Democrats & Liberals Archives

Twenty Sigma: Chaos and Order in American Governance.

1987’s crash, Black Monday, shouldn’t have happened. Yes, morally, that’s true, but I’m not simply talking about that. I’m talking about in statistical terms, if we’re dealing with things from a normal distribution. We should have been able to wait billions of years and never see a day on the stock market like this, the odds being 10 to the 50th power that things would ever turn out that way.

To provide some perspective, last year, the scientists at CERN said they were certain they found the Higgs Boson within five or six sigma. It's a million to one chance, roughly speaking, that they were wrong. More recently, we had the BICEP2 experiment in Antarctica finding evidence of gravity waves (a phenomenon predicted by Einstein's General Relativity), and of the inflation theory of the big bang, and that, too seemed to pass a five sigma threshold.

Statistically, that amounts to a 1 in 1,744,278 chance that their discovery was just an outlier result.

Scientists, when looking for a particular particle or result, often look for the opposite case, the null hypothesis. Put another way, how would this result look if we were wrong, and there is no Higgs Particle? What would the results look like if there wasn't this particular mode of polarization that seems to come mainly from gravitational disturbances?

If we properly understand how things should operate in the absence of a result we theorize would occur, if we provide the controls, if we eliminate enough alternative causes, then we can create the contrast necessary to separate right from wrong.

One way to create that contrast is to recognize when an outcome is absurd according to current theory. Then the task is to determine whether the outcome is more real than the theory, or vice versa.

In this case, it's fairly obvious that the crash of 1987 happened. A number of other highly abnormal results, approaching astronomical levels of unlikelihood, have also occurred. So, we have a choice: either dismiss the results as being a figment of our imaginations, or find a new way to look at how we come to consider something unlikely.

People's heights and weights tend to run along what we call a Normal Curve, or a Bell Curve. They're constrained by facts of human biology, so there are points at which being taller or smaller than a certain range becomes increasingly unlikely. We use standard deviations, or Sigmas, to represent that distance from likelihood on the bell curve.

Things like earthquakes, floods, internet traffic, and numbers of cities with populations of a certain level obey a different kind of law, something called a Power Law. The stock market also follows it. They operate in a fairly scale-free manner (the structure of a day's activity looks just like a year's), they tend to behave in a non-linear manner, rather than linear, and the incidence of major events doesn't tend to depend on whether something big just happened recently. However, the frequency of big events, in and of themselves, will be lower than that of minor events, and that relationship will be an curve described by an equation where one of the terms is raised to a certain power.

The implications of this are simple: rather than there being close to zero chance that these kinds of incredible events will occur, there's a good chance that it might, and that when it does, the system's going to get a hell of a hit. But for much of the time, it's going to behave fairly sedately. Unfortunately, when it does change, it will tend to shift with blistering speed.

The normality of the market's standard fluctuations, the stuff that fits in the bell curve, is deceptive. I think a major part of this is that by their nature, people are not seeking equilibrium in a market.

What equilibrium the market has, like that of a geologic fault, is mostly the result of tension and friction between different impulses. Take your visit to a car dealership. You want to spend as little money as you can in order to get something of value to yourself, while the car dealer wants you to spend as much as possible. You and the dealer might spend a lot of time arguing about what you want, going back and forth. Other factors might affect how likely it is for you get to get this vehicle you're looking for at a given price, including your credit, your ability to afford a certain car payment, etc.

The dealer, of course, will have their own set of constraints, ones that will affect their decision on what to sell it to you for. Nobody is obligated on either side to do things in an rational way, and very few people make financial transactions, even of this importance, with the full spread of the market in mind. Expedience is not a minor concern in the economy.

And this is just one of many decisions we make. If they screw up the recipe of a favorite snack or beverage trying to make it better, people might abandon it. If, though, they find an ingredient becoming more expensive, they might end up raising the price enough to alienate their base that way.

The point is not for any one group of people to get their way without constraint. We adopt a free market in the hopes that the system will autocorrect, but in my experience, the correction is always imperfect.

It can get even more imperfect, if we let it.

I know folks like to work off of this simple model of the economy, supply and demand, everything correcting itself, people acting with perfect knowledge, all if you just let it run itself. In truth, though, the system we've created doesn't simply work on calculations of supply and demand. Real business-folks will tell you that they hardly ever make that calculation. They often just adjust the prices, and see what they can get away with.

In other words, they push the system until it pushes back. And with perfect knowledge? No, not by a long shot. One of the things that made the toxic asset problem so bad for the banks' viability in 2008 and 2009 was that even the banks themselves didn't know what kinds of assets and liabilities they really had. People only began to care when some of the bets went south, and folks looked to collect.

We see this a lot in black swan economic events, a very, very imperfect flow of information leading people to discover that the bank, the corporation, or the fund that had been so hyped as a money-maker was actually worth a fraction of what it was valued at, if that. People trust that Enron's on the way up, so they keep on buying into it, and the greedy execs have no problem feeding people's illusions until they're ready to cash out.

There is an assumption on the part of some that people will act altruistically and morally in order to avoid negative social and financial consequences, but there again we get people just doing what's expedient, what serves their own perceived interests.

It's not an odd coincidence that the interests of the average person have suffered over the last three or four decades, it's only a natural set of consequences for a particular group of people overwhelming the rest of their peers in terms of economic distribution.

The system isn't all over the place because something's messing with the nature of the markets. No, the kinds of big events that hit us with 2008 are inevitable results of having a market economy where things never settle in one place, where consequence can follow consequence in a feedback loop, even to otherwise unlikely outcomes. These market crashes are a characteristic, if rare, behavior of the markets involved. That doesn't mean that we should just let them play themselves out, it simply means that something like this can and will happen at some point, and it's extremity doesn't necessarily announce itself before it occurs.

You can't predict them, so why try and create a law that tries to defuse things beforehand?

To me, it's important to notice some things.

First, systems prone to chaos often behave predictably enough up to a certain threshold. Can we, in some systems, keep the speculative froth down to a minimum, so we don't see wild and catastrophic swings both in over and undervaluing of assets?

