Tuesday, December 16, 2014

OIl's Great Fall: This Time, The Bailouts Will Be Harder

In a desperate move, Russia's central bank recently raised a key interest rate by 6.5% to 17%, propping up the ruble at least momentarily.  This was after the ruble had already lost about 50% of its value in the past few months.  Even if the ruble stabilizes, Russia verges on economic collapse. 

Venezuela was already hitting the skids when the price of oil began its big swoon.  Now, it will possibly default on its sovereign debt.  Other oil producing nations are hurting, too.  Some could survive by drawing down their financial reserves.  Others may not have adequate reserves on which to draw.

The impact of the oil price drops on major financial institutions and financial markets players is much more opaque.  When a key commodity like oil, and the currencies issued by its producers, belly flop as we have seen in the past few months, big losses are inevitable.  Some of these losses could be greatly magnified by the leveraging effect of derivatives.  A crucial question for regulators is where these losses are landing.  Surely there are losses on Wall Street and in the City of London.  But proportionately much greater losses may have been sustained by Russian and other European banks.  Dec. 31, 2014 will mark the close of financial reporting periods for many banks and other institutions. At that point, they will be required to disclose their financial conditions.  It wouldn't be surprising if the losses are big.  Talk of bailouts might follow.

It's one thing for the taxpayers of a nation to bail out the banks of their own nation.  They may be frustrated and outraged, and demand the punishment of bank executives and others.  But they have a strong interest in preserving their own financial system.  It's another thing when a foreign country wants a bailout, just after it sent its Special Forces surreptitiously into a neighboring country to seize territory by force, lied to the world about what it was doing, and then made aggressive moves against many other nations--especially those that border it and have historically been dominated by it.  The West has imposed sanctions on Russian banks.  It can't now bail them out.  It's attempting to force Russia out of Ukraine, using financial leverage as a key weapon.  It can't provide Russia with a financial bailout.

Venezuela has for years been seriously hostile toward the U.S., while getting cozy with Cuba.  Its current predicament is the result of spending way more than it was taking in.  A bailout for Venezuela has no chance of receiving Congressional approval, nor would American generosity do anything to ameliorate the key problem, profligacy by the Venezuelan government in order to win over voters.  The IMF would impose financial discipline on the Venezuelan government as a condition of any international bailout, something the current Venezuelan government surely wouldn't accept.

Free market advocates have railed for years about the bailouts made in the aftermath of the 2008 financial crisis, proclaiming that handouts to the wealthy and powerful would only foster moral hazard and encourage undue risk taking at the expense of taxpayers.  They may have their way in the wake of oil's great fall.  Some of the key players likely to need a bailout won't be getting them.  Chips will fall where they may, and we'll see how the markets operate in the absence of government intervention.  The results will be good for some, bad for others, and undoubtedly painful for many. 

A destabilized Venezuela will probably experience internal political change.  But a destabilizing Russia is much less predictable.  As long as Putin is in power, who knows what will happen?  And what is the potential for Putin to leave power?  Not much and it's not likely to happen in a gracious way.  Demagogues at risk of losing power sometimes turn to foreign adventurism to stay in control.  The farther oil prices drop, the harder these questions will become, and the more disturbing the potential answers. 

Wednesday, December 10, 2014

Oil Prices: The Next Test For Central Bankers

Most of the benefits of falling oil prices are obvious.  Consumers, whose median incomes have been falling too, are fist bumping over lower gas prices.  Businesses are seeing some energy costs fall, burnishing the bottom line.  Members of Congress, who aren't doing jack about stimulating the economy anyway, can breath a sigh of relief over the economic stimulus from the gas pump.

Falling prices, however, have downsides.  Today, the stock market tumbled because energy stocks are under stress.  The more vulnerable oil producing nations might default on their sovereign debt (think Venezuela, and maybe others).  Many oil frackers are heavily leveraged, and they could start defaulting as their cash flow sputters.  Some financial market players are surely taking losses on falling currencies of many oil producing nations (the ruble being Exhibit A).  More opaquely, but perhaps of great concern, big banks, hedge funds and other financial market players might well be taking losses on derivatives contracts bets linked to the price of oil or the currencies of oil producing nations.  With oil price losses approaching the 50% level in the past few months, it looks like we have a bursting bubble on our hands--and the potential for another financial crisis.

Recall that it wasn't falling real estate prices alone that triggered the 2007-08 financial crisis.  It stemmed from a poisonous synergy of massive quantities of poorly underwritten mortgage loans, falling real estate prices, defaulting mortgage borrowers (many of whom didn't have the ability to repay the loans, measured by any reasonable standard), a compounding of the losses because falling prices precluded the availability of refinancing, the massive impact of these losses on the financial system through diverse and obscure derivatives contracts not well understood by market players and regulators, and, ultimately, a surprising concentration of losses onto a single entity (AIG-Financial) to which numerous key players in the financial system had unmanageable exposures.  Only an unprecedented bailout by the federal government prevented the collapse of the world financial system.

A sharp fall in oil prices doesn't necessarily mean the financial system is at risk.  There was a proportionately larger oil price fall in the middle of the 1980s which didn't result in a financial collapse (although this occurred before the evolution of complex derivatives markets that allow risk to metastasize with blinding speed).  Another big drop in oil prices in 2008-09 also didn't tip the big banks into bankruptcy (although they were already in major bailout mode by this time because of the mortgage crisis, so this instance may not prove much). 

But the proliferation of risks created by today's highly imaginative financial engineering can mean that any major drop in the price of a key asset like oil could surprise us in unpleasant ways.  One lesson from the 2008 financial crisis is that regulators didn't know where the hot tamale would land, until it hit the fan.  Regulators worldwide should be sending their examination SWAT teams into the major money center banks and other key financial institutions to scope out the direct, secondary and tertiary impacts of falling oil prices.  And that should be now--as in right now--not weeks or months from today when it may be too late to take protective action. 

Tuesday, November 25, 2014

Less Heroic Policing, Please

One thing the shootings of Trayvon Martin and Michael Brown, both unarmed black teenagers, reveal is that there may be too much of a fixation on heroics in policing.  George Zimmerman, a policeman wannabe working as a community watch person, pursued Trayvon even after a police dispatcher instructed him not to follow the young man.  Trayvon, whose suspect activities consisted of carrying junk food while black and wearing a hoodie, evidently became unnerved by Zimmerman and an altercation ensued.  Because the victim was dead and therefore not available as a witness, the evidentiary record assembled by the State of Florida wasn't as fulsome as would be ideal, and Zimmerman was acquited.  But if Zimmerman had simply obeyed orders and let a uniformed officer handle the situation, in all likelihood nothing would have happened.

Perhaps the most critical moment in the Michael Brown shooting was Darren Wilson's decision to get out of his police cruiser and pursue Brown alone.  Even though backup was less than two minutes away, Wilson evidently couldn't wait for reinforcements.  It's standard police procedure to take on violent suspects with overwhelming force (which means several officers).  An officer shouldn't go one-on-one with a suspect who is much larger and stronger than the officer.  Wilson's decision to go it alone is mystifying.  He had already been hit hard a couple of times by Brown, and injured to the point where he evidently convinced the grand jury that he reasonably feared for his life.  If Brown was that dangerous, why was Wilson taking him on alone?  Given the disparity in their sizes, and the fact that Wilson was already injured, his only ability to control Brown, it would seem, was with his .40 cal. pistol.  And that turned out to be the case. 

Before the Michael Brown shooting, Darren Wilson was commended by the Ferguson, MO police department for physically subduing a drug suspect.  Physical courage and dominance, it would seem, were honored.  But the police aren't fighting wars.  Valor is something that is usually not needed in policing.  Good judgment, self-control, and non-violent outcomes should be, and for most police officers are, higher priorities.  When Darren Wilson first spotted Michael Brown, the worst things Brown apparently had done were steal some cigars and walk down the middle of the street.  This is not a situation that should have escalated into a shooting.  When it did, and Brown was shot and ran, Wilson should not have pursued him alone.  Not when the outcome of that solitary pursuit might well depend on the use of his pistol.

The grand jury decided that Darren Wilson did not act unlawfully.  But just because something's legal doesn't make it good or desirable.  Heroics in policing are sometimes called for.  But, by all indications, we need a lot less heroism and much more sound judgment. 

Wednesday, November 19, 2014

Uber Shows Us Why Privacy Matters

It appears that a senior vice president at Uber, the online taxi service, suggested that the company ought to investigate journalists who offend the company.  In particular, Emil Michael, the SVP in question, seems to have directed his remarks at a BuzzFeed reporter named Sarah Lacy, who evidently has been critical of the company. 

Although Uber has repudiated Michael's remarks and pledged not to investigate journalists, let's think hypothetically about what a nasty corporation might do in order to dig up dirt on an individual.  There is the company's own database.  In the case of an online taxi service, that would include name, credit card information, and perhaps a lot of addresses.  Some you might not want your significant other to know about if you've been less than a paragon of fidelity.  Others you might not want your employer to know about if you've been interviewing discreetly for a new job.  Of course, there could be the address of the only abortion clinic in your city or a seedy hotel where the only things you could get are services from sex workers or illegal drugs. 

In addition, businesses corporations have access to commercial databases created by shadowy companies that vacuum up everything about you they can find on the Internet and sell it for a fee.  These databases might well include archived pages from social networking and other sites that you thought you deleted years ago (shiploads of stuff on the Internet have been archived, and a deletion on the active website doesn't necessarily mean all the archived stuff is gone).  Businesses can also hire snoops to snoop around online and otherwise.  They can get the name of the driver from the online taxi service, interview him, and find out that you were getting mighty friendly with someone in the back seat when you told your spouse you were going alone to a client dinner.  Or they can find out the name of the restaurant where you were taken, and interview the bartender to learn there was someone waiting for you who whisked you away after spending five minutes at the bar. 

