Archive for September, 2007

Trade, not democracy

Friday, September 28th, 2007

Few but Mr. Bush’s dogged 29% now believe spreading democracy by force was a good stabilization strategy.

Can we find any useful insight at all, lost in the neoconservative disaster that is Iraq? Well… almost. OK, they were wrong about democracy, and wrong about using force, so their wrongness is at least 99.7% pure. But there is something rich countries can spread, by policy and by example, that automatically creates stability.

Trade and investment.

Why is this stabilizing? Because economic interdependency complicates projection of military power. Governments and citizens (particularly merchants) depend upon stability of input supplies and investments, and don’t want to rock the boat.

It’s no accident that the “axis of evil” happens to be a group of relative outcasts from the global trading system. In a confrontation between one of them and the U.S., both sides have less money to lose in a confrontation, and thus war becomes more likely.

Among the three, Iran is the most economically integrated, and thus least likely to be a threat. Look at Iran’s incentives. They are one of the more economically isolated countries in the world, and yet are absolutely dependent upon the price of oil. Could they use a proxy army (aka terrorist) to plant nukes in U.S. cities right now? Yes. Will they? No. Why? The price of oil would collapse, and with it their own economy. Even Iran’s hands are tied by its limited participation in the global trading system.

Viewed this way, it looks mistaken to economically isolate countries whose policies we don’t like. Yet this is consistently what we do. The right answer is the opposite: kill them with kindness, by throwing the trading and investment doors wide open.

Bank Run Dept.

Wednesday, September 5th, 2007

Is it time to read the fine print on that SIPC policy?

On August 20, the Federal Reserve tripled the amount Citibank, Bank of America and JPMorgan are permitted to lend to their brokerage subsidiaries, to a whopping 30% of bank assets. This is an unprecedented waiver of regulatory oversight, and calls the brokers’ liquidity into question.

Brokerage insolvency risk first emerged, quietly, with the Brookstreet Advisors insolvency in June. Brookstreet was buying (and advising its clients to buy) securities on margin, backed by mortgage-backed securities. When the subprime crisis hit, ensuing margin calls wiped out the firm and many of its clients.

Brookstreet’s failure, by itself, was just bad advice, not a systemic problem. The real concern was barely mentioned in the press: Brookstreet’s margin lender was a unit of Fidelity Investments. Fidelity, and presumably many other broker-dealers, have lent undisclosed sums of money against illiquid securities of dubious quality. They may repossess those securities in a margin call, but they cannot liquidate them at anything near face value.

It thus appears unlikely, but not impossible, that a major broker might fail.

Yes, investors’ assets are covered by the SIPC up to $500k, but they don’t say WHEN you get your money back. Individuals may not want to have all their eggs in one basket. Some alternatives that don’t require selling stocks:

  • Move your “emergency” cash to interest-bearing checking (INGDirect pays 5% and claims no subprime exposure).
  • Take physical delivery of stock certificates for long-term holdings, and put them in a safe deposit box.
  • Move mutual fund shares to be administered by the mutual fund itself, not your broker.

This brings peace of mind with relatively little effort, and no taxes or trading costs.