Second, Chaotic doesn't mean arbitrary or random. These are still deterministic systems, which means they are predictable over short periods. Most importantly, though, chaotic systems tend to have a space of outcomes they tend to land in anyways. The trick is, it's just difficult to say where in the space of results that outcome might land. You still have the space of results, though. The system will have its own kind of order to it. Additionally, there are points in chaotic system where the chaos collapses back into orderly behavior

Third, the question is, when a particular market, like the Real Estate Market, falls into a catastrophic crash, what is there to prevent other industries from following it there, too?

I think a key part of the crash that hit us was that there was nothing to keep the impacts of the downturn in the real-estate market from hitting any number of other markets, particularly vital ones. By making the system so well-connected, with vertically and horizontally integrated financial institutions, Conservatives ensured profits, but they also ensured a number of other problems.

For one thing, manipulation of the markets. The banks did a lot to ensure that even if they were selling crap mortgages to people who couldn't pay for, they wouldn't get hit with the bill for it. If they couldn't have done that, then their self-interests might have constrained them, made them more careful, even if it made them less money. You wouldn't have the conflicts of interests, with banks both originating mortgages and profiting off of their failure. The system wouldn't have gotten as out of balance as it did.

Some blame the government and the GSEs for it, but in my view, that's both naïve and misinformed. For one thing, the GSE's assets actually checked out, and their loans defaulted at a rate below the market's average. If you were looking for where the bubble was inflating, you certainly wouldn't look for it with Freddie Mac and Fannie Mae, if you knew that their market share in those critical boom years had declined, and they were already heavily regulated by the government in a way that discouraged them from taking the risks their competitors did.

No, what you had was a system that aggravated the worst weaknesses of a free market system, like water getting into reinforced concrete and cracking it as the rebar corrodes and swells.

I believe those weaknesses are what the law should aim at, the aspects of the markets that allow crises to endanger the market as a whole, but also the aspects of them that allow the whole system to get so interconnected, so sensitive, that a simple, persistent downturn in the housing market could crater the banks, freeze the world's credit, and undermine the economies as a whole.

Allowing the banks to be so conglomerated, to have so much critical economic infrastructure in the hands of so few, meant that there wasn't enough competition to ensure that somebody would be thinking in a smarter way. It also meant we couldn't just allow the failure. When you have twenty big banks, and five fail, it's harsh, but it's survivable. When you have five big banks, and four or five fail, there goes your economy. By having all the economic connections go through so few nuclei of finance, we ensured that their failure would be more than a harsh lesson, but a fatal one.

Our systems in general, these days, are organized in these similar kinds of networks, more power, more ability to affect people's lives concentrated in the hands of fewer people. If somebody screws up processing meat in one plant, it's not his or her family that has to pay the price, it's many people for miles around. If some part of the local electrical system malfunctions, the ripple effects could blackout a whole region of people.

When oligopolies take over a local cable TV provider, and then decide that only those who pay the most will get all the data rates and reliability they pay for, their decisions affect a lot of people.

Conservatives complain about people becoming dependent, but it seems like only dependence on government programs seems to be on their radar. Our dependence on a functional financial system, on our local healthcare facilities and the coverage it takes to afford them, on telecommunication systems, on agricultural systems, on computer networks and the ability of people to exploit, abuse, or even simply harm us through negligence doesn't seem to register for them.

We are not rugged settlers, off alone on our farms. We're part of a highly complex, highly technological civilization with a profound degree of specialization of labor at work. If we don't govern that, if we don't keep all that straight, if we don't put certain constraints on the people who run these things, this wonderful, rich society we have might not last too much longer.

We depend on other people, and however much we might fantasize about going back to the farm, we need to depend on them in order to survive. Our level of population is not sustainable on subsistence farming.

The Logistic equation, the equation used to model the effects that the need for food and other resources has on the population of plants and animals remains predictable to a certain degree, so long as your growth rate doesn't exceed a certain level. We manage to keep our population stable and increasing because technology has allowed us to grow a surplus of food. There are physical limits, though, physical constraints to that.

Can we keep ourselves ahead of the curve? That's the big question, and it relies on so many factors, on so many things working like they should. If our civilization, our economy begins to break down, we'll see the consequences, as our level of sustainability crashes against our level of population. When that happens, things will stop working at a predictable level, and we will experience firsthand, as many civilizations have, the chaotic consequences of decline.

Me, personally? That depresses me. It's not something I'd really like to face. I'd like to beat that curve again. That's the main reason why I insist that we move towards a more sustainable energy future. That's the main reason why I insist we need a certain level of regulation, government, and economic security.

We have become a land of hundreds of millions of people by pursuing our future whole-heartedly, rather than insisting on dragging a poorly adapted system behind us.

We need a government that fits with today's times, not a government looking to fit us to times that they're nostalgic for.

Which brings me to my final point.

Put simply, every version of American society we create is it's own creature. We can no more bring back the fifties than we can bring back to life all those people who lived during that time in history. Nor can we bring back the twenties, much less the 1700s. America didn't evolve just on the levels we could see, it's evolved on levels we're not even fully aware of. More to the point, even as people try to impose the old-fashioned attitudes and rules on society, segments of society themselves are reacting to, and reacting against the attempted forced imposition.

Chaos Theory's most famous shorthand, the Butterfly Effect, tells us that there are small little differences between what we can observe, and what's actually there, and because we don't have the omniscience to register all the different little details in arbitrarily precise and dense records, we can't predict outcomes too far ahead without screwing it up.

Society's got much more variables than that. At best, you can only reproduce part of the picture. At best, you can only reconstruct something of the past, and you will see it through the lens of somebody who lived outside of the real thing, or who can only recall it in dim, innocent memory.

We can pretend like all our problems will be solved if we succumb to our nostalgia, and attempt to make our Frankenstein's monster from the dead past, but like Frankenstein, we're going to find out that our creation is not as simple or idealized as we thought it would be, that instead what we have are pieces of other once-living ages not suited to natural life in the here and now.

Better to adapt and given new, natural, unique life to the times we are in than to indulge the nostalgia of past ages, and fail to account for the organic realities of today's.

Posted by Stephen Daugherty at April 22, 2014 10:44 AM
Comments
Comment #378037
The system isn’t all over the place because something’s messing with the nature of the markets. No, the kinds of big events that hit us with 2008 are inevitable results of having a market economy where things never settle in one place, where consequence can follow consequence in a feedback loop, even to otherwise unlikely outcomes. These market crashes are a characteristic, if rare, behavior of the markets involved. That doesn’t mean that we should just let them play themselves out, it simply means that something like this can and will happen at some point, and it’s extremity doesn’t necessarily announce itself before it occurs.

