Wednesday, November 12, 2008

Explaining the current financial crisis in a way my grandfather could never understand

Both of my grandfathers passed away in the 1990s before the and y2k bubbles burst, each to their own effects, and while alive each man was quite endearing in their own way. One of these grandfathers was a very clever man, a carpenter by trade, but a man who never assumed he knew anything more than you, unless it was how to pull a prank. He lived most of his life in South Arkansas and North Louisiana and when my family lived in a South-Dallas suburb he often would spend the afternoons of his visits in a lawn chair beside the garage, watching airliners enroute to land at Dallas Fort Worth International Airport.

Fortunately, an aircraft passed directly overhead every few minutes during the late afternoon hours and he would exclaim to me his wonder at how such a mass of aluminum and steel could fly through the air so gracefully and at such great speed.

Now I do know something about aircraft and how they fly but I must be honest and admit that I don't know very much about banking and the financial markets. And I don't think my grandfather, as aware of the human intent as he was, knew much more about banking than I. That said, I think if I could explain to my grandfather why an airplane doesn't crash, I think I could explain to him why a bank does.

As I again admit that I know little about banking, I think certain common assumptions and assertions are absolutely false. Any presumption that the current crisis is a result of the current President's lack of foresight or an evil machination of the Democratic party is at least ill thought and probably without good intent. What must we must remind ourselves is that banks don't simply hold money--banks make money by loaning your money out and having it repaid to them at a higher rate of interest than they pay you to hold it. Often banks are discussed as static in nature but are quite mobile--much like an airplane.

In flight, lift is produced by wings and propels the aircraft, my grandfather could regurgitate, but he struggled to grasp how tens of thousands of pounds of steel and aluminum could fly through the air in a manner that appears so graceful and gentle when all the while gravity was calling. And that's the secret of flying, for airplanes at least, not that gravity is defied but instead deferred.

Gravity's call is undeniable, but if the lift (and certain other physical properties) coordinate in such a way as to produce a rate of vertical propulsion equal to the rate of call by gravity then an aircraft may seem to float upon the air. So long as this relationship is balanced an aircraft may fly along for a seemingly endless period.

Most aircraft crashes are considered "controlled flight into terrain" (CFIT) and may occur when terrain is obscured by cloud or fog or when the climb or descent are not at the appropriate rate. In this case, gravity's call is often too great for the task at hand and the balance is not negotiated properly. This may seem analogous to some types of business failure, however this does not seem to fit the banking crisis.

And that sort of accident is not what people fear. What people fear is what my grandfather could not put to rest--what if lift all-of-a-sudden stopped? A slight imbalance between lift and gravity is not a big problem. This simply results in a climb or descent which, though potentially dangerous near the ground, is of little concern at 30,000 feet. This may be similar to normal business cycles during which profit may be greater or less than expected.

What most people fear--irrationally in most regards, I should add--is the stall, when lift is suddenly lost to such an extent that the immediate reaction by the aircraft is not descent but freefall. To varying degrees this situation is recoverable. For the Boeing 737, flying overhead at 33,000 feet and weighing roughly 130,000 lbs loaded up (not that weight has anything to do with lift, I just added that for drama), this situation is more dramatic.

Yet, this situation is not very likely. It could be the case that ice has accumulated along the wings such that airflow (and lift) is disturbed or a condition called clear-air turbulence (turbulence unassociated with normal weather phenomena) changes the flight conditions or, even worse, structural failure separates a wing. Any of these situations is as hazardous as it is unlikely, but the hazard is what sticks in peoples' minds and why many passengers are afraid of flying. The reality is that these situations, where the balance between lift and gravity is suddenly and tumultuously unraveled, is as unlikely as your bank failing.

Now here we are back at the beginning. How can a bank simply fail? How can so many bank executives not have known what they were doing? How can my bank with $300,000,000 in deposits be hopelessly in debt and insolvent? Debt, like gravity, is a harsh mistress and there seem to be times when a business cycle--though carefully planned in every regard--is disrupted much like an aircraft in sudden stall.

In that rare and unfortunate case it seems all that can be done is sit back and watch the bank fall like 130,000 lbs of steel and aluminum, out of the sky.

Tuesday, November 11, 2008

Would you wager on the existence of God?

That's whats being offered by a bookkeeper in the UK. The current odds are 4-1, which I understand means that there is an 80% chance that God exists. Although, the terms of the bet are very specific and payout is only made if, by scientific observation, God can be proved to exist.

That seems somewhat difficult and is probably why odds have dropped from 33-1 to the current 4-1. Still, 80% that God exists seems pretty good if you're an objective observer, but maybe someone with a better understanding of the philosophy of science can explain whether it is possible that an existence presumed to be immaterial or supernatural can be observed and proven by material and natural means.

Blogger Greg Mankiw observes this problem as he quotes author Robert Pirsig:

After a while he says, "Do you believe in ghosts?"

"No," I say.

"Why not?"

"Because they are un-sci-en-ti-fic."

The way I say this makes John smile. "They contain no matter," I continue, "and have no energy and therefore, according to the laws of science, do not exist except in people’s minds."

The whiskey, the fatigue and the wind in the trees start mixing in my mind. "Of course," I add, "the laws of science contain no matter and have no energy either and therefore do not exist except in people’s minds. It’s best to be completely scientific about the whole thing and refuse to believe in either ghosts or the laws of science. That way you’re safe. That doesn’t leave you very much to believe in, but that’s scientific too."

This is quite like the dilemma presented by Greg Bahnsen in his debate with Gordon Stein some years ago. Of course, neither Bahnsen nor Stein absolutely solved this issue--at least from a material perspective. But still, it seems that the existence of God is probably a safe bet, so long as you're not actually placing it.