Assume that you are considering investing $700,000 and that this is a large sum for you. Experts give you the names of two reputable investment houses of long standing. When you visit the first of these, Benjamin Company, Inc., the manager recommends Bailout Bonds as an excellent investment for you. He gives you good reasons for his recommendation and reassures you that he is very confident in his advice, which is based on the analysis of top experts. He urges you to act swiftly to avoid missing out.

As a cautious investor, you visit the other investment house that was recommended to you, Franklin Company, Inc., their manager advises you that Bailout Bonds would be a poor investment and that you would be better off holding on to your money than putting such a large amount into such a speculative investment. Like Benjamin’s manager, Franklin’s manager provides good reasons and she too is confident in her advice.

Given the conflicting advice, you decide to check the track record of each of these investment houses. Fortunately, numerous academic studies have been published on the accuracy of each firm’s investment recommendations since 1930. Each firm retains the advice of some of the best experts in the world. You find that on average, the Benjamin experts have been right for 50% of their forecasts – and wrong on 50%. Interestingly, the Franklin experts have exactly the same performance record.

What would you do? Our guess on what most small business people would do is to skip this investment opportunity.

The year 1930 is roughly the date of the first studies on the value of expert forecasts that relate to complex and uncertain situations. Contrary to popular opinion, the findings are consistent with our Benjamin versus Franklin story. For example, Philip E. Tetlock’s 2005 book, Expert Political Judgment describes how he recruited 284 people whose professions included “commenting or offering advice on political and economic trends.” He asked them to forecast the outcomes for various situations. By 2003, he had accumulated 82,361 forecasts.

The conclusions from the studies are that:

1) expert opinions are useless for forecasting related to complex and uncertain situations.

2) expertise does not help; College students do as well as seasoned experts at such forecasting.

3) experts’ statements about confidence have virtually no value. Indeed, if you put a group of experts in a room and have them make forecasts, their confidence goes up rapidly, but this has no relationship to accuracy.

The country faces a similar problem. But our leaders in Washington are not debating about their own investments. Instead, they are thinking about how to spend other people’s money. They have provided no scientific basis for their decision and they show no awareness of how one should properly approach such a forecasting problem.

There are ways to study this problem, but they should not be done in a rush, and they should not be done in group meetings.

We don’t know what will happen, but we do know what procedures to use to obtain scientific forecasts of the outcomes of various plans. Researchers in the field have been trying to spread the word on scientific (evidence-based) forecasting by making forecasting knowledge easily and freely available to others at http://forecastingprinciples.com

The question for our leaders is whether they should invest $700 billion when, despite their confidence, they are completely ignorant of the outcome of the investment plan.

Dr. J. Scott Armstrong. Professor, The Wharton School, University of Pennsylvania
Dr. Kesten C. Green. Business and Economic Forecasting Unit, Monash University.

I've always gone by the rule, "If you can't afford to lose it, don't risk it."
Running through the woods with my eyes closed is what I'd call risky. This bail out is far beyond that act, and more dangerous too.

Warren Buffett urged an angry and divided U.S. Congress to quickly approve an 'absolutely necessary' $700billion rescue package to combat the crisis.

We don’t know what will happen, but we do know what procedures to use to obtain scientific forecasts of the outcomes of various plans. Researchers in the field have been trying to spread the word on scientific (evidence-based) forecasting by making forecasting knowledge easily and freely available to others

Thursday, 2 October 2008
Financial Eugenics: The Paulson Plan for Survivor Bias
As I write this I don’t know the outcome of the attempt to ram through legislation for looting the US Treasury of $700 billion before the end of the Bush administration. I suspect that Congress will force the passage of the bill in some form because the media and political narrative on the necessity of the measure is unremitting and so horribly biased.

No alternatives will be considered.

No constraints on the unilateral executive authority of Hank Paulson will be considered.

No assurances that funds will be used to unlock credit markets or promote lending to the real economy (as opposed to the financial robber barons) will be considered.

Instead, the bill will get laden with an additional 300 pages of pork to sway the dissenters, adding to the tab imposed on the American taxpayer.

Having listened to all 42 minutes of the late night Treasury briefing of investment banks on Sunday, there is no doubt in my mind that this legislation represents the sort of federal largesse for Goldman Sachs, Morgan Stanley, Citibank and JPMorgan Chase that the Iraq war provided for Halliburton and Blackwater.

The most cynical moment in the call is when the Treasury official confirms, ”our preference would be to help the healthy banks become even healthier” rather than helping troubled banks or illiquid banks.

America is now a centrally planned economy where the Treasury will determine which firms survive and prosper through allocation of scarce capital to an undercapitalised financial sector.

Clearly what is going on here has nothing to do with kick starting the credit markets or stabilising the equity markets or restoring depositor confidence in banks. (Treasury official: “No provision in the legislation that mandates re-lending.”) What is going on here is a blatant attempt to provide government funds to a select cadre of firms (not all banks) which are chosen to be the survivors feasting off the carcasses of their less fortunate and less well-connected brethren as the downturn intensifies in the years to come.

The crash in equities will still happen. The debt deflation of the economy leading to mass commercial and consumer credit defaults will still happen. The collapse of many national, regional and local financial institutions will still happen. The bankruptcy of many municipalities and shortfalls in state budgets will still happen.