You can’t predict them, so why try and create a law that tries to defuse things beforehand?

Actually, there were several people who predicted the 2007-2008 market and made out quite well from it. Because unlike your theory, there was a LOT of messing with the markets, there were governmental agencies fundamentally influencing the system.

The FED was keeping rates arbitrarily low, to the point of being cheaper to lend money than to save it, creating a situation where money was basically free to those who could borrow at those low below inflation rates and then lend it out to others where they could collect 5-8 percent.

The FED was also urging banks to make less than smart loans in order to get people into houses. And to take money out of their houses.

Couple that with the moral hazard that was introduced into the system after the bailout of LCTM, they literally told banks and investment firms that if they failed, the FED would bail them out. And they did.

You are right that normally banks and investment firms would take better care in their portfolios if they were to suffer the ill effects from making bad decisions. But once they were told that they weren’t going to be penalized for those decisions, they took greater risks than they would have normally.

And those banks that did do the right thing and keep their balance sheets ready to take a normal loss were further damaged by using flawed accounting rules (MTM) that wiped their balance sheets clean when the market for subprime loans crashed, losses that didn’t match reality and preventing them from being able to make any kinds of loans at all (it wiped out nearly 4 Trillion dollars of loan capacity from the banks).

The market was being heavily manipulated, but not by the banks, by the FED at the urging of the government, both the Democrats and Republicans, to ‘get the economy going’ after the recessions coming out of the 90s and 9/11. Instead of letting it grow naturally, people wanted the quick fix.

You are also right about the bad information, the FED was using an altered calculation of inflation (one that is unfortunately still in use today) that made it look like much lower inflation was going on than was actually happening.

The fix implemented by the government as a result of this manipulation by the FED? Give them more power and control over the system. That’s interesting, don’t you think?

Posted by: Rhinehold at April 22, 2014 4:36 PM
Comment #378039
We need a government that fits with today’s times

I’ve asked this before and didn’t get an answer.
What is your version of a government that fits with today’s times, Stephen Daugherty?

Be specific, please.

Posted by: Weary Willie at April 23, 2014 8:47 AM
Comment #378042

Rhinehold-
You could predict that something had the potential to happen, certainly. But of what magnitude? Would the government act in time to sort things out, make the right choices?

If you’re an investor or a hedge fund manager, you can certainly put a position that says that you think that the markets will go a certain way eventually. Saying that a downturn was likely in 2006, actually, was a bit of a no-brainer. The graph HAS to have its ups and downs. And yes, some people said there’d be a big crash.

However, folks have looked at what the doomsayers have predicted at other times, and found that they were wrong much of the time there! It’s an odd sort of thing. We’re kind of neurologically rigged to expect the expected, and if not, then we’re going to see a lot of negative outcomes to our predictions before we make the one where we can point in other people’s faces and say, I told you so.

Yes, we had lending rates fundamentally low. Why? Because the system was so dependent on the financial markets and the real estate market, that any movement on interest rates would have started the process off earlier.

But the FED, while it could be blamed for sinking rates so low, and encouraging that behavior, can’t be blamed for what For-profit companies did. That’s their responsibility, nobody held a gun to their head. They enjoyed it, did their best to lobby to keep things down. You might look at the regulation of Freddie and Fannie as something that was meant to save the Housing Market from the crash, but in actuality, it was something the Non-bank lenders were lobbying for in order to take up the market share that Fannie and Freddie would lose.

They were the ones who lobbied to effectively outlaw new regulation on derivatives, which in the dark, often proprietary market, could not be appropriately evaluated. This is important, because one of the things that made Mark to Market rules so problematic is the trouble in that evaluation. If you can’t be sure of what the value of an asset will be such and such a time later, then can you be sure that your bank is solvent enough to do business?

Thing is, though, if it weren’t for certain changes in the laws, this wouldn’t have been a problem for the investment banks or the depository banks. They would have been separate entities only marginally affected by the derivatives market or the real estate market. Those proprietary trading desks, with their huge liabilities, would have been their own problem.

And a smaller problem, since they wouldn’t be gambling with the money of millions of depositors.

There are good reasons to require those banks to have a certain level of assets on hand before they lend. That’s part of the market constraint on overlending. By having those proprietary desks, they could both overlend themselves, and help fund the overlending of other institutions.

And why could they do this? Because the rules allowed them to pass the bad loans along the line, make it somebody else’s problem. When the secondary mortgage market locked up, the problems in who they lent to started being THEIR problem, because they couldn’t get rid of the bad assets.

The non-bank lenders, lacking any assets but derivatives, were the first to get hit. But the big banks had made big bets, too, and they shared that common assumption with much of the world, that the real estate market would continue to rise (a similar attitude to those who thought the same about tech stocks, energy stocks, or other bubbles earlier on.)

You say that the fact that they would be bailed out encouraged their behavior, but the problem with that assertion is that in the meantime they’re still answering to investors, still apt to lose money and equity if people start to think they’re handling money poorly. If it had been more obvious that they were losing money, they might have curtailed their behavior earlier, not carried it to the extreme.

If we had also denied them the ability to merge to such a great degree, we would have made bailouts less likely. I mean, if you’re one of twenty banks, and you fail, the likelihood is greater that you’re going to get taken apart by the vultures of the system than saved by the deus ex machinas. We could have let some fail as a lesson to others.

Only the fact that the banks were both huge and interconnected made that possible, and that was owed to the complexity and opacity of the derivatives market. everybody owed everybody else, the system was extremely vulnerable to negative feedbacks.

In short, my point was and has been that by constructing the system the way they did, they left few solutions to the problems short of a bailout. The market could not function as it was supposed to because all the classic controls and constraints of the market had been undermined.

I remember LTCM. You say, if we had let that fail, it could have taught a lesson. Trouble was, the big banks were as invested in it as they were ten years later. The trigger of the more recent crash was letting Lehman Brothers simply collapse. Because of the way the system was set up, that had ripple effects beyond just the company’s status as a cautionary tale.

