Fin/Inv

Gasoline-electric hybrids.  So, you might breakeven in fuel costs in about ten years of careful driving.  By then, the battery will need replacing, and to fix it, it may cost you just as much as your car is worth- or more.  Are gas-electric hybrids really worth looking into?  Well, that’s still debatable, and more on that, a little later...  I firmly believe, and a lot of other “car guys” will contest, the gas-electric hybrid is an intermediate technology at best- a solution till something truly superior or sustainable comes along.

Mention “hybrid” to most German manufacturers, and they’d almost scoff at the notion.  Since the late 1970’s diesel has always been their first choice in environmentally friendly, economical solutions to a greener automotive footprint, and they’ve done well with them.  Mercedes-Benz, BMW, and Audi/VW all offer a lineup of efficiently powerful diesels to fit the bill, even importing a handful of models Stateside.  But things are changing. 

(You didn’t think Mercedes-Benz would ever pattern a hybrid after what?  A Lexus?  Please….) 

 

Mercedes-Benz is the first to unveil the production hybrid that uses a lithium ion battery.  The very same type of battery found in your cell phone or laptop.  But isn’t this the same type of battery as found in the Tesla Roadster?  It is- but the Tesla Roadster is an all-electric plug-in, a glorified kit-car in comparison; hardly a mass-produced, sophisticated road machine like the Mercedes-Benz S-Class.    

 

The 2010 Mercedes-Benz S400 BlueHybrid™- is the first hybrid ever for the manufacturer; in fact, it’s actually a “mild hybrid” with an electric motor kicking-in for a few seconds at startup, mostly.  To note- even the use of the color “blue” over “green” sets this hybrid apart…  But anyway…  That’s just marketing.  It is the first-ever production car to use a lithium-ion battery, unlike most that use nickel-hydride types. 

 

Being a “mild hybrid,” its hybrid effect is subtle, with the thin, twenty-horse, 118 lb-ft electric motor wedged between the conventional 3.5-liter Mercedes V6 engine and the advanced seven-speed automatic transmission as found in any top-range S-Class sedan for a combined 295 horsepower.

 

The battery itself is about the size of a shoebox, made by Continental.  It has 32 cells, (made by Saft of Europe) and has the output of 120 volts, 0.9 amps per hour, neatly positioned in the engine bay- with the rest of the engines and motors, of course.  A cooling system tied to the S-Class’ HVAC system ensures the battery is kept at safe, optimal temperatures all the time, even while the car is parked, with the aid of a dedicated electric cooling motor. 

 

The engineering is so unique, that according to Mercedes-Benz, they’re confident the battery will last the lifetime of the entire car.  Now, if these were the Mercedes-Benzes of 20 years ago, I’d say that’s a good thirty years of operating service; but well, I suppose a battery that lasts as good as the car is a good estimate for “a long time.”  Whatever that is these days, I really don’t know anymore.   

 

The electric motor kicks-in under heavy load conditions, engine re-starts and kicking-in at very low speeds from a complete stop; unlike most hybrids in the market that can and will drive under complete electric power, a hybrid like the S400 uses electric motors minimally- aiding in the engine stall/shut-down to a stop and from a slow start-up in stop-and-go city driving.  The whole process is silky smooth, so unnoticeable; you have to watch the dash-mounted display to know what exactly is happening if you really care at all.  

 

In typical Mercedes-Benz fashion- the S400 is a masterpiece of cutting edge technology, but, it comes at a price- almost $90,000.  But then again, this is a big, heavy, loaded high-performance luxury sedan; that can still do zero-to-sixty in just over seven seconds, all while still getting an additional 165 miles per tank of gas over a similar traditional S-Class.  According to the manufacturer it can get 19 city/26 highway, its some 26% more efficient than the standard S550 sedan for about the same money!  You’re even eligible for a one-time tax credit of about $1,200- something to put towards rubber floormats, wheel locks, plastic driving mugs and diecast models for the kids in the dealer’s boutique. 

 

In comparing the S400 to its contemporary full-diesel, CDI S-Class siblings (not offered Stateside) the economy and footprint on the environment with the carbon emissions is about equal.  But the Swabians are not ditching diesel, the old diesel cycle just yet; diesel is technology they pioneered in 1936.  Don’t be shocked if a diesel hybrid is next.

The 2010 S400 maintains, that, while cars are clearly not what they used to be, alas, a Mercedes is still a Mercedes, and one that is "Engineered Like No Other Car..."

Remember those days?  I do.

 

 

I thought it would be interesting to combine my inflation indicator, which is derived from the trends in gold, crude oil and yields on the 10 year Treasury, with the "Dumb Money" indicator, which is derived from widely available investor sentiment data.

Say this for Dubner and Levitt -- they've provoked an interesting discussion, although probably not the one they hoped for.

Brad DeLong does in less than a weekend. He is as enchanted as Robert was*:

My personal favorite is a giant parasol 18,000 miles in diameter at L1 to absorb and then reradiate a chunk of sunlight in other bands.

but notes the reality as well:

But I have never been able to find anyone here at Berkeley who (a) knows what they are talking about, and (b) agrees with Levitt and Dubner that we know that Al Gore efficiency-and-conservation solutions are much less cost-effective than Mt. Pinatubo geoengineering solutions in dealing with global warming.

And summarizes accurately:

[Dubner and Levitt] then failed to do their intellectual due diligence about what they were told [at Myhrvold's Intellectual Ventures].

Followed by twenty (20) edits for the first half of the chapter.

First, the climate scientists called b*llsh*t. Now, the economists are coming out—and the song remains the same.

It's becoming more and more obvious why the first book described John Lott as "an economist" and Paul Krugman as a "Bush critic and NYT columnist."

*Didn't everyone already read a simpler version of idea in Arthur C. Clarke's The Fountains of Paradise. And wasn't that enough of a cautionary tale on how complicated the reality is likely to be?

CR Note: This is a guest post from albrt.

Another interesting foreclosure decision came down this week – U.S. Bank v. Ibanez by Massachusetts Land Court Judge Keith Long. The case is about securitized subprime mortgages that were foreclosed in mid 2007. The originating banks had assigned the notes and mortgages “in blank,” and the documents were then given to a custodian who kept them safely filed away while the securitization machine went to work. The mortgages were assigned to pools, and the pool trustees eventually sought to foreclose on these particular mortgages.

The pool trustees used a non-judicial process called a “power of sale.” In states that allow non-judicial foreclosures, banks can legally take back a house and sell it with little or no oversight if they follow the steps of the statute carefully. The Massachusetts statute required the banks to give notice of who held the mortgage. The pool trustees in Ibanez named the wrong party on the notices because they had not updated the assignment stamps on the documents at the time they advertised the sale.

