’s a problem with the entire society. It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences. It’s not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They’d been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans. 

The evolutionary explanation underpinning society's collective behavior:

The road out of Vallejo passes directly through the office of Dr. Peter Whybrow, a British neuroscientist at U.C.L.A. with a theory about American life. He thinks the dysfunction in America’s society is a by-product of America’s success. In academic papers and a popular book, American Mania, Whybrow argues, in effect, that human beings are neurologically ill-designed to be modern Americans. The human brain evolved over hundreds of thousands of years in an environment defined by scarcity. It was not designed, at least originally, for an environment of extreme abundance. “Human beings are wandering around with brains that are fabulously limited,” he says cheerfully. “We’ve got the core of the average lizard.” Wrapped around this reptilian core, he explains, is a mammalian layer (associated with maternal concern and social interaction), and around that is wrapped a third layer, which enables feats of memory and the capacity for abstract thought. “The only problem,” he says, “is our passions are still driven by the lizard core. We are set up to acquire as much as we can of things we perceive as scarce, particularly sex, safety, and food.” Even a person on a diet who sensibly avoids coming face-to-face with a piece of chocolate cake will find it hard to control himself if the chocolate cake somehow finds him. Every pastry chef in America understands this, and now neuroscience does, too. “When faced with abundance, the brain’s ancient reward pathways are difficult to suppress,” says Whybrow. “In that moment the value of eating the chocolate cake exceeds the value of the diet. We cannot think down the road when we are faced with the chocolate cake.”

Lewis concludes on an optimistic note:

When people pile up debts they will find difficult and perhaps even impossible to repay, they are saying several things at once. They are obviously saying that they want more than they can immediately afford. They are saying, less obviously, that their pres­ent wants are so important that, to satisfy them, it is worth some future difficulty. But in making that bargain they are implying that, when the future difficulty arrives, they’ll figure it out. They don’t always do that. But you can never rule out the possibility that they will. As idiotic as optimism can sometimes seem, it has a weird habit of paying off.

For more Michael Lewis, both past and present, simply click on the tag with his name at the bottom of this post.

Video: Niall Ferguson on the Likelihood of a China Hard Landing

Video after the break.

Video: Meltdown - Documentary (all 4 parts) on the Financial Crisis

h/t Barry R.

Video: Jim Chanos' Latest Thoughts on China

Video: Robert Shiller on Why Housing Has Not Bottomed

Video: Profile of Michael Burry of 'The Big Short'

How to Fix Our Optimism Deficit

Europeans, Japanese, and even rose-colored glasses wearing Americans are suffering from what has been described as an 'optimism deficit'. This rather unthreatening sounding phrase should not be mistaken for an insignificant economic problem.

Optimism fuels all sort of important economic activities, such as entrepreneurship, saving for the future, and social cohesion. It may in fact be the most fundamental immediate challenge facing the developed world today. But with pre-election political gridlock setting in, our leaders are big on rhetoric and short on concrete actionable ideas which can restore confidence.

There is one idea, however, that I believe could make a significant impact on restoring optimism, but before getting to that a brief personal backstory.

Blowing Bubbles

I lived in San Francisco and worked in tech during Dot Com bubble and bust a decade ago, and it taught me a lot of lessons. But perhaps the most important one didn't come until several years afterwards.

Having been away from California for a few years since the burst, I moved back (this time to Southern California) in 2003. To my disbelief I began noticing similarities between the still nascent housing bubble and the one which I had just recently had a front-row vantage. The tech bubble seemed still too fresh in my mind for the kind of speculation on housing that was taking place. While the assets were different (tech stocks vs. real estate), the underlying psychology was eerily familiar.

I did not have the foresight of Michael Burry, Steve Eisman, and the founders of garage startup hedge fund Cornwall Capital to cash-in on this observation. Instead I simply ignored peer pressure and pesky real estate salespeople who warned me that if I didn't purchase a home now I would be "priced out of the market forever". Another memorable ribbing from that era was the "you're throwing your money down the drain" by renting year-after-year. When the 2008 financial crisis hit it made the Tech Bubble look like a small financial radar blip.

Forget-Me-Nots

Witnessing two significant financial crashes in such close proximity to each other left an indelible lesson, which was to never underestimate how quickly a large number of people can forget a traumatic financial event.