Or, put another way, the Bush Administration let Lehman Brothers teach the lesson that the Clinton Administration didn’t allow LTCM to become.

The Clinton Administration was smarter. When the system tells you it’s that sensitive, that letting it just drop will wreck everything, you pay attention!

It’s foolish to act like everybody’s just an independent actor. People owe each other money. People rely on those institutions to get lines of credit, to finance their customer’s purchases, to pay them back when they agree to be paid back. Pulling at that one investment bank wasn’t going to simply destroy the investment bank.

The banks WERE manipulating the market. The mortgage system depended on the derivatives to work, to enable them to sell mortgages down the line. The government simply gave them the room, gave them the rope to hang themselves with.

And they did so in the faith that this is what you did in order to make the economy work. Yet each of these major decisions, to let the companies do what they wanted, helped lead to a worse situation, rather than a better. Why?

Because they were inclined to take growth in the markets beyond real economic growth in the real world. They essentially wanted to make themselves richer without the expense of having to reward others for increased productivity, or give them the money they needed to handle all the additional debt and bills they were being asked to pay. Too many at their level of income look at things as if it’s a trivial thing to take care of one’s needs, to take on added expenses, a perception that isn’t symmetric with how it really works for most people, who find it more difficult to make ends meet, and who find the nightmarish levels of debt overwhelming.

In essence, they created a situation where more Americans were more sensitive to increases in cost on more things. Think of it like magnetic domains in a piece of iron, only here, we’re not flipping the directions of north and south, we’re flipping people between being economically sustainable, and not being so.

By trying to suppress wage-based inflation in favor of asset inflation, the business world has created a situation where folks are only barely making ends meet, if that. Lean too heavily on that, say with predatory mortgage practices, and you guarantee a downturn. Add a bunch of speculative froth on top of that, and you get a crash, as the failure of financial institution creates a major, devastating critical mass chain reaction of people losing their ability to sustain themselves economically.

Weary Willie-
First, we need to acknowledge that our businesses don’t behave like old fashioned commercial enterprises did. The definition of a corporation, of what it can do, the scale and breadth of territory across which it can operate have changed.

Second, we need to acknowledge the effects, consequences, and problems of our transportation and telecommunications infrastructure.

Third, we need to acknowledge the need to follow years worth of experience in matters that the framers, and our antecedents up to the modern day could not anticipate.

The Constitution and other old principles beyond it should not simply be cast away, but in order for them to be effective in today’s world, we must shape our expression of them to suit the realities of today. We have to define our public space differently than folks did in the 1700s, if for no other reason than the fact we have something like telephones, cell phones, and the internet. We have to write different laws to achieve the same end, if we want to punish people who cheat people today, because there are new avenues and methods available, thanks to technology, for people to commit those crimes.

I don’t believe that many of the problems of human nature are necessarily solved by new technology. I don’t believe that just because you have the internet, you should allow folks broadcasting via public waves to turn their stations into their own ideological playgrounds. I don’t believe that people are necessarily more honest in this day and age, nor as vulnerable to shame in the public sphere as they once were.

You could theorize, for example, that one employee being rude to a customer today, in a big box store, should turn out just like it might have in the old days, in Washington’s time. However, where a store in Washington’s time tended to deal with villages or rural communities where everybody knows each other, and the business owner’s concern is local and vulnerable to local opinion, today’s stores are generally larger, more well financed, serving a larger customer base with most people strangers to one other. A viral story on the internet, or a high profile report nationally or locally might make an equivalent problem for the place, but not a person by themselves.

The dynamics of our interactions have changed, as well as the degree to which individuals can resolve their grievances.

We shouldn’t pretend otherwise. We’ll only get hurt. We need to adapt to the fact that commerce is often interstate, that we are no longer a mainly rural society (quite the opposite), and that we can express the same values the same way as we once did and still be effective.

Posted by: Stephen Daugherty at April 23, 2014 1:09 PM
Comment #378046

Thanks, Stephen Daugherty, but I didn’t ask how life today compares to life in the days of the framers. I asked you what form your government would take if you were able to put your version of government forth.

I’ll help by allowing you to limit your answer to interstate commerce, since you brought that up specifically.

Posted by: Weary Willie at April 23, 2014 6:03 PM
Comment #378048
Saying that a downturn was likely in 2006, actually, was a bit of a no-brainer.

Apparently not. The people who did call the alarm (several Austrian economists) were called alarmists and the newly elected Democratic leaders of the Senate and House were saying things were great. Nothing to worry about.

“Investor Peter Schiff acquired fame in a series of TV appearances (most in 2006 and 2007), where he opposed a multitude of financial experts and claimed that a bust was to come. He was warning about the speculation, ARMs, houses that couldn’t be sold, people walking away from them and coming bailouts for several years before in print.”

However, folks have looked at what the doomsayers have predicted at other times, and found that they were wrong much of the time there!

In fact, they’ve warned about every major economic event starting with the Great Depression…

http://wiki.mises.org/wiki/Austrian_predictions

But, let’s not listen to those guys because we don’t like what they have to say, meaning they don’t suggest that economies can just rise at high levels indefinitely… As long as we give government the power to control the market to that degree.

Yes, we had lending rates fundamentally low. Why? Because the system was so dependent on the financial markets and the real estate market, that any movement on interest rates would have started the process off earlier.

Actually, no, the process was already started. All that the low interest rates did was to prolong the process, robbing people of the ability to save and inflating the problems until when they did fall in on themselves, the result would be worse than if they had been allowed to falter naturally 10 years earlier. In fact, the 2007-2008 collapse was just the 1999 collapse finally playing itself out with much dire consequences, with the FED thinking that it could generate a soft landing and instead creating a huge mess.

Oh, and spend several years allowing people who had the means to lend out free money to people at high enough rates to become very very wealthy, creating an imbalance between the rich and the poor that people are scratching their heads over now, trying to figure out how it happened.

The economic situation in this country since the late 1990s has been one of making rich people richer and poor and middle class unable to save or better themselves at anything like that rate. It has kept every done, other than managers of money…

That is why during the late 1990s and through the 2000s, companies that used to make money making things started making money by lending it, like GM and GE as examples. That was were the money was and the FED told them that the money was there to make AND that if it went belly up they would be rescued.

The market could not function as it was supposed to because all the classic controls and constraints of the market had been undermined.