The pool trustees were not able to get title insurance for the properties after the sales, so they filed complaints with the land court asking to have their titles validated. Judge Long held that the foreclosure sales were void. The pool trustees asked the court to reconsider, and filed a lot of paperwork explaining the securitization process. Judge Long held that the foreclosure sales were still void, and also made some interesting comments along the way about the representations in the securitization documents.

Ibanez is a trial court decision, but it is apparently expected to have significant influence in Massachusetts because of the special nature of the court. The Massachusetts Land Court has the job of examining titles and conclusively certifying who owns land. This is different from most states, where private parties record title documents with a local official, but the local official usually has very limited power to decide whether the document is any good. In most states, courts will look at the records and quiet title as between the parties who are in court, but the courts will not necessarily preclude another party from coming in later and challenging the title on a different basis. I don’t practice in Massachusetts, but I would expect that because the Massachusetts Land Court is specialized and its judgments are conclusive, the judges probably try not to differ too much in their interpretation of the law. I would expect the basic points of Judge Long’s decision in Ibanez to be followed by other land court judges unless the case is overturned on appeal.

Please note that Judge Long invalidated the foreclosures, not the mortgages. In all likelihood, the holders of the mortgages will be able to go back and foreclose eventually, but they will spend some additional time and money doing it. This gentleman has been following the case and has provided some local commentary, and has also graciously posted a copy of the Ibanez decision .

There were a few points in the case that I thought were worth discussing further:

Non-judicial foreclosure. The foreclosure in this case was done using an abbreviated process without much oversight from a judge. The Massachusetts statute on powers of sale allows the bank to enter the property, publish notices, and then sell the property on a specified date at least thirty days later. If the bank is not able to use the accelerated process, it takes three years for the bank to get clear title in Massachusetts. Any time during the three year period the former borrower has a right of redemption, which means the borrower can come back, pay the bank whatever is due on the mortgage, and get the property back.

More than half the states have accelerated foreclosure processes that have little or no involvement by the court, including states that allow “deeds of trust” instead of mortgages. Banks generally like non-judicial foreclosures because they are faster and cheaper. But if the bank screws up a non-judicial foreclosure, the sale may be invalid and the bank may be liable for problems caused by the invalid sale. Many states allow either judicial or non-judicial foreclosures. If there is something wrong with the transaction, for example questionable assignments as in the Ibanez case, the bank may want to consider a judicial foreclosure. If there is a judge handling the case, the judge will usually have the power to consider evidence and decide whether the foreclosing bank really is the owner of the mortgage. Once the judge decides who owns the mortgage, the foreclosure should be able to go forward. Situations where the mortgage completely disappears and the borrower gets to keep the house without paying should be rare.

On the other hand, this gentleman has an interesting if somewhat speculative point:

The true holder of the Note was insured by AIG so they are covered. AIG and the banks were bailed out by taxpayers. So, unless the American tax payer can produce a “blue-ink” original Note, no one has standing to foreclose.

The process of figuring out whether an insurance company should be able to collect from somebody else after the insurance company pays a claim is called “subrogation.” When the word subrogation appears in a legal pleading, well, let’s just say it tends to complicate the case a little bit. It seems to me this gives the average borrower something to talk about when explaining to a judge why he or she wants to see the original note. I have not seen a case where a borrower could show that the holder of the note had been bailed out by AIG or the taxpayers, but it must have happened. In fact, I would say it seems to have happened a lot.

Representations and warranties. Judge Long mentioned several times that he was shocked to discover the security offering documents represented to investors that the mortgages had been validly assigned, when in fact the mortgages had not been validly assigned. There is a lot of law here, but Judge Long’s discussion is pretty clear on most points so I won’t try to rehash it. This certainly gives us something to think about when we are wondering why the Fed and the Treasury and all the other wholly-owned subsidiaries of Goldman Sachs are so motivated to overpay for mortgage securities. If the government ends up buying all the bonds at some large fraction of face value, then the government is probably the only party that can sue the securitizers for making misrepresentations like this.

MERS. This case also demonstrates that recorded title documents can get plenty screwed up without any help from a third party like MERS. As Tanta explained, banks have been using third-party custodians to hold original documents for a long time, and the proper assignments didn’t always get made in a timely fashion. In fact, Judge Long seemed to suggest in two footnotes that the banks would have had an easier time in this case if they had used MERS.

Title Insurance. The Ibanez banks brought these cases because they couldn’t get title insurance. For anyone who wants to avoid complications like this, title insurance is the key. Title insurance doesn’t guarantee that you’ll never have any problems – like any insurance company, sometimes title insurers will deny claims and leave you hanging. But for the most part it is the title insurer’s job to figure out if there are problems with your title, and then provide insurance to cover your legal expenses and your losses if any problems come up. The way you get title insurance is different in different states, but the policies are generally standardized in something called “ALTA” format. ALTA stands for “American Land Title Association.”

If you want to buy a house from a bank and the title insurance company thinks the foreclosure sale was no good, the title company most likely won’t insure the title at all. You should not buy a property that a title company won’t insure unless you can afford a good lawyer and are looking for adventure.

It is also possible that the title company will insure the title subject to “Exceptions.” When you get a title policy commitment before the sale, Schedule A will show your proposed coverage, Schedule B will show the Exceptions, and there will also be a list of “Requirements” that need to be completed before the title company will actually issue the policy. Requirements that aren’t completed before closing will generally migrate over to the Exceptions page.

It is very important to understand the Exceptions in you title policy. Sometimes, after careful consideration, you can decide to disregard the Exceptions. For example, my title policy has an Exception for water rights. I live in the city and have city water, so I am not going to spend a lot of time worrying about whether I have a right to drill a well. Maybe I will regret my decision in the Hard Times ahead, but basic plumbing is not one of the technologies I expect to disappear in the Hard Times, so I’m willing to take my chances. The title company also made an Exception for the racial covenants that were placed on my neighborhood in the 1920s. The U.S. Supreme Court has decided those are clearly not enforceable, and the title company doesn’t want to pay for anyone to try to relitigate either side of that question.

If a title company were trying to offer you a policy without covering a bad foreclosure, the exception might look something like this:

Any loss, claim or damage by virtue of the failure of the public records to disclose an assignment of interest from the instrument recorded in Book 107 of Deeds, page 49 to the instrument recorded in Book 109 of Deeds, page 377.

This is hard to understand out of context because it is basically a big nominal phrase without a real subject or a verb or an object. The subject and the verb and the object are “We will not provide coverage for __________.” If there are any Exceptions in your title policy that you don’t completely understand, you should probably consult a lawyer.

