John Thain, head of Merrill Lynch was fired by BofA chief, Ken Lewis, last week, after the Financial Times revealed that he had accelerated several billion dollars of executive bonuses. The bonuses were made possible after a bailout. In other words, tax payer cash is ironically what prevented this from being illegal conveyance of funds in a bankrupt company.

Anyone who has worked in an American company of even modest size will know that politeness to departing executives is a result of the threat of litigation.

I worked for a company where the CEO slept with an employee and then threatened to fire the employee for not continuing to agree to do so, which resulted in a sexual harassment suit. This was actually one of the more minor infractions, but it was the one that surfaced. Publicly, this CEO was not fired, but ‘resigned’ with an agreement that the details of this would never surface, because the board felt threatened by the CEO’s history of being litigious.

Similarly, John Thain ‘was resigned’. However, over the course of the last week something interesting happened. In newspaper coverage, resigned changed to dismissed, and even to fired. This tiny flicker of rebellion suggests that the litigation shell is cracking and if it continues it will spiral. From an historical perspective, it is even possible that Thain will end up in jail.

We are in a dangerous time where similar economic problems have historically led to public unrest. There will be a lot of public anger, and there needs to be a plan to deal with it. There are arguments on both sides as to whether focusing anger augments it or channels it away.

Evans Pritchard points out that we are a long way from 1933, where public anger was destabilizing:

The New York Stock Exchange and the Chicago Board of Trade had closed. Thirty-two states had shut their banks…Illinois and much of the South had stopped paying teachers. Schools closed for months. An army of 25,000 famished war veterans squatting in view of Congress had been charged by troopers of the 3rd US cavalry with naked sabres – led by a Major George Patton… More than 100,000 New Yorkers applied to go to the Soviet Union when Moscow advertised for 6,000 skilled workers.

Will channeling public anger against Wall St. make things worse or create an outlet? Evans Pritchard suggests that in the Depression, actively punishing Wall St. helped, and that FDR channelled public “anger against Wall St., diffusing it”.

Although revenge is sweet, directing mob anger at people like Thain could make things worse. Currently, the government (and Ken Lewis) may be able to quietly purge places like Merrill and put things in order rather than publicly lynch Thain. But they can’t do nothing at all, because as Evans-Pritchard points out, we are in 1931 and 1933 is around the corner.

Link

I recently commented on the fact that AIG sleazily announced bonuses under the cover of the term ‘retention’ and the Thanksgiving holiday.

I got a surreal reply from their PR dept., full of ‘the dog ate my homework’ style excuses. If they are going to this kind of extraordinary length to corral private bloggers, clearly AIG’s self-entitled executives are more focused on people taking away their toy allowance than the mob storming their batman-like, skyscraper palace and pinning their reality-challenged heads under the blade of a guillotine.

The reaction, after all, is reminiscent of Marie Antoinette’s ‘let them eat cake’ for its sheer gall and total cluelessness.

Here is the email I got, for your amusement:

Dear David Galbraith:

Given your recent coverage of our company, I wanted to let you know that you can contact me if you are looking to get AIG’s perspective on an issue relating to the company.

I also I wanted to give you a heads up that we have responded to a letter from Representative Cummings regarding AIG’s retention planning. Here is the letter we have sent (I have attached it above).

Our key point is this: our highest priority is to pay back the government. We will do this by selling some of our high quality businesses. In our industry, the value of those businesses is based on two things: people and capital. The people that run those businesses are stars in their field. They are the ones who made AIG the largest player in insurance, and they are constantly being solicited by our major competitors. These employees are not with, nor have ever been with AIG Financial Products, the group that sold the credit default swaps. These folks are employees of AIG’s core insurance operations. Moreover, we’ve been informed by credit agencies that if we lose key insurance employees, our credit ratings will suffer (this is detailed in Mr. Liddy’s letter to Mr. Cummings).

For us to get the best value out the businesses we’re selling, and to ensure that our core insurance businesses remain profitable, we need them to stay. If they leave, the value our businesses will decline, and we will have less money to pay back taxpayers.

