Ape Man

If Stuart Staniford is wrong, he is making one of the most rigorous wrong arguments I have ever seen. He now has a third essay up making the case that Saudi Arabia is facing involuntary cuts in production.

You would think that his last two essays would have covered all there is to cover with currently available data. But in this essay he gets into the issue of water. Specifically, he talks about how much water is being brought up with the oil.

You see, when the pressure gets low in an oil well, a common technique to keep production up is to pump water down into the well. To grossly oversimplify things, the more water you pump down in the well the more water is going to come out with the oil. The higher the water content in your oil, the closer you are to closing up shop.

Anyway, in Stuart Staniford’s latest post, he makes a convincing argument that the water levels in the Saudi oil point to big problems ahead. I think his latest essay is well worth reading as always. But I want to point out that wither you buy his theory is largely irrelevant to whether you should be concerned with the facts he brings up.

It seems to me that if you deny Stanford’s theory, it you must accept that there has been a fundamental shift Saudi policy away from cheap oil. This shift will have much the same implications for Oil consumers as if Stanford’s theory that cuts are involuntary is correct.

First off, let me say that I am constitutionally inclined to doubt any talk of resource scarcity. To my mind, resource problems are usually an indication of the folly of man, and not any natural lack.

In spite of my constitutional make up, I have to confess that sometimes you just don’t get the rain you want. And as a kind of corollary, I have to allow that sometimes you just don’t have the resources you would like. The essays that have been written that set out to debunk Staniford have not been convincing and I am coming to the conclusion that Staniford may well be right.

The reason that I have come to believe Staniford in spite of my constitutional make up has much to do with the weakness in explanations put out by Staniford’s opponents for the Arabian production cut. To believe that Saudi Arabia is cutting production voluntarily, you have to believe a lot of things that I just can’t swallow.

For example, as soon as prices went above 30 dollars a barrel in 2004, Saudi Arabia dramatically kick up its oil production by about 1.5 million barrels of oil per day almost in the blink of an eye. But even though prices kept rising, Saudi Arabia’s production leveled off at around 9.5 million barrels of oil per day. They stayed at the level until sometime in 2006. At which point production started dropping even though the price of oil was above 60 dollars a barrel.

Now those who disagree with Staniford argue that this drop is voluntary. But why did Saudi Arabia think that above 30 was to high in 2004 and above 60 was to low 2006?
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Maybe it’s just me being too tired from working to much over time, but it seems to me that Tyler is letting his emotions cloud his judgment. I just can’t think of any other reason why he would approvingly quote this on his blog…..

But remember, the tech bust devoured about $9 trillion in corporate equity; next to that, the subprime problem looks like an insect bite—unless it spreads to the rest of the mortgage market.

Maybe it’s just my ignorance showing through, but this seems like an absurd comparison to me. I waited to see if any of Tyler fine commentators picked up on this, but they seem to have dropped the ball.

Maybe the problem is just me, I don’t know.

Let us say that I create a company that has 1,000 shares. Let us say I sell one share to my mom for $5. Do I now have a company worth $5,000? How much money have I lost if I can’t find another sucker to buy my stock? $4,995? This is how I saw the accounting being done in the tech boom era.

Now let us say I loan $500 to some one and they only pay me back $5 dollars. How much money have I lost? $495 dollars right?

If you are Michael Mandel (the guy Tyler was quoting) you would say I lost 10 times as much money on my company as I did on my loans. I would disagree….

Now I am not saying that no real money was lost during the tech boom. I am not even saying that more money will be lost in the housing slump then on tech stocks (though I suspect that this will be the case.) But I do think it is awful sloppy reasoning to say that the 9 Trillion dollars of equity “lost” during the dot.com bust dwarf the potential loses in the sub-prime.

There are a lot of people on the doom and gloom sides of the housing bubble debate that are letting their emotions get the better of them. But most of optimists seem to be stretching things equally far if not farther.

I have been working too much overtime to keep up with my favorite blogs. But I did manage to catch the post by Tyler Cowen on Bryan Caplan’s summarization of his next book. The post kept my mind occupied during a long night of plowing snow. Two lines from the post in particular stuck in my mind. This line……

This will be a good popular book, but I don’t yet understand Bryan’s attack on education.