There is plenty more to talk about, but this is already almost as long as the MERS post, so I’ll stop here. Ibanez appeared several times in the comments this week, but CR was the first person I heard about it from so no hat tips, except to Tanta for having all this figured out a few years ago.

CR Note: This is a guest post from albrt.

When Google bought YouTube, the deal was mostly panned. (but I liked it — the increase in G’s value paid for the deal almost instantly) )

Now, their CEO is admitting they overpaid:

“Schmidt had his reasons for asking his board to OK an offer of $1 billion more than what he thought the site was worth. The CEO made the comments during a deposition he gave in May as part of the copyright lawsuit Viacom filed against Google and YouTube in 2007. In short, he believed that Google had to offer that much, or competitors, presumably Microsoft or Yahoo, would walk away with the increasingly popular video site.

“This is a company with very little revenue,” Schmidt said while being questioned by Stuart Jay Baskin, a Viacom attorney. “(YouTube was) growing quickly with user adoption, growing much faster than Google Video, which was the product that Google had. And they had indicated to us that they would be sold, and we believed that there would be a competing offer–because of who Google was–paying much more than they were worth…We ultimately concluded that $1.65 billion included a premium for moving quickly and making sure that we could participate in the user success in YouTube.”

Source:
Schmidt: We paid $1 billion premium for YouTube
Greg Sandoval
C/Net, October 6, 2009
http://news.cnet.com/8301-31001_3-10360384-261.html

In a scathing, more-than-100 page sealed complaint, the US and a complainer (Rudy Vigil) allege that some of the nation's largest banks, including JP Morgan/Chase and Citigroup, have defrauded the US Federal Government by running what amounts to the same scam that happened with subprime lending in the student loan arena.

Specifically:

"The alleged False Claims Act violations arise out of Nelnet's false records, statements and certifications of compliance with Higher Education Act ("HEA") statutes, regulations and Department of Education ("DOE'd") policies that (1) forbid the offering of inducements to any individual in order to secure applicants for FFELP loans such as Consolidation, Stafford and PLUS loans and (2) forbid engaging in fraudulent or misleading advertising.

Gee, really?

Where have we seen this before?

Undisclosed "yield spread premium" anyone?

The difference here is that "ysp" was not, at the time, unlawful.  However, offering "inducements" (or if you prefer the more common terms, kickbacks or bribes), under the Higher Education Act, is.

Indeed, there is a long list of specifically-prohibited actions, including discrimination against those not on preferred lender lists, illegal inducements including the payment of points, premiums, payments or other inducements.  "The rules prohibit inducements to educational institutions, individuals, or other parties. In particular, inducements to colleges and their employees, as well as inducements to students, are prohibited."

Further, the rules go on to disqualify violating lenders from the HEA under conditions where that lender commits a prohibited act, specifically:

DISQUALIFICATION FOR USE OF CERTAIN INCENTIVES. -- The term "eligible lender" does not include any lender that the Secretary determines, after notice and opportunity for a hearing, has after the date of enactment of this paragraph --

1. offered, directly or indirectly, points, premiums, payments, or other inducements, to any educational institution or individual in order to secure applicants for loans under this part;
2. conducted unsolicited mailings to students of student loan application forms, except to students who have previously received loans under this part from such lender;
3. offered, directly or indirectly, loans under this part as an inducement to a prospective borrower to purchase a policy of insurance or other product; or
4. engaged in fraudulent or misleading advertising.

The truly nasty part of this lawsuit is that it appears that Nelnet was well aware of these practices and in fact had been sued in the past over them.  Specifically, the above link has the following paragraphs:

On April 20, 2007, the Nebraska Attorney General announced a settlement with Nelnet Inc., an education lender. Nelnet agreed to pay $1 million to an education fund and to adhere to a code of conduct similar to the one established by the New York Attorney General. It prohibits revenue sharing, opportunity loans, gifts and trips to higher education employees, and paid advisory board service. In some regards it is stronger than the New York Attorney General's code of conduct. For example, Nelnet also agreed to provide borrowers with the better of the direct-to-consumer channel or school channel rates regardless of how the prospective borrower reached Nelnet. Nelnet also supports requiring a minimum of three lenders on preferred lender lists, at least two of which are unaffiliated. In other ways it is weaker. For example, the restriction on paid service on advisory boards is limited to financial aid administrators who are involved with student lending. The prohibition on staffing financial aid offices merely requires proper disclosure and transparency. Nelnet agreed to adopt this code of conduct nationally by August 15, 2007.

On April 25, 2007, the New York Attorney General announced settlements with Bank of America and JP Morgan Chase, where both lenders agreed to adopt the attorney general's code of conduct. Johns Hopkins University announced that it was adopting the Code of Conduct and that it was dropping all preferred lender lists. The University of Texas system had also previously dropped all preferred lender lists.

On July 18, 2007, Nelnet published a summary of findings to date with regard to an ongoing review of its marketing practices, announcing, among other measures, that it was terminating its referral fee relationship with approximately 120 college and university alumni associations.

On July 31, 2007, the New York Attorney General announced an agreement with Nelnet in which Nelnet agreed to contribute $2 million to the national education fund and to adopt the code of conduct. Nelnet also agreed to stop paying alumni associations for loan referrals. This settlement is in addition to the $1 million settlement with the Nebraska Attorney General. However, the New York Times reported on August 1, 2007 that Nebraska Attorney General Jon Bruning has decided to forgive Nelnet's $1 million settlement with Nebraska in light of the $2 million settlement with New York. Higher Ed Watch criticized this lender forgiveness, noting campaign contributions from Nelnet to the Nebraska Attorney General. This may represent a violation of the Nebraska Rules of Professional Conduct. On August 10, 2007, Nebraska Attorney General Jon Bruning announced that Nelnet has agreed to pay the original $1 million settlement after all. The Associated Press reported that the Attorney General approached Nelnet about reinstating the settlement in order to avoid creating the "perception of a conflict of interest".

Reading the entirety of the above link is well worth your time, as is pondering whether there is truly ANY corner of lending in our economy that has not been punctuated with acts that at best violate ethics and at worst violate the law.

More importantly these alleged scams in the education sector have been part and parcel of the reason that college education cost has risen at such an outrageous rate.  Absent the "free money" afforded by rip-offs such as are alleged here no university system or college could have possibly maintained an escalation of price at multiples of the increase in wages within our economy.

As such merely accusing the banks of such conduct is insufficient.  We the parents must also rise and demand that the outrageously opportunistic parasitic games played by colleges and universities end immediately, and withdraw our consent to the exploitation of our children at the hands of these latter-day robber barons.

