I had the privilege to listen to listen to a presentation by David M. Walker, Comptroller General of the United States on his last day in office. He took the opportunity to go over a presentation that he has given in various forums over the past few months to explain how his generation, the baby boomers, have not been good stewards of our economy. He is concerned that, if things don't change, we will not be able to sustain our economy or our current standard of living. If his predictions are correct, the baby boomers will be the first generation in American History to leave the economy in worse condition than they found it.

The graph below is is one of the first in his discussion of trends in federal spending.

Click on the slide to view the entire brief. Shows the growth of mandatory spending compared to discretionary spending such as defense

As you go through the brief, keep in mind

• We are paying compounded interest on our growing debt
  
• We are a rich nation today because nations around the world believe that we are a good economic risk, and spend lots of money in the U.S.
  
• The U.S. economy would be in grave danger if the markets were to flee the U.S. dollar because we were no longer a safe investment

One last slide from his brief to help make the point.

In this slide Walker makes the point that the U.S. spending is already exceeding revenue, and if no action is taken by 2040, we will not have enough revenue to cover some of our mandatory obligations (like Medicare & Medicade) and discretionary spending such as National Defense and Diplomacy . Sad to say, if our economy gets to the 2040 scenario, the average American will have more to worry about than medical coverage and national defense.

Mr Walker presented a compelling argument for fiscal reform and restraint, I encourage everyone to check out his briefings posted on the GAO site and watch as he transitions into the private sector.

Did Enron Kill Innovation in America?

I was fortunate enough to sit through a presentation of a venture capitalist, I can't say who or what company because we operate on the principle of non attribution (you get better info that way). She had several extremely interesting points that I will attempt to weave together to get a little closer to the answer...

Up until 2003, IPO's were among the best ways for a company to acquire the funding needed to further a good idea. Granted there were several bad ideas that went public on the stock exchange but they were quickly weeded out by market forces. The bottom line is that IPO's are a great, market driven way for companies to raise money.

Sarbanes Oxley has increased auditing burden placed on public companies and discourages IPOs for companies less than 200 Million dollars in annual revenue because of the huge cost. To comply with the SOX (AKA Sarbanes Oxley), companies must hire a staff of auditors, accountants and attorneys to ensure their continued compliance with the new laws designed to prevent fraud in corporate America.

Congress mixed up market exuberance with fraud when they created SOX. Market exuberance is a natural psychological element of a market. Simply stated; when people get excited about an idea they throw their money at it. If the idea is really good it becomes self sustaining, making its investors a nice profit. If its not so good it falls short, costing the investors their stake in the company.

• This is good!
• This is Capitalism!
• This is what our economy is built on!

Fraud is when people with malice of forethought enter into an agreement with the intention of bilking their counterparts in the agreement out of their stake. This was the case with Enron, MCI and others in the early 00's.

• This is Fraud!
• This is Criminal Behavior!
• Protection from fraud is one of the most important roles a Government can have in a market based economy!

SOX was put in place in response to Corporate Fraud to protect investors from the massive criminal behavior observed in the Enron scandal. Unfortunately, Congress didn't take into consideration the second order effect that it would have on the American entrepreneur. We should re-look at SOX and ask our selves these questions:

• Is SOX making it to expensive for startups to access public funds?
• Is the reduced availability of venture capital hindering inventors and entrepreneurs?
• Did Enron start a chain reaction that will stifle a major American Innovation Engine?

How does Google make so much #@#$ without charging us?

Wired magazine just published an article about the search engine industry by Chris Anderson, the author of "the long tail", called "Free". The article goes into how Google pioneered the use of Cross subsidy advertising to provide unbelievable service to its customers for FREE. It also explains why Google keeps giving us more stuff like google earth, google docs, and Grand Central (Someone click the Call me button!) all for free. Check out the article its well worth the read.

Who created all of this money we've been spending?

The following is an excerpt from a paper I wrote about the interdependency of foreign exchange currency markets, and the mortgage crisis.

Traditionally the money supply has been fairly well understood and controlled by an age old system of leveraging reserves to loan money to borrowers. The federal monetary policy regulated the percentage of reserves required to be maintained by the bank, freeing the bank to lend the remainder, making profit form the interest. In the old days the bank would keep the loan on their internal books, which in turn acted as an incentive to minimize the risk of the loans they issued.

In recent times banks and non-bank lenders (good example of non bank lender in this article from 1998) have developed a system by which they package loans and sell them to investment groups. These groups then use the loans as collateral for securities and sell the securities to investors. This process does two things, first it eliminates risk for the lending institution by taking the loan off of the origonator's books. Second it provides a loophole for lenders to subvert the reserve requirements established by the Federal Reserve allowing them to lend up to 100% of the value of the property.

