Friday, December 5, 2008

Wal-Mart vs. FEMA

I read this not-very-interesting research paper today that compared Wal-Mart's response and FEMA's response to Hurricane Katrina.  The reason why this paper isn't particularly interesting is because, as we all know by now, FEMA's response was just awful.  In fact awful is probably an understatement.  It might even a little generous.  Actually, if all Wal-Mart did was ship half a carton of Ramen noodles to New Orleans, they would still have beaten FEMA's response by a mile (FEMA's head, Michael Brown, apparently didn't realize that many of us would consider waterboarding of displaced 9th Ward residents an "ineffective response").
All kidding aside, you can read the report if you want but I'm sure you won't find it enlightening. What you may find dis-enlightening, however, is the report's conclusion... that the government is incapable of responding to disasters and therefore FEMA should be replaced by Wal-Mart. Ummm... what?  
I've written about this type of cynical assumption before - that conservatives in power purposefully wreck the government then turn around and point at the wreckage as proof the government doesn't work. Horwitz's paper does exactly that.  It celebrates the Wal-Mart response as proof the private sector should be allowed to run everything and that the government should step aside.  
It's typical that Dr. Horwitz, a conservative professor who has previously blamed the entire financial crisis on Fannie/Freddie and the Community Reinvestment Act (both of which are debunked Republican talking points), would leave no room in his conclusion for managing FEMA properly. He doesn't care that governments in other countries work just fine or that the government's response to 9/11 worked well. As a free market champion Dr. Horwitz's response to any governmental failure is proof the government doesn't work rather than proof this government doesn't work.  So his concluding proposal is for future administrations to seriously consider more outsourcing to private companies rather than for future administrations to fix the wreckage Bush created.  
Strangely, what's missing from Horwitz's report is the examination of the millions the Bush administration doled out to private companies like Bechtel, Halliburton and Gulf Stream Coach, all tasked with rebuilding New Orleans. Where, I wonder, is the report on the private sector's efficiency regarding the rebuilding effort?  Well, perhaps Horwitz is happy to see free market efficiency at it's finest -- after all, what's more profitable or efficient than for Bechtel to take piles of money without actually y'know doing anything with it? That's the absolute pinnacle of profitability. That's a free lunch. Money for nothing. Arbitrage. All hail the efficiency of the private sector... the meantime, please just look the other way on accountability, since none of these private companies will be held accountable for not actually doing anything with taxpayer money. 

Thursday, December 4, 2008

Truly Useless Information

Free Exchange has an interesting post today about Insidious MBAs.  It adds to the general sentiment in the comments from my last post on the subject -- namely that MBA students arrive at B-School with no morals (or an amoral world view). 
Shortly after the Enron debacle [my professor] asked me how business schools could better teach ethics to help reduce such behaviour in the future. I told him you cannot teach ethics to MBAs. By the time you're an MBA student (typically mid to late 20s) you're either an ethical person or you're not. No business school class can make you realise embezzling money is wrong if that's your inclination.
I agree with that sentiment but will add that MBA professors are definitely trying their hardest to turn out highly moral individuals. Nearly all our professors dispense lessons and teach with an almost heavy-handed approach to morals.  The types of books we're given to read (especially in the more qualitative classes like HR, Management, Leadership) when not conveying direct strategic lessons often extol the benefits of highly virtuous management.  Gentle, magnimous management styles are encouraged and case studies back up the benefits of leading in such a way.  The benefits of corporate social responsibility and the stupidity of trying to defraud customers or shareholders is a constant, constant, constant drumbeat. 
Professors should be applauded for their work in this regard, but what if examining bad moral decisions isn't enough? Mark Thoma points to the problems with financial engineering and says MBAs and Financial Engineers may not be learning enough (or enough of the right stuff) as it is. As his post notes, and as Nassim Taleb has famously decried in his book The Black Swan, our Financial Engineering program teaches Black-Scholes up the yin-yang but little else, but Black-Scholes is a formula that doesn't translate beyond academic mathematics -- it simply doesn't work in the real world.
So the FE students and the brave few MBAs who took this class have spent four months studying their brains out for nothing. This, despite the fact that our derivatives professor admitted to the class yesterday that, as a former engineer, he's quite familiar with Nyquist Sampling, Brownian Motion and Mandelbrot's fractals and could probably teach them. 
Why he hasn't adjusted the program until now is probably because there has been no demand on Wall Street for quants with knowledge of these theorems. I recall an old Jack Welch speech from a few years ago to a bunch of students about how the market shapes what kind of MBA students the b-schools churn out.  If the market wants quants who only know Black-Scholes, then that's what the b-schools will deliver. Why would academia bother to teach them something different when Wall Street only wants Black-Scholes disciples?  Students won't get hired, paid a ridiculous salary and be able to give a portion of their piles of money back to the school if their skill sets don't match what Wall Street wants.
I suppose I might be one of the last MBA students to learn Black-Scholes. It would seem the financial world is changing and with it, B-School curriculums will change as well.  This is obviously disheartening to me for more than a few reasons, but it's mostly frustrating because I could have completely skipped derivatives (which has, by far, been the most difficult and challenging class I've had) and still earned an MBA in Finance. Derivatives is an elective course for us MBAs, and only a required course for the FE students.
So I could have easily graduated without putting myself through learning a difficult skill set I'm never going to use not just because it's out-of-vogue but because it's also completely useless.
Awesome.  None of this is helping me study for the derivatives final I have in two weeks.  

Tuesday, December 2, 2008

Highbrow Blogging

So I saw this blog readability site the other day (hat tip: JES) and at first I was happy about the props it was giving my writing skillz, but then I became concerned. I started wondering what kind of rating system it's using and what my rating should mean to me. 
JES and others haven't been happy with their ratings and, to be honest, at first I was hoping for a Double Doctoral Degree Rocket Scientist rating. So I conducted thorough analysis of the software (and by 'thorough analysis' I mean 'drank beers while watching tv') and concluded that the readability test works perfectly well. The system rates blogs based purely on readability and doesn't rate content at all (which should have been obvious to me since it's called a blog readability test).
Anyway, after realizing this, my rating concerned me because it could be a sign that my posts are not as clear and concise as they should be. To test my hypothesis I ran the blogs of Brad Setser and Felix Salmon (smarty pants, finance bloggers I follow) through the rating system to find out whether or not I was right. 
Nearly all of Setser's post require a Master's in finance or economics to properly comprehend, and a healthy portion of Salmon's require the same. But their blogs were rated as High School and Junior High respectively. To me, these ratings undoubtedly proved the system was rating writing style and not blog content.  
What does this mean for me?  Well, Setser and Salmon boil down exceedingly complex financial arcana into readable articles that high schoolers can understand. I turn fart jokes into scholarly dissertations. Setser and Salmon write about derivatives, leveraged financial intermediaries, fixed income arbitrage and illiquid securities while, most of the time, I'm just trying to find excuses to write the name Dick Butkus. 
I suppose I could find my blog's rating flattering. On one hand, it shows I'm in rarified Joycean air -- Finnegans Wake, after all, was nothing more than a 650-page fart joke gone horribly wrong.  But on the other hand, how many freakin' people have actually ever read Joyce? Sure we all like to lie and say we have, but we haven't. Nobody has. And the few who have are usually insufferable. Anyone who's read Finnegans Wake cover-to-cover is so bitter at having lost numberless hours to reading and trying to decipher Joyce's fart-joke prank that they have to act like it's scripture afterwards to save themselves from psychosis.  
Is this the future of my blog? Are these the type of readers I have? Am I reading way too much into this readability test?  Who knows... but on a more serious note, what do you think Dick Butkus's blog looks like?