No one is perfect.  For many, their imperfections can be uncovered online or through information available online.  Private interests can be bad.  Some can be evil.  There are fewer legal constraints on private interests digging up dirt online than there are on the government.  It's creepy to think that NSA or some other government agency might be sneaking peaks at our e-mail accounts.  But, ultimately, the government is subject to a variety of constraints that, at least sometimes, can be invoked.  A business corporation or other private interest that wants to do evil is much harder to rein in because of the paucity of rules.

Privacy laws are like locks on doors.  You lock your doors to keep undesired people out of the privacy of your home.  Privacy rules keep undesired people out of the privacy of your data.  Everyone wants a nonpublic place where they aren't subject to prying eyes.  Even the Uber SVP, Emil Michael, who reportedly claims that his inflammatory remarks were meant to be off the record.  (See http://www.cnbc.com/id/102199538). From the vantage point of his petard, Michael acknowledges the desirability of privacy.

It's unlikely Congress will do anything useful in the foreseeable future.  But if it wanted to shock us with a pleasant surprise, it could enact a strong set of privacy rules for online data and the use of online data.  After all, privacy matters.

Wednesday, November 5, 2014

Economic Consequences of the Mid-Term Elections

The economic consequences of yesterday's mid-term elections will be zero.  In order to boost the economy, the federal government would have to raise taxes, cut spending or both.  Even though President Obama now faces a majority Republican Senate as well as House, he won't agree to major tax cuts and the Republicans won't agree to major increases in spending.  So the fiscal impact of the mid-term elections will be effectively zero.  With the federal deficit lower than the historical average of 3% of GDP, there's room for fiscal stimulus but no political impetus for it.

Modest spending boosts may come from an increased military role for the U.S. in the Middle East.  Trying to suppress ISIS is becoming a game of whack-a-mole.  And American air power may have to target an al-Qaeda affiliate called the al Nusra front as well.  But such mission creep will be constrained as there is no public support for a resumption of ground warfare by U.S. troops.  The defense budget won't provide major stimulus.

Monetary policy is the only real game in town, and central bankers are the croupiers.  The Fed has just ended quantitative easing in the face of 3% plus growth by the economy, but there's nothing that stands in its way if it wants to fire up the monetary printing press again.  Just the push of a few computer keys, and the QE program is up and running again.  The Japanese central bank has recently placed a lot of QE chips on the table, putting a punch bowl on the table even as the Fed takes one away. 

The newly empowered Republicans in the Senate will probably increase pressure on the Fed to step back from accommodation.  That would be a fool's errand, as there is nothing the Republicans could actually do over the next two years to substitute for the loss of Fed accommodation.  If Republican pressure on the Fed slows the economy to stall speed, look for smashing Democratic victories in the 2016 Presidential and Congressional elections.

Monday, November 3, 2014

Has the Supreme Court Entrenched the Two Parties?

The upcoming mid-term elections, in which Republican gains are strongly anticipated, are much more about anger than beliefs.  Voters are inclined to throw the bums out (which in some cases may mean Republicans instead of Democrats).  They are anti-incumbent and only incidentally sometimes in favor of the challenger. 

This would seem the ideal environment to launch a third political party.  The Republicans and Democrats have become increasingly insular--from each other, and especially from the middle of the electorate.  The strong showing by Independent Greg Orman in the Kansas senatorial race illustrates the willingness of voters to consider candidates from outside the box. 

But Orman, if he wins, will caucus with one party or the other.  He isn't looking to lead the charge for a third party.  Big Republican Money is flowing into campaign coffers to inflame voter anger.  Big Democratic Money is flowing in riposte.  Any attempt to create a third party would be crushed by these financial woolly mammoths. 

The Supreme Court in recent years has struck down various limits on campaign contributions, opening the way for large contributors to throw their weight around.  Even though voters may be increasingly ready for a choice other than Tweedle Dee and Tweedle Dum, few with deep pockets would be willing to fund a third party.  The existing parties, with their gerrymandered incumbents and established infrastructure, enjoy exacerbated advantages from the Supreme Court's antipathy toward restrictions on campaign contributions.  Regardless of the mood of the electorate, the chances for a third party to take root shrink as funding for the Republicans and Democrats increases.

There are political insurgencies.  But they take place within the established parties.  The Tea Party and its sympathizers have swung the Republican Party away from its traditional power brokers.  And the election of a black man to the White House came from the most successful political insurgency in over 40 years.  But, if you're hoping to see colors other than red and blue on political maps, you'll be waiting a long time, thanks in no small part to the Supreme Court.

Wednesday, October 22, 2014

The Turmoil of Economic Inequality

Of all the potential dangers of economic inequality--slow growth, reduced upward mobility, and so on--social destabilization is the most worrisome.  This is when people say, "Enough.  We're not waiting for things to happen.  We're making them happen.  Our way."

The pro-democracy demonstrations in Hong Kong were nominally over Chinese attempts to limit the freedom of Hong Kong's elections by vetting candidates.  Only pro-Beijing candidates need apply. But growing economic inequality in Hong Kong fueled the anger of the demonstrators.  Wealthy Chinese are buying up prime real estate in Hong Kong, pushing prices beyond the reach of the local middle class.  The wealthiest Hong Kong residents are, like the 1% elsewhere, growing disproportionately richer.  Job and other opportunities for many others are looking bleaker.  Middle class Hong Kong residents began to see less and less for themselves in the status quo.  They didn't take things quietly.

Democracy is a mechanism by which the 99% push back against the growing wealth and power of the 1%.  Without democracy, oligarchs and plutocrats flourish.  China has an authoritarian government, whose powerful members and their families are intertwined with China's economic elite.  The ordinary citizens of Hong Kong have no voice in the northern capital.  Public protest is only way for them to be heard.

Modern day mandarins in Beijing no doubt shivered when protest banners unfurled in Hong Kong.  Since the days of dynastic China, rebellions against the central government have usually ignited in southern China.  Far from the seat of power, the discontented more readily questioned claims to the Mandate of Heaven.  Indeed, both of the rebellions that unseated the last emperor, and then the Chinese Nationalist government (now a vestige on Taiwan), began south of the Yangtze River.  In recent weeks, Communist cadres have no doubt been taking more business trips to warmer climes.

Turmoil from economic inequality is not limited to Hong Kong.  In the city by the bay, middle and lower income San Franciscans have bristled at the invasion of the geeks from the Silicon Valley.  Young technocrats have driven up real estate prices and Yuppified neighborhoods that heretofore took pride in their eccentricity.  Charter buses used for commuting by the options-compensated have been attacked by the not-so-well compensated.  The so-called trickle-down theory isn't entirely benign.  Capitalism has losers, and the losers will push back.

America is a democratic nation, although increasingly dominated by Big Money as a result of U.S. Supreme Court decisions striking down various limits on campaign contributions.  Democratic Party get-out-the-vote efforts in 2008 and 2012 have held the forces of wealth at bay for now.  But countries tend to work best when they have a government of the people, by the people and for the people.  Economic inequality cannot continue to increase indefinitely; and consequently, it won't.  The only question will be how it ends.  Let's hope it doesn't end badly.

Sunday, October 5, 2014

The Student Debt Dilemma

Some predict that student debt will be the next asset bubble that will make the financial markets crash.  That's unlikely, but student debt is a huge and growing problem that gnaw away at economic growth until something changes.

Student debt won't bubble and burst like mortgages because the impact of losses wouldn't be centralized in the financial system.  The reason why mortgages, and their kissing cousins, mortgage-backed derivatives, almost blew up the world's financial system in 2008 is that when the ship hit the sand, the impact of losses was concentrated on the largest financial institutions, in particular an insurance company called AIG.  These institutions would have been rendered insolvent toute de suite, and the financial system would have been engulfed by a roaring flushing sound.

Some 20% or so of student loans are in default, and very possibly many more will never be fully repaid (for various reasons, it's sometimes possible to avoid default by paying small amounts of student loans but not be repaying fast enough ever to fully pay off the debt).  The impact of these losses will be spread out over time, and much if not most of it will fall on the U.S. government.  Which means that taxpayers will bear a lot of the burden, along with private investors.  But it will be a diffuse, albeit large, burden rolling out over years and decades.  There won't be a sharp poke in the eye at a discrete moment in time that will trigger a financial crisis.

But the aggregate amount of student debt keeps growing (it's over $1 trillion now), and the burden of repayment is growing commensurately (especially since interest rates on federal loans will float, and given today's ultra low rates, they can float only in one direction).  The burden of defaults and other nonpayment will also grow.  It's anecdotally said that student loans are holding up everything for many young adults--marriage, car purchases, home purchases, having children, and so on).  Maybe it makes sense that the sharing economy (car sharing, bike sharing, and the various iterations of the rental economy) is booming.  Young people can't afford to buy things, so they purchase the use of things for short periods of time.  This may be good for the environment, but it hinders economic growth.  If the burden of student loans becomes heavy enough, the impact could be lifelong, and entire lives could end partially unlived.

Student loans are almost impossible to discharge in bankruptcy.  It's easy to get federal loans--you just need to be admitted to an accredited institution--so there's an understandable reason for making them hard to ditch.  Otherwise, taxpayers could be asked to give free college educations to vast numbers of people.  And college educations provide lifelong benefits, so it's arguably fair to ask people to repay college loans, even if it takes a lifetime.

