Tea Cartel Drug Wars, or the Boston Tea Party

First, credit to Malcolm Gladwell and the Revisionist History podcast, my favorite along with SYSK. I encourage you to listen to them all and this this episode that inspired this post: http://revisionisthistory.com/episodes/33-tempest-in-a-teacup.

I started writing this with a preamble that grew into a longer post so I posted that separately: https://adoingword.com/2021/01/11/news-the-new-opium-of-the-people/

This is just a quickly-written summary. Pull on any one of the many threads here and you’ll find stories of intrigue and drama that would fill a COVID quarantine year with Netflix series.

And on to the party! Here’s the story we all were taught to memorize and recite in school:

  1. The colonists were just trying to settle their colony and drink their tea, which they loved because they hadn’t really found coffee yet and there were very few Starbucks.
  2. Evil King George III and Britain wanted to exploit the colonies and get more money so they taxed the tea.
  3. On December 16, 1773, a band of valiant colonists disguised themselves as Mohawk Indians, boarded the tea ships, and dumped the tea into the harbor.
  4. Events unfolded from there and they won the Revolutionary War forming America!!!

The first red flag if you’re thinking critically is, if this band of rebels cares about the people and the tea why didn’t they just steal the tea and give it away like Robin Hood? Pull on this thread and the whole sweater comes apart. It’s not that the opposite story is true and the British were the victims, but the actual story is much more interesting and ripe with lessons of power politics.

The patriots wanted the tea destroyed. Why?

The tea trade in the colonies and most of the world was controlled by the British East India Company (BEIC) and the Dutch East India Company (DEIC). All tea from the BEIC had to be brought to London, sold at auction, taxes paid, and then shipped across the Atlantic ocean to the new world where additional taxes were collected. Meanwhile the DEAC, aka the competition, was shipping and selling directly to the colonies at a lower price and selling on the black market. The Tea Act was passed in May of 1773 to remove this restriction and enabled the BEIC to ship tea directly to the American colonies. In addition, the duties Britain charged on imported tea would be waived on tea sold in the colonies. So victory for colonists, they get lots of tea and the price goes down! This would be good for all those tea consumers! What’s not to like?

But lets go back eight years to understand this tax issue. The crux is that the British expected the colonies to pay taxes, as colonies tended to do. The Stamp Act of 1765 required a tax to be paid and a stamp applied to, oddly enough, paper, including wills, deeds, newspapers, pamphlets and most annoyingly then, even playing cards and dice (not sure how they stamped the dice…) . The tax had to be paid in British Currency which is another great thread to pull on – reserve currency and how it’s used…

After months of protest and an appeal by Benjamin Franklin before the British House of Commons, Parliament voted to repeal the Stamp Act in March 1766. However, the same day, Parliament passed the Declaratory Acts, asserting that the British government had free and total legislative power over the colonies. I think the British really signaled their weakness here and fueled the fire: “We’re going to repeal our taxes on you, but reserve the right to levy them in the future”. This was the crux of the issue. It wasn’t that the taxation was unfair, it was that the colonists didn’t want them to have control, especially without representation.

The Townshend acts followed in 1767 to actually levy new taxes, including the tax on tea.

Why did Britain need to raise money? Were they just trying to exert control? Probably, but they had an acute need as well to pay off the immense debt of the Seven Years’ War (1756-63) and the much longer dispute with France and to a lesser extent Spain over control of the new world There is another super interesting set of threads to explore here about how the colonial powers manipulated the Native American tribes to fight for them against the others.

In summary, the British and the French battled it out for the new world for decades until they were in debt, and then when the British got the French out the colonists objected to even a tax on paper (and dice) to pay for what the British saw as their liberation.

Another great set of threads to explore is the Spanish who form the backdrop in which all of this took place but that’s too much for today.

By 1770 the colonists were getting pretty feisty so the British repealed all the Townshend duties except the tax on tea. This wasn’t so much about tea but rather just an assertion of control each time you take a sip of that tasty tea. Again, weak move Britain. Side note – a significant amount of the tea at that time was green tea. I find it fascinating to envision Ben Franklin, Sam Adams, and Patrick Henry making their green tea.

By 1773 it wasn’t that the tax burden on tea was significant, but that the patriots were getting increasingly powerful and needed a catalyst to push things forward.

But first, lets switch from politics to economics. Events that might seem kind of random like the tea party tend to be surprisingly helpful to the wealthy people in power, and the patriots were very much in power in the colonies. They were also smugglers.

If trade in a good that is desired is illegal, restricted, monopolized by a government entity, or taxed, what happens? Smuggling, or bootlegging. And that’s just what the colonists did. Even without a tax the colonists weren’t keen on trade controlled by the BEAC.

The colonists found an ally in the DEAC. The Dutch had minimal footing in the new world so were not a governance threat, and were also suffering due to competition with the BEAC. They supplied tea to the colonists who ran the distribution network. And it wasn’t just tea, but all kinds of goods in and out of the country. After decades of this the cartel (patriots) had become quite wealthy and powerful.

What ignited the tinderbox? In May the Tea Act allowed the BEAC to bypass England and sell tea competitively directly to America without additional taxes. They also had a huge inventory backlog to deal with. This would flood the market with cheap, good quality, legal tea that would undercut the profits of the smugglers and cartel (patriots).

The tea party wasn’t a band of colonists angry over the high price of tea. It was was a carefully orchestrated move by the Sons of Liberty which included John Adams, John Hancock, James Otis, Josiah Quincy, and Paul Revere, and many others you’ll recognize. Over the years they were also extremely skilled and/or lucky in playing the global political chess game, letting others fight the traditional colonial wars while they swooped in with a savvy disruptive strategy.

The tea party met many needs:

  1. Stick it to the competition in the smuggled tea business and keep the price supported
  2. Create a great story to fire up the colonists
  3. Antagonize the British into action

Word spread quickly throughout the colonies and it made a great story to rally the troops. News reached England in January (long trip time there) and it infuriated Britain and the BEAC causing parliament to end it’s policy of appeasement with what became known as “The Intolerable Acts” in 1774. I’m not sure if there was any winning move at this point but cracking down from across the Atlantic was too little too late.