If our young adults wish to be exploited in such a fashion that is their right and privilege as adults, but it is my considered opinion after examining a litany of such abuses for more than a decade, all of which have gone unchecked and all of which have occurred with the full knowledge and consent of the colleges and universities in the United States, that I will not subscribe to nor assist in any such scam when it comes to my daughter. 

I therefore call for a general boycott by all parents in the completion, filing, or provision of ANY family financial information, including but not limited to the FAFSA.  Specifically, the following is an outright scam and fraud upon our young adults:

Under Federal law your family is primarily responsible - to the extent they are able - for paying for your college expenses. To determine how much your family can afford to pay towards your college expenses, we must collect your financial information and if you are a dependent student, we must also collect your parents' financial information.

This statement, by the way, is a lie.

Federal law does not change legal realities as ensconced in The Constitution of The United States, as The Constitution is the supreme law of the land.  At the age of 18 you are a legal adult, entitled to all of the rights and privileges thereupon (excepting the consumption of alcohol.)  You may tell your parents to piss off and never speak to them again.  Your parents do not have a right, at 18, to control your coming and going, they cannot control where you live, who you sleep with or what you eat or drink.  Your right to travel, live as you wish, and determine the path of your own life is unrestricted irrespective of your parents' wishes, as a matter of The Constitution. 

This does not (and should not) prevent your parents from contributing, on their own volition, to a young adult's education but it most certainly must prohibit the rubric of mandatory "contributions" to someone who is, under The Constitution, Federal and State law, a legal adult with all rights, duties and privileges that attach.

There is in fact no federal law that states that a parent is required to pay for their child's college education.  What the law actually states is that The Government will not provide you with free money unless your parents "contribute" to the extent that their formulas say they can.  That's a very different thing indeed, but the government, like your college, is not above lying to you as a student - or the parent of one.  The parents of a student are in fact under no legal obligation to provide any information requested.  Of course the government isn't obligated to provide you with "free money" (really, money they stole from a taxpayer at gunpoint) either! 

If you're a student, do you want to attend a school that lies to you before you even get there?

If you're a parent, do you want to "contribute" to a school that lies to you (and your son or daughter) before they even set foot on the campus?

It is time to break the backs of these lenders and universities that have declared financial war on this nation, including a long-standing pattern of conduct of violating the law with impunity, all of which has caused the spiraling of college costs to a degree that is absolutely unsupportable by any means other than raw theft from the public.

If you EVER want to see college educations return to an affordable status then you must support and enforce within your own household a total and complete boycott on this rank attempt by the financial industry to extend to you, as an adult, a demand for payment at any rate a college so chooses for "educational expenses" for another legal adult (even though they may be your progeny.)

College education used to be something that could be paid for through working while attending school along with scholarship monies for those who showed promise in their educational future. 

Today, college educations are virtually dependent upon transfer payments and tens or even hundreds of thousands of dollars in debt taken on by families and students, induced and coerced by both schools and lenders who do not even comply with the law in an astounding number of cases, and whom have together lobbied for Federal Laws that are blatantly unconstitutional attachments of financial obligation for those who are, under the law, legal adults.

This is Constitutionally indefensible and amounts to nothing other than preying upon our youth through the use of them as "levers" to both induce them to take on unconscionable debt and, when possible, abuse their parents - all for the benefit of the banksters who, this lawsuit alleges, don't even comply with the thin protections that Federal Law is supposed to provide!

Professors Hamilton and Krugman have mentioned that Q3 GDP will probably be reasonably strong, see Hamilton's No L and Krugman's A smidgen of optimism. I agree.

But I don't think growth in Q3, or even in Q4, are the question. The key question is what happens in early 2010.

The following graph shows the contributions to GDP from changes in private inventories for several recessions. The blue shaded area is the last two quarters of each recession, and the light area is the first four quarters of each recovery.

Click on graph for larger image in new window.

The Red line is the median of the last 5 recessions - and indicates about a 2% contribution to GDP from changes in inventories, for each of the first two quarters coming out of a recession. But this boost is always transitory.

Following the 1969 recession, changes in inventory added 6.2% to GDP in the first quarter of recovery - and GDP increased at an 11.5% (SAAR) that quarter. No one is predicting a quarter like that. But a 1% to 2% contribution from changes in inventories is possible.

And Personal Consumption Expenditures (PCE) will be strong too.

The following graph shows real PCE through August (2005 dollars). Note that the y-axis doesn't start at zero to better show the change.

The quarterly change in PCE is based on the change from the average in one quarter, compared to the average of the preceding quarter.

The colored rectangles show the quarters, and the blue bars are the real monthly PCE.

The July and August numbers suggest PCE will grow at about a 3.6% (annualized rate) in Q3, however retail sales suggest less growth in September (July and August were boosted by cash-for-clunkers). So maybe we will see 3% PCE growth in Q3, and that would mean a contribution to GDP of about 2%.

Add in positive contributions from net exports, an increase in residential investment (for the first time since Q4 2005), some increase in equipment and software investment - and Q3 should look pretty healthy. Yes, investment in non-residential structures will be ugly, but overall private investment will be positive (first time since Q3 2007).

However, I expect early 2010 to be a different story.

Changes in private inventories is transitory, and without a pickup in end demand, the boost will end soon.

Usually increases in Residential Investment (RI) lead the economy out of recession and provide a boost to employment. This time, with the huge overhang of vacant housing units, I expect any further growth in RI to be muted.

PCE also usually leads a recovery, however this time household balance sheets are still in need of repair - and I expect the personal saving rate to increase over the next year - leading to slow PCE growth.

Non-residential investment in structures will be a drag throughout 2010.

On the plus side, exports might continue to provide a boost (an export led recovery?)

Although I expect solid GDP growth in Q3 (and probably OK in Q4), I think GDP growth in 2010 will be sluggish, with downside risks.

Professors Hamilton and Krugman have mentioned that Q3 GDP will probably be reasonably strong, see Hamilton's No L and Krugman's A smidgen of optimism. I agree.

But I don't think growth in Q3, or even in Q4, are the question. The key question is what happens in early 2010.

The following graph shows the contributions to GDP from changes in private inventories for several recessions. The blue shaded area is the last two quarters of each recession, and the light area is the first four quarters of each recovery.

Click on graph for larger image in new window.

The Red line is the median of the last 5 recessions - and indicates about a 2% contribution to GDP from changes in inventories, for each of the first two quarters coming out of a recession. But this boost is always transitory.

Following the 1969 recession, changes in inventory added 6.2% to GDP in the first quarter of recovery - and GDP increased at an 11.5% (SAAR) that quarter. No one is predicting a quarter like that. But a 1% to 2% contribution from changes in inventories is possible.

