Act II—Dr. Michael Burry

Continuing our story of The Big Short by Michael Lewis, the next character is Dr. Michael Burry. Trained as a neurosurgeon and suffering from Asperger’s Syndrome, Mike Burry has an incredible head for figures. In spite of his difficulty with human relationships (or maybe because of it), he senses the flaws and contradictions in complex financial systems long before others detect them. 

v1.bjsxMDM1NDIyO2o7MTcwMjE7MTIwMDs1NzYwOzM4NDA     v1.bjsxMDM1NDE5O2o7MTcwMjE7MTIwMDs1NDYwOzM2NDAScenes from the movie The Big Short starring Christian Bale

A couple years earlier he’d discovered credit default swaps. A credit default swap was confusing mainly because it wasn’t really a swap at all. It was an insurance policy, typically on a corporate bond, with semiannual premium payments and a fixed term. For instance, you might pay $200,000 a year to buy a ten-year credit default swap on $100 million in General Electric bonds. The most you could lose was $2 million: $200,000 a year for ten years. The most you could make was $100 million, if General Electric defaulted on its debt any time in the next ten years and bondholders recovered nothing. It was a zero-sum bet: if you made $100 million, the guy who had sold you the credit default swap lost 4100 million. It was also an asymmetric bet, like laying down on a number in roulette. The most you could lose were the chips you put on the table; but if your number came up, you made thirty, forty, even fifty times your money. “Credit default swaps remedied the problem of open-ended risk for me,” said Burry. “If I bought a credit default swap, my downside was defined and certain, and the upside was many multiples of it.”

The only problem was that there was no such thing as a credit swap on a subprime mortgage bond, not that he could see. He’d need to prod the big Wall Street firms to create them. But which firms? If he was right and the housing market crashed, these firms in the middle of the market were sure to lose a lot of money. There was no point in buying insurance from a bank that went out of business the minute insurance became valuable. . . Goldman Sachs, Morgan Stanley, Deutsche Bank, Bank of America, UBS, Merrill Lynch and Citigroup were, to his mind, the most likely to survive a crash. He called them all. Five of them had no idea what he was talking about; two came back and said that, while the market didn’t exist, it might one day. Inside of three years, credit swap on subprime mortgage bonds would become a trillion-dollar market and precipitate hundreds of billions of dollars’ worth of losses inside the big Wall Street firms. Yet when Michael Burry pestered the firms in the beginning of 2005, only Deutsche Bank and Goldman Sachs had any real interest in continuing the conversation. No one on Wall Street, as far as he could tell, saw what he was seeing.

v1.bjsxMDM1NDE4O2o7MTcwMjE7MTIwMDs1NTAyOzM2Njg      v1    Scenes from the movie The Big Short starring Christian Bale

The market made no sense, but that didn’t stop other Wall Street firms from jumping into it, in part because Mike Burry was pestering them. For weeks he hounded Bank of America until they agree to sell him$5 million in credit default swaps. Twenty minutes after they sent their e-mail confirming the sale, they received another back from Burry: “So can we do another?” In a few weeks Mike Burry bought several hundred million credit default swaps from half a dozen banks, in chunks of $5 million. None of the sellers appeared to care very much which bonds they were insuring. He found one mortgage pool that was 100 percent floating-rate negative-amortizing mortgages—where the borrowers could choose the option of not paying paying any interest at all and simply accumulate a bigger and bigger debt until, presumably, they defaulted on it. Goldman Sachs not only sold him insurance on the pool but sent him a little note congratulating him on being the first person, on Wall Street or off, ever to buy insurance on that particular item. “I’m educating the experts here,” Burry crowed on e-mail.

