Margin Call

There has been a lot of commentary on the movie Margin Call, so I might as well add my two bits worth (and a new category called Arts and Entertainment).

A margin call is what happens when a company invests with borrowed money and finds its investments losing value. It has pledged to maintain a certain “margin,” meaning a certain ratio of its own money to borrowed money. When its investments lose value, lenders make a margin call, telling it to put up more of its own money. The company is forced to sell assets to meet the margin. If it has to sell its assets at fire sale prices and cannot raise enough money, it is toast. There are no margin calls in Margin Call, or even mention of a margin call, but it is presumably the fear of a margin call that leads the characters to do what they are doing.

An unnamed financial company in New York in 2008 is clearly in trouble from the very start. A major downsizing is underway, with the comment, “These are extraordinary times.” The senior risk manager on the floor is called away from his urgent research, offered their severance packet, and told all his access is cut off as of now, and their security guard will escort him out; we hope you understand you recognize this is not punitive. He says he is working on something important and can he finish it? The answer is no. Asking who is behind this, his higher-ups deny everyone, but hesitate at Sarah Robertson. Despite the security guard leaning over his shoulder, he manages to download his important research onto a USB key and hand it off to a young floor level analyst on the way out. Once out the door, he picks up his cell phone to call the analyst, only to find he has already been cut off.

All of this, of course, is a well-worn movie trope and raises the suspicion that he was fired because he Knew Too Much. The suspicion is strengthened when the young floor-level employee sticks around after everyone else leaves and discovers that the company has invested in a huge pile of crap (in the form of mortgage backed securities, although that gets relatively little emphasis) at extreme leverage. If it falls below a certain value, it will wipe out their entire assets several times over – and it already has several times, but no one has noticed so far. No one mentions margin calls, but if they get one, they are toast.

He calls his colleague and their superior (who speaks with a British accent) from their favorite strip club. They call in their boss (played by Kevin Spacey, who is older than when I last saw him). They take this to Robertson, the head of risk management who fired the senior risk manager who found this out. Robertson and her team then proceed to allay our suspicion that he was fired because he Knew Too Much by appearing to be surprised and caught off guard. They need some time to confirm, but it does, indeed, turn out to be true, so they call in the CEO, John Tuld (accent I can’t place), who arrives by helicopter. Tuld says he sees only one option – dump (or, as they say in the financial world, unwind) this load of crap* before anyone else figures out it is crap. Kevin Spacey objects. If they are only selling and not buying, how long can it be before everyone else figures out what is going on. And if they trick other companies into buying a load of crap, no one will ever trust them or do business with them again. But Tuld is firm, and Spacey yields.

All the higher-ups seem shocked by this development, and we are just about to conclude that the senior risk manager really wasn’t fired because he Knew Too Much. But as soon as Robertson and Tuld are alone, she says she warned him but he didn’t listen. The risk manager had been warning her for some time, so we get definite confirmation that he was, indeed, fired because he Knew Too Much. And Tuld tells Robertson someone has to get the ax for this, and she has been chosen.

The next morning, Spacey tells his floor traders, in effect, that he is asking them to destroy their careers forever for the sake of the company by dumping a load of crap on unsuspecting buyers who will never forgive them for it. He offers special bonuses if they succeed – they will need them, given that they are being asked to kill their careers. So they start making calls, pretending they are offering a great deal. The day goes buy and we see them sitting in front of their computer screens, watching returns go down and down as buyers figure out what is going on. Apparently all-out market panic looks a lot different than it used to. The senior risk manager is paid an outrageous bribe to sit in a closed room and not tell anyone. After the successful unload, Tuld comforts Spacey by telling him that crashes like this are normal and happen quite regularly.