Thursday, November 20, 2008

Amoral MBA Students

MBA students, perhaps not to anyone's surprise, are cheaters.  MBA students cheat on the GMAT's so they can get into top B-Schools.  MBA students also willingly admit to cheating once they're in B-School, and MBA students obviously act amorally and immorally once they're out of B-School.  
Keep this in mind as I present the results of an informal, professor-administered poll taken in my Derivatives class this Tuesday.  The class discussion began with talk of everything that's been happening lately, as usual, and the professor believed illegal actions will eventually come to light regarding actions at the Wall Street firms (pressuring ratings agencies, exchanging favors for good ratings on toxic CDO's etc.).  Some students expressed anger at the immorality of it all, others questioned whether anything illegal had actually happened or whether it was simply irresponsibility that caused it all.  In light of the class discussion, the professor presented a class with the following situation:
You work somewhere in the finance industry nine months from now, and I present you with an opportunity to make $5 million.  However, you have to do something illegal to get the $5 million. The chance you'll be caught for doing this illegal act is 50%. Further, the maximum sentence you'll receive is four years and the chance of receiving the four years is also 50%. No matter what happens, if you're caught and sentenced to three years, you'll still get to keep the $5 million.  Would you do it?
Almost everyone in class raised their hands.
Here are the demographics of the class, as best I can guess.  It's a mixed class with both MS and MBA students since Derivatives is an elective for MBA-ers.  The class size is roughly 90 students, all ranging in age from 26-34 (my best guess).  The mix is approximately 50% Asian and South Asian, 40% American (all races) and 10% other (from the accents I'm guessing Russian, German, South American and Latin American).  Males comprise about 70% of the class.
There were little demographic differences among those who raised their hands, at least as far as I noticed, other than the few married women who didn't.  If you must know, I also raised my hand, but it's not a static answer for me. I'm on the upper end of that age range and four years is a long time for me to be rotting in a jail cell.  I've got friends and family I love dearly and wouldn't want to miss seeing.  I'm also certain that if I figured out who exactly I'd be damaging with my immoral / illegal actions, I might not follow through.  I find it's a lot easier to answer "yes" to a question of an illegal act when the question is asked in a void, but it's also much tougher to actually follow through on that act in real life.  
All this is beside the point, however. MBA Students (and MS - Finance students) are supposed to be smarter and (I suppose) less immoral than rest of the world.  I imagine the results of this poll would skew quite high if given to the population at-large, but the class this poll was asked of are supposed to be future leaders -- future leaders of large corporations that will hold the financial well being of tens of thousands, or even hundreds of thousands of workers' lives in their hands.  
All the students wrote essays to gain admittance to school, and all their essays discussed the "good" they'd like to do in their future career as well as the unique and interesting career paths they believe that earning an MBA will open for them (management consulting and investment banking, at the time the essays were written, are unique?).
Anyway, nearly all the students I know are in B-School to make more money.  There are few non-profit, humanitarian types in the program but for the most part we're all here just to earn larger paychecks. That's it. Plain and simple.  
So basically, 90% of MBA students are not just generally a bunch of cheats but also liars since their admissions essays were anything but honest!  And yes, I'm completely comfortable extending generalizations to every B-School and MBA student in the country after the completely unscientific and informal polling I conducted at mine.  I wonder if, when they're reading the admittance essays, the adcoms aren't just looking for the most riveting piece of fiction they can find since we all lied about our future hopes to save the whales and the rainforest? Well, maybe after we make our first $100 million we'll have whaletanks installed in our mansions and rainforest terrariums installed in our million dollar greenhouses, thereby following through on the empty promises we wrote in our essays.
All this pretty much got me wondering whether financial gain attracts the amoral / immoral or whether the amoral / immoral are attracted to financial gain?  I have to admit that I give the professors a lot of credit for trying their hardest to sway us and the HR Profs do an especially admirable job in this respect, but if the students are already money chasing cheaters, what difference can a few enlightened lectures make?  
Anyway, in the wake of the meltdown and news items claiming MBA degrees are no longer worth it, I'm really starting to think I should have earned my Master's in something less sleazy, more honest and more respected....  like law!  Hey, at least I'd have a job next year prosecuting all those immoral MBA-ers who caused this mess. 

Tuesday, November 18, 2008

NFL Overtimes

There's a lot of animosity in the local media here in Philly directed toward Donovan McNabb for not knowing that NFL games can end in ties.  Presumably, McNabb might have played differently if he'd known that games can end in ties but I don't want to weigh in on that debate. Instead, I'd rather ask why the NFL hasn't converted to the college system? NFL overtimes don't grant equal possessions to each team (which has been a problem for a long time), and the sudden death format is unfair because of this.
College overtime games can sometimes have ridiculous 70-69 scores if there are multiple overtimes and the league probably doesn't want to invalidate old touchdown, yardage and scoring records, but there are ways to ensure the scoring doesn't get blown out of proportion in "equal possession" overtimes. 
The easiest way to do this is for the NFL to adopt the college model but simply adjust it.  NFL teams should begin the 1st overtime with equal possessions from the 20. Then from the 30. Then from the 40. Then from the 50. The second overtime should, like college, require a two-point conversion if the team scores a touchdown.  It's still possible overtime games could end up with high scores, but the chances under this kind of system would be greatly diminished while satisfying the "fairness" problem of the current overtime system, providing fans a much more exciting game and also eliminating ties (something I think American sports fans hate more than losses).  
Update: Apparently McNabb also didn't know that playoff games and SuperBowls don't end in ties.  Which makes me wonder what he thought would have happened then?  Did he think teams that end up tied in a playoff game both advance?  How miserable would that be for the poor third team that has to play the other two??? Sheesh...

Good Financial Innovations?

I missed the opportunity a few weeks ago to offer my thoughts on the debate between Dani Rodrik and Steve Randy Waldman about financial innovation.  Rodrik sparked the debate by asking for:
... some examples of financial innovation -- not of any kind, but the kind that has left a large enough footprint over some kind of economic outcomes we really care about.  What are some of the ways in which financial innovation has made our lives measurably and unambiguously better?
My answer to Mr. Rodrik would be... Mortgage Backed Securities.
Unbelievable huh? How can I possibly say Mortgage Backed Securities are financial innovations that have made our lives measurably and unambiguously better?
Well, I can say it because the creation of the secondary mortgage market has been invaluable to millions of Americans (perhaps even hundreds of millions).  By creating a secondary market for mortgages, more people are able to borrow to get the home they want.  MBS's allow regional banks to diversify their mortgage pools and stay afloat, even if tough economic times hit their region.  For instance imagine if, in sunnier economic climes, the automakers collapse but no secondary mortgage market exists.  All the Michigan autoworkers would default on their mortgages and the regional banks holding all those mortgages would also fail (if the banks had been willing to lend to everyone in the region in the first place). The domino effect caused by failing banks in a state that's also decimated by job losses would be catastrophic.  Failing regional banks would cause "Main Street" problems on a terrible scale for whatever region they're in. But by packing up mortgages and sending them somewhere else (or by buying mortgages from a different region), the regional banks, and the region itself, are more insulated and protected from this kind of catastrophic failure. 
What we have to understand (and what Mr. Rodrik should understand) is that the ability to securitize a mortgage has been exploited and although Mortgage Backed Securities are now seen as tools of financial destruction they've probably helped every homeowner who is reading this blog to buy their home.
Financial engineering instruments are tools, plain and simple. They're neither inherently good, nor inherently evil, they're just tools. So the right question isn't "what financial innovation is good?"  The right question is, "How do we stop shysters from using financial innovation for evil?"
After all, nobody asked whether or not airplanes were good after 9/11.  We asked how to stop terrorists from flying them into buildings. The current situation is no different. There are a huge range of financial innovations that offer loads of potential benefits to millions of people both directly and indirectly.  When I pull out my "FE toolbag" (if you will), I'm able to structure payments and cash flows from any investment in any way imaginable.  Smooth cashflows from an investment are incredibly helpful and desired by every business on the planet.
But, as the good finance profs teach, all financial engineering relies on prior assumptions about the underlying investment. If your assumptions are wrong, then your FE instruments won't matter in the least -- and might actually exacerbate your problems. Financial Engineering in its (relatively) short rise to popularity, has instilled a lot of false confidence in the investors who have used them. First it was Salomon in the '80s, the LTCM in the '90s and then (apparently) everyone in the 2000s.  All these people, at some point in their use of FE instruments, either believed they had successfully engineered their way out of danger, or had magically FE'd their way into fantastic profits. They all forgot, or didn't care, that if the assumptions about the underlying investment are wrong, then all the FE instruments in the world won't matter in the least when the piper comes calling.
Now then, I can understand if Mr. Rodrik, and others, want to say that FE instruments have no value because accurate predictions about the future of any investment are a crap shoot at best... but that's a completely different argument. The argument should be whether or not we can stop the exploitation of financial innovation for profit (and also the disturbing tendency of risk managers to blindly trust derivatives as perfect hedges). It doesn't matter whether the answer to this problem is oversight and regulation of the instruments, oversight and regulation of the people who use them, or even if the eventual answer is a consensus that abolishment is the only way to stop their abuse.  In the end, the only thing that matters is making sure financial innovation isn't abused anymore.
And if, in the end, we can't stop people from profiteering through financial engineering tools and abolishment becomes our only answer, then that says more about human beings (and the MBA whizzes on Wall Street) than it does about the instruments themselves.