But student debt has become a bear trap for those who default.  Of course, their credit scores are knocked down.  That seems fair enough, but that's also where the kidney punches start.  Many employers won't hire a person with credit problems.  If you are laid off and then default on your student loans, you may not be able to get a new job to repay them.  Sometimes, you lose a professional license (like a nurse's license), which makes it even more difficult to find a job to repay the loan.  Defaulted loans continue to bear interest and penalties are imposed for default, thus ballooning the amount you have to repay.  So, if you have significant student debt, here's what you have to do:  (a) never lose a job; (b) never get so sick that you have to take major time off from work; (c) tell your aging parents that you can't help support them in their old age; (d) tell your spouse he or she can never lose a job, get so sick that they have to take major time off from work, and provide no support to their aging parents; and (e) never do anything that would otherwise result in default.  Getting to like rice and beans, network television broadcast to a TV with rabbit ears, and knitting your own socks, would also be good.

What will happen is, eventually, substantial relief will be given by Congress to student loan defaulters.  The exact scope and terms of the relief aren't easily predicted.  But it will happen.  Why?  Because the problem has become too big, and full repayment is increasingly unlikely for too many borrowers.  Since students from middle and lower income classes are the most likely to take out loans, the burdens are distributed in a regressive way.  Sooner or later, that will find expression in the ballot box.  When too many people labor under the burden of student loans, their combined political voices will overwhelm the lobbyists and influence peddlers employed by the student loan industry and the educational institutions that free-ride on easy educational credit.

There's a precedent for allowing student loans to be discharged in bankruptcy--that's bankruptcy itself.  When Lord Cornwallis' Redcoats surrendered at Yorktown in 1781, there was no such thing as bankruptcy.  Debtors were not only expected to repay their debts in full, but could be imprisoned until they did so.  As one might expect, the use of debtors prisons wasn't always fruitful.  A debtor in prison couldn't work or otherwise do much to repay.  But debtors were commonly imprisoned in the belief that the world was a better place for it.

However, as America grew into a bustling, vibrant industrial nation, voices of reform argued for giving debtors a chance for a fresh start.  Freed from old debt, individuals could more fully participate in the economy and provide for their families, thus strengthening future generations.  Creditors pushed backed, contending that a man's word should be his bond and that shiftless, lazy and prevaricating deadbeats shouldn't be able to hoodwink those that extended credit in good faith.  But the voices of reform won the debate, and America became one of the early adopters of the concept of bankruptcy.

Permitting bankruptcy shifts risks, placing more of the burden of default on creditors and less on borrowers.  As a consequence, market forces led creditors to adjust their practices, raising interest rates on all borrowers and eventually adopting the credit scoring system.  In effect, all borrowers pay for the defaults of some, but all borrowers have the option of bankruptcy.  Since you never know when life may blow up in your face, this may not be so bad.

The student loan crisis will eventually impel something similar. The sheer, growing size of the problem will force change.  Student loans increasingly are no longer just the problem of some, but the problem of many, most and perhaps even all. Of course, if student loans become dischargeable in bankruptcy, other changes will result.  Interest rates on the loans would likely increase, so that all borrowers cover the costs of defaults.  And educational institutions may be required to pay a portion of defaulted loans--at least for those students who don't graduate, so that colleges don't accept applicants who are unlikely to graduate and then free ride off the loan revenues from those students.  These changes would be appropriate, since taxpayers shouldn't have to fund handouts for the educational sector. 

The current student loan crisis is yet another illustration of the problems of easy credit.  Easy credit at first seems like a bargain, and everyone loves it.  But there's no free lunch, and the costs of easy credit will eventually emerge.  When the problem becomes so severe that it cannot continue in the present form, then it will change.

Sunday, September 21, 2014

The Online Challenge For Higher Education

Higher education is moving online, and that's a trend that will continue and expand.  The costs of college degrees have risen sharply over the past 40 years and this trend shows few signs of abating.  Cost considerations alone will force many students to look for online alternatives.  It doesn't matter that physical institutions offer the benefits of face-to-face classroom interactions and social opportunities that could create lifetime friendships.  When college costs continue to rise 5% or more a year, and incomes rise scarcely at all (except for the top few percent), numerous students from less privileged backgrounds will be financially squeezed out of traditional college experiences.  How quickly and how far online education grows depends on how purveyors of online education and traditional colleges confront certain basic challenges.

Online education has to prove that it can provide a quality education, one that makes its graduates competitive in the marketplace for good, well-paying jobs.  Online students obviously won't enjoy football Saturdays, beer in the student union, or impromptu chats with professors; nor will they be able to disgrace themselves with embarrassing behavior on fraternity row on weekend nights.  And it's difficult to replicate certain educational experiences online--laboratory work for physics and chemistry classes isn't quite the same if all you're doing is watching someone else do it through a computer monitor.  But the educational content of many, and perhaps most, college courses can be presented online with little or no loss of substance.

The online educational process may be more adaptable to meeting the needs of employers.  Physical institutions tend to subscribe to a traditional belief in the value of a broadly based liberal education.  While this concept remains valid, it isn't essential for everyone.  The billionaire founders of Microsoft, Oracle and Facebook are all college dropouts.  The denizens of academe may sneer at trade schools, but Europe's most powerful economy--Germany's--includes trade schooling as a crucial part of its educational system.   There is more to life than work, but life really stinks if you need a job and don't have one.  If online schooling can produce competitively employable graduates, it will transform education the same way that Amazon and Alibaba have transformed retailing.

Physical colleges have overpriced their product, and now confront an overcapacity problem.  The elite schools (the top 100 or so) will continue to do well because there will always be a certain segment of the population willing to pay (or having parents willing to pay) the costs of a name brand sheepskin.  Students aiming to be professionals--doctors, lawyers, and so on--will benefit from the friendships and contacts they make by being on campus. Students who don't really know what they want to do may be able to find a focus for their energies from exposure to the breadth of topics covered by a liberal education.

But the days when getting a college degree in anything and still being readily employable for a good salary are long gone.  There is increased pressure on kids at the high school level to choose a field and get a focused education so they can get a job.  Mid-tier colleges that provide good students with a good general education will find that's often not enough.  And even as they struggle to adapt, they'll be competing against numerous other mid-tier colleges that are struggling to adapt.  Reality is that a lot of mid-tier colleges have limited half-lives.

Much of the problem lies in the easy availability of educational loans.  There is no meaningful underwriting process for these loans.  Anyone admitted to an accredited institution can get a loan.  And, in order to preserve the principle that there's no free lunch, these non-underwritten loans are virtually impossible to discharge in bankruptcy.  For many kids, educational loans are like a pact with the devil--easy to enter into, but binding for eternity.  Many colleges are culpable participants in this pact.  They used the availability of easy education credit to raise tuition and fees much faster than incomes were rising, and to pad the compensation of administrators and top level college officials.  They aren't stuck with having to repay defaulted loans of their students.  So they have every incentive to encourage students to take out loans that benefit the college and its officials, but impose no costs when the educations they provide aren't sufficient to land the students good jobs.

Political considerations preclude any meaningful reform of college loan programs that would balance the costs and benefits, particularly by penalizing colleges for churning out graduates who can't repay loans that the colleges helped them obtain.  But economic forces will compel change.  Many high school graduates, looking at the bear trap college loans can become, will choose low cost routes through community college, trade schools, and, increasingly, online education.  Many physical colleges that have floated on the cushion of educational loans will have to downsize or close, as their cost structures cannot be sustained by their likely future revenue stream.  They will no doubt lobby the political process, whose knee jerk reaction will be to make college loans even easier to obtain.  But that will, if anything, make the problem worse, not better.  Students, having been served too many coffee drinks by well-educated baristas, won't take the bait. 

The economy as a whole is better off if students can obtain high quality, low cost educations.  Indeed, as the American middle class continues to decline, inexpensive higher education may offer one of the few avenues for recovery.  The end result will be workers who can succeed, prosper, and consume, rather than have pauper's lives in quasi-debtor prison. 

Wednesday, September 3, 2014

Easy Money: Reinvesting Dividends

Some of the easiest money comes from reinvesting dividends.  Over long periods of time (such as 20, 60, or 80 years) dividends accounted for a little more than 40% of total stock market returns.  Stated otherwise, if you spent dividends, as opposed to reinvesting them, your portfolio would have enjoyed only a little more than half the return it could have gotten with reinvested dividends.  Remember that reinvesting dividends has a compounding effect, and compounding is very, very good for your net worth (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html).  Your total return can be greatly magnified with compounding, accounting for well over half the long term return.

It's easy to reinvest dividends when you invest in mutual funds.  On the account opening form, just check the box for reinvesting dividends and interest, and the mutual fund's administrator will do the rest. Dividend reinvestment plans (DRIPs) offered by the company issuing the stock are clumsier, since you have register with the company and the shares are less liquid (not so easily sold).  Some brokerage firms will reinvest dividends received in your account.  However, you may not have from DRIPs or brokerage accounts the diversification that offers a reasonably steady flow of dividends.  The easiest way to reinvest dividends is through mutual funds (make sure you choose a fund with low costs).

You'll have to pay taxes on the dividends if they're held in a taxable account (although possibly at a lower rate than what you pay for ordinary income).  If your investments are in a tax-sheltered account like a 401(k) or IRA, dividends will be reinvested as a matter of course and you'll pay taxes when you withdraw the money, or convert or transfer to a Roth account.  For money from tax sheltered accounts, taxes will be assessed at ordinary income rates.  But taxes are imposed on dividends even if you don't reinvest.  So they're don't really affect your decision whether or not to reinvest.

Reinvesting makes money for you while you're sleeping, cooking dinner, playing golf, mowing the lawn or indulging in more screen time than you'd ever allow your kids.  Don't pass up this chance to make easy money. 