It wasn’t about taxes. It wasn’t about tea. It was about power and getting more for them and less for the British. But, it usually doesn’t work well to just come out and say that so that’s where you get the rhetoric, even today. It works well to be oblique with a “demandless” movement like the tea party, “Occupy Wall Street”, “Black Lives Matter”, or “Defund the Police”. All of these could be expressed as power transfers from x to y, but that doesn’t play well on the news. Instead all these forces entwine to create an act that seems almost random but catalyzes a move towards the desired result for those with power.

The tea party was a brilliant move.

I’m not interested in judging or figuring out who was more right or wrong and forcing this into a Hollywood movie narrative of good vs. evil. When you do that you lose all the substance. It’s like eating refined flour vs fresh fruits and vegetables. It’s not that refined flour is good or bad, it’s just insipid and without real flavor, texture, or nutrients. The founding fathers weren’t just a bunch of innocent farmers that got pissed about higher taxes and rebelled. That’s boring refined flour and there’s nothing much to learn there.

The founding fathers were complicated bad-asses – generally wealthy, self-motivated, super smart political and economic actors that executed a multi-decade strategy to play immensely more powerful global powers against one another to create a power vacuum that they could fill with a very quick 9 month war (July 1775 to April 1776) with relatively low casualties (6800 died in battle, more will die of Coronavirus in the next two days). They created the Boston Tea Party as a brilliant PR move that quickly spread through the colonies and the world.

Good job patriots!

It’s very interesting to look through modern events with this lens. Was the attack on the capital a wild and wooly bunch of crazy rebels fighting for something? Or are they pawns in a much larger narrative? Interesting question for a school class might be: who are the political entities involved and what do they have to gain or lose? Who are the economic entities involved both for and against? There is a story that is much bigger and more interesting than an attack on the capital.

There are also parallels to current “antitrust” arguments against the big tech companies. Antitrust law was meant to protect consumers. If one company has a monopoly then they could charge monopoly prices and consumers would be hurt. It is a law to protect consumers, not their competition, but that seems to be forgotten. Are you paying too much for Facebook? Google? Like the tea party, there is a premise that this is done to protect consumers but ask yourself “who are the political and economic parties that would benefit from taking power from the large tech companies?” These are going to be the powers driving this effort.

Footnote for those wondering how to get away with insurrection: The disguise was part of the PR narrative to identify themselves as Americans not just colonists. They didn’t really think people would believe the disguise. They were very concerned about getting caught but it was their disciplined code of silence that successfully kept them safe. More recent insurgents might consider that live streaming and posting on Twitter isn’t the best plan, though kudos to the horned hat guy for trying. https://www.bostonteapartyship.com/participants-in-the-boston-tea-party

News, the new Opium of the People

I wrote this as a preamble to the post about the Boston Tea Party but it soon took a life of it’s own. It’s a work in progress.

Last night Jen mentioned how schools don’t really teach critical thinking. I think that’s just the understatement of the century. In schools, church, and in general history is taught with a standard narrative:

  1. There are good people just trying to do their thing
  2. There are bad people that want to fuck things up for everyone
  3. The bad people do something bad
  4. The good people fight back

There are two endings:

  1. The good people endure fierce battles to win, yay!
    • American Revolution
    • Civil War
    • The Taliban and Bin Laden
    • 2020 US Election (or 2016 depending on your point of view)
  2. The good people are valiant but lose and it is very sad.
    • The Alamo
    • Custer’s Last Stand
    • Vietnam
    • 2016 US Election (or 2020 depending on your point of view)

This teaching leads to people to use a problem-solving algorithm of:

  1. Identify the bad people
  2. Locate them
  3. Keep them from doing bad things through
    • Force/Law/Imprisonment
    • Keeping them impoverished/muted
    • Cutting them off from decent society
    • Education
    • Killing them

The actual algorithm is something like this:

  1. There are powerful political entities that are usually working together when it helps them maintain power yet they are also deeply in conflict long-term. In general incremental power gains trump long-term strategy, this is a long game.
  2. There are powerful economic entities (companies and wealthy people) that exist on the pretext of serving the people (customers) but also have their own interests.
  3. The political and economic entities have a deeply symbiotic relationship but also recognize the other as the primary foe long-term. If politics won you’d have classical communism, and if economics won you’d have classical free-market capitalism, both of which tend to result in rebellion. If you want to maximize the power held by those with power (not the people) then an alliance is the best strategy.
  4. Acts of drama and violence are either created or seized upon and put into the good vs. bad narrative propaganda to keep one part of the population blaming their misfortune on another part of the population. This keeps the population from scrutinizing the role of those in power and asking difficult questions like why, since they they have the power to stop them, do these things happen? It also keeps the population dependent on the entities in power for the solution.

News, not religion, is the opium of the people.

No one likes talking about the actual algorithm. It’s much more difficult than changing your profile photo to black or wearing a MAGA hat. It quickly gets quite complicated, fairly boring, and sounds like a conspiracy theory. Why would people do all that for just this one case? But it’s not, it’s all the cases.

Travel Plans

Writing this partly just to keep it straight myself, but more to share with others. If I/we are nearby lets meet up! If in the general area then maybe we could alter plans a bit to make it work.

May 10: Portland for Mother’s day

See mom for a long¬†weekend and help around the house ūüôā

Maybe stay a bit more.

May 13-15: Road trip to Santa Cruz

May 16-21: Santa Cruz

May 22-29: Drive to L.A. for “Digital Hollywood

Work from there.

Memorial-day weekend in Santa Barbara or SLO.

May 29 РJune 22: Santa Cruz

May 31 – June 2: Present at Augmented World Expo – Santa Clara

June 23 – July 1: Yosemite hike!