Saturday, November 15, 2008

Fear and the Liquidity Trap

Paul Krugman put up his analysis of liquidity traps and how he thinks they can be stopped.  I love Krugman but I think his use of expectation theory (as to how it relates to the money supply) is a little off base. Expectations about the future of the economy and expectations about future job security are what drive future spending (or cash hoarding) much more than expectations about the future of the money supply or future monetary policies.
Krugman believes the government has to fool the public into believing it's going to keep interest rates low and the money supply high almost indefinitely to avoid a liquidity trap. If sufficiently fooled he believes this will lead to spending and will stop people from hoarding cash.
I find this hard to believe.  Fear of unemployment and fear of future economic conditions are greater fears.
Economists tend to look quite a bit at the unemployment rate when calculating the severity of a recession, but the duration of an inflated unemployment rate is just as important. US Unemployment spiked to over 25% in 1932 and remained  above 14% for nearly 10 years (from 1930-1939).  Contrast that to our non-Great Depression high of just over 10% in 1982, that lasted less than two years.
An inflated unemployment rate of 10% that lasts for more than few years affects more than just 10% of the workforce.  During that time, it's not a constant 10% of the people who remain unemployed, but rather a revolving, cycle of workers gaining and losing jobs that ultimately affects a much larger portion of the population. People who have lost their jobs, fought for another one and then lost it again will have a hard time being convinced that jobs and money are future guarantees.  People who have experienced a decade long cycle of this may never be convinced again.  Which goes a long way toward explaining why Great Depression survivors hoarded cash their whole lives.
Okay, so that helps explain the Depression, but what about Japan in the 1990s and their liquidity trap?  Their recession was not nearly as deep nor as long as the Great Depression, so why the liquidity trap there?  Why did it take ten years for their people to resume spending and producing?  Well (and I admit this theory may be a bit of stretch) the Japanese are a different culture.
They're a small, tightly-knit group of islands that value honor and work above most else. Japan's population is a largely homogeneous group that holds a collective devotion to 'honor' and views the loss of a job and the loss of money, as disgraceful and dishonorable. Failure is nearly always viewed as a personal flaw in Japan as opposed to we Americans who frequently blame everyone and everything else failures.  The Japanese worker's ability to provide for his or her family in the future, and the loss of their honor if unable to do so, resulted in hoarding of cash when the country faced economic uncertainty.  There are, of course, a number of other factors and more hard and concrete evidence that the Japanese government may have flailed a bit during the years following the Asian crisis and that may have exacerbated the problem, but taken together with the Japanese mindset so fixated on honor, it seems likely that a liquidity trap couldn't be avoided.
In short, I believe the length and duration of the coming recession are what could potentially cause a liquidity trap in the United States, not misdirected fiscal policy or wrongheaded government spending.  If (as the Austrian Economists like to say) the boom leading to the collapse is sufficiently large, then the resulting recession will match it in length and depth. So if this recession is long enough and deep enough, and if consumers weren't saving enough during the boom period, then nothing will stop the recession from being deep and long. The end result could quite possibly be a universal skittishness, constant fear and a lifetime of uncertainty about the economy that will haunt the recession's survivors.
My grandparents and great grandparents are perfect evidence of this.  They lived through the Great Depression and those years affected them so deeply that they really never increase their spending for most of their lives.  They put their money in CD's, low-risk bonds and savings accounts that, most of the time, didn't beat inflation.  My American grandparents, in particular, were doing this until their recent passing just a few years ago. No amount of fiscal or monetary policy or even decade long booms convinced them of the resilience of the US economy, nor did long, sustained booms convince them that jobs and money weren't impermanent, ephemeral things.  In short, they were motivated to hoard by their fears just as the Japanese were motivated to hoard by their fears.
Let us hope this recession is not as deep and long as some fear (though Mr. Krugman himself was on CNBC last week predicting the recession and inflated unemployment would last through 2010 or perhaps 2011… yipes).
In closing, I'll leave you with a nice video of Peter Schiff, an Austrian School adherent who runs his own brokerage firm.  Mr. Schiff is seen in the video predicting the recession and collapse and debating with Felix Salmon's personal enemy, Ben Stein (who appears particularly gas-baggy in these clips) about the economy and the value of financial stocks.  Most of the people Mr. Schiff debates with laugh at him.
Oh, and lest you think I'm an Austrian School devotee myself, please realize I don't share their views about the uselessness of the Fed and government, in general.  

Thursday, November 13, 2008

What Happens if CitiBank Collapses?

It's not fun being right sometimes.  For example, I wrote a blog post in March, and another one two months ago, noting that the size of a financial institution has no relationship to its stability or long-term survival.  Specifically, in both posts I lamented the size of CitiBank and wondered what would happen if the $1 trillion (now $2 trillion) bank were to collapse. 
The FDIC cannot protect all of CitiBank's depositors if the massive behemoth of bank goes under.  What's troubling is that it only took eight months for me to be proved correct.  I thought it would take much longer.
I'll re-cap the brief argument I made about the Gramm-Leach-Bliley Act (GLBA), passed in 1999 that allowed banks like CitiBank to rapidly consolidate and grow so large.  GLBA overruled the Glass-Steagall Act of 1933 which prohibited banks from offering investment, commercial banking and insurance services all under one roof.  
When the financial crisis began in September, a lot of people actually praised GLBA since massive commercial banks like CitiBank and Bank of America could swoop in and buy the failing investment banks, thereby preventing widespread bankruptcies.  I pointed out that panicky investors wouldn't be able to distinguish between losses in a bank's investment or insurance division vs. profits in the bank's commercial banking division.  Panicky investors are likely to sell and scared depositors likely to withdraw their deposits if only one part of the bank is failing.  
I noted that GLBA might indeed be beneficial in the short-term but that it was undoubtedly very dangerous in the long-term, and, like a broken record, I noted that size wouldn't save a bank from failure. I honestly didn't think it would only take two months for me to be proven right.  
CitiBank is currently in the crosshairs of the market and it will have extreme difficulty staying afloat as an independent bank. CEO Vikram Pandit elected to expand CitiBank during the crisis, hoping size would insulate him from danger, but that hasn't happened.  And now CitiBank is not only too big to fail, but probably too big to save.
Citi might well turn out to be Hank Paulson's largest and biggest headache. There's no one he can sell it to -- it's far too big already. Which means that Paulson's only real option, if things deteriorate much further from here, is nationalization. Bits of it could be sold, at a price -- the retail bank to Santander, perhaps; other bits to JP Morgan or Goldman Sachs -- but the losses to the taxpayer would be enormous, and the disruption associated with breaking Citi up and then trying to integrate the pieces in the middle of a major financial crisis would likely be devastating to the economy.
This doesn't make me happy.