This month marks the four-year anniversary from what was arguably the canary in the coal mine moment, the July 2007 collapse of two Bear Stearns hedge funds, both of which were heavily invested in mortgage securities. Bear Stearns itself blew-up approximately nine months later, and it would take until September 2008 for the crisis to reach its nadir with the simultaneous implosion of Lehman Brothers, AIG, Merrill Lynch, and a bevy of other financial firms.

The case of Citigroup bears special mention. Its collapse and bailout marked the third time in last quarter-century that the firm needed to be rescued by the government (the other two instances being the 1982 Latin America debt crisis and the late 1980s bust in commercial real estate which sparked the S&L crisis). Yes, that's right, about once every 8 years on average Citibank blows-up and needs a taxpayer funded bailout. If an inglorious banking prize equivalent to baseball's golden sombrero doesn't already exist then one should be created and promptly awarded to Citi!

While Rogoff and Reinhart caution against the following type of thinking, I do suspect that this time is different from 2003-2004. I don't believe as many people have forgotten the financial crisis as did the dot com bust, and not just because the 2008 crisis was much more spectacular in its magnitude. There are two big differences between then and now:

1. Protracted high unemployment, which in the U.S. is at 9.2%, and in places like Spain is over 20%.

2. The sovereign debt crisis that is hitting not just European countries such as Greece, but is also hammering away at confidence in the U.S. with daily headlines about nearing the debt ceiling.

A sense of widespread and growing economic unease can be seen in recent polling data:

A New York Times/CBS News poll finds that 39 percent of respondents believe “the current economic downturn is part of a long-term permanent decline and the economy will never fully recover.” (in October, only 28 percent of people believed the U.S. economy was in permanent decline -- marking an 11-point increase between now and then) 

The survey is only one of a recent spate indicating widespread distress over the state of the economy. On June 8, a CNN poll found that 48 percent of Americans believe another Great Depression is either very likely or somewhat likely.

The 2008 financial crisis was a severe blow to economic confidence and optimism, by far the biggest since the Great Depression. The most important and personal asset for the vast majority is housing, which lost one-third of its value from the peak and recently began a double dip. This combined with high unemployment and the suffocation of too much debt is at the heart of the current economic unease.

What Did Taxpayers Receive in Exchange for Bailing-out Banks?

The fundamental instability of the financial system was laid bare for all to see during the 2008 crisis. The public also got a glimpse of just how dangerous Too Big to Fail financial institutions are as governments around the world rushed to bailout megabanks and firms like AIG with taxpayer money. What did taxpayers get in exchange? As much as Paul Volcker, Adair Turner, Sheila Bair, and other well meaning and respected technocrats would like us to believe that Dodd-Frank, Basel III, etc. repaired the foundational cracks, the ongoing sovereign debt crisis casts serious doubts on these claims.

Today, people aren't wondering whether the next proverbial shoe will drop. People are instead bracing for when the next economic tsunami will make landfall. Will it be this week with Greece, end of this month with the U.S. debt ceiling, or sometime around the next major elections, when historically (and peculiarly) financial crisis seem to appear? The exact timing is uncertain, but there is broad understanding that another major financial crisis will strike, and perhaps soon.

This sense of pending chaos has left many people in a state of economic paralysis and dealt a collective blow to confidence and optimism. As Austin Powers would put it, we've lost our economic mojo.

A Key to Fixing Our Optimism Deficit

A big key to restoring economic optimism is the establishment of a sturdy foundation for the financial system.

Our current financial system is opaque and not well understood by the general public or many experts, such as macro economists, almost all of which failed to see the crisis coming. Apocalyptic terms are often employed when discussing it, and a fear that it may come crashing down at any moment feeds existential worry and creates a drag on productive economic activity. For example, concern of another crash inhibits lending and investment, reduces entrepreneurial risk taking, and may be responsible for the stockpiling of cash we're seeing at many large corporations, like Apple which is sitting on approximately $60 billion.

How best to provide the financial system with a rock solid foundation? Is simply restoring Glass-Steagall enough? I don't think so.

The most far-reaching, comprehensive and achievable plan is the one outlined by Professor Laurence Kotlikoff, which he calls Limited-Purpose Banking. I believe that title may in fact do a disservice to his well thought through ideas, which go far beyond banking and include insurance and other areas of the financial system (e.g., regulatory consolidation of the 120 government agencies currently charged with supervising various elements of the financial system).