And Personal Consumption Expenditures (PCE) will be strong too.

The following graph shows real PCE through August (2005 dollars). Note that the y-axis doesn't start at zero to better show the change.

The quarterly change in PCE is based on the change from the average in one quarter, compared to the average of the preceding quarter.

The colored rectangles show the quarters, and the blue bars are the real monthly PCE.

The July and August numbers suggest PCE will grow at about a 3.6% (annualized rate) in Q3, however retail sales suggest less growth in September (July and August were boosted by cash-for-clunkers). So maybe we will see 3% PCE growth in Q3, and that would mean a contribution to GDP of about 2%.

Add in positive contributions from net exports, an increase in residential investment (for the first time since Q4 2005), some increase in equipment and software investment - and Q3 should look pretty healthy. Yes, investment in non-residential structures will be ugly, but overall private investment will be positive (first time since Q3 2007).

However, I expect early 2010 to be a different story.

Changes in private inventories is transitory, and without a pickup in end demand, the boost will end soon.

Usually increases in Residential Investment (RI) lead the economy out of recession and provide a boost to employment. This time, with the huge overhang of vacant housing units, I expect any further growth in RI to be muted.

PCE also usually leads a recovery, however this time household balance sheets are still in need of repair - and I expect the personal saving rate to increase over the next year - leading to slow PCE growth.

Non-residential investment in structures will be a drag throughout 2010.

On the plus side, exports might continue to provide a boost (an export led recovery?)

Although I expect solid GDP growth in Q3 (and probably OK in Q4), I think GDP growth in 2010 will be sluggish, with downside risks.

Even today, this is a very informative interview from May, 2009 with "three top-notch portfolio managers with different views and management styles. Mark Headley lives and breathes investments in Asia as Chairman of the Matthews Asia Funds. Steve Leuthold relies on his quantitative models to find values at the Leuthold Funds, and Steve Romick can go short and long in his go-anywhere FPA Crescent Fund."

Looking at an email inbox numbering 1934 and listening to my Pandora station, I noted that many emails ask me to recommend training programs for traders.

Alas, that's an impossible task.

The reason is that training programs need to match what (and how) developing traders want to trade. The best educational offering in the world isn't worth the time, money, or effort if it isn't teaching you what you want to learn and leveraging your talents and skills.

What that means is that due diligence is key in evaluating any educational program. If the program is legit, it will have a well-developed curriculum that instructors are willing to share with you. The curriculum should highlight the specific information that is imparted, skills that are taught, and ways in which skills are introduced and drilled. The curriculum should also highlight the types of trading that are taught: the holding periods of trades, the markets traded, and the risk/reward of the setups taught.

If I am interested in a medical school, I can learn not only the specific courses that are taught, but also who teaches them and how they are taught. You should demand no less from an educational program in trading. If you cannot obtain details, assume that the details haven't been thought through.

Similarly, it is important to balance the cost of education with the need to protect one's trading capital. Personally, I would never spend more than 10% of my trading capital on educational products, services, and software; my actual expenditures are considerably less. That isn't to say that there aren't good, expensive services out there. It simply means that, just as a high school student with limited funds would think twice before applying to an expensive private college, a trader with limited capital should think carefully before laying down the equivalent of an Ivy League tuition for trading seminars and programs.

Finally, make sure that what you would learn in a commercial program is meaningfully different from what you can obtain free of charge (or for limited cost) in the public domain. Spending hundreds or thousands of dollars for the same technical analysis setups you could read in a dozen books makes no sense whatsoever. Sadly, it happens all the time.

A good educational program is one that teaches unique information and skills that are directly relevant to the kind of trading you are pursuing. It teaches that material in an engaging manner that allows for hands-on, practical learning through experience. Ultimately, your best teacher will be market experience. Good training programs don't produce expertise or elite performance, but they can hasten the learning curve.

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Nassim Taleb is the best-selling author of Fooled By Randomness and The Black Swan: The Impact of the Highly Improbable. So called ‘Black Swan Events’ are climactic, random and hard-to-predict events that have been entirely unexpected, and often hitherto perceived to be impossible.

At this breakfast event chaired by Danny Finkelstein, Comment Editor of the Times, Nassim Taleb explains the relevance of his ideas to the economic crisis, and argue for measures to create a more Black Swan-robust society. David Cameron responds and takes part in a discussion with the audience.
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You know that the government and the giant banks are not being responsive to the needs of the economy and the American people when even PhD economists and economics professors are calling for protests.

Indeed, many top experts and even politicians say that the American political system has suffered almost total regulatory capture, where Wall Street calls the shots. See this, this, this, this, and this.

As respected financial commentator Yves Smith points out, PhD economist Dean Baker, economics professor William K. Black and others are helping to organize peaceful protests outside of the annual meeting of the American Association of Bankers.

Smith notes:

If you saw Michael Moore’s Capitalism: A Love Story, a disconcerting bit was his discussion of a series of research reports put out by Citigroup for some of its asset management client in 2005 on “Plutonomy”. It argued that a world ordered to suit the whims of the top 1% was well underway. The only thing that might get in the way was that the other 99% had the force of numbers on its side.

Sometimes it takes a show of numbers to change the dynamic. As Baker pointed out:

The elites hate to acknowledge it, but when large numbers of ordinary people are moved to action, it changes the narrow political world where the elites call the shots. Inside accounts reveal the extent to which Johnson and Nixon’s conduct of the Vietnam War was constrained by the huge anti-war movement. It was the civil rights movement, not compelling arguments, that convinced members of Congress to end legal racial discrimination. More recently, the townhall meetings, dominated by people opposed to health care reform, have been a serious roadblock for those pushing reform….

A big turnout at this event can make a real difference.

Baker is correct about Vietnam.

Specifically, in a little known fact, Nixon was considering using nuclear weapons in Vietnam (and see this).

At that time, Nixon was also repeatedly publicly saying that he didn't care what the American people thought about Vietnam, and that he was going to escalate the war anyway. However, according to a biography by a well-known historian, when Nixon saw hundreds of thousands of protesters on TV, he dropped his secret plan for nuking Vietnam. Remember, Nixon dropped those plans even though he said he didn't care what people thought.

Indeed, this has happened repeatedly throughout history whenever people have been willing to stand up. The Ukranian people stood up to tyranny and won. The East German people stood up to tyranny and won. The people of the Philippines, Serbia, Czechoslovakia, Indonesia and other countries around the world have won against tyranny whenever ordinary people have poured into the streets in massive numbers and demanded freedom.

Note: Any websites publicizing this or any other protest should have web readers click an "I Agree" button promising to be peaceful before they are taken to the web page giving specifics about when and where the protest will occur.