Conservatives in Power

I recently provoked a politically-fueled economics debate on another blog that is neither an economic blog nor a political blog.  As such I want to move any further discussion here. There were a number of questions floated by other commenters regarding the statements I made, but the one that drew the most criticism specifically, was a statement I made that laid a large portion of the blame for the current recession at the feet of George W. Bush.  
I further went on to say that the conservatives in this country have recently splintered into a number of differing groups (social conservatives, free-market, laissez-faire Libertarian conservatives and even big government conservatives like Ron Paul). 
I said it has become difficult to quantify conservatives across all classes, but almost all conservatives who reach a level of power in the federal government become free-market Libertarians who pray at the altar of Big Business. Dubya and the rest of the Bushies are the archetypes of this conservative Libertarian movement. 
The Bushies have had such a collective admiration for business that, once in power, they did everything they could to systematically destroy the government and privatize everything.  This isn't Sprizouse's personal conspiracy theory, but rather current 'ruling' conservative dogma. The bulk of this movement began in the 1980s with Reagan who realized that by wrecking the government, he could turn around, point at it and say, "Look the government doesn't work, we should privatize everything."
Let me borrow from Thomas Frank to best illustrate:
Misgovernment by the conservatives in power is the result of a philosophy of government that considers the free market the ideal of human society. This movement is friendly to industry not just by force of campaign contributions but by conviction.  The movement believes in entrepreneurship not merely in commerce but in politics, and the inevitable results of its ascendance are, first, the capture of the state by business and, second, what follows from that: incompetence, graft, and all the other wretched flotsam that we've come to expect from Washington.
The correct diagnosis is the "bad apple" thesis turned upside down. There are plenty of good conservative individuals, honorable folks who would never participate in the sort of corruption we have watched unfold over the past few years. Hang around with grassroots conservative voters in Kansas, and in the main you will find them to be honest, hardworking people.
But put conservatism in charge of the state, and it behaves very differently. Now the "values" that rightist politicians eulogize on the stump disappear, and in their place we discern an entirely different set of priorities—priorities that reveal more about the unchanging historical essence of American conservatism than do its fleeting campaigns against gay marriage or secular humanism. The conservatism that speaks to us through its actions in Washington is a conservatism institutionally opposed to those baseline good intentions we learned about in elementary school. 
Conservative leaders in Washington laugh off the idea of the public interest as airy-fairy nonsense; they caution against bringing top-notch talent into government service and declare war on public workers. They have made a cult of outsourcing and privatizing, they have wrecked established federal operations because they disagree with them, and they have deliberately piled up an Everest of debt in order to force the government into crisis. The ruination they have wrought has been thorough; it has been a professional job. Repairing it will require years of political action.
Frank's doomsaying is a bit further forward than mine. I don't believe the government is beyond saving, and two terms of a progressive agenda enacted by Obama and a liberal Congress should help. But I'm not going to try to predict the future, I'm just trying to point out how well Dubya followed the groundwork laid by Reagan. Bush consistently appointed incompetent people at the top of every agency in Washington, just like Reagan before him (remember James Watt of the EPA?). 
Dubya put coal industry lobbyists in charge of the Department of the Interior, BigPharma guys in charge of the FDA and grossly incompetent men in charge of FEMA which helped the conservatives in Washington "outsource" the rebuilding of New Orleans to profiteering private companies (the ninth ward is almost completely rebuilt after only four years...ummm, maybe not). 
Again, lest you think this is conspiracy theory, examine just a small collection of the Dubya appointments and judge for yourself.  
Alberto Gonzales – Attorney General
Gonzales disgraced the Department of Justice as Attorney General by putting loyalty to the President above duty to the country. 
Hank Paulson – Treasury Secretary
Bush put Paulson, a man so incompetent he doesn't understand the basics of balance sheets, in charge of the Treasury.  This is the man in charge of the Treasury?  A man who asked the American taxpayer to give him $700 million, no questions asked, no oversight?
Paulson is also the man who lobbied to have looser ibanking regulations (lowering of the net capital rule) and the right to leverage through the roof, all of which led to the financial crisis (as well as a large portion of the sub-prime mess created by aggressive investment bank lending).
Joe Allbaugh / Michael Brown – FEMA
Bush first appointed his campaign manager, Joe Allbaugh, to the head of FEMA despite the fact that Allbaugh had no appropriate emergency or management experience.  Then Bush put Michael Brown in his place, a man who had never in his life managed more than two people, and whose career pinnacle to that point was investigating misconduct at horse shows.
J. Steven Griles – Secretary of the Interior
The Department of the Interior is set up to conserve and protect federally owned land.  Griles, a former coal industry lobbyist lobbied for MORE strip mining during his lobbying career.   
Scott Gottlieb – FDA
The FDA is set up to protect consumers from harmful drugs and food not properly examined for pesticides.  Gottlieb was a former BigPharma guy who had previously been critical of the FDA. Gottlieb pressured scientists at the FDA to fast track drug approvals without rigorous research, and once halted a study on a multiple sclerosis drug after three patients lost blood and one died. Gottlieb halted the study saying it was "an overreaction" because the disease, not the drug was probably to blame.  
Kenneth Tomlinson – Corporation for Public Broadcasting
Tomlinson was forced to resign after investigations found he was trying to push PBS news content in a more conservative direction.  
Stephen L. Johnson –  Administrator of the EPA
The EPA is supposed to be a watchdog on the health of the environment but under Johnson’s leadership the EPA has closed the EPA’s network of technical libraries without awaiting Congressional approval. The agency has also abandoned proposed rules protecting children and workers from lead paint and violated the Endangered Species Act in failing to consider the harmful effects of pesticides on salmon… the common thread in all these actions is service to corporate polluters above public health.  But perhaps Johnson's greatest feat is his attempt to block 17 states from reducing greenhouse gas emissions and improving fuel economy… HE’S THE DIRECTOR OF THE EPA PEOPLE!!!
I could go on and on but I'm not sure it's necessary; I think the evidence is there for anyone to see. This isn't, as I've said misgovernment done accidentally, but misgovernment done on purpose, to create cynics of the public.
When we see these governmental disasters, the natural question we ask is, "Did these disasters happen because government doesn't work?"
But the question should be, "Did these disasters happen because THIS government and THIS governments fundamental philosophy doesn't work?"
As the '08 election (I think) indicated, Americans are starting to believe that it's Dubya's philosophy of government that doesn't work.  The public's conclusion during the Reagan years, as well as the first four Dubya years, was that the government was patently incapable of functioning.  But government obviously does work in certain circumstances, not to mention how well it works in plenty of other countries.  
It's natural to blow off government failure with cynicism and lest you think I believe Democrats are immune from failure, scandal or graft when in power, believe me I'm not. I'm not excusing Democratic scandals nor excusing any future Democratic failures, but what the public should understand is that the ideals of the Democratic party revolve around a properly functioning government, while the ruling ideals of Republicans has been to govern in such a way as to increase the public's cynicism by wrecking the government.  
This systematic destruction almost always gives ruling conservatives a new lease on life. More than a few others are starting to take notice as well: (below is a nice 6:00 minute video from Rachel Maddow's interview on the Colbert Report where she says letting the Bush administration govern is like hiring a vegan to be your butcher).  
As a final thought, I'll leave you with a tidbit from an interview with Thomas Frank:
Conservatives have had a beef with the civil service for a really long time. This is part of their identity. I was able to find an article published in 1928, and it was written by—or maybe it was an interview with the president of the US Chamber of Commerce.  A man who was a big player in the 1928 Coolidge administration (a big conservative powerhouse).  The title of the article was— "The best public servant is the worst one."   
What he meant by that was that you don't want good people in government. You don't want talented folks in government, because then government will work, it will be effective. And if government is effective, then people will start to expect it to solve their problems and who knows what comes after that. It’s all downhill from there, from his perspective. And the funny thing was—then you start researching the history of conservatism and conservative’s in power say things like this all the time; that we don’t want the best and the brightest in government. 

Thursday, September 18, 2008

Investment Bank. Dodo. What's the diff?