Three days later he heard from Goldman Sachs. His saleswoman, Veronica Grinstein, called him on her cell phone, which is what she did when she wanted to talk without being recorded.  (Wall Street firms now recorded all calls made from their trading desks.) “I’d like a special favor,” she too wanted to buy some of his credit default swaps “management is concerned,” she said. They thought the traders had sold all his insurance without having any place they could go to buy it back. Could Mike Burry sell them $25 million of the stuff at really generous prices, on the subprime mortgage bonds of his choosing? Just to placate Goldman management, you understand. Hanging up, he pinged Bank of America, on a hunch, to see if they would sell him more. They wouldn’t. They too were looking to buy. Next came Morgan Stanley—again out of the blue. He hadn’t done much business with Morgan Stanley, but evidently Morgan Stanley, too, wanted to buy whatever he had. He didn’t know exactly why all these banks were all of a sudden so keen to buy insurance on subprime mortgage bonds, but there was one obvious reason: the loans suddenly were going bad at an alarming rate. Back in May Mike Burry was betting on his theory of human behavior. The loans were structured to go bad. Now in November, they were actually going bad.

 

 

 

 

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American Judges Speak Out Against Mass Incarceration

 

 This country exceeds by far every other advanced country in the world in the numbers of its citizens it holds in jails. A punitive justice system put in place thirty years ago, intended to reduce crime, has only succeeded in swelling the ranks of the unemployable and creating a gigantic correctional institution industry. In this article  from the June 23 New York Times, Alan Feuer tells us how some judges today have reacted against it:

new-york-city-criminalThe New York Criminal Court

In a speech last week to a group of New York lawyers, a federal judge from Brooklyn assailed the criminal justice system in which he has worked for more than 40 years, saying that the country had to “jettison the madness of mass incarceration” and find an alternative to overly punitive sentencing to address the problem of crime.

The speech by Judge Raymond J. Dearie of the Federal District Court in Brooklyn, at an event sponsored by the New York Criminal Bar Association, may not have struck new ground in its critique of the justice system. But it did put him in the company of other federal judges in Brooklyn who in recent months have come forward with scathing appraisals of things such as mandatory sentencing guidelines and the disregard paid to the socioeconomic roots of crime.

Last month, for instance, Judge Frederic Block wrote an extraordinary ruling saying that courts should pay closer attention to how felony convictions affect peoples’ lives with “collateral consequences” such as ineligibility for public housing and the denial of government benefits. And in March, just before he moved into private practice, Judge John Gleeson used his final decision from the bench to reiterate his own preference for handing down sentences other than prison time to some nonviolent offenders.

All three judges were, in some sense, working in the mold of Jack B. Weinstein, one of the longest-sitting judges on the federal bench in Brooklyn, which is formally known as the Eastern District of New York. In 2011, at age 87, Judge Weinstein went on a walking tour of the Louis Armstrong Houses in the Bedford-Stuyvesant neighborhood before issuing a novelistic ruling in a gang case. The nearly 130-page decision discussed the housing project’s paltry median income, its crumbling infrastructure and the effects of segregation and discrimination on its residents.

“It’s true that there’s a degree to which Eastern District judges have been vocal, but there are a lot more cases out there — they’re just below the radar,” Judge Gleeson said in an interview on Thursday. “I think there is some leadership going on in Eastern where the judges are inclined to speak about these problems. But they’re not the only ones who see them and act on them.”

Judge Dearie, a former prosecutor who once served as the United States attorney in Brooklyn, gave his speech on June 13 at the Loeb Boathouse in Central Park. He started by touching on themes that would not be unfamiliar to most criminal-justice reform advocates.

He confessed to wanting to “scream out in frustration, sadness and anger” at being forced by Congress to impose mandatory sentences on many defendants who appeared before him. He also said that most criminals are “not evil incarnate” but rather act out of “weakness, need, sometimes desperation.” He added, “So many defendants I see are without schooling, skills, hope or direction, and no term of years is going to change that.”

Insisting that his words were not a cry for a broad application of leniency — “Retribution and deterrence have their place in sound sentencing jurisprudence,” he said — Judge Dearie nonetheless questioned the practice of prosecutors and law enforcement officers to gauge their success by how many years a defendant spends in prison.

“Why this love affair in this country with lengthy incarceration, to our great embarrassment as a civilized nation?” he asked, according to a transcript of the speech.

New Study Reveals Some European Labor Markets May Be Superior to Ours

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This article by Neil Irwin in the New York Times, Tuesday, June 21, suggests that unlike our vaunted highly-flexible labor market, France’s (and even Spain’s and Japan’s) less flexible one may be more successful in keeping its members employed:

What if the very thing that is often viewed as one of the United States’ sources of dynamism — flexible labor markets — is the driving force behind the economy’s greatest weakness: millions of people who are neither working nor looking for a job?