Everyone attending a protest should sign written pledges in advance to be peaceful and not use any violence under any circumstance.

Everyone should dress nicely for protests. As Yves Smith says: "Dress nicely! One favorite strategy is to dismiss protestors as ruffians.".

Everyone should also bring cellphone cameras or videocameras. If police turn violent or use agents provocateur to incite violence, we film it all, and broadcast it worldwide on the web. That would make the government look really, really bad.

If you see anyone trying to incite violence, have a group of people escort them away from the protest.

Robert Waldmann

This McClatchy article by Kevin G Hall seems important to me. It does rely a lot on accusations by disgruntled ex employees, but I guess that is unavoidable.


The lede

WASHINGTON -- As the housing market collapsed in late 2007, Moody's Investors Service, whose investment ratings were widely trusted, responded by purging analysts and executives who warned of trouble and promoting those who helped Wall Street plunge the country into its worst financial crisis since the Great Depression.

I suggest you read this...... and watch this 4 minute excerpt from a speech.....

"Those who make peaceful revolution impossible will make violent revolution inevitable - John F. Kennedy, 1962"

The US government is on an unsustainable path. Deficits are soaring and the Obama administration is planning massive tax hikes.

Moreover, businesses have little reason to hire already because of massive overcapacity. Add increasing health care costs to the list of reasons for businesses not to hire.

Given that government spending crowds out private investment, these policies all but assures that unemployment is going to remain high for a long time as noted in Structurally High Unemployment For A Decade.

Killing The Goose

Last week in Thoughts on the Economy: Problems and Solutions I listed the problems and some of the solutions facing the economy. It was a discussion between John Mauldin and I about his weekly E-Letter Killing The Goose.

John and I agreed on many, but not all solutions. I would also like to add something I have proposed before, killing the Davis-Bacon prevailing wage act.

Muddle Through Where Art Thou?

Back in 2002, the usually optimistic Mauldin proposed the economy would somehow manage to "Muddle Through".

However, because of the unsustainable path we are on. John has changed his mind. Please consider these excerpts from Muddle Through, R.I.P?

I defined a Muddle Through Economy in the past as one of slow growth (in the area of 1-2%) and a slack employment environment, such as we had in 2002 and the early part of 2003. In early 2007, I suggested we would return at some point to such an environment at the end of the recession I was predicting.

However, gentle reader, never in my wildest dreams did I think we could be
looking at government deficits of $1.5 trillion dollars and actually budgeting future
deficits of over $1 trillion as far as the eye can see. And there is real reason to think that under current plans, $1 trillion deficits are optimistic.



Look at the graph above from the Heritage Foundation. They suggest that current policy would bring us closer to a $2 trillion deficit by 2019. And that assumes nominal growth that is north of 3% and unemployment dropping back below 5% in reasonably short order.

Japanese Disease

Some readers wrote this week telling me I am far too worried about a rising government deficit. Right now we are at roughly 42% of debt to GDP. In 1989, at the
start of the lost decades, Japan had a debt-to-GDP ratio of 51%. Now it is at 178%, and the world has not come to an end for them. In fact, they are running massive government deficits today and plan to do so for a long time. Why, I am asked, can’t we be like Japan?

In 1989, private Japanese debt (businesses and consumers) was at a debt-to-GDP
ratio of 212%. Now it is at 110%. And the total of both government and private debt is roughly the same (within 5%) of where it was 20 years ago. Along with running large trade surpluses, private debt has been exchanged for government debt. Savings have fallen from the mid-teens to about 2% today, as the country is rapidly aging and now using its savings to live on. And how much has all that government spending helped the country?

Before I answer that, read these paragraphs from Hoisington Asset
Management’s latest letter (last week’s Outside the Box):

“The federal government’s promise to extricate the U.S. economy from this
recession involves more spending (increasing public debt) and more subsidies for
consumers, such as car rebates and home buying incentives (more private debt). In other words, more debt is supposed to solve the problem of over-indebtedness. The truth is that this policy merely indentures its citizens further without providing any income for repayment of debt.

“This means there is no long term income benefit from stimulus programs.
According to the latest academic research, the most recent $800 billion stimulus plan will boost economic activity in the short run, but will surely depress economic activity over time. The government problem is complicated by the fact that the tax multiplier is 3, meaning that a 1% change in taxes will change GDP by about 3% over time. More recent research (Barro & Redlick, September 2009, "NBER Working Paper 15369") suggests that a 1% cut in the marginal tax rate would raise GDP in the ensuing year by 0.6%. With the deficit rising due to a zero spending multiplier, the tendency will be to try to raise taxes to pay for this higher level of expenditures, which will further depress aggregate spending and output.”

For all intents and purposes, Japan has had no growth for almost two decades.
Their nominal GDP is where it was 17 years ago, and the number of employed people is at 20-years-ago levels. An aging population has masked their unemployment problems, as older citizens retire. Their savings went to government debt. Taxes were raised numerous times. Since government deficit spending has no long-term multiplier effect, growth has been nonexistent. (By the way, that research about multiplier effects has also been done by Christina Romer, the chairman of the current President’s Council of Economic Advisors, and further explored by European economists. There is general agreement on these facts.)

Large government deficits choke off the very investment that we need to create
jobs. In the name of doing good, the unintended consequence is to make it more difficult for small businesses to start up and create jobs. And we all know that small business is the engine for job creation.

The New Muddle Through Economy

This is not a prescription for a return to normal growth. We are headed for a New
Normal that is less than what the market currently believes. Unless the deficit comes
under control at some point, we face the real prospect of catching Japanese Disease and suffering yet another lost decade. Can we Muddle Through? We have no choice but to do so. But it will not be fun. It will not be long-term 2% growth and employment going back to 6% any time soon. Can we reverse the course? With a different attitude and leadership in Congress, maybe we can. But it won’t happen next year, and it’s unlikely in 2011.

I am afraid we will have to put my old friend Muddle Through, as I previously
defined him, back in his box for a while.

Japan Rethinks A Dam

In light of the above discussion of the Japanese Disease (something I have talked about on many occasions as well), please consider Japan Rethinks a Dam, and a Town Protests.

The clatter of construction machinery still fills this forested mountain gorge, where legions of men in hard hats busily pour concrete, clear hillsides and erect a huge, unfinished bridge whose concrete supports tower over the valley floor like crucifixes in an immense graveyard.

It seems an apt analogy. Japan’s new government has suspended the $5.2 billion Yamba Dam being built here and turned this valley four hours north of Tokyo into a symbolic final resting place for the nation’s postwar order, which relied on colossal public works spending.

The Democratic Party government of Prime Minister Yukio Hatoyama has chosen this dam as the first of 48 national government-financed dams that it wants to scrap, worth tens of billions of dollars.