It's the end of the financial world! A catastrophe of epic proportions the likes of which we never thought we'd see in our lifetimes... unless you count the IMF Crisis of '97.  Or perhaps LTCM's collapse in '96.  Or the 1987 stock market crash. Or the S&L Crisis of the '80s or the...
Okay so maybe you've seen other 'once-in-a-lifetime' crashes and we'll probably see another Wall Street crisis in the future, but I have to admit that, as the country wades into the second recession of the Bush Presidency, things over on The Street look particularly insane right now.  
Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch and AIG have all fallen and before it's over Morgan Stanley, Goldman Sachs and Washington Mutual will probably go with 'em (and take another, as-yet unknown AIG down too).  Seems like a pretty big deal. I obviously gots lots to talk about.  Buckle up and let's get started with the oldest stuff first:
The Fannie Mae and Freddie Mac (or Frannie) collapses played out exactly as I predicted. Shareholders of both companies feared a Fed takeover the minute takeover rumors began. Since a takeover would wipe out shareholders, investors bailed and knocked the stock price to zilch.  
The two mortgage giants were suddenly cash strapped and neither company stood any chance of raising capital through equity issuance and no financial institution out there had the kind of cash on hand Frannie needed (not that they'd have loaned them the money if they did have it).  This self-perpetuating downward spiral was inevitable once it started.  But it's not a bad thing that this has happened.
Frannie was far from collapsing, like Bear and Lehman, yet the sheer size of the two institutions, as I've lamented before, needed to be scaled back.  The larger a financial institution becomes, the greater the odds of a systemic collapse of the entire financial system if, or when, that huge institution fails.  So Frannie's been taken over (at least for the short-term) by The Fed and will be downsized or chopped up or whatever (the process will take years, most likely).  As I've said, this is a good thing.  But events are shaking out in the private sector in a diametrically opposite way.  Lehman collapsed but used a combination of bankruptcy and a buyer (Barclay's) for their separate divisions.  Merrill Lynch has been acquired by Bank of America.  Morgan Stanley and Goldman Sachs will probably merge with a traditional bank before the year's out.  These are not good things.  A troubled bank absorbed by a healthy bank only creates a bank twice as big but a bank that still has the same chance of failing.
To understand how we got here let me first examine the rise and fall of the current investment bank business model over the last 25 years.
In the early 1980s Salomon Brothers became the first investment bank to actively trade (and trade heavily) with their own in-house prop desk (basically an internal hedge fund).  Until then the investment banks were mostly advice firms, set up to advise corporations on what would happen to their stock price if they issued more shares, bought another company or sold off a division. A publicly traded company wants to know how their stock price and financial position is going to be affected by their actions. 
But once Salomon set up their prop desk, everything changed.  The advice they gave to corporations got better and more accurate.  The Merger & Aquisition advisers at Salomon suddenly had direct access to highly intelligent people who studied the markets minute-by-minute.  The in-house traders had intimate, inside information about worldwide capital markets and how they worked and how they'd react.  To tap into this information, all the M&A advisers had to do was walk over to the prop desk and talk with the traders (as a side note, this is what gave rise to insider trading scandals in the '80s and '90s -- in-house traders, trading on proprietary information could ply the market however they wished).  With an active prop desk raking in profits, the i-bank itself could now also provide cash for deal financing.  
A small, advisory investment bank cannot compete with one that trades because the smaller firm lacks the most accurate information about the capital markets.  But to get that intimate understanding of the capital markets requires a lot of money -- usually more money than an M&A advising operation alone generates.  In addition to the computers and floor space, the people needed to monitor the different worldwide markets are expensive.  And the people who really know what the markets are going to do, and how they're going to react, are even more expensive. After all, these are not people who are likely to want to give M&A advice for a living.  
The in-house prop desk was the only solution.  And all the other i-banks either had to copy the model or disappear.  Incidentally, the i-bank that's least likely to collapse, Goldman Sachs, was also the last one to create a prop desk (reluctant until 1992).  Goldman's execs were always concerned about their client relationships and were hesitant to set up an in-house trading desk that might take positions against their cients (i.e. shorting a company that the M&A guys knew was distressed). But Goldman's nervous hand-wringing stopped once the desk opened and made obscene amounts of money.
The internal hedge funds all got up and running and by the mid-'90s and the i-banks had mulitple income streams (from the prop desk, the M&A services, etc.) and they started believing they had the strength and capital position of an actual bank.  They started believing they had consumer or commercial deposits rather than completely leveraged positions.  Which would eventually come back to bite them all... but we first have to understand why they started leveraging themselves to the hilt.  
The initial, outrageous success of the prop desks came mostly because extremely intelligent people with proprietary information were trading on that information and recognizing opportunities and quickly jumping on them.  I-bank traders knew the markets so well and had been steadily hiring a stream of freshly minted M.I.T. and Harvard grads that they were constantly recognizing big opportunities in small, previously unprofitable markets.  The i-bank traders weren't making money trading the ho-hum stocks on the S&P 500.  They were trading bonds.  Until Salomon began trading bonds in the early '80s, nobody on Wall Street thought there was any profit to be made in bond trading. 
But the i-bank traders were geniuses.  They saw that bond's were priced two percent higher (or lower) than they should be and were able to bet that they'd fall into line.  So the i-bank traders traded bond futures and credit spreads and international currencies; weird things that the rest of Wall Street didn't understand. But Salomon's guys were also making a killing, and their huge profits drew attention and the rest of the i-banks quickly joined the party. 
By the mid-90's every one of them had prop desks up and running, staffed with MBAs from M.I.T., PhDs from Harvard, and Nobel-Prize winning academics.  But what happens when every investment bank monitors obscure markets and each one has perfect mathematical models and perfect financial analysis?  The opportunities disappear.  Spreads tighten.  The bonds that were mispriced fell back into line.  When this happened the margins on trades shrunk and the previously opportunity-rich obscure markets began returning the same profits as the ho-hum index of the S&P.  So what did the genius traders to?  First they began heavily leveraging their positions... they started betting $500 million on half-percentage point moves to make the same $10 million they'd made before.  That strategy caused the collapse of the first major hedge fun, LTCM in 1996.  So what next?  Well the i-bank traders began trying to create mispricing opportunities. And this is what gave rise to the popularity of the derivatives market.
Derivatives are financially engineered instruments that Wall Street brainiacs began using to try to outsmart the other Wall Street brainiacs.  Derivatives were bundled up into such complex packages that counterparties and rating agencies didn't understand them.  This led to mis-priced securities, it led to the re-widening of bond spreads, it caused interest rates to move in the wrong direction. And voila, all of sudden, new opportunities!
But once again, the guys working at the other i-banks were no slouches, so the derivatives continued spiraling upward in complexity to achieve their ultimate end. They eventually became so complex that even the CEO's and upper management of the i-banks themselves didn't know how they worked or what positions their trading desks were taking.  And when an investment bank CEO, who's a Wall Street lifer, doesn't understand the derivatives trades his traders are making it's probably not something he should actively involve his firm in.  
Perhaps the most recent notable example of this was when JPMorgan's analysts combed through Bear's books during the buyout negotiations.  JPM's analysts couldn't decipher Bear's positions, that's how complex they were.  The only thing the analysts really knew was that the underlying assets of the trades were junk (defaulted sub-prime mortgages). The analysts piled together as much information as they could and made a recommendation to JPM's execs for an $8 per share offer for Bear  The Bear execs immediately fired back.  The current CEO and former CEO both claimed that the analysts hadn't properly understood the trades.  They said that only Bear's in-house traders were smart enough to understand the positions and that Bear's positions were incredibly valuable (obviously they weren't).  If this doesn't scream that nobody understood the derivatives markets then I don't know what does.  
Let me put their complexity into better context.  Most of us are willing to admit that, on average, the top graduates from the top business schools, (Wharton and Harvard MBAs for example) are smarter than the average Joe.  Probably a lot smarter. But by late 2005, every Billy SixPack in the country knew the housing bubble was bursting, and every Billy SixPack also knew that subprime mortgages would eventually start defaulting.  Meanwhile, what were all the Ivy-League geniuses doing?  Still trading mortgage-backed securities... almost three years later.  
The fact that Wall Street's wizards were still trading worthless junk long after the housing bubble burst proves the geniuses had finally managed to outsmart not only each other, but themselves as well. Congrats guys. You wanna put those big brains toward something more useful now?  Something that might benefit society at large?  
Anyway, as this crisis deepens and Morgan Stanley and Goldman Sachs join the other i-banks on the scrap heap I think we're going to see a lot of criticism levied at derivatives and perhaps rightly so.  In a letter to BerkshireHathaway's investors in 2003, Warren Buffett said, "derivatives are the financial weapons of mass destruction."  Seems like a prescient statement by the Sage of Omaha, and he's certainly no dummy.  Derivatives definitely helped get us into this mess but I don't necessarily think they're as evil as he claims and blame gets thrown everywhere (not necessarily wrongly) during a crisis.  Derivatives are only evil, if they're used for evil ends.  
They're useful tools for every business, not just Wall Street firms.  With derivatives for instance, I can financially engineer any kind of situation for a company to smooth out its cash flows.  If you're a CEO of a manufacturing company concerned that the prices of your raw materials are going to rise, or fall, or fluctuate wildly, or rise dramatically for three months and then flatten out or fall for two years or whatever... basically if you think you have any kind of idea on how your prices are going to move, then with derivatives I can engineer the situation so that your cash flows remain smooth.  That's useful.  
Credit Default Swaps are also invaluable.  They help hedge risk. But it's when they're used to create profit rather than to simply hedge risk that they can become problematic. What derivatives really need (if they're not evil, like most critics claim) is better monitoring and oversight. 
The ratings agencies have, thus far, escaped this whole mess with their reputations intact, but they should have done a better job of understanding the derivatives markets.  Their mis-rating of mortgage backed securities is partly to blame for the situation we're in.  Had they downgraded some of those securities in 2005, Wall Street might not be in the dire straits it's in.
And, looking back, how hard could it have possibly been for them to recognize that housing bubble had burst.  Once home prices evened out and began falling, subprime borrowers (who were mostly loaned short-term ARMs) were bound to start defaulting.  If they couldn't use rising equity in their houses to payoff their ballooning loans what happens?  Default.
Somehow Wall Street and the rating agencies didn't see this coming when everbody else on the planet did. A more likely explanation than an inability to 'see' it coming is that none of the genius i-bankers cared enough to put in the hard work and actually look.  Unwinding a derivative trade is time consuming and difficult but as the i-bankers raked in the money, I'm sure it also became a tiresome chore. Why bother to check whether the stuff being traded is actually worth anything, when everyone else is still trading it?  It's gotta be worth something because the geniuses at the other four i-banks haven't stopped.  So the collective arrogance of the highly intelligent overruled common sense and stopped them all from realizing they were all making colossal mistakes. 
So the i-banks kept trading and the rating agencies shirked their responsibilities but, like an umpire trying to make up for a bad call, the ratings agencies apologized to the world by making sure they correctly rated AIG.  The downgrade of AIG's credit led to the its government takeover and the sweep of fear throughout the market.  Great job fellas.       
Most of what I've talked about in this post has already been mentioned by the big media, but the one thing nobody's talking about (yet) is the end result of all this financial distress:  the merger of i-banks into consumer banks.  The Gramm-Leach-Bliley Act of '99 deregulated the industry and allowed investment banking operations, insurance, and consumer banking to all reside within one institution. Financial experts now seem seem to think that Merrill will be safe trading within the confines of Bank of America's insulated vaults.  Or that Bear's trading desk will be safe within JPMorgan.  But this is only more dangerous.  
What happens five years from now when Merrill's traders lose a billion on some ridiculous trade?  Will the Bank of America CEO bail them out?  They're now people who work within his own company. He's friends with the traders, they drink together after work, his kids go to school with their kids. Will he use consumer deposit funds to bail out the trading desk's massive losses? Perhaps he won't.  Perhaps he's cold-blooded enough to let the trading desk collapse. Perhaps he can be that surgical and simply cut off a limb. But fear and panic rule the markets and what happens when The Street gets word that Merrill is collapsing within BofA?  The share price starts dropping, the depositors and shareholders start scrambling to get their money out and BofA falls into a downward spiral.  Does any of this sound familiar?  Does it sound like Fannie and Freddie?  'Cause it really oughta should.
So far, one-year into this credit crunch, we've seen three i-banks fall, but the average American hasn't been directly hurt.  Sure, loan requirements are up, money's tighter, unemployment's spiked, the economy's screaming at breakneck speed into a recession, but imagine what would happen if Merrill collapsed Bank of America tomorrow?  There's more than $700 million in deposits in there. Those are "average American" deposits.
I hear you saying that Fannie and Freddie had $5 Trillion in mortgages and we saved them. That's true. But the numbers that have been tossed about by the media thus far ($30 Billion for Bear / $200 Billion for Frannie / $85 Billion for AIG) are not real.  Most of that money won't be used and will never really change hands.  If $700 Billion in deposits at BofA go up in smoke however, the FDIC and The Fed will have to fork over that money to all the average Americans who lost their savings.   
Newsflash.  The FDIC and The Fed do not have that much money.
As it stands, financial experts are quite happy letting the banks consolidate into these new massive entitites we haven't seen since the Great Depression.  Before the Gramm-Beach-Bliley Act of '99 repealed the 1933 consolidation laws, the i-banks would have simply withered and died.  If this had happened in 1998 the i-banks would have collapsed and been seen no more. Their business model became a fundamentally flawed one, so why shouldn't they wither and die like every other flawed business model in the free market dies?  Why do experts seem to think it's acceptable to let them merge into the confines of bigger, consumer banks? 
Banks can't "consolidate away" risk.  A chart might explain it better, but I can't make one.  Just picture in your mind that a bank's size is sometimes capable of limiting its risk: if, for instance a bank is operating solely in Texas and wants to insulate itself from regional failures in the Texas economy it can grow and expand into other sections of the country.  This growth helps spread risk, but there's a final limit -- a final end to the amount of risk that's ever capable of being "consolidated away".  Whatever this nebulous, nearly impossible to determine top end is, that's ideal size of a bank.  In any event, the current crisis has proven that size doesn't prevent collapse yet the private sector's answer to bank failures is to consolidate failed banks into healthy ones and grow even bigger.  
The "too big to fail" label has thus far been given to finanicial institutions whose possible collapse threatens the very fabric of the worldwide banking system.  LTCM was too big to fail.  Bear was given the label.  Fannie, Freddie and AIG too.  Please make sure you welcome JPMorgan-Bear, Bank of AMerrill, Wachovia-Stanley and Goldman bank-to-be-named-later, to the party.