Saturday, August 30, 2014

The Next Market Bubble

Bulls and bears alike wonder when the next market bubble will emerge and pop.  In recent years, major stock market downturns have come from bursting bubbles.  Recessions, threats of war, terrorist attacks and other disturbances have caused market ripples.  But the big gut wrenchers--the nosedives that wrecked your retirement--have come from the popping of asset bubbles.  The gross over-valuation of tech stocks in 2000, the ridiculous real estate lending of 2005-07, those are the events that clobbered equities.  What does the future portend?

Today, the mess in the Middle East grips our attention.  Medieval atrocities by the Islamic State, a mosh pit with weapons in Gaza, mind-numbing slaughter in Syria and sectarian strife in Iraq appall and fascinate.  But none of them will significantly drive down stock valuations.  They just don't have the economic impact.  The Ebola epidemic is now raging out of control in West Africa.  But America's economic exposure to West Africa is miniscule.  And the disease isn't likely to present a major threat to the industrialized world.

Is there an impending market bubble that could burst and dynamite the world's financial system?  The answer is maybe, in Europe.   The European economy is slowing.  Growth is seen only on alternating Sundays.  The EU stays afloat on a cushion of sovereign and bank debt--a lot of it.  With Europe's slowing economy, it will be tough to pay down this debt and expedient to refinance by issuing even greater amounts of debt.  Risks to larger members like Italy and France are rising.  The EU is a financial and currency union without a unitary government.  Thus, it is tailor made to borrow in bulk without governmental controls to interfere.  We in America know from the 2007-08 mortgage crisis what happens when you bulk up on debt that can't be easily repaid.  The vast amount of European debt presents potential systemic risk, just like the vast amount of American mortgage debt outstanding in 2007.

Exacerbating Europe's problems is the war between Ukraine and Russia.  As Russia's direct involvement in combat is becoming increasingly clear, the war is likely to have ever greater impact on Europe.  Sanctions by the West will probably be heightened, and Russia's retaliation will likely hit Europe harder than America.  Europe's financial system could begin to totter as the EU is pushed into recession and capital flees the Old World.  (Indeed, part of the buoyancy of U.S. stocks can be attributed to the arrival of capital now fleeing Europe.)  A run on the Euro could be the straw that breaks the bubble's back.

The European Central Bank, as always, does a fan dance about how accommodative it will be.  While it's become much more interventionist in the past couple of years, it remains constrained by its anti-inflation charter and the stolid, ever-frowning Germans. Maybe the ECB will save the day.  Or maybe not.

Europe's economy, as a whole, is larger than America's.  A tummy ache there could affect the rest of the world.  if you're worried about where the next bursting asset bubble could come from, keep your eye on Europe.

Tuesday, August 19, 2014

Vladimir Putin and the Art of War

Sun Tzu, the Chinese military strategist, wrote in The Art of War:  "[T]hose skilled in war subdue the enemy's army without battle.  They capture his cities without assaulting them and overthrow his state without protracted operations."*  This would seem to have been Putin's approach from the beginning of Ukrainian crisis.  Without a shot fired, Russian troops seized Crimea.  Crimea was low hanging fruit, since Russian military personnel were already there on a base that Ukraine had allowed Russia to maintain.  Vlad the Invader was no doubt emboldened by the ease and bloodlessness of this victory to seek control of eastern Ukraine.  And he probably hoped to use his success in Crimea to bluff and bully Ukraine into surrendering without Russia having to fight a hot war.

But things haven't gone Putin's way.  After initial ineffectiveness, the Ukrainian military has rallied and is now on the way to retaking all of eastern Ukraine (except perhaps for Crimea).  Only two major cities (Donetsk and Luhansk) remain in rebel hands, and both are surrounded by the Ukrainians. While a substantial news blackout seems to exist with respect to combat operations, it's clear that the Ukrainian military has suddenly attained the ability to use heavy weapons effectively against the more lightly armed separatist forces.  The success of Ukraine's air force is unclear; the separatists tout shootdowns, but the Ukrainian military is mum on successes.  If Ukraine's air force can now effectively support its ground forces, the separatists haven't got much of a chance.  Air power, as the Islamic State learned the hard way in Iraq, is still the trump card on the battlefield.

How has Ukraine so suddenly become so capable in battle?  One wonders if there aren't advisers in Ukraine, who speak the language with non-native accents and can offer the benefit of experiences from other wars.  No military in the world has as much experience as the U.S. military.  And the Iraq War, fought on flat terrain in and around towns and cities, would have been similar in many ways to the fighting in Ukraine,  It is hard to imagine that there aren't U.S. Special Ops personnel and CIA agents working with the Ukrainians.  Recent claims by Ukraine that its artillery pummeled a Russian armored column entering Ukraine at night, if true, would strongly indicate an American role.  How could Ukrainian artillery smack the yogurt out of a Russian column at night without precise targeting information, such as might be provided by American satellites and drone aircraft? 

But now is not the time for Ukraine and the U.S. to celebrate.  Putin cannot afford to be seen as a loser in this war.  If he were, he'd lose his job, and maybe more.  He'll lash out like a cornered rat if forced to face definitive defeat.  Even as we write, there are reports of rebel reinforcements being sent from Russia into Ukraine--some 1,200 men with 150 armored vehicles, including 30 tanks.  (There we go with U.S aerial surveillance again.)  Putin won't stop fighting.

Yet, the Ukrainian military is holding its own and more.  If Putin overtly sends Russian troops into Ukraine, he'll probably sustain more casualties than the war weary Russian people will tolerate.  (Russia took painful losses in Afghanistan and in the wars in the Caucasus.)  Western sanctions would escalate sharply and capital flight from Russia, already a torrent, would become a flood that would impress Noah.  The Russian economy could crater, threatening to take Putin down with it. So an overt invasion of Ukraine by Russian troops entails tremendous risk.

Putin is for practical purposes limited to using the separatists rebels, who are now outnumbered and outgunned.  As a result, he has violated one of Sun Tzu's principles:  "If weaker numerically, be capable of withdrawing."  He cannot commit the forces needed to win, but he cannot withdraw.  He is trapped.

What will Putin do?  Most likely, he'll continue and perhaps increase the covert assistance and support he's been giving the separatists.  The more success the Ukrainian military enjoys, the more desperate Putin will become, and the more covert action he will take.  Since there seems to be a ready supply of separatist rebels, Putin could keep the war going at least for a while.  If the Ukrainian military defeats the separatist forces on the battlefield, the rebels could go underground and fall back on terrorist tactics that have become all too familiar in today's world.  And Putin could apply the economic weapons he's used in the past, such as shutting off the natural gas Russia exports to Ukraine and Europe.  Ukraine may well be on the way to battlefield victory.  But instability and disruption will continue.

*Sun Tzu, The Art of War, translated by Samuel B. Griffith, Oxford University Press, 1963. 

Monday, July 28, 2014

The Failure of European Economic Integration

Economic integration--intertwining the economies of nations--was supposed to promote economic efficiency, prosperity and ultimately peace.  The idea was that if nations need each other to keep their economies humming, they wouldn't start a shooting war.  Continental Europeans, having suffered tens of millions of deaths in two world wars, were particularly impassioned with this idea.  Who can blame them?  Arms races and wars hadn't solved their problems.  The League of Nations didn't solved their problems.  Why not give mutual dependence on each other for cheese, wine, sardines, sausage, and pasta a chance?

At first the idea seemed to work.  The EU prospered in its early years.  We now know those salad days resulted to a large degree from inexpensive borrowing by poorer EU nations, who snarfed up too much easy money and now struggle to avoid the death of a thousand budget cuts.  But optimism held sway in the early days of the EU, and economic kumbaya was extended to the nations of the former Soviet Union, including the big brown bear itself.

Economic integration provides leverage.  The proponents of the EU thought that the leverage would be used to restrain aggression. But leverage by itself is morally neutral, and can be used for good or evil.  Give leverage to a son of a ditch (sp), and he'll use it for evil.  This is what we see in Ukraine today, where Vlad the Invader has seized Crimea, and is sponsoring a "rebellion" in eastern Ukraine against the Kiev government, a war that is increasingly being conducted by Russian soldiers and Russian operatives.  As Russian personnel take over the fighting, the war is morphing into a clash between nations.  This is exactly what economic integration was supposed to prevent. 

Europe's response to Vlad's invasions has hardly gone beyond a tepid wrist slap, and talk of stronger sanctions is matched by behind the scenes maneuvering to prevent any economic consequences from the sanctions.  The horror of the shoot down of Malaysia Airlines Flight MH 17 was quickly followed by France reaffirming its intention to deliver a Mistral class helicopter carrier to Russia, a substantial warship that Russia apparently could not itself build.  Economic integration, it would appear, trumps moral rectitude.

Putin is using economic integration as a weapon, and in his insidious hands, it's devilishly effective.  Europe is dependent on Russia for gas and oil, and can't easily substitute other suppliers for Russia.  Putin has apparently increased his support for the rebels in Ukraine since the Flight MH 17 atrocity. He has much to gain by doubling down.  His increased aggressiveness forces the U.S. and Europe to struggle to respond, and this struggle heightens the divisions between the New World and the Old. He renders NATO a hollow shell, something the Poles have publicly admitted.  Putin doesn't have to conquer Ukraine, or even eastern Ukraine.  All he has to do is keep stirring the pot, and in so doing highlights Europe's dependence on Russia and America's weakness.

Economic integration doesn't turn a monster into a nice kitty.  When done with a dastard (sp), he remains dastardly, and will look for opportunities to slip the knife between the ribs of his trading partners.  The Europeans have, through economic integration, delivered themselves unto evil, and they are now paying the price.

Friday, July 18, 2014

Malaysia Airlines Flight MH 17: Putin's Money Problem

Inevitably, lawsuits will be filed over the shoot down of Malaysia Airlines Flight MH17 in eastern Ukraine.  Typically, the plaintiffs' attorneys will name as defendants just about everyone who had any connection with the shoot down and his uncle.  The airline itself will surely be a defendant.  But we know that.  What's interesting is that Vladimir Putin might, depending on circumstances, be a defendant.

