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Commentary: Econophile’s Top 10 for 2008

The economic reality is that there really were only eight events — but their impact sure was significant.

Econophile could only come up with the top eight most important events for 2008. If I tried for 10 I would be trying to make something that’s not important ... important. These events and ideas that will, in my opinion, have the most impact on your 2009.

1. Barack Obama, an African-American man, is elected president of the most powerful nation in the world.

Phenomenon. I can’t think of a better word to describe it. This charismatic man seemed to sweep across the country with calm dignity and uplifting speeches and gave people hope about the future in an uncertain world. In with the new new and out with the old. Let me set the stage: I don’t think I agree with his policies. I say this because we don’t know what his policies will really be until he assumes the office. I don’t see from his position papers or through the selection of his advisers that he’s bringing anything particularly new to the debate.

The significance of his election to me is that he is black. That alone is a transcending, uplifting event. In light of the record of the United States of America on slavery and race, we’ve all come a long way. Obama is irrefutable evidence of that. His election could mark a new era of good race relations in America. That is change.

2. The Crash of ‘08 nearly takes down the world.

I’ve talked quite a bit about this recently. I spelled out what I thought was the “why.” (Please see “The Law of Unintended Consequences.”) What is interesting to me is that when I go back and read the classic treatises on the subject of business cycles (Ludwig von Mises’ Human Action; Murray Rothbard’s America’s Great Depression) you can see current events unfold exactly as they predicted. Actually, it is rather frightening; no one should be having a schadenfreude moment here. I see this as a failure of current mainstream economic thought. While the Keynesians will try to portray this event as a being caused by deregulation and the “free market”, it is a classic tale of government intervention. I am working an article on the debacle and its future to be published this month.

3. Chalk one up for the Black Swan: The failure of risk analysis.

Very few investment advisers I have talked with have read or understood the risk theories proposed by Nasim Taleb in his books, Fooled by Randomness and Black Swan. The usual responses I get are either: “I don’t need a book to tell me there’s risk in the market,” or, a variant, “We are aware of Taleb and understand SIx Sigma events.” Which answers tell me immediately they don’t have a clue. Taleb’s theories were vindicated by the performance of Universa Investments, which uses his investment philosophy and risk models. Their clients made big gains during the recent market crash — up to 110 percent. (See “Black Swans, White Swans, and Fat Tails.”)

The Six Sigma-type of event utilized by existing risk models (the Black-Scholes-Merton model) is supposed to be an off-the-scale risk event. More correctly referred to as a deviation of 6 on a Gaussian scale, it is an event considered to be so rare as to not be worth considering in investment risk models. The proponents of these models keep getting creamed in the market. (See “Some People Never Learn.”) Taleb turned all this on its head by asserting the model isn’t relevant and these “highly improbable” events happen rather regularly and can’t be predicted. No one listened. So much for safety in numbers.

4. We trusted them: The shattering of mainstream economic assumptions.

The Crash of ‘08 has more significance than just the economic implications. A whole generation or two of people have come face to face with the result of economic mismanagement. This isn’t an event that’s limited to government actors. The supposedly sophisticated investors and advisers have been shaken by their losses and the speed of the collapse. The guy in the Chevy truck is shaken. Our parents or grandparents were shaken by the Great Depression of the 1930s and World War II. Most people living today were born after WWII and until now had never been faced with the prospects of a depression. My econ professor in the early ‘60s said we would never repeat the Great Depression because our government knows what it’s doing. Yet the prospect of a depression is raising its ugly head again.

Trust in mainstream economics has been shattered. These economic principles guided our government fiscal and monetary policies, Wall Street, industry and banks. I look at it as a failure of Keynesian, interventionist economics. These guys were the smartest guys in the room, so to speak, and they screwed up–big-time. (See “The Smartest Guys in the Room.”) Now we are allowing them to use failed Keynesian models to get us out of the mess they created. I think the danger is that we will turn away from whatever vestiges we have left of free-market economics and turn to a version of European socialism. This would be the end of America’s greatness.