Saturday, September 13, 2008

Top Ten Trance Songs

It's been a little while since I posted, but I really don't care.  If you haven't figured out yet that I'm not a "regular" blogger then this post will certainly convince you.  My posts are usually of War-and-Peace type lengths, so my postings contain as many words as some people write put into 60 posts.  I also hope that (*goes off to check blog stats*) all fifteen of my regular readers understand how difficult it is to write 8,000-word blog posts filled with nothing substantive.  It's difficult dammit!

Anyway, a dear friend pointed out that it's been awhile since I last posted and she wanted me to write something else (not because she finds my writing or my thoughts interesting, mind you, but rather because she's bored out of her skull at work).  Nothing like having a friend compliment you, huh?

Well Ms. Linds, let's just see if you can endure a stomach churning 8,000-word post about the economics of Techno music and the accompanying list of Ten Best Trance Songs of All Time.  I bet you won't make it halfway through!  Woooohahahahaha!!!

Here goes:

I love music and enjoy a wide range of music, I think.  Only two genres fail to grab my listening attention: R&B crooning (think K-Ci & JoJo) and Gospel.  Other than that, it's pretty much open season on Sprizouse's ears, but I'm not alone in my diverse musical tastes.  The digital revolution (mp3's, iTunes, iPods etc.) has taken the monopoly of production out of music producers' hands while the problem of shelf space in traditional stores (that used to only be able to stock the 6,000 most popular CD's), has been factored away with unlimited storage space on hard drives and the web.  What we, the consumers, are left with is an incredibly wide range of music to sample from.  The music industry has created a Long Tail where the most popular songs are still the most popular but more and more people are choosing to listen to stuff down in the tail.  Chris Anderson, editor of Wired and author of the wonderful boo, The Long Tail, explains it in much more detail than I can, and I highly recommend reading it... but I'm getting off track.

The digital revolution has proven that consumers enjoy a much wider range of music than the music industry previously thought.  Despite this taste explosion however, it seems to me that artists, albums and songs from two of my favorite genres still get almost universally dissed and dismissed.  The victims?  Country Music and Trance (Techno or EDM - Electronic Dance Music, depending on your definition).  

How many times have you had a friend say they love all types of music except Country?  I still get scoffed at when some catches me listening to a Trance song.  The "Club Sprizouse" jokes start and my friends laugh and I just squish it all down into a little ball in my gut and smile.  I think both genres are dismissed for distinctive yet different reasons that are completely unrelated to the music.  My argument about why you should listen to (and appreciate) Country deserves its own essay, but I'll save that for another day.  For now, I'm going to address Techno (or Trance, the subgenre I love) and try to convince you to give it a chance.  

Teenagers from here to Timbuktu know that your inherent coolness (and your personality) can be quantified by your clothes, hair style, and taste in music.  But this theory, largely because it's spouted by teenagers, is stupid.  The type of music you listen to is never a confirmation (nor dismissal) of your coolness.  Despite that, there's something subversive going on within Trance music; a culture that tries to limit the music's popularity and an uncomfortable "mocked" feeling some first time listeners receive from the culture's arbiters of taste.  These people are also ones you should ignore as readily as you dismiss most teenagers' stupidities.   

Trance music is best viewed like an iceberg.  Only a handful of songs ever make it to mainstream popularity.  But DJ's all over the world mix and remix and create new songs practically every day.  The ease of mixing and creating new tunes can be done with a PC and $150 worth of software, so the industry churns out enough new music each year to fill warehouses upon warehouses with CD's. Why then does only a fraction ever achieve mainstream popularity?

There are four key reasons for this:  the first reason is the aforementioned underground culture. Techno, Trance, EDM or whatever you want to label it, arose in an underground fashion.  The culture that surrounds the music, therefore, often bucks back against an artist who breaks through (or who tries to break through).  Once an underground artist reaches a set, critical mass of popularity their previously loyal, underground fanbase abandons them or worse, turns against them completely.  Why does this happen?  Why do the undergrounders (if you will) refuse to follow an artist on his upward rise to mainstream popularity?  The answer is hard to define.  And the question itself only leads to more questions because to answer the question we first have to understand what it is underground fans are looking for.  

Do undergrounders really have a cool, edgy, experimental, misunderstood taste that lives on the border of musical revolution?  Are they the earliest of early adopters?  Or are they, like most teenagers, just dying to be different and therefore listening to eclectic musical styles only to distinguish themselves from the herd and "appear" cool?