Actual hike is June 25-28:

  • June 24: Pick up permit, camp at Tuolumne Meadows
  • June 25: Hike to May lake, drop packs, climb Mt. Hoffman, camp back at lake.
  • June 26: Hike to Glen Aulin
  • June 27: Down and back to Waterwheel falls – no packs.
  • June 28: Up the Tuolumne river to the meadows and out – leave or camp at Tuolumne
  • Tahoe? Santa Cruz after?

July 1 – July 13: Seattle – fix up house

July 13-16: Beachbody Summit in New Orleans

Jen is killing it!

July 16-24: Texas

USAA in Plano first

Then Austin

Around July 24 to August 16: Back to Seattle

More house fix up?

Canada road trip Salt Spring music festival and visit Celia? Mark and Tracey?

Ray Wyle Hubbard – Bainbridge Aug 4 and 5, Salt Spring August 7

See friends and family! Hike!

Beach house rental?

August 16-20: Wesselpalooza!

August 20: To Burns

Solar Eclipse the morning of August 21

Stay with Theresa and (maybe) Rob!

August 22-24: Drive on south back to Santa Cruz

Santa Cruz the end of August to beginning of September

September: Europe

Work: Belgrade, customers and partners, Hoofdorp, Cisco Ireland

Nathan and Rachel before or after for a week!



Very Light Hiking Gear

To equip everyone for our upcoming Yosemite hike I had to either get stuff for the kids, or get new stuff for Jen and me and give what we have to the kids. I like the second option!

I did quite a bit of research so I thought I’d share it here. There are a lot of cool and funky options for getting super ultralight – using trekking poles as stakes, forgoing the tent walls and/or bottom, forgoing a freestanding tent and using guy-wires and poles (requiring soft open surface), getting a pack that is sized exactly for the trip length, or a sleeping back without an upper part that requires you to wear your down jacket. I decided against all of these optimizations – hence the term “very light” instead of “ultralight”. I want a normal tent that I can set up on solid rock, one pack that can accommodate different kinds of trips, and a nice comfy sleeping bag.

Here’s the list:

Tent: I got this some time ago with my REI 20% off coupon. I think it was around $300 originally. They don’t make it anymore but there are lots of options in this price and weight range. It’s just under 2.5 lbs.¬†REI Dash-2

Sleeping Bag: Clearly the easiest and¬†cheapest option is get a higher temperature rating with less fill. I wanted something comfortable down to a frosty morning. If it’s colder I can always put on my jacket and long underwear. Feathered Friends Swallow is real nice, has 950 down and is nicely made, but at $499 is expensive and not lighter, though it is warmer. In the end we loved the the feel of the Marmot. And it’s super light – 1.5 lbs!¬†You have to make sacrifices to get any lighter than that. We got it for 20% off of the $319 with our REI coupon.¬†Marmot Hydrogen Sleeping Bag

Sleeping Pad: These have climbed a lot in price (some over $200), sophistication, and comfort. I didn’t spend too much time here. If we want to upgrade we can give these to the kids. The REI Flash was on sale for $79 (normally $99) with an R-value of 3.2 which should be fine for normal temps. It gets nice and small and comes in at just over a pount.¬†REI Flash Sleeping Pad

Backpack:¬†I wanted something that could be small for overnights, but expand for longer trips, emergencies, or things like bear canisters of food that are big, if light. The Hyperlight looks unusual and potentially awkward yet it seems to live up to it’s promise to be very well made and comfortable. It has an internal frame so you don’t have to mess with packing it perfectly. And the Cuben fiber is also waterproof so you don’t have to carry a cover, or worry about a fall in a river. The design is clever, with no zippers, just a roll-down top that easily goes from enormous 70L capacity to a day-pack. And I really like the mesh pocket all around – much easier to just throw stuff in and find it easily than to have a bunch of little pockets. And at 2.19 lbs there’s nothing lighter. Or more expensive – $365 is a lot but Backcountry.com had a 20% coupon to match REI’s offer so I used that to help a bit.¬†Hyperlite 4400 Windrider

Stove: No competition here. The JetBoil is nice but the engineering on this is exceptional. 1 lb. MSR WindBurner

Puffy: My old Feathered Friends jacket is almost ten years old and quite warm so I’ve been shopping for a lightweight one for a while. The ubiquitous Patagonia is nice but doesn’t fit me well. I found this one on Backcountry.com marked down from $325 to $146. At 9¬†oz it’s ridiculously light (Patagonia is 13) and feels great!¬†Marmot Quasar

I also found these and love ’em. They are almost weightless at 1.2 oz, and collapse flat. A Nalgene is 6 oz. If we each carry 2 that’s a savings of 20 oz, or about $300-400 to do the same in a tent or sleeping bag so this is quite a deal! I now keep one in my laptop bag for getting water in the airport or for an unexpected hike or long run. The other nice thing is being able to bring some extra bottles for the case when¬†extra water is needed. On this trip we may camp on Clouds Rest¬†a few miles past the last water so with some of these we can fill up with extra water for the night without taking up space on the rest of the trip.¬†¬†Platypus SoftBottle

Basic kit for just me: Tent 2.5, Bag: 1.5, Pad: 1.1, Backpack 2.2, Pad 1.1, Stove 1.0: Total: 9 lbs

With Jen’s bag and pad we’re at 11.6 lbs.

Not bad! Plenty of room for some good wine!

The Big Short, Longer Version

We watched “The Big Short” the other night! I thought it was great – Steve Carell was just amazing as a serious guy. But, the terrible brilliance of the situation, as well as the lessons for today, are not evident from the movie.

I’m writing for myself as much as anything. Even after reading this and many other books on the subject it’s still challenging for me to fully understand the past, much less the parallels to today. I will share my amateur understanding of it, and welcome corrections and thoughts¬†from those that know more. I am quite sure that some of what I say is at least partially wrong so help me out!