The movie ends up feeling unsatisfactory for at least two reasons. One is that ultimately Man Who Knew Too Much movies don’t work so well on Wall Street. Traditionally the Man Who Knew Too Much and manages to hand it off to someone else usually turns up dead shortly afterward and the recipient is soon on the run for his life. By contrast, the worst Wall Street can do is threaten to withhold money. The effect is rather like what I had watching The Lives of Others, about the soul-destroying totalitarian regime of Communist East Germany. Except it was a soul-destroying totalitarian regime that no longer tortured or killed, and that only imprisoned if there was sufficient evidence of an actual crime. Granted, publishing embarrassing stories about the skyrocketing suicide rate was a crime that carried a prison sentence, but the usual threat to a dissenter was no more than a ruined career. And likewise money means a lot to people on Wall Street, especially if they have debts. We even fear for characters’ lives, though always at their own hand, and never with justification. And it can be telling that a threat to career or money can be as intimidating in the end as the threat of something more dire. But somehow it takes a lot of the dramatic tension out of a Man Who Knew Too Much movie to know that only money is at stake.**

The other unsatisfying thing about the movie was that it doesn’t correspond to any real event. Although the CEO is named for Lehman Brothers CEO Dick Fuld, the company can’t possibly be Lehman. After all the movie appears to end with the company dumping its load of crap and thereby dodging the bullet. Lehman famously did not dodge the bullet. More realistically, it might be equated to Goldman-Sachs, which did survive (and is much resented for it). Except the movie not only ends with the company dumping its crap first and surviving, it certainly implies that this was the catalyst that brought the whole house of cards crashing down. Except that neither Goldman Sachs nor any other finance company (so far as I know) survived by dumping its crap first. Nor was the catalyst that turned growing anxiety into all-out panic anyone unloading its toxic waste on everyone else. It was the failure of Lehman Brothers.

Granted, Margin Call is a work of fiction and is going to heavily fictionalize what happened. But fictionalizing characters and companies is one thing; fictionalizing events that brought down the system is quite another. In effect, the movie portraying as history events a mere three years old, events that still have major repercussions today. Presumably the audience has a fair idea what actually happened. This makes historical accuracy especially important. More than anything else, I left the movie uneasy because I could not place it in real time.
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*Tuld calls it "a bag of the most odorous excrement ever assembled in the history of capitalism."
**This is not to deny that you can make a good movie with lots of dramatic tension about Wall Street. You just have to find some other way to go about it.

Damning With Faint Praise

I will say this much for the parade of Republican front runners. I prefer Gingrich to Cain. I prefer Cain to Bachman. I prefer even Bachman to Donald Trump. So I guess the Republicans are trending in the right direction.

After a couple of hundred more that way, they might come up with a decent candidate.

What do Trump, Bachman, Cain and Gingrich Have in Common?

Aside from all being some-time Republican front runners, what do Donald Trump, Michelle Bachman, Herman Cain and Newt Gingrich all have in common? Answer: None of them has ever been governor of a state. Mitt Romney, by contrast, has been a state governor. So have other promising-looking Republicans who either went nowhere or decided not to even try -- Chris Christie, Haley Barbour, Mitch Pawlenty and Jon Huntsman. After fielding a set of candidates top-heavy with governors, Republicans just don't seem to like any of them. (Rick Perry is the anomaly, but I will get to that soon).

The reason is easy to see. Members of Congress are free to be as nutty as they want, confident that their colleagues will outvote them. CEO's have to run a company, but most of their decisions are non-ideological and irrelevant to national politics, which leaves them free to say whatever they want. Even Speakers of the House can get dangerous but ideologically pleasing legislation through, confident that either it will fail in the Senate or the President will veto it.

Governors do not have these options. Their options are essentially two.

The first is to take the business of governing seriously. This will make them popular in their states and therefore seem like likely candidates. But inevitably it will mean deviating from ideological purity and making concessions to reality, objective and political. This is unacceptable to the Republican base these days. Rick Perry is the anomaly, the one governor who did manage to be a front runner with the Republican base. But he joined the race late and flamed out almost at once, as soon as people started scrutinizing his record and finding out that he made the sort of ideological compromises that are inevitable in successful governing.

The second is to maintain rigid ideological purity, make no compromises and give no ground. This fires up the base for a while, but invariably it is a disasterous way to govern. And invariably governors who are unable to govern become unpopular fast. And unpopular governors just don't look like promising candidates, no matter how ideologically pure they are.