This bill is about engineering survivor bias to friends of the Bush administration so that they profit disproportionately from the collapse of these markets using the funds provided by the taxpayer via the unreviewable and unconditional authority of the Secretary of the Treasury.

The basic plan is to set up a federal money laundering operation. Bad assets come in, get laundered by the Treasury and put in a new AAA “wrapper” (as it’s termed on the call), and good assets go out, issued as Treasury guaranteed securities. Whether the final value of the legislation this week is $700 billion or $150 billion is irrelevant as long as the laundering operation can accommodate the throughput, as that number is only a cap on total extensions at any one time.

The SEC will support the plan and survivor bias by relaxing FASB 157 on mark to market accounting. If there is no agreement on what an asset is worth, it is worth whatever the firm holding it says in its Level 3 accounts or the Treasury Secretary accepts in buying it.

The Federal Reserve will support the plan by relaxing the definition of “control stake” in US banks and bank holding companies to allow secretive cabals to hold through private equity and offshore hedge funds. No one knows the beneficial owners of these ill-transparent private equity investors, and so it is the ideal way to reward loyal and helpful insiders, legislators and officials – as well as cede further ownership of American assets to foreign stakeholders who would be politically unacceptable if publicly acknowledged. Many foreign creditors are irate at the losses their funds, banks and pensioners have sustained from investments in the United States, and this plan provides a secret way to buy them off and keep them lending and investing as their own economies are roiled by the deflation to come.

For the past year the survivor bias has been orchestrated from the Federal Reserve, with its extension of innovative credit facilities and selectively engineered rescues or forced mergers. That has been very useful, but that well is now dry. The Fed has no more good assets to trade for the bad assets the banks can offer. And the supply of bad assets just keeps growing as market illiquidity spreads further from the core of the mortgage backed securities market. Instability is now leading to a realistic threat that the Fed and Treasury could lose control of the deflationary process.

Part of the reason the Paulson Plan is so attractive is that it recapitalises the Fed by promoting the unwinding of repos and lending facilities which left the Fed holding toxic assets. As the repos and credit facilities gradually unwind, these toxic assets can now be taken back by the banks and exchanged for good cash. The Fed gets its balance sheet Treasuries and cash back to restore its flexibility to intervene anew.

Favoured private equity and insiders who swap US dollars for equity in the banking system will presumably be aware of the survivor bias being engineered on their behalf. Sovereign wealth funds, investment funds and private equity investors ripped off in the first round of recapitalisation may be willing to come back in once it is clear to them that the next round will benefit from official favouritism. Warren Buffett’s timely stake in Goldman Sachs is clearly linked to his confidence the Paulson Plan will benefit them disproportionately.

A factor which is probably critical but has received little discussion is that literally thousands of Bush administration apparatchiks will need jobs come January, and a fair selection of GOP House and Senate legislators and their aides too. What better way to enahance their CVs in their final months in power than to distribute $700 billion or so in pre-Christmas largesse to the most remunerative employers in the world? And what better way to ensure the corporate largesse is returned to the GOP to win back the White House and Congress in 2012 as the recession fuels public anger?

And then there is a huge arbitrage opportunity as well so that everyone makes money for years to come. According to the conference call, the pricing on offer from the Treasury will be a bit below Level 3 pricing. The toxic assets will be repackaged and resold with a new AAA wrapper, possibly priced well below what the Treasury paid, assuring a huge profit on both immediate liquidation by the banks and ultimate maturity by investors. The Fed gets its cash and Treasuries back; the banks make huge profits; the foreigners and off-shore tax avoiders get disguised ownership of the American financial system; the taxpayer gets ripped off. What’s not to love?

Think back to Fisher’s Theory of Debt Deflation in Great Depressions. Dollars become “bigger” as deflation takes hold because each dollar can buy more assets as assets deflate. That means that as these clowns crash the markets, their $700 billion of liquid cash funnelled to their friends and recycled through the Treasury laundrymat can progressively buy up the rest of the pieces on the gameboard at low discount prices. Game over with those who caused the crash and robbed the bank winning.

Deflation is going to happen – globally. Either we can use the course of deflation to shape healthy economies that will provide growth and employment and productive returns on investment in future, or we can allow deflation to further enrich those miscreants whose irresponsible policies led to the violent financial collapse we are about to experience.

There is a fundamentally healthy economy in America – somewhere underneath all the financial excess and chicanery and all the financial/oil/military/healthcare/developer corruption of local, state and federal politics. It will be a painful and slow process to kill off the metastasising cancerous growths on the economy, but if Americans achieved that, they could embrace a healthier and more productive and more prosperous future.

I would like to believe Americans expressed the courage to change over last weekend when they 25 to 1 rejected an unconstrained and unconditional bailout of Wall Street in favour of cold turkey deleveraging of the economy. I wish I could believe that it mattered in the political calculus, but the result of the House vote on the bill will tell us that.

Fight the survivor bias. It’s not your survival they’re engineering.

Bankonit27 - The Government is under terrific pressure to get this done right now! Are you in agreement with that? Or is Wall Street capable of stumbling along for a few more weeks/months on its own? Or ... ?

Please note, this is not meant as bait to start a fight. Just curious about an insider's view of this.

Kelly Cook