The movie portrayed a simple story. The mortgage industry pushed bad loans. The banks bought them, repackaged them into CDOs, and sold them to unsuspecting large investors. A standard huckster story. And the lessons appear equally simple – bankers are bad so regulate them, jail them, fine them, etc…

But the actual situation was much more complex. Anyone can buy high-risk, high-reward “junk” bonds anytime. It’s not deception for a bank to sell C-rated bonds – that’s just an investment choice. But in this case, the banks discovered how to take one investment, the subprime loan, transform it, and dramatically increase it’s credit rating. The interesting story is how they did that.

Pandora’s box was opened in the 80’s and 90’s with general banking deregulation and the 1999¬† repeal of most of the Glass-Steagall act. The act was created during the depression to separate consumer banking (where your savings account is) from investment banking (the part that takes risks, makes investments, creates and sells financial products). The¬†made¬†both parts fairly boring. Your savings account was safe and invested prudently. And investment banks could play only with their own money, or the money of their customers.

Recombining them created immense opportunities for creativity and innovation. Much of this could and probably did benefit the economy and consumers. But it also helped enable¬†“to big to fail”. If a banks investment losses exceeded their assets and it went bankrupt, it would also wipe out the money in all those¬†savings accounts. Because savings accounts are government FDIC insured, the government will have to step in. If the bank makes a huge risky investment and it pays off, they get to keep all the money. If they lose, the government covers it. They don’t lose their company, their jobs, their paychecks or bonuses. What thinking person would not take advantage of this situation? Would you turn down millions of dollars because you’re worried about hurting the economy?

These changes didn’t cause the meltdown, but they created favorable conditions.

The first technique used was diversification. A diversified mutual fund allegedly provides a portfolio of stocks that is, in aggregate, less risky than the individual stocks. The banks allegedly do hard work and use their unique knowledge to do this, and therefore, they can charge a premium (expenses) for owning the fund. But ever owned a diversified portfolio of “diversified” mutual funds during a recession? It doesn’t feel so diversified when they all go down by 40% give or take 10% (alpha). Still, you buying a mutual fund and paying expenses¬†is an investment choice, not fraud.

Housing loan CDOs are similar, but they are a collection of loans instead of stocks. The theory was that Florida housing might go down. Or Seattle. But not all together. So by grouping them together, allegedly with sophisticated financial models to minimize risk, they were worth more. With CDOs, instead of paying expenses you pay for the added value with a higher rating and correspondingly higher cost. ¬†You take a pile of C ratings and through the magic of diversification create a B. This is the literal equivalent of printing money. But it’s still not fraud. It’s standard operating procedure. If you don’t want it, don’t buy it.

Enter the ratings agencies. Three companies: S&P, Moodys, and Fitch, control 95% of the world’s ratings. Ratings on all kinds of things – corporate bond offerings, municipal offerings, companies themselves including the banks, and even countries.¬†When banks create any new bond they have to take it to one of these three to get rated. The agencies are allegedly impartial and well-informed. But they are also paid for rating the bond, not accurately rating the bond. There is no accountability. They do not suffer if they rate incorrectly (though there could be some desire to use one agency over another based on both accuracy, and inaccuracy).

When rating¬†something like a corporate bond, banks don’t care that much what the rating actually is. The company comes to the bank to create the bond, they get it rated, and it’s the company not the bank that benefits from a better rating. This is that boring banking talked about in the beginning of the film. So the bank appreciates a high rating for their customer, but there’s no money in it for them. ¬†There is also a long history of procedures and practices used¬†to evaluate the company.

In this case the banks created these CDOs based on a large number of individual loans that they themselves owned, not their customers. They then used complex math to allegedly made them less risky. They then took these CDOs to the ratings agencies. The first problem here is that unlike corporate bonds, the banks themselves are the ones to profit if the ratings are higher. In fact, the only way this business will exist for either the banks or the ratings agencies is if the ratings are indeed higher than their constituent parts. So not only do they have incentive to put their thumb on the scale, it is just about the only way they can compete.

The second key factor is complexity. In my experience few companies openly and intentionally violate the law. Not necessarily because they’re moral, but because it’s just too hard to keep a secret. What they do is bend rules in their favor, especially when the rules are complex or unknown.¬†It was honestly very difficult to know how to price these things. Complexity increases the uncertainty around what the rating¬†should be, which inherently increases the range of possible ratings.¬†¬†So if you’ve got some flexibility, why not rate them at the high end? So they did.

If complexity creates pricing flexibility which leads to higher ratings which leads to immense profits. How do you make more money? Increase complexity!

Enter tranches. In the past consumers bought broccoli. Consumers had to buy the stems but usually threw them away. So producers decided cut them off and sell broccoli crowns. Consumers are willing to pay more because they get just the part they want. But what to do with the stems? They cut them up into little shreds and put them in salad mix, which also costs more. Consumers feel good because they get their broccoli without having to even really notice it. And everyone wins. Yay!

So instead of¬†selling the CDOs themselves¬†they began dividing¬†them into categories (tranches). Not by sorting the loans, but by making different promises. If 10% of the¬†underlying loans fail, the lower tranches lose but the higher tranches would be unscathed. It might take a default¬†rate of, say 70% before the higher rated tranches would be affected. They then got each of these rated, essentially taking a big B-rated CDO¬†and creating C-rated and A-rated CDOs. Both products are attractive in their own way. The low-rated CDOs¬†have an attractively high return if they don’t fail (the term “aggressive” appeals to investors…), and the A-rated CDOs¬†are solid safe investments.

And now feed both of these products back¬†into the machine. Create CDOs made up of these new CDO tranches with really fancy math that further diversifies the risk.¬†This lower risk justifies higher ratings than their constituent parts. And the immense¬†complexity makes the rating into more and more of a judgement call, which means flexibility to incorporate a bias. It’s literally a money machine.¬†You take a synthetic financial product, run an algorithm on it, and turn it into other products that you can sell for more. Fun!

All you need for this machine is a steady supply of high-risk loans. And the riskier the better. Solid loans have little room for improvement, the process only works¬†on the bad ones. People place responsibility for¬†the subprime loans on the home buyers, the mortgage brokers and companies, and the banks involved. But this is like blaming the drug dealers on the drug problem. If there’s supply, demand, and immense money to be made, chances are good that a way will be found.