That is a provocative idea that Obama administration economists explore in a new report looking at one of the crucial flaws in what on the surface is a healthy job market. Even as the unemployment rate has fallen to 4.7 percent — low by historical standards — millions of working-age Americans have pulled out of the labor market entirely. They neither work nor count as unemployed.

These missing workers are predominately less educated men, and their numbers have been mounting for decades. The White House Council of Economic Advisers calculates that in 1964, 97 percent of men with a high school degree or less in the so-called prime-age working years of 25 to 54 were working or seeking work. That is now down to 83 percent.

In the United States, there is less standing in the way between an employer who wants to hire someone and a person who wants to work than in most Western European countries or Japan.

Many economists have traditionally viewed this as positive. Yes, it means that workers are more vulnerable to being fired when the economy slumps, and many jobs come with fewer benefits like paid vacation and sick leave. But that should help the economy adapt to a changing world more quickly and ultimately lead to higher incomes. A mainstay of American and British economic commentary is preaching to the likes of France and Italy that they need more flexible labor markets.

In theory, this flexibility should create more opportunities for anyone who wants work to find it, in contrast with European countries where companies are more reluctant to add jobs because regulations and union rules make it costly to fire people or sometimes even change their jobs.

Yet a higher proportion of working-age men are in the labor force in many of these countries with inflexible labor market policies. In the United States, 12 percent of 25- to 54-year-old men were neither working nor looking for work in 2014. That number was 7 percent in Spain and France, and 4 percent in Japan. And that’s despite a more generous social safety net in those countries that would, you might think, make it easier to drop out of the work force.

In other words, whatever the costs and downsides of European-style labor markets, they don’t seem to inhibit the number of prime-age men who work. They may even make less educated men more likely to remain part of the work force.

Perhaps men without much education are more likely to seek work when positions offer job security and when regulations and unions push wages higher than they would be on a more open market. And perhaps that effect counteracts the economic negatives of these policies in terms of fewer jobs and less dynamic businesses.

“One traditional defense of American-style labor market arrangements is that though they may result in more inequality, the labor market will function better as a result,” the White House economists write. But the international comparisons “suggest that a successful labor market requires, at the very least, more than just flexibility but also policies or institutions that help connect workers with jobs or facilitate their taking jobs through subsidized child care or flexible workplaces.”

The data, they add, “suggests that the American labor market has room to improve when it comes to creating conditions for meaningful employment.”

What would those be? The Obama administration emphasizes policies to increase “connective tissue” in the job market. Those include improving community college and job training programs. The report also advocates improved unemployment insurance, and wage insurance programs that would provide income to people whose pay gets cut.

The economists also note some other factors that could explain the United States’ poor showing, particularly astronomical incarceration numbers. The male population in the United States includes many more former prisoners than in other advanced democracies, and they are disproportionately likely to be out of the labor force.

“The analysis in this report has shown that simply making labor markets more ‘flexible’ is, at least, not sufficient for effective functioning and that making labor markets more ‘supportive’ is essential,” the report said.

The White House study is part of a broader conversation that is only beginning about the failures of the American economy to create opportunities and good-paying jobs for less educated people, especially men. And it’s not just about economics. The absence of those opportunities has coincided with rising rates of depression, opioid abuse, early death and a range of social dysfunctions among this same demographic group of less educated, working-age men.

There is no guarantee that a more European-style labor market would solve America’s missing male worker problem, let alone solve those much bigger problems. But the international comparisons suggest less flexible labor markets might have some advantages.

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And the Jews’ passover was at hand, and Jesus went up to Jerusalem  And found in the temple those that sold oxen and sheep and doves, and the changers of money sitting: And when he had made a scour…

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Pension Holders Need a New Retirement Plan, Not Stock Tips

Why Force Amateurs to Gamble Their Future on Shaky Stock Prices?

dont-be-surprised-if-this-is-the-start-of-a-stock-market-crash- Floor of the New York stock exchange October 31, 1929
Steven Rattner, who wrote this article, is a Wall Street executive and a contributing opinion writer to the New York Times. It appeared in the June 21 issue.