Trump, Bachman, (Perry) and Cain have all enjoyed a brief burst of popularity, only to burn out as they proved not fit for the job. Now it is Gingrich's turn in the sun. But fear not, my friends. If Gingrich flames out, that still leaves Rick Santorum. He's never been a governor either.

Cain and Foreign Policy

To be fair to Herman Cain, though, I don't think he is as clueless about foreign policy as some people do. Granted, saying that China is “developing” nuclear weapons would be clearly disqualifying if it meant he actually didn’t know China was a nuclear power. But given that Cain served as a Navy consultant, possibly specializing in Chinese military capacity, I am inclined to give him the benefit of the doubt and assume he misspoke.

Likewise, when asked if Pakistan was friend or foe, his much-maligned answer was basically correct – no one knows. Pakistan is playing a dangerous double game and we can only guess the outcome. Anyone who claims to have a simple answer whether Pakistan is friend or foe is a whole lot less qualified than someone who says it is impossible to tell.

Nor do I agree with people who mock his interview about Libya. Granted, it takes him some time to scan his memory banks, access the subject, and process an answer. But when he does, he makes three perfectly reasonable points: (1) Qaddafi was a really bad guy; (2) it does not logically follow that his successor will be any better; (3) we should therefore proceed with extreme caution before supporting the rebels against him. These are, after all, exactly the arguments opponents of invading Iraq made, and they were right. Cain is also on solid ground saying he can't answer whether he would have intervened if he were President because his decision would depend on intelligence about the rebels that he does not have access to.

Cain’s comments may sometimes lack polish, but they show significant nuance and awareness of subtlety. His real problem is that he is appealing to an audience that opposes nuance and subtelty on moral and religious grounds, and quite possible shares their views. So all nuance and subtelty must be eschewed in favor of an approach to foreign policy that would separate our friends (presumably Israel and everyone who toes Israel’s line) from our enemies (presumably everyone who ever disagrees with Israel) and to give absolute support to our friends and
absolute opposition to our enemies. Yet his answers on Pakistan and Libya sound very much like acknowledgements that the real world isn’t that simple.

If those answers sound a bit awkward, I suspect comes not just from lack of knowledge about foreign policy, but from wanting to impose a simple friend vs. foe framework on the real world and being constantly confronted with evidence that it isn’t that simple. In effect, a man who sees the world in black and white is attempting to process Technicolor and having difficulty. Depending on one's viewpoint, this could be disqualifying -- or it could mean that his foreign policy wouldn't be as bad as his opponents may fear.

More Things I Don't Understand About the Economy

In the recent past, why did pump prices keep rising, even as oil prices were falling?

And now, why do pump prices keep falling, even as oil prices are rising?

Will the Chief Executive of Godfather's Make a Good Chief Executive of the US?

I wanted to post about Herman Cain for some time, but the “R” key on my keyboard stopped working, and how can you write about HeRman without an “R”?

I have been wanting to post about Cain since he gave his response to allegations of sexual harassment. Cain said:

Our nation has very serious problems, particularly of an economic nature, and Barack Obama does not have the skill, knowledge or will to solve them.

I do.

Unfortunately, the media-driven process by which one must seek this opportunity is fundamentally unserious. I have touched on this before - the emphasis on "gaffes," gotcha questions and time devoted to trivial nonsense - and everyone knows the process only became further detached from relevance this week as the media published anonymous, ancient, vague personal allegations against me.

Once this kind of nonsense starts, the media's rules say you have to act in a certain way. I am well aware of these rules. And I refuse to play by them. . . . These rules stink. Can the process by which we pick the leader of our nation be any more absurd?
......

The nation needs its tax structure reformed, its spending brought under control, its debt reduced and its overall governing structure made far more responsive to the needs of the people. The nation needs many other problems addressed. If it's OK with the American people, I would like to address them.

In theory, this is well-spoken, even eloquent. Cain is certainly right to complain about our dysfunctional media and its fascination with the pettiest and most inconsequential aspects of the candidates at the expense of more serious, substantive issues.* He is also right to refuse to play that game. Not so certain is his claim that the sexual harassment allegations petty and inconsequential. This remark happened, after all, right after a woman accused Cain of reaching under her skirt and pulling her head into his lap. Still, let’s assume Cain’s point, that these are trivial allegations, much less important than the substantive questions of who has the answers to our problems. The statement ultimately only works if Cain really does have the answers. Color me unconvinced.