More often than not, I think it's the latter.  And it's this latter group that creates the culture around an artist no longer being "cool" or being "cutting edge" once they become popular.  Any artist in any genre, be it music, writing, painting, sculpting or film making wants, more than anything, to have their work appreciated by as many people as possible (any artist who says otherwise is lying).  The artist's desire for exposure is not for want of financial reward but for the internal psychological rewards she gets from having her work admired.  This reward is an infinitely more powerful motivator than money.  Therefore when a Trance DJ makes a track that's a little more pop-like than normal perhaps he's just hoping to drag in a few more listeners to both himself and the genre.  

The underground "cool-hunting" fans therefore shouldn't automatically crucify a DJ who does this because when they do, I believe it ends up limiting what the artist is allowed to attempt from that moment onward.  A DJ who goes "pop" is almost never embraced back into the underground scene nor is his experimentation supported by his newer "pop" fans.  But it's the set of "cool hunters" who can most easily change, who can forgive both themselves and the artist, and if they did, then perhaps we'd have more artists able to mix styles more freely between edgy-experimental and popular.

The second reason for Trance's lack of mass airplay is that most songs lack lyrics.  This doesn't make the songs any less brilliant musically than what the Beatles have produced, but it does make them less accessible, like modern versions of Rachmaninoff.  Kurt Cobain's voice is distinctive and instantly recognizable and his scratchy vocals added a lot of depth and power to Nirvana's songs.  It takes only a split-second to identify a Nirvana song because of Cobain's voice, but conversely, sometimes an entire Trance album won't help a listener distinguish it as an Armin Van Buuren or Paul van Dyk creation.

Cobain's voice also gives Nirvana a much more recognizable genre fingerprint than the muddled clues left by a lyric-less Trance song.  Few people would mistake Boston for Nirvana and fewer still would categorize them together in the same genre.  But a person who's never heard either might listen to instrumental versions of Smells Like Teen Spirit and Boston's More Than a Feeling and think they're just remixes of each other (Cobain lifted Boston's riff to create Spirit's hard-edged cut... don't believe me? Go listen to 'em).  This absence of vocals highlights one of the problems with Trance.  There are many different subgenres of Trance: ambient, epic, acid, hard, progressive etc., and the DJ's switch between genres, often on the same album.  Vocal artists are given leeway to do the same, but a Madonna song is a Madonna song whether it's a club banger, a ballad or just a straightforward pop song.  Trance that lacks lyrical fingerprints can leave new listeners confused when they pick up Paul van Dyk's In Between and realize it sounds nothing like Out There and Back.  This is not an insignificant problem. 

As an addendum to the vocal absences, I believe lyrics often do more harm than good on Trance songs.  Most often, the Trance song that reaches a moderate level of popularity has had some gawd-awful lyrics haphazardly shoehorned into an otherwise marvelous track, and this ends up creating even more backlash from within the EDM community (see: Hall, Richard Melville).  But putting forward the Trance songs with vocals as representatives of the genre does the genre a disservice as well.  Those aren't the best Trance songs!

The third reason for Trance's lack of popularity is that it most often arises from within a culture, a lifestyle and a moment.  These heavily influence the reason (or lack of) for a song's mainstream success.  Trance is intimately tied to the club-and-dance scene and it's hard to separate the music from the events it fuels.  The average listener has trouble appreciating the listenability of Trance songs outside the club because tracks are rarely played outside a club's walls.  Therefore the music's memory imprint for most becomes that of a drunken, bass-heavy night at Palladium during an orgy-filled Spring Break, and it's never listened to, or appreciated again.  This is perplexing to me and the only solution I have is that you give Trance a chance outside the club.

Trance makes the perfect soundtrack for any number of other activities outside clubbing.  The songs are great traveling songs, exercise tracks and some are even delicate enough to accompany a dreamy, early evening, summer sunset.  If you end up listening to it outside the club, and then one day you do manage to get to Acapulco, and PvD throws on Nalin & Kane's Beachball to close an incredible set at seven in the morning, then you'll be genuinely excited to hear the song and you'll feel it's the most perfect song he could have chosen.  You won't just be dancing your brains out to some random track that some random DJ is spinning.

Finally, the fourth reason for Trance's lack of popularity is how easily a DJ can mail in a live performance and how, since a Trance show has almost no real "live" component to it, the average listener isn't able to distinguish between, let's say, an Oakenfold show or a Ferry Corsten show.

I've seen quite a few famous DJ's spin in my day and some were less than awe-inspiring. At times I've felt like I could have stepped behind the wheels, faded back and forth between songs, and if the cocktail specials were cheap enough, and the bass loud enough, then most of the audience wouldn't know the difference.  But I've also been to a fair number of shows where DJ's have been visibly sweating behind the tables, mixing and matching tracks, tearing through sets while controlling the tempo and energy of the crowd.  It's shows like these that can make you a fan forever but it's the bad ones that will make first-time listeners scoff at the talent of the DJ and never give the music another chance.   This fourth problem is (usually) only an issue reserved for the genre's most hardcore audiophiles and once you've fallen in love with Trance, the inconsistency of shows might be a problem, but you've got to fall in love with it first, BEFORE it becomes a problem.

Anyway, that's it.  Those are the four reasons standing between you and sonic bliss.  But there's one more thing left: a list of Trance's best songs ever, to get you started.  Therefore, allow me to present, a compilation of the best the genre has to offer that will get you hopefully encourage you to explore the genre in depth. 

10.) Tiesto - Adagio for Strings

Numbers nine and ten on my list were the hardest to choose.  My top eight stood out immediately but then there were a number of tracks all fighting for inclusion into the last two spots.  The choice of Adagio was particularly painful since I think Sasha's Xpander and Banco De Gaia's Heliopolis and even Tiesto's Ten Seconds Before Sunrise are all better.  But considering the audience I wrote the post for, Adagio ended up fitting best.  

The original version of Adagio is, in my opinion, one of the saddest orchestral pieces of all time, but Tiesto has successfully turned it into a hardcore dance track so that transformation in and of itself is probably worthy of note.  The orchestral original was created by an Italian refugee fleeing Mussolini's fascist regime in between the time of the Great Depression and the start of WWII.  The original masterfully captures the sadness and overwhelming uncertainty of the world at that time but Tiesto's version, for my money, doesn't displace any of that atmosphere.  It still sounds sad to me.  But then again, I've never been at a club and seen someone spontaneously break into tears when Adagio is spun.  In fact most clubgoers usually tear up the floor en masse when a DJ drops this song, so it obviously doesn't sound sad to anyone except me.

The other problem with Adagio is that Hybrid may have perfected the orchestral, Trance song and their work is completely original, while Tijs just shoved Barber's delicate beauty into a bass thumping Trance track.  But in the end, I appreciate the fact that I'm able to listen to a different version of Adagio than Barber's and it's one I appreciate more for Tijs' attempt rather than for the end result.  So that's why it makes the list at Number 10.   

9.) Hybrid - Finished Symphony (deadmau5 Mix)

deadmau5 (pronounced deadmouse) is a newer DJ who was given the chance to remix one of the greatest Trance songs of all time.  However, instead of reworking Hybrid's masterpiece, it's almost like deadmau5 created an entirely new track.  When I first gave this a spin I was expecting to hear at least some vestigial remains but there's really nothing left of Hybrid's work at all.  Perhaps deadmau5 did this out of fear of not living up to the original, or arrogance he could do better or maybe outright laziness.  Whichever the case, his version abandons the original in favor of deadmau5's sound and if it had been labeled an original work I'm not sure anyone would have known.  This version is a simple 4x4 with a very slowly developing wave that favors simplicity over the complexity of its progenitor.  But there's real power in the simplicity.  the rising wave is a pleasure to let wash over your ears as it builds and I can't stop listening to it.  This track is similar to deadmau5's original piece Faxing Berlin (which I also liked) but the fact they're both so similar in style leads one to wonder about this cat's talent level (or mouse, as it were).  I caught him at a show in Philly this summer and thought he did a pretty good job with a decidedly non-Trance crowd, so until he proves me wrong this song stays on the list at Number 9.

8.) Robert Miles - Children 2000 (Trance Remix)

If you've been to a club at any point in the last twelve years you've probably heard Children (either the original or a remix). Personally I could have put either the original or this one on the list, but the 2000 Remix hasn't been played as much and shakes off a little of the song's staleness.  The piano work on the song is tremendous and is the track's defining trait.  I love piano work in my Trance (as a few other songs on this list will prove) but few do it as well as this one.  If you're searching for newer piano stuff, Mike Foyle's been pretty good recently.  Anyway, Children makes the list at Number 8.