5. Bernie Madoff: The shattering of financial trust.

Bernie couldn’t have come along at a worse time. On top of all the other economic problems we have, he steals $50 billion from some of the most sophisticated financial operators in the world. I see it as kind of a culmination of the Fed’s easy money policy. How did these sophisticated players let him do it? They abandoned all standards of financial and, often, fiduciary responsibility because of their complacency and belief in the system of government oversight.

I point out in my article (See “Bernie Made Off with the Money.”) that these people believed in the old boy network (“It’s those insiders who make all the money.”) They believed the markets were safe from people like Bernie because all those other prominent investors were in it and, as we all know, regulators wouldn’t let this happen. I believe this is a direct consequence of credit bubbles created by our government. Bubbles allow people believe that money is easily made without the necessary hard work. And, they don’t have a clue about real risk. I don’t think hedge funds will be the same for quite some time.

6. The shoe chucker: A symbol of the end of the Bush era.

When reporter Muntadhar al-Zeidi threw his shoes at President Bush in Baghdad he became a world hero. Not just among Muslims, but just about everywhere. Now there are video games where you can throw shoes and other objects at Bush. The point is that this gesture is a fitting end to the Bush era in politics. I can’t really think of anything Bush did right. OK, maybe invading Afghanistan and kicking out the Taliban after 9/11. But he should be harshly criticized for abandoning Afghanistan and invading Iraq. His foreign policy has been a disaster. We went from a world where everyone supported us after 9/11 to everyone hating us, or at the very least, not respecting us. Did we win the war in Iraq? Maybe, but that misses the point. It was a huge mistake to go in there. We could have bombed Saddam Hussein whenever we wanted if we thought he was a real threat. He, as it turned out, was a paper tiger.

How about domestic policy? When Bush first got in office he imposed steel tariffs as a payoff to unions and the steel industry. Then in his second term he promoted the largest increase in federal entitlements in many years with the prescription drug plan. He paid lip service to the free market while doing many things to destroy it. The greatest credit bubble in history took place on his watch. He also took the Republican Party down with him. He and his religious followers turned it from a somewhat free market-oriented opposition party to a force for imposing his moral values on the country, damn the Constitution. Goodbye, George.

7. Derivatives: Not gone, not forgotten.

As Mark Twain said, “The report of my death was an exaggeration.” It is true that collateralized debt obligations (CDOs) and their derivatives helped cause the Crash of ‘08. Like many new instruments the consequences were not well understood. The introduction of credit default swaps (CDSs, a purported investment insurance) magnified the problem almost geometrically. AIG wasn’t the only one writing swaps. And the same obligations were sold multiple times, all backed by swaps. We are now in the unwinding phase and trying to determine the risk and value of all this paper.

I predict that once all this unwinds that CDOs will still be around. They are a useful finance tool. The bundling up of properly underwritten mortgages, for example, provides capital for the housing market. Because it is new doesn’t mean it is bad. These CDOs were actually well-designed and written for the purpose they served. What went wrong was the deterioration of underwriting standards caused, in large part, by government intervention in the mortgage market (Fannie, Freddie and Congress). I believe that CDSs will also survive, albeit, conforming to better standards. A properly designed exchange market, backed by NASD standards, will allow the market to quantify and rate these guarantees as well as the underlying CDOs.

8. Invasion of the iPhone: 10,000,000 phones; 300,000,000 apps.

The iPhone brings us closer to the handheld computer. The iPhone isn’t new but it really came into its own in 2008. This marks the beginning of the end of the desktop computer. For the first time this year laptops outsold desktops. Something is happening. The promise that Apple offered was not just a cool little phone with a clever screen. The 300,000,000 applications that were sold for it can do almost anything you want, from finding a restaurant while you’re walking through SoHo, knowing where your friends are, wine-buying advice, on-the-fly financial and market data, games, weather, traffic cams, use it as a level or a flashlight, whatever.

They are everywhere now. Even my less than technically astute friends have them. It will take forever for the competition to catch up. Buy one now. Caveat: the battery stinks when you use 3G; the operating system isn’t perfect; it can crash your PC; you’re stuck with ATT.

— Jeff Harding is a principal of Montecito Realty Investors LLC. A student of economics, he has a strong affinity for free-market economics. This commentary originally appeared on his blog, Subprime Crisis Forum.

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