For starters, he doesn’t have a clue about foreign policy, and he’s proud of it. But at least Cain understands foreign policy is not his strong suit. Maybe he can find a really good Secretary of State (George Schultz, will you come out of retirement?) and delegate foreign policy to him (or her). What Cain does see has is area of expertise is the economy. He is confident that, as a businessman, he is better qualified to deal with the economy that any politician and that, by applying business principles to the government, he can turn the national economy around. Is he right about that?

I will touch only briefly on his 9-9-9 plan. It has been dissected enough in other places. First, the 9% corporate tax is on gross earnings, i.e., total revenue minus raw materials and does not allow businesses to deduct wages as an expense. This will make hiring much more expensive and tend to discourage it, exactly what we do not want under conditions of high unemployment. Second, its regressive nature will tend to depress consumer spending in lower income groups and, by extension, depress the economy. Passing such a regressive plan may also be more difficult than Cain thinks.

Besides making taxes simpler and more regressive, the other half of Cain's program is cutting spending. Cain likes to boast that turned around, first a troubled regional section of Burger King and later the entire company of Godfather's Pizza, and that he can therefore turn around the economy. One of the ways he did this was by cutting expenses and shutting down less profitable restaurants in the chain. By cutting off its weaker branches, he was able to restore the company as a whole to profitability. The implication is that he will do the same to government and, by extension, turn around the whole economy.

This is, after all, a fairly typical business mindset, but it doesn't translate so well to government. For one thing, although shutting down an unprofitable restaurant is painful and throws people out of work, it doesn't compare to shutting down large portions of government, which means eliminating important services. For another, businessmen sometimes forget that the object of government is not to make a profit, but to govern. But most of all, although businessmen are no doubt good with the micro aspects of economics, what works best at the micro level does not necessarily add up at the macro level, and businessmen often do not understand that.

A business has to maintain a positive cash flow or it will fail. A government is under no such obligation. People sometimes try to argue to a businessman that the same rules don't apply to a government as to a business because government can print its own money. But I don't think the problem is that businessmen don't understand that. I think they understand it very well. (Cain certainly does; he served on the Kansas City Federal Reserve Bank). The problem is not that businessmen don't understand that; it's that they are mad as hell about it. They don't want the government to have its own set of rules; they want government to be held to the same set of rules they are.

On the other hand, it may well be that businessmen don't understand the implications of the different rules that apply to government. When a business runs into economic trouble, its best survival strategy is often to downsize, as Cain did. But, of course, when all businesses are downsizing at the same time, the result is that the overall economy gets downsized. We call that a recession. Another is that government is so big that when it downsizes, the result is a downsizing of the whole economy. Perhaps some businessmen would say they know that; that's why they want to shrink to government to the size where it won't matter so much. The problem with that, of course, is the time to do that is when the private sector is expanding fast enough to make up for the shrinking government. When the private sector is doing the downsizing (or hasn't grown enough to make up for the last downsizing), the government can use its advantage in borrowing to offset the shrinking private sector and limit how much the overall economy shrinks.**

In short, I would expect a President Herman Cain to seek to respond to our economic problems the way CEO Cain responded to the problems at his restaurant chains -- to downsize and eliminate the less profitable operations in order to a restore a positive cash flow. I would expect him to assume that is the key to good macro-, as well as micro-, economic health. I would expect him and the country to learn the hard way that he was wrong.

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*To take a few examples from the last election: Is Hillary’s high-pitched laugh too grating? Do Obama’s bowling scores make him out of touch? McCain looks hideous against a green background!

** Some link I no longer remember quotes a small businessman who is mad as hell that the government doesn't have to cut back when he does. When asked what he thinks Obama can do to improve the economy, his answer is two words: "Cut spending." The columnist then points out how many of the business's orders are from government these days, and won't cutting spending mean less orders? The businessman admits he never thought of that. I am guessing Herman Cain's mindset is much the same.