7.) Humate - Love Stimulation (Paul van Dyk's Love Club Mix)

This song would fit perfectly on van Dyk's later album Out There and Back right about Track 3 where I'd lay it in between Another Way and Traveling.  It's not hard to see the similarities between this song and what PvD would later do on his full-length masterpiece.  This is another great piano song that's accompanied by a choral yowl in the background that deepens the overall tone of the song.  The track flows easily and beautifully through emotions but for a Trance song, I find it's always one that ends too soon.  I like my Trance long; it needs that much time to lift me up and take me away and transport me to another place.  Stimulation could be ranked higher but it always leaves me wanting more so I'll leave it wanting more by leaving it at Number 7.

6.) Nalin and Kane - Beachball (Gabriel and Dresden Remix)

I never fell in love with the original version of this song but I think G&D did a marvelous job remixing it.  This is a perfect summer song, and it will almost always remind me of that early morning in Acapulco.  The gentle female cooing and the ambient sounds of waves and seagulls laid over a peacful melody always put me in a peaceful frame of mind.  Even the lyrics don't damage it as the singing is kept simple and used sparingly.  Perfect summer listening at Number 6.

5.) Chicane - Offshore (Ambient Mix) Cafe del Mar

If you've ever heard Love on a Real Train (for those that haven't, it's the song that plays during the sex scene in Risky Business), then you've probably thought it could have been great if it only had a bassline or a even a lightly used drum beat.  Offshore is close to that ideal -- it's basically a version of Love with a bassline and a beat.  Unfortunately the track's melody is a pared down version of Tangerine's classic and this can be unsatisfying to some.  I however, think it works well since Love always has a restless, fidgety kind of feel where Offshore's sparser melody feels more comfortable and at ease.  The song itself is another, relaxiny, beach-type song in the same vein as Beachball and one that rekindles memories of Ibiza for me.  Offshore is a quintessential Ibiza song but not in the amped up AVB- or Tiesto-at-Amnesia (ICE CANNON!!!) kind of way, but more in an evening-cocktails-on-the-steps-at-Cafe del Mar kind of way.  

Offshore always reminds me of the time during a vacation after you've just wrapped up an entire day on the beach.  You've been hanging with your friends all day long, tanning, swimming, jet-skiing or whatever.  You're the first to shower and throw on some summer-club duds and you're back down at the hotel pool bar having a quiet cocktail.  The sun has fallen halfway below the horizon and the previously crowded beach is now quiet and empty enough for you to hear the waves lapping the shore.  You're enjoying a cold tropical drink and waiting for the rest of your crew to finish showering and dressing before, one-by-one they meander down to join you.  The night ahead still holds tantalizing promises.  You've got a nice dinner planned with everyone; the laughter will be loud and genuine and afterwards you'll all live life to the nuts during a raucous, memorable night at Amnesia, Palladium or Dady'O.  

I don't think I've done it justice, but doesn't that "calm-before-the-storm" time of day need it's own description? Some sort of adjective that describes that fleeting hour in it's entirety, something much better than what I've offered?  Like "vacation witching hour" or "sunfall before the storm" or something? The phrase "pre-gaming" doesn't do it justice and only conjures images of drinking in an apartment at college.  Well, as per usual, I'm off-track.  Offshore comes in a Number 5.

4.) BT vs. Paul van Dyk - Flaming June

This is another Trance masterpiece that teeters close to the precipice of being overplayed.  However it's one I'm still not tired of hearing so I always wonder how long it's going to be before I find it stale.  Flaming June is another piano filled Trance track (we know I love them) but it's also one of the harder dance songs on my list.  It's considered by many to be a classic of the Trance genre and I've heard almost every DJ from here to the Netherlands drop it into a set.  It never fails to get the crowd amped and I've always felt it was one of the best closing songs for a DJ's set. 

3.) Salt Tank - Eugina 2000 (Progressive Summer Mix) Paul Oakenfold

Salt Tank's original version of Eugina is a nearly flawless composition.  I'm one of those who believes it's nearly perfect but I think Oakenfold may have improved it, ever-so-slightly.  The rising synth waves at the beginning never fail to inspire and always make the track feel like it's preparing the listener for liftoff.  To me it's a perfect track to open (or close) some sort of outer-space movie and, since Oakenfold has mostly moved into scoring movie soundtracks I think it's a reasonable assessment to say that.  The track loses a little luster toward the end but the first four minutes are brilliant.  Eugina 2000 is Number 3.

2.) Hybrid - Finished Symphony

We've reached the track that set the standard for any kind of string or orchestral arrangement in a Trance song and one that spawned a thousand imitators but (as of yet) no equals.  I can't say much about this song that hasn't already been said.  It's epic, it's huge, it's fantastic.  The build, breakdown, rebuild and final crescendo are second only to one other...

1.) Tiesto - Suburban Train

I've been listening to this track for six years and I've listened to it way too much in the last six years but it still hasn't lost any appeal.  After all that time my ears still hunger for it more than any other Trance song.  The history of Suburban Train starts with Kid Vicious, who's Re-Form was remixed by Tijs and then eventually turned completely into Suburban Train.  Some feel Tiesto should have labeled this a remix of Re-Form but Van Gelderen is instead listed only a producer on ST.  This is one of the issues many a Trance fan has with Tijs -- accepting credit for work that isn't his.  Anyway, as far as Train goes, it isn't just better than Re-Form, it completely transcends it.  

It's hard to explain what's so fantastic about this song. Other Trance songs have followed the same build, breakdown, rebuild, crescendo formula of Suburban Train, in fact most successful songs have followed this blueprint as far back as Beethoven and Bach (and probably further).  But just like not other string-infused Trance song has yet bested Finished Symphony, no other anthemic Trance track has done it better than Suburban Train.  

The first 2:15 is a slow build, letting you know something's getting started, but there's nothing impressive here yet.  Slow and steady, like a train picking up steam the first four-note tickle and hint arrive at 2:30 and the song begins to change.  It leads into a patient breakdown that takes a minute (3:15-4:15) to finish and yet the song's still only hinted at the epic sound growing within it's glacial build.  The last rebuild is as patient as the breakdown and the result of all the patience is a stratospheric payoff and from 4:50 on the song simply flies.  Unquestionably the jewel of all Epic Trance.

So that's it... all the reasons why Trance isn't popular, 10 songs to get you started and help MAKE it popular and the reasons why those 10 songs are great. 

If you find you agree with my taste then below are a few honorable mentions:

Mike Foyle - Shipwrecked (I liked the Sean Tyas version of this one too)

Armin Van Buuren - The Sound of Goodbye (the Simon & Shaker Mix is really good too)

Final Ramble: I sometimes wonder about the timing of the Trance scene and whether it's faded at all since I left it.  I think my views on the fall of Trance are distorted since I'm not as heavily ensconced in the club scene anymore, but I do wonder.  What I'm saying is that I sometimes want to criticize my tastes (or this list, for instance) since most of the songs I've listed are the ones I learned to love during my club days circa 1998-2004.

I first started listening to Trance when a friend passed me a bootleg of Oakie's first Creamfields show.  I loved it so much I went and bought PvD's Seven ways and Oakenfold's Tranceport shortly thereafter.  Then in 2000, two of the signature Trance albums came out: PvD's Out There & Back and Oakenfold's Perfecto Presents Another World (with the Eugina remix on it).  A year later Tiesto released In My Memory (with Suburban Train and Dallas 4pm) and the first (and still best) of his In Search of Sunrise albums.  Finally, A Clubber's Guide to Trance, a definitive album of the time (with Finished Symphony, Xpander, Gouryella, Saltwater, Cream and Out of the Blue on it) was alsor released around this time.

A lot of people who love and follow Trance would rank most of these albums, artists and songs as among the very best.  The music was taking off just as I had taken the last of four major vacations to Spain, Cancun, England, and Ibiza (1998-2000) and the European Club scene was absolutely exploding with Trance.  It started hitting U.S shores in 1999, and freshly 21 I spent the next four years catching awesome shows up and down the east coast in NYC, Philly, DC and Florida.  By the end of 2003 I stopped hitting the clubs every other weekend and I haven't specifically traveled to catch a DJ since then (chance encounters in Acapulco with AVB, PvD or Tiesto notwithstanding).  I still try to catch a big-time DJ if they come through Philly but that's pretty rare these days.

Anyway, what I'm trying to say, in a roundabout way, is that's it's possible that I only think the songs I've listed here are the best because they're the Trance songs I always heard at shows.  Of course it's also possible there's never been any better Trance made and the scene is dead and 1998-2003 were it's golden years.  After all, if in 1996, I reflected on the Grunge scene and thought it had peaked, I would have been absolutely right.  No grunge or Seattle sound was ever better than from 1990-1995.