And this line….

I view the contemporary higher education story as “more value” and “more waste” coming together.

The reason Cowen’s short post on a book that is not even finished yet caught my attention is because I have wrestled long and hard on a personal level with the value of education (In particular, the value of higher education). As might be guessed from my earlier posts, I don’t hold with Cowen’s view of education.

To do justice to my thoughts, I should write a proper essay. But I fear that overtime and other constraints are going to prevent that. Yet it seems a shame to devote so much thought to a post without throwing up at least some kind of response. So here goes a slap dash response shorn of any supporting facts and figures…..

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Felix Salmon is one of those people who do not think that the busting of real estate bubble is going to amount to anything. In this post he rips into a New York Times article that suggests that a crisis looms in the market for mortgages. Most of Felix’s gripe against the New York Time’s article revolves around something that I still don’t understand very well. Namely, the market for subprime MBSs.

But notwithstanding my ignorance, I still have to wonder what Felix was thinking when he said this…..

Morgenson also talks at great length about the enormity of the market in MBSs, but never stops to point out that the vast majority of that market is in bonds issued by Fannie Mae and Freddie Mac, and that no one has any worries whatsoever about those securities crashing.

Um…..

Is Bernake somebody? This just in from the CNN News…..

“The size and the potentially rapid growth of GSE portfolios, combined with the lack of market discipline faced by GSEs, raise substantial systemic risk concerns,” Bernanke said via satellite to a banking conference in Hawaii.

Is Greenspan somebody?

This is Greenspan in 2005……

“The strong belief of investors in the implicit government backing of the GSEs does not by itself create problems of safety and soundness for the GSEs but it does create systemic risks for the U.S. financial system as the GSEs become very large,” he said.

I don’t know much, but I am pretty confident that saying that nobody has any worries about Fannie Mae and Freddie Mac’s securities is a big stretch. To give you an idea of how vulnerable Fannie Mae and Freddie Mac are consider this quote from Martin Hutchinson….

However there’s a snag here, and that’s Fannie and Freddie. With $3.8 trillion of the $10.7 trillion of home mortgages, they should suffer $350 billion of losses. Since they have an upper mortgage amount limit of $417,000, they will have fewer loans on the coasts than average, and fewer loans against grossly overpriced McMansions than average. They may also have fewer sub-prime loans than average, though they have been active in negative amortization rubbish. Thus their losses may be lower than average, perhaps only $250 billion.

However, there’s a snag here. Fannie and Freddie’s combined capital is only $79 billion. That means they are almost certain to default, and to require bailout by the long-suffering U.S. taxpayer. The one consolation will be that their losses on inappropriately hedged interest rate risk on their $1.4 trillion of directly owned mortgages, about which Bernanke was concerned, will be dwarfed by their simple credit losses on their guaranteed mortgages as a whole.

Ignore Hutchinson’s estimates of how much Fannie and Freddie stand to lose if you want to. The point is that losing less than 5% of the money that Fannie and Freddie have guaranteed in mortgages market will destroy their entire capital and then some. Loses on that scale don’t strike me as at all that inconceivable given the scale of the problems in the real estate market. If they did suffer losses on that scale, how will they make payments on those bonds that Felix says that nobody has any worries about whatsoever?

Of course, Fannie and Freddie have an implicit government guarantee so they will probably get bailed out.

But I don’t think that was Felix’s point. I gather that he does not think that the woes affecting the subprime market are going to have any significant effect on Fannie and Freddie. To my mind, that is a very dubious proposition.

Maybe I am revealing my ignorance again, but wasn’t the whole point of Fannie and Freddie to make housing more affordable for lower income people? Does that not imply that the problems that are infecting the subprime market will also affect them?

This is from Bloomberg…..

Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

I don’t know why people aren’t making a bigger deal out of this. There was a small post in Calculated Risk and Noriel Roubin included it in one of his doom and gloom lists. But in general, the story seems to have been ignored.

Personally, I would like to know what those traders know that I don’t know……..