Regards,

Nick Ashooh

AIG

Regarding the line: “we’ve been informed by credit agencies that if we lose key insurance employees, our credit ratings will suffer”. Yves Smith puts it best:

“What rubbish. Do you really think there are a lot of senior executive jobs on offer in the insurance industry these days? And have you ever heard of credit ratings being dependent on a particular manager staying in the saddle? CEOs get deposed without there being any ratings impact. This explanation comes perilously close to being a bald-faced lie”.

An excellent item in the comments thread on this piece in the UK Telegraph about the impending printing of dollars to combat deflation. It states that we have already had deflation for the last decade, a period when you could buy a T-shirt for less than 30 years ago, or a Chinese DVD player for less than a Hollywood DVD:

“Why do people not understand we have had deflation for the last 11 years, it was on the imported goods from China. This is what caused us to get into a mess as we decided for an arbitrary reason that inflation had to be 2% and so we kept rates low and had an inflation boom in services and assets.
Now it is reversing as the deflation from China has run its course and becomes inflation, hence the assets and services must deflate.

Letting rip with money supply and govt spending will end with significant inflation and not the “old equilibrium” that they seem to be looking for. it will erase the debt but will not give people jobs…..”

[It will give people jobs - but perhaps, not long term jobs, if this is money spend purely to bootstrap, it does matter what the long term investment benefits are. Spending on weapons or patching up existing infrastructure won't be good in the long term.]

Prices over the last decade depend on which frame of reference you use. The convenient view in places like America and Britain was that asset prices like houses were rising rapidly relative to goods. People borrowed against these assets and banks leveraged the borrowing further.

If, as is entirely reasonable, you look at this from another frame of reference, then house prices stayed the same, and wages dropped as China started to replace our manufacturing base, producing cheaper goods. Only one thing did rise - oil.

So what is happening now? A switching of the frame of reference.

It seems that a bunch of people are coming to the same conclusion:

That massive stimulus spending may actually only work in places like China. I’m not convinced, but the implications are disturbing, given that the government has run out of other weapons.

I’ll try to summarize their argument as best I can, correct me if I’m wrong:

It is China that is analogous to the US before the Great Depression, not the US.

i.e. China own US treasuries, US owned gold; China is a massive exporter, the US was before WWII.

The conclusion is that massive internal stimulus programs will work in China converting an economic engine which is externally driven by exports into an internally driven one. The more ruined other economies like the US are, the better this will work, because it will quickly destroy international trade and create an even bigger stimulus for a domestic market.

None of this actually precludes Keynsian policies from working in the US, except their efficacy will be far less than for China. This is because a domestic economy with American goods would result in prices that would be far more expensive than what we have been used to. In China the result might actually be the opposite.

What we are seeing is inevitable, the reduction in trade between emerging and developed economies will result in a period of regulation and trade barriers as the global economic engine temporarily (as in 50 years) fragments into smaller economic systems before eventually rebooting interconnected systems of free trade. The problem is that these periods tend to create wars precisely because there are rival, competing, less connected economic systems which are disrupted.

I like to think in pictures and imagine the following:

There is an economic, ‘figure-of-eight’ shaped system of connected ‘whirlpools’ that comprises people making cheap things in places like China for people to buy in places like America.

With every turn of this whirlpool, the difference in price between Chinese and American production shrinks as China becomes more developed and people make more money, to the point where the energy required to maintain the inertia driving the whirlpool in the same direction increases. The resulting system slows, becomes unsustainable and the whirlpool disappears.

The chaotic unpredictability of current markets are the result of the exact same mathematics that governs the messy collapse of such things as whirlpools.

When new whirlpools, or economic engines re-emerge, they will be more like separate spirals rather than linked figure-of-eights. This is not a result of deliberate policy, such as regulation, but the result of universal law, spontaneous emergence of single spirals are more likely than complex interconnected systems of flow.

The whirlpool that represents America will require more energy, compared to China, to make it spin, like a whirlpool in a viscous fluid. This is because the substance of which it is comprised is people with higher expectations and costs. It will therefore be smaller or grow less fast, and the people caught in its sticky vortex will be unhappy.