 HAVING long fretted over the state of our retirement system, I was delighted that the Department of Labor is vigorously defending its new rule requiring brokers to recommend only investments that are in the best interests of holders of retirement accounts.

Hats off to the Obama administration for forcefully addressing the very real conflict between commission-based financial advisers and their clients. But the country’s retirement problems are vast and require much more reform. In fact, we need a complete revamping of our pension arrangements.

Once upon a time, many Americans enjoyed an employer-based, defined-benefit system in which they could depend on a no-hassle pension of a specified amount.

But about two decades ago, faced with mounting costs and increased regulatory burdens, employers began replacing traditional plans with “defined contribution” plans like 401(k)’s.

That created two immense problems. First, only about 10 percent of participants have been contributing the maximum amount allowable.

As a consequence, the average American household approaching retirement in 2013 had just $111,000 in 401(k)’s and I.R.A.s, a fraction of the six to 11 times annual earnings needed to be financially secure, according to calculations by Alicia Munnell, an economist and retirement expert at Boston College.

More important, the move to defined-contribution plans turned every American with a retirement account into an investment manager — a tough business for even the savviest professionals.

Last November, Goldman Sachs — an exceptional firm — issued six investment recommendations for 2016: buy stocks in large banks, sell yen and so forth. In early February, Goldman abandoned five of them, after huge losses in just a few short weeks.

Nor are the Wall Street firms’ records with individual stocks anything to brag about. In this year’s first quarter, the stocks rated highest by analysts fell and the stocks rated lowest rose.

If highly paid professionals often fail to deliver, the notion of amateurs trying to play the game is nuts. What sane person would try to rewire his house or take out her own appendix? And yet under our supposedly improved retirement system, Americans are encouraged to allocate their assets, evaluate mutual funds and even select individual stocks.

It ain’t working. In the first quarter of 2016, domestic mutual funds — a favorite investment vehicle for these retirement accounts despite their chronic underperformance — had their poorest showing in nearly two decades. Through June 15, the 20 most popular funds for 401(k) assets were up 0.6 percent so far in 2016, compared with 2.4 percent for the Standard & Poor’s index.

Finally, even with reforms like the new Labor Department rule, the system is rigged against most individuals: As small investors, they pay higher fees and don’t have access to the smartest advisers. As a professional investment manager, I’m appalled at what I see happening to many friends.

While we can’t simply blow up the current system, we should take the smaller step of requiring companies (other than small businesses) to offer revamped 401(k)’s, including mandatory contributions from employers and employees totaling at least 10 percent of wages annually.

Those funds should be professionally managed by independent, multiemployer entities created for this purpose and structured to avoid the conflicts of interest inherent in our current system. (To minimize the burden on Americans who are already struggling, the program would be phased in.)

Until we fix the broader mess, individuals should follow a few simple rules:

  • Try to save as much as possible of your income, ideally 10 percent to 15 percent.
  • Never, ever pick a stock or an actively managed mutual fund. Use only low-cost index funds.
  • Emphasize equities when you are young; fixed income as you get older. Better yet, consider target-date funds, which do this rebalancing for you.
  • If you have a good 401(k) plan and you change jobs, either leave it where it is or move it to your new employer; I.R.A.s should be your last choice. They often come with higher fees and at least until the new rule takes effect, bad advice.
  • Don’t cash out early.

As a nation, we indisputably face a retirement crisis. The one advantage of our current system is that we each have the ability not to make it worse.

Wall Street Dysfunctional? A Couple of Englishmen, at least, Think So.

 

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In an article entitled What Good Is Wall Street? by J. Cassidy in the November 29 New Yorker magazine we find the following devolution of banking over the past thirty years: 

In effect, many of the big banks have turned themselves from businesses whose profits rose and fell with the capital-raising needs of their clients into immense trading houses whose fortunes depend on their ability to exploit day-to-day movements in the markets. Because trading has become so central to their business, the big banks are forever trying to invent new financial products that they can sell but that their competitors, at least for the moment, cannot. Some recent innovations, such as tradable pollution rights and catastrophe bonds, have provided a public benefit. But it’s easy to point to other innovations that serve little purpose or that blew up and caused a lot of collateral damage, such as auction-rate securities and collateralized debt obligations. Testifying earlier this year before the Financial Crisis Inquiry Commission, Ben Bernanke, the chairman of the Federal Reserve, said that financial innovation “isn’t always a good thing,” adding that some innovations amplify risk and others are used primarily “to take unfair advantage rather than create a more efficient market.”