Not undermined, manipulated by the FED.

I remember LTCM. You say, if we had let that fail, it could have taught a lesson. Trouble was, the big banks were as invested in it as they were ten years later. The trigger of the more recent crash was letting Lehman Brothers simply collapse. Because of the way the system was set up, that had ripple effects beyond just the company’s status as a cautionary tale.

It wasn’t LTCM that needed taught a lesson, it was the rest of the investment community. Remember, had LTCM failed, so would have Bear Stearns. By bailing them out and then giving them free money (borrowed money at rates lower than inflation) to lend to people, they got very very rich… But doing so while they were highly over leveraged. Why would they over leverage themselves like that? Because they knew that if they failed, the government would bail them out.

The Clinton Administration was smarter. When the system tells you it’s that sensitive, that letting it just drop will wreck everything, you pay attention!

They weren’t smarter at all! They just made things worse by creating a situation where moral hazard was put into place, bubbles were created and then pushed off the reckoning to be someone else’s problem to deal with. THIS IS the reckoning of the 1990s bad management coupled with the 2000s bad management on top of it. It started then, not in the mid 2000s…

“In 2004 Stefan Karlsson wrote that the next crisis will be more serious than the mild recession of 2001 one; as it is, in fact, that very same crisis, only postponed.”

http://mises.org/daily/1670

Still, given the bursting of the great stock market bubble of the late 1990s, the 2001 recession was indeed surprisingly mild even if the official numbers underestimate its severity somewhat. Compared to Japan in the 1990s and even more so America in the 1930s, America today has seemingly absorbed the bursting of a stock market bubble seemingly well. Or have the problems simply been mostly postponed?

But the sector that poses the biggest threat to the economy is the household sector which is spending and borrowing at an unsustainable level. The household savings rate which in the early 1980s was more than 10% of disposable income is now only 1% which is a record low and actually somewhat lower than when the stock market bubble reached its peak. At the same time household debt has risen steadily, from roughly 65% of disposable income in the early 1980s to 80% in the early 1990s to 95% in 2000 to 114% in the second quarter of this year.

In particular, mortgage debt has risen very fast. Mortgage debt has doubled relative to disposable income since the early 1980s from just over 40% to 85% today. Record low savings and record high debt levels means that there is a substantial risk of a downturn in the household sector.

In a recent speech[1], Alan Greenspan tries to downplay the risk of a collapse in the household sector by saying that not only was household debt at a record high, but household assets were also at historically high levels. The partially deflated stock market bubble has lowered the total household assets to income value somewhat from the historic highs reached in early 2000, but it is still far higher than in the early 1980s. Household assets have risen from roughly 500% of disposable income in the early 1980s, to 570% in the early 1990s to 730% at the height of the stock market bubble. Now it stands at 660%.

While the rise in asset values until 2000 was mostly a result of the recovery of stock prices from the depressed levels in the early 1980s to the extremely overvalued levels in 2000, in recent years the stock market bubble has deflated to a high extent, while a new bubble, this time in housing prices has appeared

The conclusion is that Alan Greenspan and George W. Bush did not prevent the stock market bubble of the late 1990s from turning into a crisis. They only postponed it.

Posted by: Rhinehold at April 23, 2014 8:24 PM
Comment #378052

Stephen

You really should be conservative. Conservatives are the ones who best understand the unpredictable nature of the economy and the world in general. We know that not every event falls on that normal curve and/or our estimate of risk based on past performance no longer works in the face of changes. We know there will be discontinuities, such as the stock market crash of 1987 or the more recent collapses.

That is why we seek robust systems rather than planned ones.

Government can and must set basic rules. It cannot and should not try to manage process in detail.

Posted by: CJ at April 23, 2014 9:12 PM
Comment #378057

The first major government bailout of a bank was the Continental Illinois bailout in 1983. The Reagan administration was concerned about a systemic effect on the entire financial markets if Continental Illinois was allowed to collapse. It led to the popularization of the terms “too big to fail” and the concept of a “moral hazard.”

The LCTM bailout was not a government bailout. While the FED played a supporting role in helping to arrange the bailout, the actual bailout was entirely a private sector event. The “canary in the mine” lesson from LCTM was that the mathematical risk models being employed by Wall Street firms were seriously flawed. Unfortunately, the lesson was not learned leading to an even greater collapse in 2008.

http://en.wikipedia.org/wiki/Long-Term_Capital_Management

Posted by: Rich at April 24, 2014 9:58 AM
Comment #378058

C&J,

You must be kidding! It was a “robust” deregulated financial market that collapsed in 2008. It was the conservative Reagan appointee to the FED, Alan Greenspan, who had opposed regulation on important derivative products, e.g., default swaps, and admittedly reduced FED regulatory actions in the banking sector. He testified before Congress in 2009 about how disappointed he was that the financial markets under a relaxed regulatory scheme had not been self correcting.

This is how Greenspan felt about the banking system in 2005, note his approval of sophisticated risk management models employed by banks in that era despite the evidence of LCTM in that regard:
“Two years ago at this conference I argued that the growing array of derivatives and the related application of more-sophisticated methods for measuring and managing risks had been key factors underlying the remarkable resilience of the banking system, which had recently shrugged off severe shocks to the economy and the financial system…”

This is what he said after the implosion:
“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,”

On the issue of the failure to regulate subprime lending:“Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

“This modern risk-management paradigm held sway for decades,” he said. “The whole intellectual edifice, however, collapsed in the summer of last year.”