In a civil lawsuit, such as those that will be filed, legal liability does not necessarily depend on proving that the defendant deliberately pulled the trigger or ordered the downing.  A person who was negligent or reckless with respect to supporting and arming the rebels in eastern Ukraine (assuming they're the ones who actually fired the missile) might have civil liability.  Information reported indicates that Flight MH 17 was following a well-established international route at a cruising altitude of 33,000 feet, which is typical of commercial airliners.  Just what do you think might happen if you give a bunch of Ukrainian rebels under air attack from the Ukrainian air force a missile system capable of reaching that high?

Since the Ukrainian separatists might not have the expertise to operate a missile system such as the one that evidently downed Flight MH 17, Russian personnel may have had their eyes on the radar screen and fingers on the trigger.  If so, the link to Putin may be strengthened, and his potential for personal liability increased.

If Vlad faces potential personal liability to the Flight MH 17 plaintiffs, he could have a serious money problem.  Although he denies having money stashed in the West, news reports have suggested he may control tens of billions of dollars of assets, maybe as much as $50 billion.  The plaintiffs' attorneys and the insurance companies that make payouts to MH 17 claimants have a powerful incentive to hunt down that money, if it exists.  And who knows?  Maybe they'll succeed.  In that case, Vlad could lose some or all of his hell or high water fund.

The nation of Russia, too, might be liable if it is shown to have provided the missile system.  And it's potential for liability would be heightened if Russian personnel actually operated the missile system.

There is historical precedent for holding bad actors on the international scene liable for civil liabilities.  In 1988, Libyan agents bombed Pan American Airlines Flight 103.  The next year, Libyan agents bombed a commercial airliner flown by UTA, a French airline (UTA Flight 772).  In both cases, the nation of Libya ultimately paid substantial sums of money (totaling billions of dollars) to settle civil claims. 

One big problem for Vlad is that the toothpaste is out of the tube and he can't put it back.  With the plane already shot down, all he can do is scramble to cover his butt.  Current news reports indicate that heavily armed men of uncertain identity are blocking international investigators from getting to the crash site.  Perhaps other men of uncertain identity have recovered the black box and . . . well, maybe the black box will be another victim in this tragedy.  Possibly, many bankers in Western nations are working day and night to shift assets of shadowy Russian entities to new and more obscure locations that are likely to entangle the curious in a briar patch of banking secrecy laws.  But Russia itself can't disappear, nor can it conceal all of its assets. 

The Obama administration has been accused of taking a tepid tack on sanctions over the Russian invasion of Ukraine.  European nations have been criticized for being even more equivocal.  But, to make a living as a plaintiff's attorney, you have to be as shy as a great white shark.  And, unless they have accidents with poison-tipped umbrellas, plaintiffs' counsel for Flight MH 17 claimants may be relentlessly pursuing Vlad and Russia for years.

Thursday, July 10, 2014

The EU Bubble

Today's kerfluffle in the stock markets over the debt default of an entity affiliated with Portugal's largest bank reminds us that if there is a financial bubble anywhere, it's in EU sovereign and bank debt.  EU sovereign debt and the debt of EU banks have become almost synonymous.  That's because they are linked by a problematic circularity.  EU banks have invested heavily in EU sovereign debt.  EU nations, in turn, have pretty much become the guarantors of the debts of their banks.  Thus, the banks borrow to invest in sovereign debt, and the sovereigns in turn guarantee the banks' debt that funds the sovereigns.  It's rather clever, as long as nothing goes wrong.

However, one could note that EU banks and sovereign nations appear to be burdened with each others' liabilities, and that the guarantees of EU nations accordingly have limited efficacy.  Given that the EU and its banks, in toto, can be reasonably described as overleveraged, this circularity can become a circular firing squad if there is a run on a major EU bank or an EU sovereign member nation.  This is particularly so since no EU nation can issue its own currency and pay its or its banks' debts with printed money.

Of course, the European Central Bank has in recent years made a show of pointing to shining armor it could don and white horses it could mount to ride to the rescue if there is another European financial crisis.  And it has adopted accommodative, money printing-like maneuvers when the going got tough (like letting EU banks use sovereign debt as collateral for borrowings at the ECB without any discounting of their face value).  If the dustup across the pond is limited to Portugal, the ECB should be able to find one way or another to keep the cookie from crumbling.  But if other EU nations, particularly larger ones like France, begin to waver, the EU financial bubble could burst in a nasty way.  The economic consequences could be bad.  Given the growing extremism in Europe, the political consequences could be worse.

There are some asset classes in the U.S. that may be getting bubbly.  Many Internet stocks are suspect. Housing except for the $1 million and up price range seems to be struggling.  In addition, small cap stocks haven't been doing well recently and may turn out to be a bubble bursting.  But it's unlikely that the frothiness of these asset classes could re-trigger the Great Recession.   On the other hand, if the EU sovereign nations can't keep their banking systems on an even keel, then all bets are off. 

Wednesday, July 2, 2014

Guinea Pigs On Facebook

There's a bunch of guinea pigs on Facebook, around 689,000 of them.  You wouldn't recognize them as rodents if you just looked at their Facebook pages.  Instead, you'd probably think they were people, some younger than the age of 18.  But guinea pigs they are, used by Facebook in an experiment to manipulate users' emotions by making the news feeds these users received either more negative or positive, and then measuring the effect on posts written by the g-pigs.  Evidently, g-pigs' emotions could be changed positively or negatively by the content of the posts they received.  In other words, emotion manipulation by Facebook seems possible.

Facebook claims that its terms of service allow this kind of experimentation.  If you didn't read the terms of service, then bear in mind that the possibility of this kind of horseship (sp) is exactly is the reason why you should read them.  But it may also be the case that Facebook's terms of service were kind of general, and written in that uniquely obtuse and obstructive language called legalese.   We would guess they didn't include a guinea pig clause, which explicitly informed users that they might be selected to be subjects in experiments in emotional manipulation where they wouldn't be informed of their selection and the emotional manipulation would be conducted in quite a non-obvious way.  So even if you were among the assiduous 0.01% who actually read the terms of service, you still might not have realized that you had just registered for the guinea pig draft and could be called up for service at any time.

Of course, one suspects that Facebook might not have wanted to let the g-pigs know what was going on.  Unknowing g-pigs would likely produce more meaningful experimental results than users who knew what was going on.  And if one considers Facebook's corporate interests to be more important than the interests and dignity of its users, then all this might make sense.  But if users are thought to be deserving of fair treatment--radical notion, that--then you'd have to conclude that Facebook really stinks for having done this.

The world is full of emotional manipulation: advertisements, political campaigning, editorials, op-ed pages, robo-calls from every manner of charity you never heard of, etc.  And when it's clear that the game is to manipulate your emotions, that's okay (at least when it's directed at adults).  But when emotions are manipulated sneakily, and your participation isn't made known to you, then that's a reason to avoid Facebook and any other social networking websites that pull similar carp (sp). 

You have to wonder if the emotion manipulation experiment signals that Facebook has reached its zenith and is in decline.  Has Facebook run out of bona fide, valuable services to provide to users?  Is it now stooping to emotional manipulation to keep existing users and bring in new ones?  Do we really need Facebook, or have we been manipulated into thinking we need Facebook?

Thursday, June 26, 2014

Partition Iraq

Joe Biden, while a Senator, got it right.  Iraq should be partitioned.  Not that prescriptive advice like this really matters any more because the partitioning has already happened and there really isn't any way to undo it.

ISIS, the Sunni extremists, already control northwestern Iraq, along with a good chunk of northeastern Syria.  No one will be able to dislodge them.  The Iraqi government's army is too busy surrendering territory and weapons to retake lost ground.  The Assad regime in Syria no longer has the ability to defeat a force as powerful as ISIS.  And the U.S. isn't sending in ground troops, without which you can't take or hold territory.

The Kurds have carved out a homeland for themselves, anchored by the city of Kirkuk, and they won't give it up, not after centuries of subjugation.  Certainly, the Iraqi army can't retake the Kurdish territory, and the Kurdish paramilitary Pesh Merga appears more formidable than ISIS. 

The Shiites in Iraq hold the southern and southeastern portions of the country, which contains most of Iraq's oil wealth.  Why fight for the less valuable land farther north when they already hold the jackpot?

Trying to keep Iraq together is guaranteed to produce unmanageable friction and endless warfare.  The Iranians now have their claws into the Baghdad government, and won't give that up.  America's Sunni allies on the Arabian Peninsula--Saudi Arabia, Kuwait, Qatar, etc.--have many secret supporters of ISIS, who will be royally p.o.'d if the Shiite government in Baghdad is able, with American assistance, to repress Sunni tribes in Iraq.  The Kurds have quietly allied themselves with Israel and sometimes with America, and pissing them off could weaken America's influence in the region.

America's power in the region might increase if Iraq were partitioned.  Even though once betrayed by the CIA, the Kurds would still ally themselves with the U.S., and offer American personnel a centrally located place from which to operate.  The Shiite Baghdad government might want to maintain friendly ties with America in order to counterbalance the Iranians.  Yes, the Baghdad government has cozied up to Iran.  But the Iranians are Persian, and the people in Baghdad are Arabs.  Iraq and Iran fought a bitter war with over a million dead in the 1980s, and the Baghdad government won't want its territory to become a province of a new Persian empire.