Japan had around 60 large dams under construction in 2005, making it the world’s fourth largest dam-building nation, according to The International Journal on Hydropower and Dams, despite having a land area smaller than California’s.

Decades of pouring concrete have been widely blamed in Japan for cluttering rural areas with needless dams and roads to nowhere. They have also saddled the country with the developed world’s largest national debt — nearly twice its $5 trillion economy. Mr. Hatoyama’s party has vowed to replace Japan’s postwar “construction state” and the jobs it created with something closer to a European-style social welfare system.

That my friends is exactly what public work stimulus projects do on average. Now Obama wants to gut public schools, rewire them, and make them energy efficient. At what cost? At what benefit?

Expect other infracture projects as well. Some may be useful, many won't. The money has to come from somewhere and that somewhere is higher taxes, a cheapening of the US dollar, or both.

Such infrastructure projects did not work in Japan and they will not work here.

Did Muddle Through Ever Work?

For many years it seems like muddle through worked. Indeed on average it did. But averages are deceiving. From 2003 through 2006 if you worked in real estate in any capacity the odds are you did well. If you worked in manufacturing the odds are you didn't.

If you lived in Chicago or Seattle you did better than average. If you lived in Detroit, Toledo, Akron (or Michigan or Ohio in general), things seemed more like a depression.

On average Florida muddled through. But in 2005 people were camping out overnight in lines praying to have the chance to buy a condo. Today it is ground zero of the residential real estate bust.

Factor in the bonuses proposed at Goldman, and other financial institutions. One might conclude on average we are still muddling through.

Yet, there are vast sections of the country where Muddle Through did take place on a more even keel. My hometown of Danville, Illinois muddled through, at least on the surface.

The real estate boom and bust completely passed Danville by. Is that muddling through? I can easily make a case it is. Yet beneath the surface towns like Danville are in slow decay with no source of jobs, homes in general decline, and an aging as well as shrinking population.

In the bubble areas there was a wildly uneven boom, on the back of cheap financing and poor economic policies but that was never the road to a sustainable muddle through. Now the Obama administration, just as happened in Japan, and the Great Depression before that, has taken a bad situation and vowed to make it worse.

In the meantime we have unheard of corruption and influence peddling in DC, hell bent on maintaining policies of the Bush Administration that will make the rich richer, and the middle class poorer.

So muddle through is now on the back burner. The reality is muddle through only worked on average anyway, and the averages were very deceiving.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

First, Saturday Night Live:



And then: A rebuttal from Princeton economist Alan Blinder.

• The best unknown activist investment of 2009 (Greenbackd)
• Words from the wise (Financial Armageddon)
• CME in talks to buy CBOE for $5 billion (Bloomberg)
• UBS warned U.S. customers by registered mail their account details may be given to U.S. tax authorities (Reuters)
• Goldman can spare you a dime (NYT)
• The extinction of ethics in finance - The Fallout (Reality Arbiter)
• China's September data suggests that the long-term overcapacity problem is only intensifying (M. Pettis)
• As we have long claimed, others now seeing Wachtell as biggest BofA loser (BreakingViews)
• Good news on Wall Street means... what exactly (Matt Taibbi)
• VIX posts worst losing streak in four years as Dow tops 10,000 (Bloomberg)
• Earnings coming from companies that are not merely recipients of Chinese and US excess liquidity benefits: may get very ugly quick (CNN)
• Look beyond usual suspects in countdown to next crisis (FT)
• Malone not in talks to buy NBCU, would be at a lower price (Bloomberg)
• Global banking body may be needed (Reuters, h/t Joe)
• Goldman Sachs: "Trading with advantages" (The Agonist, h/t news item)
• Overleveraged autosupplier Continental AG to sell junk bonds, idiots to buy (Bloomberg)
• Real homes of genius: An Economic Investigation of La Mirada. Median Sale Price, Incomes, Trends, Shadow Inventory, and the case for no Price Bounce. Mortgage Equity Withdrawal Home Value from $157,000 to $570,000 (Dr Housing Bubble)
• SG: Worst case debt scenario (The Big Picture)
• Ottawa's bubble (Greater Fool, h/t H.)

A lone suicide bomber, on foot managing to catch unawares five "senior commanders" in Iraq where only the smartest and best organized insurgents are still alive to mount such action might be a three or four sigma event. A lone suicide bomber, on foot managing to catch unawares five "senior commanders" of Iran's Revolutionary Guard by waiting by the entrance of the complex where they were to meet local tribal leaders... that's a bit rarer still. Whisperings of western involvement in the incident are... still just whisperings.

One wonders, however, what strength Tehran will now have to divert to Sistan-Baluchestan near the Pakistan and Afghanistan to beef up security, where those forces will come from and what confusion the loss of senior commanders in the area will cause. All in all, rather an effective bit of work if you are in the force disruption business. Crude longs: take note.

Kevin Hall at McClatchy Newspapers writes: How Moody's sold its ratings -- and sold out investors (ht Atrios)

A McClatchy investigation has found that Moody's punished executives who questioned why the company was risking its reputation by putting its profits ahead of providing trustworthy ratings for investment offerings.

Instead, Moody's promoted executives who headed its "structured finance" division, which assisted Wall Street in packaging loans into securities for sale to investors. It also stacked its compliance department with the people who awarded the highest ratings to pools of mortgages that soon were downgraded to junk.

How can securities be rated AAA one day, and junk the next?

The rating agencies pocketed the fees, and investors (including the Fed) still use their ratings. As Atrios jokes: "Not sure there have been negative consequence for them, so call it a win!"

Daniel Fermon of Société Générale produces some of the more unusual market research and especially charts and graphs.

What I have seen  of them is frequently intriguing, and oddly thought provoking. I can stare them them for long periods of time while trying to suss out just what they mean — sometimes with only modest degrees of success.

Still, they are strangely appealing, fully of symmetry and grace. I find them oddly beautiful:

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Source:SG Cross Asset Research

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Source: Congressional Budget Office, SG Cross Asset Research

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Source:
Worst case debt scenario
Protecting yourself against economic collapse: Hope for the best, be prepared for the worst
Daniel Fermon
SG Cross Asset Research,
Société Générale, 13 October 2009

by Rebecca

The G7 G20 Leader's statement, number 20., regarding the IMF's mission and governance (bold font by yours truly):

The IMF should continue to strengthen its capacity to help its members cope with financial volatility, reducing the economic disruption from sudden swings in capital flows and the perceived need for excessive reserve accumulation. As recovery takes hold, we will work together to strengthen the Fund’s ability to provide even-handed, candid and independent surveillance of the risks facing the global economy and the international financial system.