From a bank's perspective this is a real win-win situation. Banks can now reduce their overall risk profile by selling off all but the very best loans, making them very stable. The Fed using it's traditional means of monitoring a banks reserve requirements are very satisfied.

The investors using the loans as collateral are also very happy with this new business process. Using new technology to help police the default risk of the loan packages, companies securitize the loan packages with some degree of confidence. The new security is in most cases less volatile than many other financial instruments, and offer a good rate of return for a reasonable risk. Unfortunately there is a dark side to this portion of the securitization process, since the rating of loan packages as securities is relatively new, there are not strong regulatory standards established providing the FED with oversight capability. The result is that the securitizer, often faced with a conflict between profit and reliable transparent ratings, can inflate the rating of the security.

I believe that this conflict of interest in the risk rating of this type of security is at the heart of the current loan crisis. On one hand the securitizer makes the most money on his investments by giving the investor the impression that these are low risk real estate backed securities with a great rate of return. On the other hand, he has to encourage the lenders to make loans no matter what the risk to keep the gravy train rolling. Meanwhile, the investment firms are acting under a different set of regulations than banks while perfoming a banking function... creating money!

The investment companies are effectively augmenting the money supply outside the traditional means established and monitored by the Federal Reserve. Would-be borrowers with some equity (or in some cases the expectation of equity) now have a way of securing money against their collateral quickly and at a reasonable cost. Borrowers can now take their expectation increased equity and convert it into money quickly for near term projects or expenses. Although the mechanisms are quite different, this approach to securitization of loans provides a means to generate revenue much like public corporations have been able to do in the past by selling stocks against their future profits or securing ventue capital.

I hope this makes sense...

I'm committed

I have been on the fence in this political race until last night when my kids asked me who I would support in the upcoming elections. I took account of the candidates positions and records and realized that the only candidate that I could support was John McCain. Just for fun (and so I can remember for next time), I'll go over my thought process.

First, National Security: If we pull out of Iraq before we have a chance to put the pieces back together, we will be facing a much more dire security risk from the Middle East than if we bail out because it has turned uncomfortable, and unpopular. It will take political courage to stick with Iraq until it is self sustaining (my estimate... 2 to 10 years).

The Economy: I have been playing with a couple of economic models over the past few months and if they are as comprehensive as they are advertised to be, the Medicare, Medicaid, and Social Security situation will become a real problem within the next ten years. If you don't believe me, just look at the growth projections from the Congressional Budget Office. We can't afford another large entitlement program that is going to increase exponentially as baby boomers retire.

Taxes: Targeted tax cuts act as incentives, to expand business. If you lower the burden on business they will respond by growing, more importantly growing businesses make more jobs than shrinking business. If you want to shrink business you tax it. The AMT is a very regressive tax, it is basically a success penalty, do we really want to dis-incentivize success?

Education: The democrats want to improve education, which I support, unfortunately, they want to increase taxs and re-allocate to tuition, which will increase the supply for educated adults but will decrease the demand for them. I personnally think that tax incentives could be created for companies to invest in the educational process, after all they are going to be the ultimate benefactor of an upgraded workforce.

Immigration: Immigration is one of the toughest problems we face today! Huge national security problem, but it is also a huge demographic and economic issue as well.

Developed countries have all had problems with a lower birthrate than required to maintain a vibrant workforce. Our illegal immigration is filling a vacuum caused by our low birth rates and hot economy; if we were to eliminate the illegal workforce our economy would have millions more jobs than workers. In that situation the only two options are to shrink our economy, or to export jobs to other countries; none of the options would be popular. Our illegal immigration problem has made our demographic crush much less painful that of Japan, Europe, or Russia who are going through a much more severe demographic problem than we are. China is going to see a real problem when their one child policy hits their workforce in 10-20 years.

Rule of Law: Rule of Law is the counterargument to the demographic/economic argument, how can a nation of laws (rule-of-law is to governments what opposable thumbs are to mammals) reward a large population of citizens for breaking the law? I don't believe you can! To make matters worse, amnesty would not fix the demographic/economic problem that caused the illegal behavior to begin with. The illegal immigration problem is tough, and I'm not sure anyone has it figured out.

Goning back to McCain, he demonstrates the courage and conviction that I think will make him a very good President. While he and I don't completely align on the issues, his principled approach to policy gives me some comfort that he will not stray far from the positions he has articulated during his campaign, and I can support that.