As for the Sunni area now controlled by ISIS, the U.S. could do what it did during the 2007 surge:  buy off the indigenous Iraqi Sunni tribes.  That's how the U.S. defeated al-Qaeda once before, and it's a way to undermine ISIS now.  The whack jobs that control ISIS impose an extremely harsh form of Islam--even al-Qaeda gave ISIS the boot because it thought ISIS unduly brutal (imagine that!).  The indigenous Sunni tribes in Iraq tend toward moderation, and won't be happy with the beheadings, stonings, non-medical amputations, and other barbarism that ISIS will inflict.  It's a safe assumption that U.S. Special Forces personnel and CIA agents have already started slipping into ISIS controlled areas.  Money talks, and thoughtfully large sums of money placed in the hands of the right Sunni chieftains might well lead to an ousting of ISIS.  The Sunnis might well want to carve out their own independent state, and the U.S. shouldn't get in the way.  A stable, moderate Sunni state in northern Iraq is far less likely than an ISIS caliphate to serve as an incubator of Islamic extremists who would target the U.S.  Especially if American aid flows generously to such a nation.  And America's allies in the Arabian peninsula might look favorably upon such a sanctuary for their religious brethren.

Partitioning has flaws, but not as many as the alternatives.  Yugoslavia no longer exists, but its constituent parts have learned with assistance from NATO how to refrain from ethnic cleansing.  The borders of the Near East (Israel, Jordan, the Palestinian Authority, Syria and Egypt) are the result of partitioning.  Yes, there's a lot of tension and some low level warfare in the Near East.  But the utter chaos of today's Iraq isn't present.  And South Asia is functional, if not entirely peaceful.

Re-uniting Iraq will involve combat and civilian deaths, probably a lot of them.  All of America's elites, war hawks, chicken hawks, experts, pundits, and bombasts don't have an effective way to put Iraq back together again, not unless hundreds of thousands of American troops are reintroduced to re-fight the ground war.  And that ain't happening.  It's better to leverage the new status quo, which we can't change anyway, to our advantage. 

Thursday, June 12, 2014

How To Reduce Volatility in Your Retirement Income

The S&P 500 has dropped three days in a row, and after all the market calm of recent months, many investors must be thinking that the apocalypse looms.  There are understandable explanations for the recent downdrafts.  Islamic radicals of the Sunni variety have rapidly seized several towns and cities in Iraq, along with American weapons and vehicles provided to the Iraqi government (and the administration worries about giving small arms to moderate Syrian rebels?).  Iranian paramilitary troops, who are Shiites, supposedly are fighting alongside Iraqi government troops to retake territory seized by the Sunni radicals. Is Iran now a more important ally of the Iraqi government than the U.S.?

Russian tanks have reportedly rolled into Ukraine, where the fighting is escalating.  Bashir Assad is winning in Syria, and the moderate rebels that the U.S. supports seem to be almost inconsequential.  Most of East Asia is squabbling over this island or that, with contending nations issuing many a proclamation declaiming a neighbor as a ratfink, a double ratfink or even a triple ratfink. 

Domestic politics also create uncertainty for the markets.  Eric Cantor, House Majority Leader, was just defenestrated in a primary election by a guy from far right field whose name, even if we mentioned it now, you probably wouldn't recognize.  (But we're going to, because it's Dave Brat, a marvelously fitting name for a guy who ousted the Majority Leader.)  Cantor, who outspent his opponent's six-figure campaign by $5 million, convincingly proved that money isn't everything.  Not even in politics.  The Koch brothers must be scratching their heads about what checks to write next.

The markets will always be plagued by volatility.  And it tends to pop up when you least expect it.  That might be inherent in the definition of volatility, but you know what we mean.  Yogurt happens, but you don't want your retirement finances smeared with yogurt.  While there are no complete protections against the ups and downs of life, here are a few ideas for calming the financial waves.

Build Up Social Security Benefits.  Disregard the hyperbole.  Social Security will be there when you retire.  Maybe not exactly as it is now, but nevertheless in a meaningful form.  Any politician who votes to eliminate or sharply reduce Social Security retirement benefits will end up doing an Eric Cantor faster than Eric Cantor as voters reject the idea that they should have to eat dog food in their old age.  Work as long as you can to build up your benefits.

Get a Pension.  If you're lucky enough to get a pension, stick out it long enough in that job to qualify.  Although classic defined benefits pensions are usually found these days only alongside the remains of diplodocus, lasso one if you can.  Other pension arrangements, like cash balance plans, are a lot better than no pension. 

Save More.  Saving more is a salve for portfolio instability and financial insecurity.  Those that have the saving jones won't have to get loans.

Use Retirement Accounts.  Retirement accounts like 401(k)s, IRAs and so on offer tax advantages that let you leverage your retirement savings, while limiting your ability to prematurely spend your savings.  A particular advantage to a 401(k) account comes if your employer provides a matching contribution, which is the freest money most people can get.  Use these accounts as much as you can.

Diversity Your Investments.  The values of all assets wax and wane.  But they usually don't wax and wane in unison.  More commonly, some assets get yeasty while others do the fallen souffle thing.  And vice versa.  So a diversified portfolio is usually kind to your antacid budget.  There are moments, like the 2008-09 financial crisis, when it seems like almost all assets belly flop.  But these cognitively dissonant interludes are the exception and not the rule. 

Consider an Annuity.  A fixed annuity (one that pays a specified dollar amount per month) or a fixed annuity adjusted for inflation can be a reasonable way to provide a steady income.  Annuities aren't cheap, and you should buy only from an insurance company with a strong credit rating. Don't put more than about one-third to one-half of your portfolio into an annuity because cash needs in old age can be unpredictable and it helps to have a nice pool of cash or cash equivalents.  Be very cautious about variable annuities--they often have high expenses, and the point here is to reduce volatility, not subject yourself to it in another form. 

Health Insurance and Long Term Care Insurance.  Financial volatility can sometimes come from sudden increases in expenses, and not just decreases in portfolio values.  Health care and long term care needs are the biggest landmines in the journey through retirement.  Most retirees are covered by Medicare, but if you're not, then buy something else.  The Affordable Care Act, despite all the teeth-gnashing on the right, is likely to be a good option if you don't have anything else.  If you have a significant net worth, consider buying long term care insurance, especially if you have a spouse who may depend on that net worth after you've gone to the great Dance Party in the sky.  It's expensive, but so is long term care.  If you want more than the quality of care given to Medicaid patients, long term care insurance may be a good choice.

Part-time Work.  Okay, you want to hear about retirement, not employment.  But part-time employment reduces the extent you need to draw down your savings, so you can keep more powder dry for later.  It also lessens your risk of dying from the boredom of day time TV.  It may boost your Social Security benefits (depending on your work history).  And the dignity of work is better than the indignity of looking for sales on dog food.

Saturday, June 7, 2014

Going Negative in Europe

"Going negative" is a political term of art, usually meaning that one candidate campaigns primarily by throwing mud at the other candidate(s).  In our jaded times, going negative has come to predominate.  Trash talking, if nothing else, captures attention.

These days, Europe is going negative for political reasons, although not in the usual sense.  The European Central Bank announced recently that it was cutting the interest rate it pays on deposits from banks to -0.1%.  In other words, banks that deposit funds with the ECB will pay a 0.1% fee for the privilege of having the ECB hold their money.  The ECB claims to be concerned with a low nominal interest rate of 0.5%, and supposedly cut rates below zero to spur bank lending.  Whether more lending will be done is unclear, as banks in the EU have been awfully finicky about extending credit in recent years (except to sovereign nations that sometimes aren't creditworthy).  Banks could cover the costs of the ECB's negative move by lowering interest rates paid on deposits (i.e., on longer term deposits that still have a positive rate) and increasing lending rates for existing borrowers. There's no necessary reason for them to make new loans.

The 0.5% inflation rate that supposedly led the ECB to go negative isn't strikingly different from the low inflation that already prevailed in Europe. One can't help wondering how much the EU was motivated by politics, as opposed to monetary policy.  The EU's badly conceived structure--a monetary union without true fiscal controls--encouraged overly enthusiastic borrowing by sovereign members, particularly those that were economically weaker.  The resulting debt crisis was met with the EU's BYOB (bring your own bailout) policy that meant austerity for those least able to cope, and economic recession (or, in some EU member nations, depression).  It's hardly surprising that political extremism flourished.
Nationalistic parties in Europe have recently made striking gains in EU parliamentary elections (yes, in the election of delegates to the EU Parliament, a quarter of whom now would favor the dissolution of the EU).  It must scare the mudcakes out of the ECB's bureaucrats that a quarter of the EU's governing body would be pleased to defenestrate the ECB.

Moreover, nationalistic impulses in Russia led to its seizure of Crimea from Ukraine.  Even though Russia formally transferred Crimea in political marriage to Ukraine in the 1950s, Vladimir Putin (Vlad the Invader, one might call him) seems to believe that Russia nevertheless holds a droit du seigneur to take Crimea for itself. In addition, Russian nationalism (plus surreptitious Russian military intervention) has fueled unrest in eastern Ukraine, leading to civil warfare.  It now looks like Ukraine may go the way of Syria.  Neither side is strong enough to win, and both sides are supported by outside interests that cannot afford to lose.  Russia can protect its interests by keeping the insurgency going at a low boil, just enough that Ukraine is afraid to cozy up too closely to NATO.  America has to do something to help Ukraine, but can't offer enough military assistance to decisively defeat the insurgents.  (Given the pathetic performance of the Ukrainian military, the only way the insurgents can be defeated is if we send in the Marines, and that ain't happening).  So, the nastiness of irregular warfare and flight of civilians from war zones, so familiar to observers of the Syrian civil war, is now being replayed in Ukraine.