Last week I was in New York talking with Emerging Market strategists and economists. Most of them attended the IMF meetings in Istanbul, Turkey - according to them, the monster takeaway from the meetings was that the sky's the limit in terms of FX reserve accumulation (in EM economies). Put this way, the IMF is unlikely to be successful in its aforementioned goal of preventing the "need" of excess reserves, at least over the near term.

Key markets in Asia (China, or South Korea) and Latin America (Brazil) remained rather resilient to the credit crunch late in 2008 due to sufficient (even excessive) reserves holdings. Brazil, for example, was able to supply private-sector financing needs by draining FX ($USD) reserve holdings. South Korea and other Asian economies, too.

The chart below illustrates reserve holdings across key countries in LATAM (Latin America) and Asia - notice the sharp drop at the end of 2008.


It's an incredulous thought: that policy makers in EM countries - whether the reserve accumulation was for precautionary reasons (LATAM) or stemming from export-led growth (Asia) - won't be filling the reserve coffers at increasing rates; the process is already underway.

Reserves in Brazil are now 230% higher than they were in 2007 (January), 197% in China, 190% in Thailand, and 163% in Hong Kong. Hong Kong is interesting; amid their strict dollar peg, the Hong Kong Monetary Authority is accumulating reserves faster than most countries (Hong Kong will be the country to watch as the peg against the dollar is sure to result in some inflationary pressures, given that Hong Kong's economic fundamentals are stronger than those in the US at this time - another post).

Record inflows of late into EM financial markets (bonds and equities) are providing plenty of liquidity and contributing to reserve accumulation of late. However, having sufficient FX reserves has proven to be the best insurance out there against a stoppage in external financing. And as long as inflation pressures remain muted, acquiring reserves is not too costly economically (there are administrative costs, though, from sterilization when US Treasury rates are near zero).

The Treasury recently released the Semiannual Report on International Economic and Exchange Rate Policies; it states that officially no foreign central bank has explicitly manipulated their currency since 1994 but pointed the finger at China for their currency policies that inhibit the unwinding of global current account imbalances. An excerpt from page 3:

Although China’s overall policies played an important role in anchoring the global economy in 2009 and promoting a reduction in its current account surplus, the recent lack of flexibility of the renminbi exchange rate and China’s renewed accumulation of foreign exchange reserves risk unwinding some of the progress made in reducing imbalances as stimulus policies are eventually withdrawn and demand by China’s trading partners recovers.

It's farcical to think that the G7 can browbeat EM countries into curtailing excessive reserve accumulation. To be sure, export growth is simply not going to grow China at rates sufficient to maintain jobs growth (9% or so) and reserve balances are likely to be increasingly focused inward domestically (supporting the financial system, local governments, etc.). However, what seems to be very real is that targeted reserve accumulation, in whatever currency but still heavily weighted in $US, buffered EM countries from catastrophe and is not going away.

Rebecca Wilder

P.S. for those of you who want to know a bit more about reserve accumulation in China, Brookings wrote a nice topical piece earlier this year.

“Oil could reach between $150 and $200 a barrel because known reserves of crude are declining. International relations, particularly between the U.S. and Iran, will help guide prices. Natural gas is very cheap,”

Jim Rogers in the interview between sessions at an ETF Securities Ltd. investor conference

Submitted by Roger Dadodger

Yep, the yellow water has been falling on the floors of many of Wall Street's finest hedge funds. They're all glued to their toobs watching footage of the insider trading arrest of Raj Rajaratnam, founder of Galleon Group, a prominent New York-based fund firm that manages $3.7 billion. Raj, according to allegations published in the Wall Street Journal, played it fast and loose with insider trading rules by talking to prominent executives inside publicly traded companies and to executives who had specific information on pending deals and earnings at publics. Other hedges are probably not the only ones scared out of their minds. Other fearful parties likely include Gerson Lehrman Group, DeMatteo Monness, and the thousands of "consultants' who work for them. Who are these guys and why should they be afraid of what befell Raj?

Because if this signals a new wave of enforcement of insider trading rules and Reg FD, then Raj and Galleon may only be the first bodies to fall. And everyone whose been around the alternative investment community knows that Raj was an extremely avid  user of expert networks - of Gerson Lehrman Group and DeMatteo Monness, in particular. These networks are ad hoc groups of consultants pulled together by a handful of well-heeled middlemen. The consultants are billed as industry experts. Many are simply that. Others are executives at publicly traded companies who claim they can provide market color without giving out any inside information (such as this guy who works for a prominent Chinese gaming company, Giant Interactive, that has been a hot issue in a very hot sector). Still others are at privately held companies but may have access to highly sensitive information that could possibly cross the insider threshold (such as key managers or sales reps at technology distribution companies or at cell phone distribution companies such as BrightStar, which are prominent distributors of Apple iPhones).

Now, why would Raj pay these networks upwards of $1 million per year to access these expert networks and their Rolodexes? I won't answer that question as I am not a lawyer and can't judge what is and what is not insider trading. But it does seem like an awful lot of money to get market color. All of this said, the expert networks probably will not suffer much even if the SEC rains down subpoenas on them. They keep no recordings of the phone calls that transpire between their hedge fund clients and the expert consultants on their payrolls.

They claim to have no idea of what actually goes on during those calls. And, most importantly, they make the consultants sign rock-solid indemnifications before allowing them to join the expert networks and access the feeding trough that can pay out as much as $400 or $500 for easy phone work talking about an industry they already know. In other words, its the consultants who are on the legal and financial hook -- even though most of the expert networks generally mark up these calls by 100% or more and have profit margins north of 50%. So, how many of these consultants anticipated they would ever stare down at an SEC probe?

Probably none because the SEC had largely been a pussycat when it comes to truly enforcing insider trading. Gerson and DeMatteo do regularly tell their consultants and their clients not to provide or accept inside information, (In fact, Gerson forces its consultants to undergo training and subjects them to regular tests). You would think that if compliance were such a big deal then phone calls would be recorded and transcripts keep on file in order to head of exactly the fate that has befallen Raj. Oh, and they must have papers on record showing that each consultant's superior (or in some cases, the company CEO) knows what is going on and has signed off in their own hand. Um, not really. So could many of these guys be breaking NDAs for a nice hourly rate? Indeed that might be possible, although who am I to judge.

As it stands, a word to the consultants who work for these expert networks and often risk their careers for $500 dalliances with hedge fund managers making seven figure sums -- JUST BE CAREFUL OUT THERE, EXPERT NETWORK CONSULTANTS.

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For much more on "Expert Networks" please read here, here and here.

Commentary from my Harvard colleague Ken Rogoff.