Posted by: Rich at April 24, 2014 10:37 AM
Comment #378059

Rhinehold,

It was not just Austrian school economists that predicted the financial crisis in 2008. The following is a list of economists compiled in the book “No One Saw This Coming”: Understanding Financial Crisis Through Accounting Models” by Dirk Bezemer:

•Dean Baker
•Wynne Godley
•Fred Harrison (UK)
•Michael Hudson
•Eric Janszen
•Steve Keen (Australia)
•Jakob Madsen & Jens Kjaer Sørensen (Denmark)
•Kurt Richebächer
•Nouriel Roubini
•Peter Schiff
•Robert Shiller

A slightly different list was compiled by World Economics Review:
1.Steve Keen
2.Nouriel Roubini
3.Dean Baker
4.Joseph Stiglitz
5.Ann Pettifor
6.Robert Shiller
7.Paul Krugman
8.Michael Hudson
9.Wynne Godley
10.George Soros
11.Kurt Richebächer
12.Jakob Brøchner Madsen

http://www.investorhome.com/crisissurvey.htm

Posted by: Rich at April 24, 2014 4:29 PM
Comment #378060

Rhinehold,

It wasn’t just Austrian school economists that predicted the financial crisis.

http://www.investorhome.com/predicted.htm

Posted by: Rich at April 24, 2014 4:35 PM
Comment #378061

Rich,

You are correct, there were others who predicted it too. However, Austrian economists have predicted the great depression, the 87 crash, the .dot com crash, the lack of a recession after WWII ended (Keynes said that the depression would return as government spending decreased), etc. They have a pretty good track record, which begs the question, why do people disregard them?

Posted by: Rhinehold at April 24, 2014 4:47 PM
Comment #378062

I don’t know why Rhinehold. It doesn’t seem to me that any of the economic “schools” have a stellar track record. It’s not called the dismal science for no reason.

Posted by: Rich at April 24, 2014 5:51 PM
Comment #378063

Daughty writes; “First, we need to acknowledge that our businesses don’t behave like old fashioned commercial enterprises did. The definition of a corporation, of what it can do, the scale and breadth of territory across which it can operate have changed.”

If only you could recognize that government doesn’t behave like it used to as well.

In his opening remarks Daughty attempted to inform us that the Constitution simply isn’t up to the job of performing well in today’s world. He maintains that as society becomes more complex there should be less reliance on our founding documents. They are now only relevant concerning social issues and no longer apply to how government should perform with regard to fiscal issues.

Our modern society should acknowledge that those here illegally are not breaking our laws and should be given full citizenship because they sneaked in across our border and it’s simply to difficult to deal with them so we must change our laws.

Government has created a huge class of people which it deems worthy of government largess because they fall into an artificial poverty level and must be supported by those who work.

Government is now permitted to break laws congress has passed or to amend them to suit their goals. The constitution doesn’t provide for this so…according to Daughty…the constitution must be old fashioned and ignored.

Government is now permitted to tax people for not buying the products they demand be bought, and to ban products that people want.

Government has decided that balancing our national budget is old fashioned and that debt no longer matters. As a result we have over $17 Trillion in current debt and over $100 Trillion in unfunded liabilities.

Government has decided that discrimination is constitutional if it favors certain people over others. Government has decided our founders not only believed equal rights (for some), but equal results for all.

George Washington, Thomas Jefferson, John Adams, Ben Franklin and many others are simply too old fashioned in their ideas to be relevant today. Now is the time to rely on the socialist leaders of the 19th and 20th century.

Daughty’s government believes that government trumps the individual and equality is more important than freedom.

Posted by: Royal Flush at April 24, 2014 7:34 PM
Comment #378066

Rhinehold-
You think only your people were saying trouble was on the way? I have Atrios (AKA Duncan Black) on my links, and he was saying this was trouble for some time. Others were raising concerns. But we were told the market would take care of itself, would police itself!

You say it’s because government intervened in the markets. Really? The Federal government passed a law essentially FORBIDDING further regulation of the derivatives market. It said, we’re not going to keep you from merging anymore. It said, we’re not going to keep you out of high risks parts of the financial sector.

Anything else? It’s just the Financial industry using people like you as their dupes to keep those profitable lines of business open.

You know, here’s the thing: Brooksley Born was saying that this was going to be a problem back in 1998, back when LTCM collapsed. Derivatives have this wonderful capacity to build castles of air, especially when they’re traded as proprietary products, rather than on the open market, where everybody can see what assets they contain, and what their worth is. It is the uncertainty as to that worth that made many assets toxic. If they had simply plunged in price, people could have bought them at their rock-bottom price, and made a killing selling them for more. But these assets had such clouded and opaque characteristics that people couldn’t tell what they were worth.

Not knowing meant they couldn’t take action, and the market to market rules meant that the potential worthlessness of those assets put the banks in danger of being insolvent.

Things tend to get chaotic, in my experience when you have a lot of things depending very sensitively on one small, difficult to track detail. The Derivatives market was the real moral hazard, not the bailout. The bailout was something only fools would expect not to occur with a massive economic failure on the horizon. Capitalism isn’t a suicide pact.

It’s like a drug addiction. Derivatives create huge economic highs for the banks that get involved with them. They can make money hand over fist, regardless of market conditions, regardless of whether the loans are good or bad… in fact, If the loans are bad, they make more money, because people get behind, accrue late fees, penalties, etc.

The system has gotten too interconnected with too few actors in it, meaning that more business and more economic activity is being routed through each one. They owe each other money, count that owed money on their bottom lines, and there really isn’t as much of a limit on how complex and convoluted the bets are, or how recursive the whole mess gets.

It’s like building up dry brush and twigs in a forest, because you haven’t let the forest fires burn as natural. If derivatives were more normalized, more out in the open, more regulated as to complexity and kind, you would see people pay better attention to their role in finance, to what’s being traded, and what the assets are worth.

By doing things the way they are, the banks are creating a situation in which a great deal of their market can collapse in a short time, based on arbitrary, small problems with the market. With LTCM, it was a bad bet on the Ruble that unraveled the company. With 2008, it was that simple reality that a boom had to be followed by a fall in prices. They never created the system to accept that outcome!

In other words, Wall Street, in the course of it’s strained efforts to defy market gravity, and make money doing it, essentially doomed its system to be unable to robustly deal with predictable downturns, inevitable problems. And they did it to themselves, and continue to do it themselves. You might threaten them with letting the system crash, but really, that didn’t work when they first tried it this last time. In fact, we have had one crash after another in my lifetime, and the only lesson these people learn is don’t be the one who crashes. They’re not dealing with matters rationally, they’re rationalizing that failure only happens to the folks who don’t know how to bet right. They are no more susceptible to being warned away by failure than a gambling addict is.

In it’s way, your economic theory is no better adapted than theirs is. You expect people to behave with rationality they don’t with moral judgment they don’t exercise.

Royal Flush-
You’ve done a good job of not understanding the gist of my argument. What I’m saying is that we need to develop our interpretations of the Constitution so that changes in the world around us don’t undermine the strength of those protections, or the effectiveness of government at what it’s being asked to do.