Other regulators have gone further. Lord Adair Turner, the chairman of Britain’s top financial watchdog, the Financial Services Authority, has described much of what happens on Wall Street and in other financial centers as “socially useless activity”—a comment that suggests it could be eliminated without doing any damage to the economy. In a recent article titled “What Do Banks Do?,” which appeared in a collection of essays devoted to the future of finance, Turner pointed out that although certain financial activities were genuinely valuable, others generated revenues and profits without delivering anything of real worth—payments that economists refer to as rents. “It is possible for financial activity to extract rents from the real economy rather than to deliver economic value,” Turner wrote. “Financial innovation . . . may in some ways and under some circumstances foster economic value creation, but that needs to be illustrated at the level of specific effects: it cannot be asserted a priori.”

Turner’s viewpoint caused consternation in the City of London, the world’s largest financial market. A clear implication of his argument is that many people in the City and on Wall Street are the financial equivalent of slumlords or toll collectors in pin-striped suits. If they retired to their beach houses en masse, the rest of the economy would be fine, or perhaps even healthier.

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From the end of the Second World War until 1980 or thereabouts, people working in finance earned about the same, on average and taking account of their qualifications, as people in other industries. By 2006, wages in the financial sector were about sixty per cent higher than wages elsewhere. And in the richest segment of the financial industry—on Wall Street, that is—compensation has gone up even more dramatically. Last year, while many people were facing pay freezes or worse, the average pay of employees at Goldman Sachs, Morgan Stanley, and JPMorgan Chase’s investment bank jumped twenty-seven per cent, to more than three hundred and forty thousand dollars. This figure includes modestly paid workers at reception desks and in mail rooms, and it thus understates what senior bankers earn. At Goldman, it has been reported, nearly a thousand employees received bonuses of at least a million dollars in 2009.

Not surprisingly, Wall Street has become the preferred destination for the bright young people who used to want to start up their own companies, work for nasa, or join the Peace Corps. At Harvard this spring, about a third of the seniors with secure jobs were heading to work in finance. Ben Friedman, a professor of economics at Harvard, recently wrote an article lamenting “the direction of such a large fraction of our most-skilled, best-educated, and most highly motivated young citizens to the financial sector.”

Most people on Wall Street, not surprisingly, believe that they earn their keep, but at least one influential financier vehemently disagrees: Paul Woolley, a seventy-one-year-old Englishman who has set up an institute at the London School of Economics called the Woolley Centre for the Study of Capital Market Dysfunctionality. “Why on earth should finance be the biggest and most highly paid industry when it’s just a utility, like sewage or gas?” Woolley said to me when I met with him in London. “It is like a cancer that is growing to infinite size, until it takes over the entire body.”

 

 

 

 

 

 

 

 

Visa Abuses Harm American Workers

From the Opinion Page of the New York Times, June 16, 2016, comes this article by The Editorial Board:

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Technology workers from Abbott Laboratories gathered in April at a North Chicago bar after the company laid off about 150 of them.                  Credit Joshua Lott for The New York Times

 

. . . There is no doubt that H-1B visas — temporary work permits for specially talented foreign professionals — are instead being used by American employers to replace American workers with cheaper foreign labor. Abbott Laboratories, the health care conglomerate based in Illinois, recently became the latest large American company to use the visas in this way, following the lead of other employers, including Southern California Edison, Northeast Utilities (now Eversource Energy), Disney, Toys “R” Us and New York Life.

The visas are supposed to be used only to hire college-educated foreigners in “specialty occupations” requiring “highly specialized knowledge,” and only when such hiring will not depress prevailing wages. But in many cases, laid-off American workers have been required to train their lower-paid replacements. . . .