The third key factor here is leverage. If you buy a subprime loan and then sell it, the leverage is 1. If the loan defaults¬†the total loss to the economy is the amount of the loan and nothing too crazy happens. But the ability to create a synthetic product that is based on the attributes of the loans and not the loans themselves can greatly increase leverage. It’s like going to Vegas and taking out a loan to make a bet on the horses. Then taking the potential future value of that bet and using it as collateral on a new loan. Then making a bet with that loan, and repeating… If you win you win big, but if you lose you loose much more than you even have.

I’m not going to get into it much here as it’s neither new nor unique, it’s just what investors of all kinds¬†do. The key takeaway is that leverage meant that one loan defaulting meant¬†a total loss that was very much larger.

Note that at this point there’s still no way to bet against these CDOs. Banks¬†could theoretically create a completely synthetic product to do so but this is where my knowledge runs out. I think it’s complicated and/or prohibited.

But the story gets better. At the end of the day the loans inside all these CDOs are risky and people know it. And banks really like the highly rated bonds better because the market is much bigger Рpension funds, money-market funds, etc. How could you fundamentally change the game?

The answer, and the next piece of the puzzle, is¬†insurance. A car loan is actually a fairly risky proposition. You can crash your car or it can get stolen. By itself, a car loan interest rate would be many times what it actually is because the interest rate would have to incorporate this risk. Instead of doing this banks require you to carry insurance. The insurance company takes on this¬†risk in return for¬†the premium they charge the car owner. The loan itself roughly matches the equity in the car that can be repossessed in the case of default, so it is both secured and insured, and therefore very low risk. This makes it highly rated when it is sold, and gives it a low interest rate. It’s not bad or fraudulent, it actually nicely separates the two different functions.

Despite dealing with risk, insurance is rather boring. The companies are pretty good at assessing the risk of cars, houses, lives, boats, etc. ¬†And they compete against each other based on rates. That’s no fun. What they needed was something new to insure. But what?

How about these CDOs? Investors fear high-risk investments¬†for the same reasons they would have a hard time dealing with car loans without insurance. There are all kind of messy, nitty-gritty real-world details like repossession, hurricanes, and floods that are hard to price. That’s what insurance companies do.

AIG led the way here. Banks showed their CDOs to AIG, which wrote up insurance policies against default, which banks then bought. Almost like car loans. These are credit default swaps (CDS). With an insurance policy, the only way the CDOs could default is if the insurance company itself failed, or if the bank failed and stopped paying the premiums. They were therefore, only as risky as the companies themselves, which were rated AA+, or the same as US treasury bills. The insurance policies made any financial instrument as safe as US treasuries. cha-ching!

Cheap money, easy loans, and subsequent rises in housing prices fueled consumer spending, building, and general economic growth. This economic growth created a huge demand for high-rated investments Рsafe places for people and pensions to put their new money. And the loans used for the housing, combined with financial genius, provided the fuel. Absolutely genius.

Stopping here for a key takeaway. Bad people are generally limited in the damage they can cause. The big danger is a robust system that appears perfectly fine to most people involved, and at most marginally immoral, but as the whole, rewards negative behavior with huge rewards.

At this point there would have been a global meltdown, but no movie. There was still no way for individual investors or funds to profit from it. Remember the scene where the Deutsche Bank salesperson was so eager to sell their credit default swaps? A good question to ask of anyone eager to sell is “why?”. If an investment is such a good deal for me, why did you fly here, come into my office, and spend your day pitching it to me?

Why would Deutsche Bank want to sell investments that they think will be great for the investor and a bad deal for themselves? The salesman was portrayed as a rogue trader who knew the system was going to fail and thought his own employer was stupid. This was fun for the movie but is not how global financial systems work. The banks thought they were going to win from the transaction. Why?

Remember how the banks bought those swaps? They used those to increase the rating on their CDOs, and then they sold those CDOs to investors. At that point they pocket the difference between what they paid for the subprime loans and what they were able to sell the CDOs for and enjoy their new yacht.

But there’s one problem. Swaps, like insurance premiums, must be paid for each and every month. Big-ego investment bankers on their new yacht really hate paying money each month to dumb old insurance companies. They want this stuff off their books. Why it took Michael Burry to bring the solution to them is one of the remaining mysteries to me. They should have figured it out for themselves.

Back to the car analogy – imagine you buy a car, buy insurance on it, and then sell that car to someone else for a higher price because you promise to pay the insurance on it for the life of the car and will replace it if it gets lost or totaled. If insurance is, say $3,000 per year, you might be able to charge $12,000 more than you paid. You could then pocket the difference. One problem is the risk of the car being lost or totaled, but you’re convinced that won’t happen. The remaining problem is the $3,000 per year to maintain the insurance.

Michael Burry called them up and offered to not only pay the premiums, but also pay them for the opportunity to do so. It must have been an exceptional moment for them! They are sitting there with this unfortunate byproduct of the money machine that they think is just an¬†annoying financial obligation, and now someone wants to buy it from them. It’s beautiful. This is why the banks were quite happy to create this financial instrument and sell it to the traders.

It also left the banks with what is called naked risk. They owned neither the car nor the insurance, but they were responsible for the payoff if it got totaled.

I’ll admit I’m over my head on the last bit. Does anyone know exactly how the bank responsibility to cover default on the CDOs is expressed? Do they come with some kind of a contract?

From there on the story is simple and predictable. Couple naked risk with massive leverage and an inevitable government bailout if something goes wrong and the rest is obvious.

I think the main takeaway for today is to look for systemic flaws in ratings. One thing that would have prevented the crisis is if the ratings had accurately reflected the risk.

What jumps out at me is the ratings on the sovereign debt (treasury bills here) of most countries. They seem quite optimistic. The levels of debt are so high that there is little margin for error. Any significant economic problem at this point would decrease the ability of many countries to make good on their debt payments. This would then decrease their credit rating, and correspondingly increase the cost of any further borrowing.