You don’t seem to acknowledge the friction the real world imparts on things, or your people’s role in things. Trillions of that debt is the result of Republican fiscal policy. Trillions of that debt come from wars your people decided to fight, and the huge budget increases you poured into the defense department.

You talk about people just being given money to lay around, but that sort of welfare disappeared during the Clinton Administration. You just keep repeating stuff about it because it seems you’re not done using it to play the victim.

You talk about illegal aliens, but it doesn’t occur to you that whatever punishment people might deserve for breaking the laws, the laws were so poorly enforced for such a long time that the problem has expanded beyond what we have the brute force energy to resolve the way you want. You won’t accept a compromise that will still have people toiling for years in order to earn a chance at citizenship, and in the meantime will have them registered, documented, known to the authorities, and warned to be on their best behavior. Obama’s been tougher in terms of deportations than Bush ever was, but you folks will never give him credit, because he doesn’t pretend that we can just wipe away the issue.

As for the rest? God, what arrogance. You folks act as if you’re the exports on the constitution, yet I end up in arguments with people like you as to whether the Army has the right to depose the President, the person actually alleging that the provision for that is in there.

It just gets to the point where there’s nothing for it but to conclude that it’s just an affectation, an arrogant attitude of superiority mainly supported by ego.

The ideas of the framers are relevant, but not perfectly so, and why would that not be the case. They dealt with a mix of universals, but they also dealt with a different time and situation for our country. The key is to promote their very relevant principles, while acknowledging that we are the stewards of our own time, and must avail ourselves of America’s two hundred years of experience in self-government, rather than simply assume we can do no wrong if we try to govern everything as if it were the 1790s.

Posted by: Stephen Daugherty at April 25, 2014 3:15 PM
Comment #378068

Let me condense my thoughts a little better here. I have a tendency to go point by point on responses.

My science background makes my approach to things very matter-of-fact. You deal with things as they are. We can pretend that people behave rationally in an economy, that we should set up the rules and such to suit this, encourage this, but experience and scholarly study, especially the psychological kinds, tells us that people are only somewhat rational, and that a whole herd of social, heuristic, and emotional impulses accompany things. Impulses, by the way, that professionals in sales, marketing, investing, and other fields have not remained ignorant about.

People design stores to where you have to move through many other different points to get to the things you need. They adorn everything with “low prices” even when they’re not, to get your attention, sell you a point of view.

People in the Mid-Oughts where absolutely bombarded by Ditech commercials, by commercials for refinancing and mortgages. CNBC and other outlets hyped the big stocks, played down the possibility that the ride could end. It never changes, really. People jumped on this bandwagon as they did every one before.

If that is nature, then the booms and the busts are going to happen. Question is, how far are they allowed to spread, and how well do we isolate the problem, when we can?

I think we’ve created a system that helps make relatively small problems into crippling large ones, when it doesn’t have to. The weaknesses in that system provide openings for the inevitable boom-bust cycles to crack the system.

If we act as if the market is well-behaved, as if these things are astoundingly astronomically unlikely, those problems will have that opportunity, in my opinion.

On the subject of the Constitution? I believe it’s lasted this long for a reason. I don’t believe it’s purely about constraining the government. No, it does something much more interesting: it creates a government of strong power, but which is only authorized to use that power in certain places, in a certain time and manner. Rather than being a sphere that includes the entirety of our lives, or one whose edges are distantly visible from where we stand, our government is kind of fractal in its structure, self similar on different levels, extended into our lives, but only partly so.

I believe this is a large part of what’s given our government the longevity it has, compared to governments around the world, even in Europe. A weak government would have resulted in American being picked apart and destroyed. An overly strong one would have inspired one rebellion after another (instead of just one)

The Framers didn’t entirely intend to construct it this way. Some wanted the weak government, others one as strong as their European counterparts. What we settled on, we settled on because we recognized that everybody needed a stake in the government, but that stake couldn’t overwhelm everybody else’s. The framers, unlike the folks who tell us today that they are the framer’s heirs, understood that whatever their beliefs and principles, they needed a country where those beliefs and principles could coexist.

That meant compromise.

You know, we can all pretend that if we just got what we want, it would all be for the best. I’m sure the Republicans reading this believe just as strongly as the Democrats that what they think is true is true, and everybody else should believe that.

Reality is, though, people will differ in their opinions, and that’s not going away. Question is, how does this Republic function in the meantime? Disenfranchising your enemy, though it gains you short term power, only leads in the long term to them being even more bitter rivals of you before, ready to do unto you what you did unto them.

What the framers hit upon in composite, not quite realizing it, was a system that allowed people to at least try and compete for power, and be moderated, smoothed down like rocks in a river, by the give and take required in order to gain that power.

All this BS scaremongering about what people like me want strikes me as a desperate attempt on the part of Republican leaders to hold on to power. Who really wants to destroy their homeland, their economy, have their nation go bankrupt. It’s not for nothing that many Tea Partiers rationalize that nothing will happen if they push that debt ceiling thing. They couldn’t’ continue to support their Tea Party Candidates if they thought it over again, and concluded differently.

Americans want this BS over. I think they’d like things to get back to normal, back to calm and function. Most are not looking at the folks in Congress as brave fighters, but as juvenile delinquents too invested with fighting one another to actually sit down and do the work they’re supposed to.

I believe in having deep principles, and the Constitution is part of that for me. But I also believe that those principles have to be expressed in the real world, and expressed well. That it fit some form of logic is not enough, the value behind it has to be preserved, too.

Posted by: Stephen Daugherty at April 25, 2014 3:53 PM
Comment #378069

Daughty writes; “Obama’s been tougher in terms of deportations than Bush ever was, but you folks will never give him credit, because he doesn’t pretend that we can just wipe away the issue.”

LOL…that’s a good one.

22 Senators Find Their Spines, Let Obama Have It

“Twenty-two senators (all Republican, natch) sent off a blistering letter to the Man Who Would Be King, President Obama, warning him that his selective non-enforcement of the country’s immigration laws shows “an astonishing disregard for the Constitution, the rule of law, and the rights of American citizens and legal residents.”