Lawmakers from both parties have denounced the visa abuse, but it is increasingly widespread, mainly because of loopholes in the law. For example, in most instances, companies that hire H-1B workers are not required to recruit Americans before hiring from overseas. Similarly, companies are able to skirt the rules for using H-1B workers by outsourcing the actual hiring of those workers to Tata, Infosys and other temporary staffing firms, mostly based in India.

Criticism of the visa process has been muted, and reform has moved slowly, partly because laid-off American workers — mostly tech employees replaced by Indian guest workers — have not loudly protested. Their reticence does not mean acceptance or even resignation. As explained in The Times on Sunday by Julia Preston, most of the displaced workers had to sign agreements prohibiting them from criticizing their former employers as a condition of receiving severance pay. The gag orders have largely silenced the laid-off employees, while allowing the employers to publicly defend their actions as legal, which is technically accurate, given the loopholes in the law. . . .

 

 

Old and on the Street: The Graying of America’s Homeless

Extracts from a newspaper article by Adam Nagourney from the May 31 New York Times

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But it is the emergence of an older homeless population that is creating daunting challenges for social service agencies and governments already struggling with this crisis of poverty. “Baby boomers have health and vulnerability issues that are hard to tend to while living in the streets,” said Alice Callaghan, an Episcopal priest who has spent 35 years working with the homeless in Los Angeles.

Many older homeless people have been on the streets for almost a generation, analysts say, a legacy of the recessions of the late 1970s and early 1980s, federal housing cutbacks and an epidemic of crack cocaine. They bring with them a complicated history that may include a journey from prison to mental health clinic to rehabilitation center and back to the sidewalks.

Some are more recent arrivals and have been forced — at a time of life when some people their age are debating whether to retire to Arizona or to Florida — to learn the ways of homelessness after losing jobs in the latest economic downturn. And there are some on a fixed income who cannot afford the rent in places like Los Angeles, which has a vacancy rate of less than 3 percent.

But homelessness is rising in big cities where gentrification is on the march and housing costs are rising, like Los Angeles, New York, Honolulu and San Francisco. Los Angeles reported a 5.7 percent increase in its homeless population last year, the second year in a row it had recorded a jump. More than 20 percent of the nation’s homeless lived in California last year, according to the housing agency.

Across Southern California, the homeless live in tent encampments clustered on corners from Venice to the San Fernando Valley, and in communities sprouting under highway overpasses or in the dry bed of the Los Angeles River. Their sleeping bags and piles of belongings line sidewalks on Santa Monica Boulevard.

The aging of the homeless population is on display in cities large and small, but perhaps in no place more than here on Skid Row, a grid of blocks just southeast of the vibrant economic center of downtown Los Angeles, where many of the nation’s poor have long flocked, drawn by a year-round temperate climate and a cluster of missions and clinics.

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Outside the Hippie Kitchen, which feeds the homeless of Skid Row three mornings a week, the line stretched half a block up Sixth Street on a recent day, a graying gathering of men and women waiting for a breakfast of beans and salad. Garland Balancad, 55, scooping food from his plate, said he had more to worry about than his next meal, where to hide his shopping cart or which sidewalk to lay his sleeping bag on after dark. “I’m getting old,” Mr. Balancad said, lifting himself to his feet with a cane. “I don’t want to go into one of these shelters. I don’t want to get some disease.”

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For Ms. Welker, who has been divorced and on her own since 1981, this is the latest stop in a tumultuous journey. She lived in Lancaster, in California’s high desert, until she was evicted about five years ago, unable to pay the rent. She tried to sleep on the streets, shivering on the sidewalks at night, until she finally pleaded for a room in the home of a daughter. “I told my daughter I’m not going to make it because of my handicap,” she said, referring to her right leg, which she said she almost lost after she was hit by a car.

Her daughter put her up for a few years, but Ms. Welker said she eventually left, ending up on Skid Row a year ago. She said she had since lost touch with all three of her children. “They don’t even know how to reach me,” she said. “They are probably going nuts. I didn’t want to interfere with their lives.”

It is not the older homeless people whom Ms. Welker worries about as she surveys Skid Row from the perch of her wheelchair. It is the younger ones, who are slowly changing the makeup of this world.