Reading updated Wikipedia entries for bankers since the ‘great recession’ started and discovered this gem:

Fred Goodwin of RBS:

Awards
* December 2002 - Forbes “Businessman of the Year”" by the global edition, which described him as an original thinker with a fast-forward frame of mind who had transformed RBS from a nonentity into a global name.
* April 2003 - No.1 in Scotland on Sunday’s Power 100
* December 2003 - “European Banker of the Year” in 2003
* June 2004 - Knighted in the Queen’s 2004 Birthday Honours list, for his services to banking.
* December 2008 - Nominated by Slate Magazine columnist Daniel Gross for World’s Worst Banker

Link

[ picture above shows the AIG board in 2005, with "a tradition of providing very long-term incentives to key managers of American International companies around the world", according to the insurer's annual report for 2002 ]

In France, decades of socialist policy have resulted in a sense of entitlement amongst workers, while decades of monetarist policy in the US and UK have resulted in a sense of entitlement amongst managers.

After the embarrassment of expensive, taxpayer paid, corporate retreats and huge continuing compensation, this week, the bottomless, bail-out money pit, called AIG, used their PR machine to congratulate themselves publicly, that bonuses and salary would be reduced for top executives.

To highlight the sleight of hand here, in case you missed it, they used tax payer money to make themselves look self-sacrificing, while not sacrificing anything but tax payer money. But the real chutzpah is that they aren’t even doing that really. As this story in the FT reveals, AIG are burying compensation in large ‘retention bonuses’, and releasing this news over Thanksgiving to hide it further.

I am in France, for a month, where I have already just about gotten into a fight for shouting at someone tagging a 17th Century building in broad daylight.

Sadly, in France, where the state gives you so much, it breeds a culture of entitlement which reveals itself in the little things, like people not bothering to pick up dog shit, or rich looking kids out shopping, carrying bags of purchases from expensive stores, defacing three century old buildings right in front of the cops (that was the scenario). Of course, there is graffiti in America, just as there is dog shit, but there are fewer punks at street level, with an endemic sense of entitlement.

In America, where the state gives ordinary people way too little, people tend to be polite and pick up their dog shit. There is, however, a different culture of entitlement there, and it is at the corporate level where the private sector has given so much for so long. Ironically, rather like ordinary French people, for non-ordinary people like AIG management, the state is now giving them so much. A tax payer bailout of AIG is surely necessary, but it has been justified so that ordinary people suffer less, not management.

Technically, AIG executives may be behaving within the law, if only because the law hasn’t caught up with what’s currently happening. In moral terms, however, they are behaving in a manner much worse than some self-entitled punk defacing an ancient monument. The manner of what they are doing is also very different - they are trying to cover up their mess.

As everyone knows, its the coverup that gets you.

Link. Commentary.

In 1960, France had 200,000 cafes, said Bernard Quartier, president of the National Federation of Cafes, Brasseries and Discotheques. Now it has fewer than 41,500.

And this was before the credit crunch.

Given that cafe society in places like England, has grown massively in the same period, this shows quite how extraordinary France would have appeared then.

Krugman: “This is an economic emergency.”

Accross the Curve (the best finance blog, of which I barely understand 50%): “The break even spread on 10 year TIPS is about zero. The market is predicting no inflation for 10 years.”

Calculated Risk: “The current stock market decline is the worst since the Great Depression.”

This has to be capitulation point.

“Think of Ireland. Rotate it 90 degrees clockwise, make it a third bigger and hang it like a pendant from the Arctic Circle. Crack open the earth’s crust below to release limitless supplies of geothermal steam, then fill its territorial waters, all 200 miles of them, with an abundance of cod…Now allow this country’s banks – virtually unregulated – to borrow more than 10 times their country’s gross domestic product from the international wholesale money markets. Watch as a Graf Zeppelin of debt propels its self-styled “Viking Raiders” across the world’s financial stage, accumulating companies like gamblers hoarding chips. Then sit on the sidelines as the airship flies home and explodes, showering its blazing wreckage over this once proud, yet tiny, nation.”

Robert Jackson’s definitive piece about Iceland. A middle class, white, failed state..

via the excellent Naked Capitalsm

Surreal but true, a sign of unpredictability punishing South West who hedged against fuel price rises. Perhaps this gives some idea of what is in store for hedge funds. Link