“Despite Administration claims of deporting record numbers of immigrants, critics have shown the reality is that deportations have fallen by 40 percent under Obama.”

http://godfatherpolitics.com/15313/22-senators-find-spines-let-obama/

Daughty writes; “The ideas of the framers are relevant, but not perfectly so, and why would that not be the case.”

With only 27 amendments since being written and adopted by the states, I would say the constitution has done well in the test of time.

What the left likes to forget is that the United States and the Federal Government only exist because the states willed it into being.

The Constitution doesn’t deal with the daily minutia of running the government. We have a congress to enact laws and an executive branch to administer those laws. This president wants to eliminate the congress and establish a tyranny.

Posted by: Royal Flush at April 25, 2014 5:33 PM
Comment #378070

Royal Flush,

Where is the documentation that deportations have fallen by 40% during the Obama administration. In reality, the data show that the Obama administration has been the most aggressive in history. A more thorough analysis with data is provided in the following link. http://www.counterpunch.org/

Posted by: Rich at April 25, 2014 6:10 PM
Comment #378071

A corrected link to a very good article explaining the data issues related to deportations under the Obama administration.

http://www.counterpunch.org/2014/04/04/deportations-under-obama/

Posted by: Rich at April 25, 2014 6:35 PM
Comment #378072

Rich writes; “Where is the documentation that deportations have fallen by 40% during the Obama administration.”

Thanks for asking Rich.

In April, the Los Angeles Times wrote:

A closer examination shows that immigrants living illegally in most of the continental U.S. are less likely to be deported today than before Obama came to office, according to immigration data. Expulsions of people who are settled and working in the United States have fallen steadily since his first year in office, and are down more than 40% since 2009.

And last week, Julia Preston of the New York Times reported that in the fiscal year 2013, the immigration courts saw a 26 percent drop in the number of people who have been deported, thereby producing:

… a different picture of President Obama’s enforcement policies than the one painted by many immigrant advocates, who have assailed the president as the ‘deporter in chief’ and accused him of rushing to reach a record of 2 million deportations. While Obama has deported more foreigners than any other president, the pace of deportations has recently declined.

Somehow, the Obama administration is simultaneously responsible for the highest rate of deportation in 20 years and a 26 percent drop in deportation. What is going on here? As it turns out, changes in immigration law, terminology and classification are causing this confusion.>/strong>

One problem is the continued use of “deportation” in virtually all media reporting. In actuality, that category has been obsolete in immigration law since 1996. Prior to 1996, immigration law distinguished between immigrants who were “excluded,” or stopped and prevented from entering U.S. territory, and those who were “deported,” or expelled from the United States after they had made their way into U.S. territory. After 1996, both exclusion and deportation were rolled into one procedure called “removal.” At that point, the term “deportation” no longer had any meaning within the official immigration statistics. Its continued use in media reports is part of the confusion.

http://www.washingtonpost.com/blogs/monkey-cage/wp/2014/04/21/lies-damned-lies-and-obamas-deportation-statistics/

Posted by: Royal Flush at April 25, 2014 7:22 PM
Comment #378073

Royal Flush,

I suggest that you just read the article that I provided a link to. It explains the different categories of removal distinguishing between internal removal vs. border removal and provides data along those lines. It also discusses the difficulty of comparing different time frames due to changes in categorization. It does conclude, however, that the Obama administration has been one of the most aggressive enforcers of removal in history.

Once again, lets look at the data.

Posted by: Rich at April 25, 2014 9:47 PM
Comment #378076

Rich wrote; “It does conclude, however, that the Obama administration has been one of the most aggressive enforcers of removal in history.”

Sorry Rich, please read your linked article again. Interior removals were significantly less under obama.

Posted by: Royal Flush at April 26, 2014 1:17 PM
Comment #378078

Royal Flush,

What? “The evidence-based conclusion that I have reached is that it is highly likely there have been more interior removals under Obama than any previous president. Without the data prior to FY 2009, however, neither I nor anyone else can arrive at a definitive conclusion.”

Posted by: Rich at April 26, 2014 9:29 PM
Comment #378152

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Comment #378154

Rich, is your source better than both the LA and NY Times? Both are hardly conservative in their reporting.

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Comment #378156

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Posted by: mobile dust plugs at April 30, 2014 3:42 AM
Comment #378159

I think the root problem is the lack of accountability and risk to the main players. Banks and other financial institutions took unlimited risks using extreme leveraging of their customers money and when their ponzi scheme collapsed the top few suffered no losses.
Why shouldn’t they have done what they did? They garnered JD Rockefeller riches and increased their control of the political machine. Win-Win for the oligarchs, all thanks to the libertarians.

Posted by: Dave at May 1, 2014 1:47 PM
Comment #378249

One thing is for sure. All that circular, nonsensical, leftwingnut gobbledygook generates a lot of comments.

Boiling it down to more intelligible terms … growing governmental and societal chaos is the result of too many decades of moral decline, which is a cycle that repeats itself over and over, with a few variations.

It will only self-correct to some degree (if ever) when too much selfishness and too little virtue becomes too painful.

At any rate, all the signs point to another large economic correction that could happen at any time, because decades of growing government corruption Constitutional violations, and nation-wide debt has only grown much worse every year for many years, and especially since the near-global melt-down in 2008. And other corrections with increasing severity are likely to follow, because not only has little (if anything) improved, but have grown worse. It will make the 1987 market crash look mild by comparison.

At any rate, voters have …..

Posted by: D.a.n at May 8, 2014 11:04 PM
Comment #378255

Look back over the life of this country and you will see something catastrophic has happened every 3 generations. Birth, Civil War, Great Depression, Now. We’re due. It’s no coincidence the Democratic party has presided over every one of these occurrences.

The Democratic party gave us the Federal Reserve and told us it would stop the wild fluctuations in the market. It didn’t. Only 20 years later we had the greatest economic depression this country has ever experienced.

Perhaps what would stop these catastrophic occurrences would be to get rid of the Democratic Party, the Federal Reserve, and the 16th and 17th amendments.

Posted by: Weary Willie at May 9, 2014 7:35 AM
Comment #378258

Future Members of the American Right and Faux News talking heads.
- Noise maker = fake scandal creater
- Screamer = fake scandal promoter
- Sitter = fake scandal watcher

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Comment #378690

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