This happens at the same time that government spending is most needed to spur a recovery to get out of the recession.

It would also lower the value of their currency, which generally fuels inflation as imports become more expensive. The US is in a unique and advantageous position here as our debt is denominated in our own dollars. So if the value of our currency falls, so does the value of our debt and interest payments. It’s like inflation with your home loan – your own saving and income are decreased, but so is your mortgage. But other countries are not so lucky. Their debt is valued in external currencies so if their own currency devalues their debt and debt payments actually go up.

This is a nice example of a vicious circle…

But beyond individual countries, the CDO crisis was global not just because there were risky decisions, but because the banks were all intertwined. They each bought and sold all this stuff so that at the end of the day, even figuring out who owed what to who was nearly impossible.

This interdependency is at least as true on the government level. Little old Greece threatening to default led to the brink of global economic collapse. Why? Who cares if Greece defaults? The answer is lots of people. Their debt is held by governments and financial institutions that are themselves leveraged to the edge of failure.

Debt inherently requires growth. If I borrow $10,000, and promise to pay you $11,000 next year, I am making the assumption that my income will grow over the year to come up with the $1000 interest. Global debt requires global growth that is equal-to or greater than the interest rate on that debt (minus inflation of the currency in which the debt is held). Otherwise there is default. It’s not opinion, just boring math.

In 1998 a highly-leveraged hedge fund called Long-Term Capitol Management went bust. This is normal, funds historically go under and close. What was different is that their position was so large, so highly leveraged, and so intertwined with banks that it posed systemic risk to the entire banking system. To avoid this the fed orchestrated a bailout, but it was paid for by other banks. Banks could save other banks.

In 2007 the crisis was similar but it hit so hard and happened to so many banks that there were no good banks left to save the other banks. Governments had to step in to save them.

In recent years, Greece, Ireland, and other countries have teetered on the brink of default. This is quite normal – countries default. Greece defaulted as early as the 4’th century BC, and in the modern age in¬†1826, 1843, 1860, 1894 and 1932. Defaults used to mainly effect the country defaulting.

Today the world economy is much more interdependent, and also more leveraged. Even the threat of default of a little country like Greece now threatens to bring down the global financial system. Today, the IMF and strong countries like Germany can step in to save them. This seems to me similar to LTCM. Countries can save countries, just as banks bailed out the fund.

The question for the future is will sovereign default risks continue to be confined to small manageable countries, or will more, and larger countries succumb? The 2007 subprime crisis happened because risk was not, in fact, localized. It all went down together. Diversification failed to matter.

So as you look at the world, the question is, are countries like Greece unique? Or are they just the first one to succumb?¬†As I look at debt and growth rates for the world, it doesn’t look to me like Greece is that much different from a lot of countries, even our own. Sure there are lots of other factors to consider – culture, tax collection, etc… But that sounds a lot like the real-estate arguments that the L.A and NYC markets were inherently different. I don’t see it.

If 2007 happens with government debt there’s no bailout unless we find some wealthy aliens.

In the end,¬†I’m actually not that gloomy. I think homes and land will continue to have value. Companies and their products will continue to have value and grow, and employ people. And generally people have proven to be very good at dealing with issues and somehow finding solutions. We always have until now, no matter how bad it’s been!

But I think governments are in for a very interesting time. At the same time they are becoming a massive financial risk and liability, their relevance is decreasing due to technology and the Internet. I feel a lot safe in a rated, privately-managed Uber care than in a government regulated NY taxi.

The Internet has transformed a great many economic sectors. But there are several important and huge ones that it hasn’t yet. I would say education, medical care, and finance are still lightly touched. Yes they use technology, but the Internet hasn’t gone in and ripped their heart out as it did with say, bookstores, record companies, and travel agencies. And government is also largely untouched. This will change. Hopefully we will be skillful in¬†managing the transition.











Shaking the Jar

One of my favorite quotes from¬†my favorite book…

‚ÄúOn the day they dropped the bomb Frank had a tablespoon and a Mason jar. What he was doing was spooning different kinds of bugs into the jar and making them fight….I can remember other bug fights we staged later on…They won’t fight unless you keep shaking the jar.‚ÄĚ – Kurt Vonnegut, Cat’s Cradle


Outside the jar they are fireflies.¬†As any child who succeeded in catching some knows, they’re still just small little bugs. But they also seem to be doing ok, living their firefly lives, making little fireflies, and generally having a good time.

Voters are the fireflies and we generally do pretty well living our lives. But then for an excruciating 18 months every four years we are put into a jar and told that next November, roughly 49.x% of us are going to lose to the other 50.x% Рso start fighting! And by the way, you all have to buy the jar and hire the people to shake.

And fight we do! – the “debates”, media, Facebook… But we also have virtue, so we do better than that.¬†We don’t all fight. Many work hard to educate. To compel others to see the wisdom of their point of view. To watch the debates and try to learn how they should vote.

But mostly we fight. The candidates fight, the voters fight, the politicians spend a huge chunk of the day fighting rather than doing actual work. Both sides attribute¬†anything ¬†good in the world with their side, and everything bad with the other. Every group¬†thinks their own people are¬†plenty smart. It’s just all the others that are dumb. If only we could educate them so they wouldn’t be so dumb!

But one thing we do seem to agree on¬†is that it’s getting worse. The country is generally getting dumber. Surely¬†no country with intelligence could elect the past leaders (if you lost last time), or the new roster of candidates¬†(if you won last time).

I see no hope for the future of our people if they are dependent on
frivolous youth of today, for certainly all youth are reckless beyond
words… When I was young, we were taught to be discreet and
respectful of elders, but the present youth are exceedingly wise
[disrespectful] and impatient of restraint” – Hesiod, 8th century BC

Every generation in history has thought that they were¬†brilliant and the new kids were going to screw it up. And yet, all evidence points to just the opposite. One of the really annoying thing about the new kids is that they appear to be able to make billions of dollars before they’re thirty.