Policy makers at the ECB undoubtedly noticed the rising manifestations of nationalism around them, and surely understand that the fiscal austerity imposed by the doyennes of the EU isn't doing a bang up job of fostering economic growth.  That leaves the central bank as the only actor in this drama who can administer the antidote to extremism:  the promotion of economic prosperity.  So, the ECB surely is going negative for political reasons.  And that's a problem.  Central banks were created to foster financial stability, not political stability.  But, with political processes in Europe (as well as in America) moribund on their best days, the ECB is trying to bail out a life raft with a tea cup.  And it's not hard to figure out its chances of success.

Thursday, May 29, 2014

The Lucky, Lucky Fed

Soldiers want their generals to be lucky.  As capable and knowledgeable as generals may be, they still need luck to win.  And citizens want their central banks to be lucky, because central bankers often fail even if they are capable and knowledgeable.

The Federal Reserve has been very, very lucky.  Unrest in Ukraine, territorial disputes in East Asia, the usual morass in the Middle East, and now nationalist parties winning European elections, have all combined to push U.S. Treasury yields down even as the Fed steadily withdraws its quantitative easing.  Financial markets mavens who confidently predicted that this would be the year of rising interest rates and falling stock prices have had to substitute excuses and explanations for predictions. 

Some still persist in forecasting rising rates and falling stocks.  Perhaps they will be proven correct.  But if you're betting your money on these predictions, remember that you're, at least in part, betting on the Fed's luck running out.  A bet on bad luck is still a bet on luck.  If you wouldn't play the lottery or patronize a casino, why bet on (or against) the central bank's luck?  The smart thing to do is stay diversified, and be patient.  (See http://blogger.uncleleosden.com/2014/05/why-you-should-invest-like-smart-money.html.)  The tortoise tends to be a better investor than the hare.

Friday, May 16, 2014

Why You Should Invest Like the Smart Money

One characteristic of the investing strategies of the wealthy is to diversify.  Stocks, bonds, money markets, real estate, alternative investments, collectibles, precious metals, jewelry, and so on are frequently found in the portfolios of the high net worth crowd.  Diversifying is a way to win no matter what's going on with asset values, and the wealthy want to stay wealthy.

The 99% should do no different, and recent market activity illustrates why.  Bond values have improbably risen in recent weeks, while stocks are stuck in a trading range right about where they started the year.  Gold and silver went up earlier this year, but have slid back.  Real estate ended 2013 with a roaring comeback, but now seems to have stalled out in many markets.  International markets have delinked, with Asian markets generally falling over the past six months, while European markets have moved up slightly (Ukraine crisis notwithstanding).  It would not have been easy to predict this mix of events.  Indeed, it's rare to find financial analysts who predict much of anything right.  Few predicted the 2007-08 financial crisis.  Few predicted the 30% jump in stocks in 2013.  Few predicted that bonds would rise this year.

The investing patterns of the smart money reveal that the smart move is to diversify.  Don't look for a quick buck.  You'll probably get a quick loss.  Don't look to hit a home run with a single investment.  The financial press may glamorize the few who manage to do that, but generally pays little attention to the many who fail.  Don't try to predict the unpredictable.  There are rare situations, like 2008-09, when all asset classes seem to be falling in value.  That's what can happen when vast amounts of debt and other leverage enter the financial system in one-sided bets dependent on rising asset values.  When that debt begins to lose value, the assets it was used to buy are at serious risk.  But more typical is what we have today--a lot of uncertainty, but some of the uncertainty is about the upside and some about the downside.  Most of the time, diversification is the best way to play your cards. 

And if you're still unhappy about your net worth, save more.  Whether the markets are doing well or badly, adding to your pool of capital will pay off in the long run.

Tuesday, May 6, 2014

Fed Guidance in a Fog

The terrain is getting foggier and foggier for the Federal Reserve.  Most recently, GDP barely grew (at an annual rate of 0.1% for the first quarter of 2014).  But nonfarm employment grew by 288,000 jobs in April, a pretty good pace.  And the unemployment rate dropped to 6.3%.  Not that many Fed Open Market Committee meetings ago, an unemployment level of 6.3% would have been below the point where the Fed's guidance dictated a rise in short term interest rates.  But rising rates would make the stock market pout and sulk.  So the Fed has backed away from firm benchmarks for monetary policy and is electrically sliding its way toward a strictly "data-based" policy.  What does that mean?  Apparently, it means whatever the Fed thinks the data indicates it should do in order to promote full employment. But if the data is becoming less clear, then what?

For more than a decade, the Fed has worked to provide greater transparency.  That's perceived to be a good thing because it tells the financial markets what to expect.  Presumably, investors will make wiser decisions if they better understand the lay of the land.  But transparency also encourages risk-taking.  If you know what the central bank will do, you can layer on more speculative bets because one factor that might blow you up now seems predictable.  This perhaps unintended consequence of transparency tends to lock the Fed into its guidance, and limit its options, because if you do something other than what you say, all the hedge funds, big banks and other speculators might get hosed.  And then the specter of a systemic tummy ache would loom. 

With the data getting murkier as the economy recovery sputters along, the Fed has become less transparent.  Most likely, this isn't accidental, as the Open Market Committee no doubt can see that the data is telling them less and less, and benchmarks don't mean what they used to mean.  The gamblers in the stock markets can't be happy, as the odds have become harder to calculate.  Fed policy now depends on the data, and recent data resembles a pushmi-pullyu.  

The Fed still hums the low interest rate melody even though it doesn't sing the lyrics any more.  That's a pretty good pacifier for the stock market, at least for now.  But with foreign affairs descending into the mosh pit (who wants to bet Vlad the Invader won't strike again?), and the economic recovery constantly shifting back and forth between first and second gears, the data--and consequently the Fed's guidance--will probably get foggier.

Thursday, April 17, 2014

The Shrinking Deficit: a Plus for the Market

The federal deficit is projected by the Congressional Budget Office to be just under $500 billion this fiscal year (the year ending Sept. 30, 2014). (See http://www.cnbc.com/id/101581648.) That's a lot of money, but only one-third the deficit of five years ago.  In other words, the deficit is lower by a trillion dollars, compared to half a decade ago.  That's a whopping huge drop, which leaves this year's deficit at 2.8% of GDP, below its historical norm of 3%.

When deficits fall, the government competes less in the credit markets against private sector borrowers.  This makes it easier for private interests to secure investment capital, a key predicate to economic growth.

Stocks tend to rise during periods of falling federal deficits.  The late 1940s and the 1950s are one example.  The 1990s are another.  The fact that stocks have risen steadily from their 2009 lows indicates that we are in another period of falling deficits and rising stocks. 

The future direction of the deficit is unclear.  The CBO predicts that it will fall a bit more next year and then begin to rise.  However, five years ago CBO didn't come close to predicting the deficit reduction we now have.  The weird, dysfunctional cognitive dissonance that is today's federal governance somehow managed to produce this beneficial result.  Who knows whether it might stumble its way to more good outcomes.  If the deficit stays moderate (near 3%), the markets will probably benefit.  While there are many other factors fueling volatility today, the federal deficit, improbably, isn't one of them.

Thursday, April 10, 2014

When the Market Will Go Down Next

With the stock market having more than doubled since its 2009 low, the question on the table--just about every investor's table--is when will the market turn down?  Recent trading days give us a likely answer.

For the past three trading days, the market dropped sharply as momentum stocks had bad momentum days.  Today, the market rallied briskly when the Federal Reserve released notes of its most recent open market committee meeting, indicating that central bank accommodation is alive and well.  Sweeter words could not have fallen on the market's ears, and stocks rejoiced.

As long as the market has confidence in central banks, there won't be a major downturn.  If the market senses that central banks are losing control, watch out.  Corporate earnings matter for individual stocks.  But central banking is the key to the overall direction of the market. 

Monday, March 24, 2014

The Limits of Globalization

Russia's seizure of Crimea reminds us that globalization isn't all it's cracked up to be.  The fall of the Soviet Union led to self-satisfied proclamations in the West about the triumph of capitalism and history ending in a glowing halo of liberal democracies.  Economic globalization would supposedly lead to worldwide reallocation of capital and resources to ever more efficient applications, with the result that economic tides would rise everywhere and prosperity would simmer in every pot. Nations and peoples worldwide would become increasingly interdependent and interlinked, making mutual tolerance in everyone's pecuniary interest.  Pots would melt around the world, diversity would be embraced, and preschoolers everywhere would learn the lyrics of Kumbaya.

Russia is interlinked with the rest of the world today:  economically in the energy markets and the financial markets, and securitywise with America and Western Europe in terms of dealing with Islamic radicals.  But none of that made a difference when Ukraine moved toward closer links with the West.  The centuries old Russian imperial imperative--that the Eurasian heartland be controlled from Moscow--howled.  Russia endeavored to maintain strategic geographic advantage by snatching control of Crimea's ports and naval bases, securing military and trade access to warm water.  Political machinations inside Ukraine have increased, in an effort to impede its Westward shift.  Russian troops in large numbers coincidentally gather for exercises within spitting distance of Ukraine's borders.  The economic sanctions imposed and threatened by the West have had no discernible impact on Russian policy. 

Globalization was an illusion fancied by people who fancied themselves elites.  This fancy illusion could be maintained as long as one cultivated ignorance of history.  But globalization is nothing new.  Europe in 1913 had extensive cross-border economic and financial relationships.  The European elites of the day were multilingual, cosmopolitan and cultured.  Somehow, none of that prevented the ignition of World War I over . . . well, nothing.  The most ridiculous war ever fought, World War I resulted in 20 million dead and peace terms imposed on Germany that were so harsh they practically guaranteed another war.  And that war--the Second World War--would require only 21 years before exploding in a frenzy of land grabs disturbing similar to what Vladimir Putin is doing now.  Whatever economic, financial, cultural and other ties are fostered by globalization, they don't trump the tribalism that characterizes almost all peoples in Europe, Asia and Africa.

