Monday, July 13, 2009

An Asymmetric Stake in the Game

Many of the current political and financial logjams are caused by what I term "asymmetric stakes in the game."

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If we examine issues as disparate as finance, healthcare and a dysfunctional state government in California, we might find one mechanism underpins them all: asymmetric stakes in the game.

I would say this is a fundamental structural mechanism in current political and financial systems, not just in the U.S. but in many other nations and systems.

Examples abound. Government, not just Federal but state, county and city, has two extraordinary powers: it can collect revenues via taxation, permits and fees, by force if necessary, and then distribute those funds however the politicos in charge desire.

Theoretically, the voters can express their dissatifaction with the decisions made every two and four years, but thanks to district gerrymandering and manipulation, most politicos represent lopsided/asymmetic populations who tend to support one party or the other through thick and thin.

Thus a handful of "swing states" will decide close national elections.

I say "theoretically" for another reason: those on the receiving end of those stupendous revenues collected by the State have an asymmetric stake in the game: the potential losses in their own personal income are not just theoretical, they are very real, and so they mobilize their lobbying to protect their own fiefdom and perquisites with a frantic, desperate zeal.

Thus we have the California teachers union spending millions on a direct TV ad campaign to push for higher taxes, lest their own share of the tax swag decline.

And we also have the unions and others players with asymmetric stakes pouring millions into the re-election campaigns of politicos. The net result, of course, is that despite a $26 billion deficit, California Democrats have already announced that cuts in public employee benefits (pensions and healthcare)--the very costs which have skyrocketed, a key reason why agencies, universities, counties, cities and the state itself are facing massive deficits--are "off the table," sacrosanct, taboo, untouchable.

For the politicos, there is an even bigger threat: should they cross the pharmaceutical industry, the AMA, the trial lawyers, the prison guards union or other big, well-funded public employee unions, these special interest groups will not just stop funding their own campaign--they will target them for extermination by funding an opponent.

Put yourself in the shoes of a politico/elected official. You collect maybe $1 million in campaign contributions from the general public--"the little people" you are pledged to serve. You collect another million from the party organs--political action committees, etc. Then you collect $5 million from a handful of powerful special interests who hold extremely asymmetric stakes in the game of distributing the tax swag/revenues.

Who are you going to ignore or even double-cross? Not the special interests, that's for sure. Who you ignore or double-cross is the public, who has a small stake in every decision you make.

Are you going to write an angry letter to your local politico because parking ticket fines doubled from $20 to $40? No, you'll grumble to your Spousal Unit, buddies, colleagues, et al. but you'll just pay it, fuming all the while.

How about that 1% they added to sales tax? Ditto. You just pay it, annoyed, frustrated, whatever, but it simply isn't enough money at any one time to trigger your political act of protest or complaint.

How about that $50 "junk fee" they're adding to your property insurance? Ditto.

How about that $150 fee to look at your building permit application--not the permit fee, but a junk fee to raise more revenue? Ditto.

How about that 10% "surcharge" on your water bill? Ditto.

How about that 10% higher "temporary increase in state income tax"? Ditto.

How about that doubling of the fee to enter a state park? Ditto.

Added together, these additional taxes and junk fees total to a stupendous sum--in the multiple billions of dollars. Yet because we "little people" pay them in small increments and only occasionally, then our stake in the game of collecting and distributing the swag is tiny--very asymmetric to the players who are collecting the billions. They are playing for keeps, while we're playing--and losing--beer money, again and again and again.

Now if you rounded up $100 from every neighbor, colleague, family member and other person in your own network, and you walked into your local politico's office with $10,000 in a paper bag and a short list of items you wanted addressed, then you'd get a hearing.

Or if you collected 10,000 signatures to recall your local politico over these endless nickel-and-dime tax increases, then the politico would face another danger other than an desperate-for-swag wealthy special interest: an aroused, angry public who was organized to exterminate his/her political power.

But nobody ever collects the $10,000 or the 10,000 signatures of outrage--we all just pay the fines, the junk fees, the extra sales tax, the additional income tax and the higher entrance fees and passively fume. Our stake in each game of revenue enhancement is small, so we do nothing. The special interests' stake is all-or-nothing, gigantic, as important as life itself--and so they will throw their last million at the politicos in charge of the tax revenue swag and demand their fiefdom be protected at all costs.

This is how the states, counties, cities, agencies and eventually the U.S. Federal government will become insolvent and unable to pay its bloated, insanely unaffordable obligations.