But instead, we’re barraged with media telling us that it’s getting worse in general, and also, while we’re in the jar, that the¬†other side is dumb. So at best only 50% of us are not idiots.

A simple question to ask is “why?”. Why might¬†those with money and power be inclined to promote such ideas? How does it meet their needs? And as far as defining needs, lets assume for now that in a broad sense, people with power and money generally want the control to keep it and to prevent others from having the power to take it. In that case, it’s pretty obvious why it’s a brilliant plan:

  • The blame falls on the people. We the citizens are too dumb and getting dumber. At the very least the other 50% are. The reason we don’t get the government we want is because other citizens voted the wrong way.
  • Yet there is new hope every 4 years! If only this time we could get the candidates we need. The president, senate, house, and justices. And also state and local. If only my side could win then it would all be great! Democracy is fantastic, we just need the citizens to vote better.
  • It never ends. The process is the same with each election.

If¬†we’re all being told to care passionately and vote. And we’re all told by both sides that¬†the other side must be stopped. Is it at least a possibility that¬†someone is shaking our jar?

We’re being played.

The intelligence and sophistication of the voters has not changed. In some ways it’s increased. In some it’s probably¬†lower. But I don’t believe it’s significantly lower than before.

I’ll also argue that the wealthy and powerful are no more nefarious than before. Just about anyone, rich or poor, that has some money or power wants to keep it. Nothing dramatically wrong in that. If anything we’re seeing a fascinating trend towards giving it all away and doing some good.

What has changed dramatically is the sophistication of the game, and the people running the game. And not incrementally, but by many orders of magnitude.

Amazon used technology to reach¬†in and grabbed the heart out of traditional retail. That created issues and it’s far from perfect, but it was also empowering for consumers. I love my online shopping experience.

What I see is¬†that those¬†in charge of our electoral process have ripped the heart out of the system and replaced it with something immensely more sophisticated. But they’ve done it in a way that makes it appear to us as if nothing has changed. Our elections are¬†almost exactly as they were¬†in the 70’s. And we voters do the same things – we read, watch debates, talk to others, and then vote. We are no more empowered, but those playing the game are.

Expecting a loose federation of voters with day jobs to collectively make a set of informed and meaningful choices in the wake of such efforts is like taking on the US Army with pitchforks.

Even if voters are able to fight through the deception and¬†make individual choices that make sense, the game can be manipulated so that the end result doesn’t matter. The incredible growth of complex gerrymandering is basically a way of doing that.¬†Ever wonder why the popular vote and the electoral vote are¬†diverging more often? Even if voters in one district manage to¬†coordinate and align to have a coherent and meaningful vote, that district can then be rearranged to reduce their power to the margin and restore power to those running the game.

The wealthy have always manipulated government and the voters. Not because they’re evil, but because it makes sense for them. The challenge for the rest of us is that with the technology and tools available today they’re able to be incredibly¬†more effective in doing so.

The not-so-wealthy have also always tried to manipulate government and voters. But all we have are pitchforks votes.

What to do about it? Could we actually use voting to elect a government that is no longer as self-interested in preserving their power? Skeptical… Is there a way to¬†use technology to dramatically increase the sophistication of voters?

I’d love to hear¬†any ideas!



Tom’s Parenting Quotes

Sounds like one of us has a problem

Don’t make me get the beating stick

I’ll leave you here with Dr. Didi to talk about your new boyfriend

What could possibly go wrong?

This is why American healthcare is so expensive

Don’t make this an ER night

Diplo says ‘no bedtime for you!’

“loud” is a judgement call

Well, the good news is I know just what needs to be done… (Subungal Hematoma)

You could get your GED and go to Bellevue college…college boys…wait I shouldn’t say that, no college boys

What girl doesn’t love a wu-tang shirt!

I got all this fish for $3 because it’s the part nobody else wants-they asked if I wanted the head too, I said ‘next time’


Italian Food in Eight Easy Steps

Italian food is tasty! And I’d say easy.¬†It’s a layered architecture – you take tasty ingredients and add things that compliment the taste.¬†Tomatoes + garlic + olive oil + grilled chicken + shredded parmesan. Yum!

This is very different from Thai where you take many things that taste neutral to terrible by themselves and combine them in a way that plays each flavor against the others to create something amazing. Coconut milk + curry paste + fish sauce + lime juice + rice. But if you go wrong it’s not just too much garlic, or too little. It’s terrible!

So, having just returned from a visit to Italy, here is my quick guide to a big chunk of Italian cooking. It applies to making food, or what to buy when going out there.

Rule #1. Ingredients. Italy is blessed with incredible ingredients. In the US you’ll have to do some shopping. Taste and explore the subtle differences. Bread, olive oil, charcuterie, cheeses… Now on to the recipes.

#1 Slice bread. Bring to table with olive oil.

#2 Slice meat. Bring to table. Voilà Рsalumi plate! Do try to slice appropriate to the meat, and vary the thickness within the slice for things like Jamón. Different thicknesses are different experiences.

#3 Slice cheese. Bring to table. Cheese plate!

If you are in Italy I highly recommend buying the above at the store and slicing yourselves. You’ll be stunned at the amount of salumi you can get at the grocery store for the price of one little salumi plate.

I would also say that these are the highlights of eating in Italy. Oh, and of course wine. Most restaurants, especially in the tourist zones and city centers, seem to actually subtract value in moving to the following items. You can find good places, but in my limited experience it’s easier to find great Italian food in a major US city than in a major city in Italy, just because there are so many places¬†that are expensive yet stunningly mediocre and cater to tourists that never come back. I also think the internet ratings are skewed by travelers smitten more with their adventure than the actual food. I’m sure that this gets better out of the tourist zones and look forward to exploring on the next trip.

Anyway, moving on to adding value beyond ingredients.

#4 Caprese. Go¬†beyond simply cutting stuff up to add a little mixing. Slice great tomatoes and real mozzarella. Intermix the slices with fresh basil leaves and/or arugula or other fresh greens. Drizzle with a little good olive oil (they can add more). Serve with bread. You can also add a little balsamic vinegar. Key word – little. And don’t add honey, sugar or get fancy!