Tribalism is difficult for Americans to grasp.  Having built a remarkably successful, diverse nation, Americans struggle with the idea that narrow concepts of group, based on cultural and historical ties, could somehow be so important as to justify conquering and killing.  Surrounded by the enormous economic benefits of the Melting Pot, Americans don't understand why other peoples can't embrace tolerance when tolerance will allow them bigger shopping sprees at the mall. But history tells us that you have to understand and deal with other peoples' irrationalities.  War, after all, is essentially always irrational.  But there are plenty of wars, all the time.  A smart foreign policy incorporates the need to consider and address other peoples' motivations, whatever they may be.

Economic sanctions have a role in America's and Europe's response to Russia.  But it would be a mistake to think they will be enough.  The sheer exertion of power will also have a place.  This doesn't mean triggers need to be pulled.  Strengthening NATO would get through to Putin, whose attention you get only if you exert power.  A pragmatic alliance with China should be sought (recall that Russia and China fought brief shooting wars in 1929, 1934, 1937 and 1969, so the Chinese have no illusions about Russian intentions).  The Japanese, who fought two wars with Russia in the 20th Century, should get a fist bump and more.  Unavoidably, America's Cold War coalition will have to be rebuilt.  And that's okay.  What's not okay is to believe that reason, plus maybe a few trade deals, will bring Putin around.

Sunday, March 16, 2014

How Putin Makes America Look Good

Not long ago, America was having a lot of bad hair days in foreign affairs.  The war in Iraq ended without stirring speeches or victory parades.  The war in Afghanistan is winding down, but won't have a prettier conclusion.  America led from behind in Libya and messed up in Benghazi.  Then, America led from even farther behind in Syria and, not surprisingly, got an aviary flip from the Assad regime when President Obama objected to the use of poisonous gas.  To avoid being totally blown off by a two-bit tin pot dictator, the Obama Administration had to work with Vladimir Putin's autocracy for a face-saving compromise that still isn't near full implementation.  America's grand strategy of pivoting toward Asia has floundered as extremism of numerous varieties keeps provoking eruptions in the Middle East and Europe.

Now comes Vladimir Putin--let's call him Vlad the Invader--who puts the shine on the United States.  Using the most transparently farcical of pretexts, Putin seized Crimea from Ukraine.  Okay, so there was a referendum in Crimea as to whether or not to "validate" the Russian land grab.  But with thousands of Russian troops "guarding" the polls to ensure "integrity" to the voting process, we knew how the vote would turn out before the polls opened.  There is nothing America can do to prevent Russia's annexation of Crimea, just as there was nothing America could do to stop Putin's 2008 land kleptomania in Georgia.

But America can and will react.  The EU will talk a lot--and then talk some more.  It will issue a few condemnations and maybe even an excoriation.  But sanctions?  Well, let's talk some more. 

America's sanctions will be primarily economic.  And Russia will respond in kind.  America's economic interests will suffer.  But Russia's economic interests will suffer more.  Not necessarily in terms measured by dollars (or rubles), but in terms of relative pain.  Russia has a much smaller and weaker economy than America.  And Russia's economy is growing slower, with continued prospects for slow growth.  Crimea requires significant subsidies, which will further drain Russia's resources, along with the added cost of all the military "exercises" the Russian Army is staging with walking distance of the Ukrainian border.  From a strategic standpoint, Russia's nuclear arsenal is a match for America's.  But Russia's economic arsenal is far weaker.  And Russia's energy customers and trade partners will look elsewhere for supplies and opportunities, not wanting to give leverage to a bully with a powerful military.

The Cold War was primarily an economic struggle.  America and the Soviet Union engaged in a 50-year competition to build to the most advanced and powerful military.  Arsenals cost money, and America's vastly greater wealth left the Soviet Union moribund, unable to deliver prosperity or even anything approaching a First World standard of living for its citizens.

As America and Russia swap sanctions, it is important to keep in mind that, realistically, the goal isn't to force Russia out of Crimea.  That won't happen.  The goal is to turn the crisis into an opportunity to make America once again the world's shining beacon of freedom and democracy.  America's sanctions, although likely to be ineffectual in terms of sending Russian troops back to the barracks, will contrast sharply with the EU's decrepitude, and the near silence from the Asia.  As an ironic consequence, America's influence around the world, and especially in the periphery of Russia's borders with many former members of the Soviet Union and former Soviet satellite states, will likely grow.  After all, no one likes a bully.  The bottom line is Putin has made America stronger.

The outcome of the looming war of sanctions is difficult to predict with precision.  But the advantage lies with America and its great economic strength.  Germany and Japan won the early rounds of World War II.  The Soviet Union won most of the early rounds of the Cold War.  But we know how those stories ended.  Even if Putin will be able to feel like a studly fellow for a while, time isn't on his side.  Keep the faith.

Monday, March 3, 2014

Why Regulate Bitcoin?

Okay, so Mt. Gox, once the largest Bitcoin exchange, has belly flopped and lots of people have lost lots of Bitcoins (apparently hundreds of millions of dollars worth).  Mt. Gox is in bankruptcy, but unsecured creditors like its erstwhile customers usually get the back of a hand in bankruptcy proceedings.  Last year, Bitcoin was celebrated for its independence from any national authority and the anonymity it supposedly provides.  This year, the losses from Mt. Gox have many crying for regulation.  Is that a good idea?

First, Bitcoin would have to change fundamentally for regulation to work.  Anonymity would have to go.  Regulators need to safeguard the market from thieves, manipulators, and all variety of fraudsters and other crooks.  That necessarily means they need to know who is behind transactions--potentially any transaction.  It is axiomatic among financial regulators that, in order to uncover shenanigans in the market, one follows the money.  And you have to be able to find out who is behind transactions in order to follow the money.  So, if you really want regulation, say goodbye to the anonymity of Bitcoin.

But an even more important question for the nation(s) that might consider regulating Bitcoin is why would regulation serve the public interest?  Bitcoin is economically trivial.  If all Bitcoins disappeared tomorrow, the world economy and all major national economies wouldn't even hiccup.  Setting up an effective regulatory regime would require not just one nation, but the participation of all economically significant nations because Bitcoin can be bought or sold worldwide.  The costs of establishing regulatory agencies, hiring personnel, buying equipment, leasing office space, and funding investigative and regulatory processes would, by all appearances, greatly outweigh the societal benefit. 

Another risk of regulating Bitcoin is that doing so would legitimize it.  Once a government begins to regulate a financial contract, it makes that contract more attractive to mainstream financial markets players.  That would mean the major banks, hedge funds and other big players would start trading all manner of Bitcoin contracts.  A derivatives market in Bitcoins would pop up, and with it all kinds of headaches about risk management, settlement and clearance, and so on.  All for something the world doesn't need. 

And sooner or later, some form of governmentally sponsored deposit insurance would probably be sought by Bitcoin enthusiasts.  If the big banks and hedge funds add their lobbying power, such insurance might make it through Congress.  But deposit insurance could easily, directly or indirectly, end up putting taxpayers on the line to cover Bitcoin losses like those suffered by Mt. Gox customers.  Which would be just peachy--another taxpayer funded bailout in the making.

The bottom line:  don't regulate Bitcoin.  There's nothing in it for national governments or taxpayers.  We don't need more financial risk for regulators, central banks and taxpayers to worry about.  If Bitcoin is truly worth anything, it will survive in the market.  And if it doesn't, good riddance.

Sunday, February 23, 2014

The WhatsApp Deal: Did Zuckerberg Just Blink?

WhatsApp is the antithesis of Facebook.  It doesn't collect personal information.  Messages aren't stored in WhatsApp's servers.  There are no ads on WhatsApp.  As a messaging service, there's nothing on WhatsApp for strangers (or parents) to find via search engines.  It offers the one thing that's almost impossible to obtain on the Internet:  privacy.  No wonder it's growing by a million users a day, many of them in the young adult cohort coveted by commercial websites.

It's unclear what Mark Zuckerberg hopes to achieve by having Facebook buy WhatsApp.  If he engrafts WhatsApp onto Facebook, or makes it semi-clone of Facebook (i.e., has it run ads), it will surely lose much of the privacy it offers.  Facebook's business model, after all, is to vacuum up as much personal information as possible in order to cram advertising into users' faces.  But that could drain away much of WhatsApp's attractiveness to its current user base, and they could easily flee to any of a number of competitors offering private communications. 

If Zuckerberg keeps WhatsApp independent, he'll have to find some way of generating revenue--a shipload of it, since Facebook is paying $19 billion for WhatsApp and the only justification for such a Brobdingnagian price would be freight cars full of revenue.  But you can't charge users much for instant messaging services (the phone companies tried that with text messaging and users are moving away from them).  So there is a big question about what kind of rabbit Zuckerberg will pull out of the hat as a business strategy for WhatsApp.

One thing that seems apparent is that he's blinked.  Zuckerberg evidently has come to realize that Facebook isn't going to be the platform for all users all the time.  He's jumping onto one of the new, hot things on the Internet.  Diversifying Facebook's corporate profile may be a prudent move.  But the company now has two conflicting business models under its corporate roof, and it will have to sort out how to handle these conflicts.  History does not suggest success is assured by any means.  Microsoft entered various lines of business that were potential threats to its basic MS-DOS/Windows business--search engines, portals, mobile software, etc.  It didn't managed them very well, because boosting a newer technology could mean undermining its cash cow.  Newer, nimbler competitors, unburdened by these conflicts, ran circles around Microsoft.  Facebook is one of them.  But now it has taken in-house a conflict between the old (yes, Facebook is getting old) and the new on the Internet.  How Facebook handles that conflict could dictate the future arc of its growth.