Asymmetric Stake in the Game is a key concept in the Survival+ analysisbecause it plays out in so many fields in which the swag (wealth) is collected from millions but distributed to an Elite. The truly Kafka-esque nightmare that is the U.S. "healthcare" (actually sick-care) system is a prime example. The players who gorge themselves on the hundreds of billions in swag will fight to the bitter end to maintain their share of the swag, even if it eventually causes the collapse of the entire system.

And that collapse is already guaranteed. Medicare and Medicaid will implode within five years, regardless of what absurdly minor policy tweaks are implemented (simulacrum of reform trumpeted as "real reform" to the "little people").

An asymmetric Stake in the Game also plays out in the stock and financial markets. Millions of employees and self-employed people contribute to a 401K and/or IRA, and millions of public employees contribute to pension funds. A relatively small number of money managers decide how to play those billions.

Meanwhile, across town, a relative handful of players collect most of the winnings from that game. The tens of millions of players (those with 401Ks, etc.) who have lost 40% of their accumulated wealth in the past 18 months are either essentially powerless (you get to move your 401K money around any of four funds, all of which lost 40%, hey, what a choice!) or sheep lined up to be sheared by the players with an asymmetric stake in the game.

If you and I can collect $10 million in bonuses each, while our firm can reap $40 billion and then buy political protection for a mere $100 million of that swag, are we motivated to level the playing field? Of course not. We're interested in processing as many sheep as we can, and in keeping the game rigged in our favor.

The swag from the game is so gargantuan that we will move Heaven and Earth to force the Powers That Be to keep it rigged. It's literally financial life or death for us, while the "little people" who lost 40% of their stake, well, they will just sigh and passively accept their fate; maybe they'll glance at a headline in Money magazine about a hot new mutual fund or ETF, and that's the end of their discontent.

Though their cumulative losses in the rigged game total some $13 trillion, individually each passively accepts their own losses without regard to the nature of the game. Each surrenders political power to the big players because the losses don't seem to have a political source: masking the political source of the asymmetry is the key to the big players' success in keeping the game rigged in their own favor.

So the MSM dutifully spews the propaganda that the "market is a rational mechanism for price discovery" and all the rest while behind the scenes a handful of players reaps $100 million a day by gaming the trading system at its very root.

This asymmetry is largely why I believe the stock market will rally for at least a few days. Judging by the enormous number of puts (bets the market will fall from here) which have been sold--not something your average punter even knows how to do, or can do--then I conclude it's insiders who have sold all those tens of thousands of bets to punters who read all the bad news and sense the gloom around them.

But let's ask cui bono--who will benefit if by some miracle the market shrugs off all that bad news and rockets higher? If I sold 10,000 puts, I collected the upfront fees paid by the punters for that wager. But if the bet goes against me, and the market plummets, the punter gets my stock (the shares which the put controls at a certain strike price) at a price which enables him to profit at my expense.

But if the market suddenly shoots up, then the punters' puts expire worthless, and I keep the money.

Now I am seeing extremely asymmetric put/call ratios in a number of ETFs (exchange-traded funds): players and punters have gobbled up 10 bets that the market will plummet (puts) for every 1 bet the market will rise (calls).

Are the players who sold all those puts really going to let the punters pocket tens of millions of dollars in winnings? Please don't strain credulity by insisting that yes, the big players sold bets 10-to-1 that the market will drop and then they're going to let the market drop.

Look at the asymmetry. Yes, options (puts and calls) are not necessarily bets; they are also hedges. So big players might have bought tens of thousands of puts to hedge their long positions against a decline. If the market doesn't fall, their puts expire worthless, but the cost was considered "insurance."

So maybe this highly skewed put-call ratio simply reflects big players hedging themselves against a sharp decline in the market. If this is so, then that imbalance suggests a very high level of fear is present amongst major players. That could be seen as prudence, or as an extreme of sentiment which often precedes a rally.

But we should remain mindful that the average retail trader/punter will accept his/her losses in options as "part of the game" while those rigging the game will collect tens of millions if they bet heavily one way and (amazingly) the game goes their way.

I have long thought the market would rally this year, and was too early (as usual) in my expectations. Now the rally is visibly tired, sentiment is horrible, the economy's threadbare state is in focus and there is absolutely no reason for the stock market to rally--except the asymmetry of the players and the game.

Who would benefit from a sharp rally? Everyone who sold a put, for one. Everyone who owns a call, for two. Everyone who can manipulate the market higher so it punches through the support/resistance levels which all the Bulls and Bears alike are watching. If the market does rally, there will be widespread disbelief and even anguish--isn't this the shakiest, most scorned rally in the history of the planet? How could this market rally on bad news?

As if the "news" has anything to do with it. I would expect the market to plummet when there is 1 put (bet it will fall) to 10 calls (bets it will rise), not the other way round. It's called Asymmetric Stakes in the Game.

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