Professor Kotlikoff has written a book on his ideas, which you can find in the Good Books and Films section of the right-side column of this blog, titled Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking (the Stewart reference is to the thespian's role as the likeable community banker, George Bailey, in It's a Wonderful Life). You can listen to an excellent talk he gave at the London School of Economics here. His proposal has generated bi-partisan political, regulatory and intellectual support around the world. Mervyn King of the Bank of England has been one of its foremost champions.

Without going into all the technical details, Limited-Purpose Banking basically removes leverage from the financial system and makes the entire system more like mutual funds, which did not collapse or suffer from fraud during the recent financial crisis.

Here are some of the promises of Limited-Purpose Banking:

• We’ll never have another financial collapse.
• We’ll never see a run on banks ever again. 
• We’ll never see insurance companies insuring the uninsurable. 
• We’ll get rid of all the con jobs underlying the current financial system. 
• There will be no more insider rating deals, liar loans, director sweetheart deals, bonuses which amount to corporate theft, bribing of Congress. 

In short, we’ll have a financial system that’s honest and that we can trust. The financial plague will be cured, once and for all.

Interview with Larry Kotlikoff Author of "Jimmy Stewart Is Dead" from Daniela Guernica on Vimeo.

To bring back economic optimism we must build a new, more stable foundation for economic activity. This foundation can be created with a new financial system like the one proposed by Professor Kotlikoff, who is quite optimistic about the likelihood that his ideas will ultimately be implemented. It may take one more financial crisis and bailout of the banks to get the public and politicians on board with this type of reform, but I agree with Professor Kotlikoff that something along the lines of the reforms he's outlined will happen eventually.

FDIC's Bair: "They Should Have Let Bear Stearns Fail"

Today's must-read interview is with just-departed FDIC Chairwoman Sheila Bair, who sets the record straight on:

• where Paulson, Bernanke, and Geithner went wrong (e.g., bailing out Bear Stearns)
• the disconnect between President Obama's 'heart' and the people he chose for his economic team 
• what the future holds for Too Big (or more accurately 'Too Bigger') to Fail

Bair's argument on letting Bear fail is that it would have sent a strong signal to the larger, more systemically integrated firms, like Lehman, that they should raise capital because the government was not going to bail out everyone. Whether Lehman could have in fact raised sufficient capital in the wake of Bear being allowed to fail is a great counterfactual question. 

One has the impression from reading Sorkin's Too Big to Fail that Dick Fuld and Co. either expected Paulson to bail Lehman out, or that the storm would pass soon enough for the prices of Lehman's assets to recover. Paulson purportedly appealed directly to Fuld to raise capital on numerous occassions in 2008. However, given the Federal Reserve's bailout of Bear, Fuld's skepticism that the systemically more important Lehman would be allowed to go under is understandable. If Bear had been allowed to fail Fuld likely would have come away with an entirely different interpretation of how things might play out should his back get pushed up against the wall, as it did during that fateful September of almost three years ago.

The interview also makes reference to former CFTC head Brooksley Born. For anyone who hasn't watched it already I highly recommend Frontline's profile of her battle with Greenspan, Rubin and Summers on the regulation of derivatives, a Wall Street product which Warren Buffet has called "financial weapons of mass destruction".

The Greatest Trick Lenders Ever Pulled?

A pretty good candidate in my mind was substituting the term 'credit' for 'debt'.

Not all too long ago, 'debt' was clearly understood as something that, simply put, was bad.

But 'credit'? Oh boy, give me some of that!

There is a lot more to the credit/debt bubble than rebranding. But it's interesting to observe the different terms used for the same or like things, and the effect such differences can have on adoption and/or support. Some other examples:

• 'Orderly resolutions' vs. 'bailouts'
• 'Quantitative easing' vs. 'printing money'
• 'Macroprudential regulation' vs. 'financial repression'
• 'Department of Defense' vs. 'Department of War'

The observation on swapping 'debt' for 'credit' and other interesting thoughts from this talk and Q&A with novelist (and non-economist) John Lanchester.

The Flaw Movie Trailer

The Guardian reviews and compares this film to Charle's Ferguson's Academy Award winning Inside Job here.

Video: Jim Chanos on Why China is a Bigger Bubble than LinkedIn

Video: Jim Chanos on China Real Estate Bubble

Video: China's Empty Cities

Pretty rosy view from Bloomberg's Adam Johnson in the below video. For an alternative view, see these videos from Hugh Hendry and Jim Chanos.