#5 Pesto. Take a combination of pine nuts (preferably slightly toasted), shredded parmesan, garlic (preferably slightly roasted), olive oil, and herbs. Fresh basil is the classic but you can mix in others – fresh thyme, arugula, etc. Put in a food processor until it’s a rough paste that still has some character to it – not completely smooth. Experiment with proportions – you can mix, taste, edit, repeat. Or you can even omit or change the nuts, add no cheese, no garlic, whatever. Tasty herby stuff mixed. It’s not rocket science. Put on about anything,¬†bread, pasta, chicken,¬†or just eat it straight!

#6 Polenta. An underutilized star. It’s basically cornmeal porridge, aka grits. It can be coarse¬†or fine. But the difference is really in the preparation. It can be made creamy with cheese in which case it’s a lot like grits ( not my favorite ). Or it can be more coarse and made into little pancakes. From there¬†you can use the pancakes as is, or grill them which is my favorite! And then put stuff on ’em – kind of like little pizzas. Meat, sauce, cheese… Easy enough!

#7 Tomato sauce. It’s not super hard but the prepared versions are awfully good these days so I’d probably just buy it. Put on pasta as usual, grilled chicken, meatballs, grilled eggplant, vegetables, whatever!

#8 White sauce.¬†This is harder to make well. The stuff in the store that doesn’t require refrigeration is inherently pretty bad. The fresh stuff in the gourmet section is ok. I’m not going to get into it here, but if you learn how to make a basic Bechamel sauce then you can do anything – cheeses, herbs, mushrooms… Real (dulce) Gorgonzola and mushrooms is my favorite!

Mix those together in interesting ways and you have darn near everything covered. Add some grilled meat and you have a full meal!

Upcoming Fun Small(er) Concerts

The big ones are too crowded for me. I’m excited by some of these that are more rural, obscure, and generally chill… Mostly using this as a place to keep track for myself and friends. Comments and suggestions please! I’ll be updating as I find ideas.

Kicking off the year РJan 29/30: Timber Music Fest in Leavenworth. http://www.timbermusicfest.com/winter/artists/index.html

July 16-17, 2016: Darrington Bluegrass. http://www.darringtonbluegrass.com/

TBD РAugust: Doe Bay Fest: http://doebayfest.com/

TBD РPemberton! http://pembertonmusicfestival.com/

TBD РJoshua Tree Music Festival: http://www.joshuatreemusicfestival.com/

Reflections on the Broken Leg Experience

I’m now PWB (partial weight bearing)! That means that I can kind-of stand on it, and will likely be walking in a week or two, and hiking in six. Jen and I are headed to San Francisco tomorrow for a bit of fun and then a week in the office.

Before returning to normal life I wanted to capture at least a few of the experiences.

The most striking was the day after the ER visit. Realizing that this wasn’t going to pass, I canceled all my plans and trips for the next six weeks. That was tough. But the next feeling that this was an incredible opportunity. Those vast stretches of open calendar. Having no plans in the evenings, or weekends. What would I do with all that time?

My first thought was to do something incredible. Emerge six weeks later with not only a good leg, but playing guitar, speaking another language, something… Maybe meditation. With this much down time I could at the very least master this. And working out. I couldn’t use my leg, but maybe do 10,000 sit ups a day and have incredible abs. Or biceps! I scheduled a poker party for three weeks out when I was confident I’d be feeling much better.

I didn’t¬†achieve that. Life went on – guitar ok, abs ok, biceps ok. No new languages – human or computer. It did end up being a very productive time at work. And a useful period of introspection.

My progression for the first few days was dramatic. I felt much better. Friends came over and I felt ok. No painkillers, just a little Advil. Then I had surgery to put in the plate. Surgery sucks. More than broken bones (of which I’ve had many). Actually, the first 12 hours after I thought it was amazing. No pain, all fixed! Then the serious meds wore off. One Vicodin every three hours like clockwork for about a week. And generally just feeling a significant amount of pain and very low-energy. The second week was about keeping the pain level the same while tapering off the Vicodin. And the third was tapering off the Advil.

I was unbelievably fortunate that I can work from home (bed). I haven’t missed a day of work. Far from it, I haven’t not worked for a day since the accident. Fortunate first to not have my career collapse because I can’t be there for six weeks. And fortunate again to have something interesting to keep me occupied!

I was also incredibly fortunate to have Jen to take care of me. I have no idea what people do if they don’t have someone. Coffee in the morning, water, moving laptops around, breakfast, lunch, dinner… Carrying the crutches down the stairs. Driving me to appointments. Getting food! Countless helps each day.

After surgery I quickly adjusted expectations. The new goal became to keep work going while maintaining sanity and trying to enjoy what I can. Watching a few seasons of “House of Cards”, “Vikings”, and “Marco Polo” were just fine. Lots of Ted talks. And Physics lectures on quantum mechanics and string theory.

Friends were great – stopping by to visit. Party and movies at the Henry’s. With Jen and Rick’s help I managed to pull off the poker party. Dinner and a few minutes of a movie at Ricks!

One of the most memorable things was conversations with Jasper and Scout. We have great relationships but life is busy and we often have little time to talk. I generally¬†attribute that to them. I was wrong. I was surprised by what happened¬†when I was confined to one spot. They came and talked. For a long time. Great conversations! More than once I asked “are you waiting for <friend to arrive>, <dinner>?” But no, they just wanted to hang out. I realized that I have an equal role here. Too often I cut things off, going back to work or off to do something. Slowing down is good!

Physically, P90x has been great. Especially ab-ripper. It’s not just abs, but also gets the legs going without any weight bearing. I highly recommend it if you have arm, leg, shoulder issues. That said, I was surprised how much I didn’t feel like working out. I’m sure part of it was physical. Recovery takes energy. And some mental – limited workouts inside just aren’t as fun.

So in the end. No profound changes, But I would call it a positive experience. I’m appreciating each step back into the normal world, and excited to get back on the bike!