Testifying before Congress today, DNI Dennis Blair said “the primary near-term security concern of the United States is the global economic crisis and its geopolitical implications.”

Time is probably our greatest threat.  The longer it takes for the recovery to begin, the greater the likelihood of serious damage to US strategic interests…. Although two-thirds of countries in the world have sufficient financial or other means to limit the impact for the moment, much of Latin America, former Soviet Union states and sub-Saharan Africa lack sufficient cash reserves, access to international aid or credit, or other coping mechanism.  Statistical modeling shows that economic crises increase the risk of regime-threatening instability if they persist over a one to two year period.

Congressional Budget Office on the stimulus bill:

In contrast to its positive near-term macroeconomic effects, the legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth as government bonds rather than in a form that can be used to finance private investment, the increased debt would tend to reduce the stock of productive private capital. In economic parlance, the debt would “crowd out” private investment. (Crowding out is unlikely to occur in the short run under current conditions, because must firms are lowering investment in response to reduced demand, which stimulus can offset in part.) CBO’s basic assumption is that, in the long run, each dollar of additional debt crowds out about a third of a dollar’s worth of private domestic capital (with the remainder of the rise in debt offset by increases in private saving and inflows of foreign capital).

Lloyd Blankfein writing in the FT on the lessons of the crisis:

The first is that risk management should not be entirely predicated on historical data. In the past several months, we have heard the phrase “multiple standard deviation events” more than a few times. If events that were calculated to occur once in 20 years in fact occurred much more regularly, it does not take a mathematician to figure out that risk management assumptions did not reflect the distribution of the actual outcomes. Our industry must do more to enhance and improve scenario analysis and stress testing.

Absolutely right. Ever since we went off the gold standard, financial crises occur once a decade. But Wall Street’s risk models, despite all their complexity, appear to be blind to this simple fact. As Blankfein says, it doesn’t take a mathematician to understand that. It takes common sense.

Andrew Lahde, a young hedge fund manager, had a great deal of common sense. He made one of the most successful hedge fund bets of all time in 2007, delivering a near 870% return by shorting subprime.

He famously walked away last year after writing this scathing letter in which he advocates hemp and blasts the “idiots whose parents paid for prep school, Yale, and then the Harvard MBA.” The kind of people, in other words, who work for Lloyd Blankfein.

Before he left, Lahde wrote in 2008 that he was shorting commercial real estate even though prices remained high. As he explained in this letter to shareholders, Lahde realized that the commercial real estate market was doomed even as the risk models were telling everyone else to stay the course.

The losses will materialize. Admittedly I don’t have a clue how severe the losses will be. I don’t have a model that can correctly predict all the variables. Luckily no one else on the planet has such a model either. I gave up on the ability of models to correctly predict the value of securitizations a few years ago. I do know one thing though. It is safe to assume a market is dead when deal volume falls to zero, as was the case with CMBS issuance during January 2008. (emphasis added)

Blankfein at least has the good sense to admit he misjudged it all. After ticking off the numerous failures of risk management by Goldman Sachs and others, Blankfein argues against a regulation of risk that protects us from the 100-year storm. “Taking risk completely out of the system,” he says, “will be at the cost of economic growth.

Is he serious? We are entering a deflationary spiral today because of a failure of risk management that is simply breathtaking. And this is at least the second “100-year storm” to hit the United States in the past 100 years.

If Wall Street can’t design a financial system that can weather such storms, the government must.

From Asia Times’ Inner Workings:

White House economic advisor Larry Summers, a former Treasury Secretary and President of Harvard University, had  brief career at one of the world’s biggest hedge funds, D.E. Shaw & Co.

According to sources who attended meetings with him, Summers traveled to Asia during July 2007 with a pitchbook recommending the AAA-rated tranches of collateralized debt obligations to Asian sovereign funds and financial institutions, in his capacity as a Managing Director of the hedge fund D.E. Shaw.

In July 2007 the AAA-rated tranches of mortgage-backed securities backed by subprime collateral were trading at around 90 cents on the dollar. Now they are trading at less than 40 cents on the dollar. They are  the “toxic assets” that the US government now is proposing to buy from banks to unclog their balance sheets.

According to my sources, Summers enthusiastically urged Asian investors including sovereign funds to purchase such instruments just weeks after the collapse of a Bear, Stearns hedge fund whose failure triggered the collapse of the whole structured market. I do not know precisely what was in Summers’ pitchbook, but if I were a member of a Congressional committee responsible for the oversight of economic policy, I would very much want to know what was in it.