I love it when people who should know better say stupid things. Professor Nicholas Bloom, for example. “We still don’t know the value of the toxic assets central to the banking crisis.”
Professor, there is no market for those assets. Their value is currently zero. Hence, the word “toxic”. No one has proposed a mechanism to remove their toxicity, because that toxicity is holistically contained in the design and structure of the instruments themselves. IT CANNOT BE REMOVED. Due diligence would have to be performed on each and every loan in each and every bundle that was securitized and sliced into bonds. A new, responsible rating would have to be applied to the parts and to the whole. The bond tranches, their prices and their promised returns would have to be reassembled, using the new ratings. Even if this were theoretically possible, lawsuits would prevent it.
Derivatives are a dangerous game. Deregulated, they quickly become trash. Business school professors need to start educating their students about this fact. Read Steinherr, Partnoy and Das.
Now, Geithner is desperately trying to inflate the value of these tumors from zero to some agreed-upon future market price by GUARANTEEING AGAINST LOSSES, and subsidizing leveraged risk. Therefore, ANY value the assets acquire will be artificial, while the fundamentals of the assets remain toxic. In other words, it’s short-term game time, again. This is beyond corrupt. It’s ‘pay no attention to the man behind the curtain’ time. Geithner is a fraud, committed to fomenting lies.
Most importantly, though, what the public is being prevented from doing is even examining the assets in detail, to see the nooks and crannies, the clever little options, be they American, Bermudan, or otherwise. We don’t know how many there are, or on whose books they lurk. That’s what the bailout of Bear was intended to prevent. Transparency. The failure of Lehman threatened to provide transparency, and the market reacted with horror.
But transparency is the only thing that will restore confidence and the only path to long-term health.
Lastly, false declarations of imminent recovery, like the one made by chief dissembler Larry Summers, or deceptive stress test results or earnings reports provoke the fear of missing the profit opportunity of a market bottom, and the bump up to the strike price that sellers desire to lock in gains. Banks are desperate for capital. Bear market rallies, with the government at your side, are useful in that regard.
— joe
7.4.09
On Larry Summers
From Glenn Greenwald writing for Salon this past weekend:
White House officials yesterday released their personal financial disclosure forms, and included in the millions of dollars which top Obama economics adviser Larry Summers made from Wall Street in 2008 is this detail:
Lawrence H. Summers, one of President Obama's top economic advisers, collected roughly $5.2 million in compensation from hedge fund D.E. Shaw over the past year and was paid more than $2.7 million in speaking fees by several troubled Wall Street firms and other organizations. . . .
Financial institutions including JP Morgan Chase, Citigroup, Goldman Sachs, Lehman Brothers and Merrill Lynch paid Summers for speaking appearances in 2008. Fees ranged from $45,000 for a Nov. 12 Merrill Lynch appearance to $135,000 for an April 16 visit to Goldman Sachs, according to his disclosure form.
That's $135,000 paid by Goldman Sachs to Summers -- for a one-day visit. And the payment was made at a time -- in April, 2008 -- when everyone assumed that the next President would either be Barack Obama or Hillary Clinton and that Larry Summers would therefore become exactly what he now is: the most influential financial official in the U.S. Government (and the $45,000 Merrill Lynch payment came 8 days after Obama's election). Goldman would not be able to make a one-day $135,000 payment to Summers now that he is Obama's top economics adviser, but doing so a few months beforehand was obviously something about which neither parties felt any compunction. It's basically an advanced bribe. And it's paying off in spades. And none of it seemed to bother Obama in the slightest when he first strongly considered naming Summers as Treasury Secretary and then named him his top economics adviser instead (thereby avoiding the need for Senate confirmation), knowing that Summers would exert great influence in determining who benefited from the government's response to the financial crisis.
Enough said.
— Hilary Collins, PA
How are Lawrence Summers' relationships with DEShaw, other hedge funds and banks, different from Dick Cheney's relationships with Halliburton, the oil companies and the defense industry?
— Robert Henry Eller, Milan, Italy
Summers is just one of the academics who both fueled this 40 year ponzi scheme to make MBAs from elite universities like Hrvard and Penn Wharton school the kings of the world.
what did this lockstep army of academics get? money, tenure book deals but adulation fo the crowds. They wanted that time on the stage
The biggest disappointment of this entire meltdown is the duplicity and greed of colege proessors.
they committed the age old sin of lying to their students for personal gain.
shame
soon the entire extent of this corruption of university faculties will come to light.
it will include their complicity in the securitization of school loans, software deals, on line universities you name it .
but it was in their books that they lied about our american history our constitution our heritage that they had the most damage.
— Publicola, Philadelphia
Why shouldn't a brilliant, superbly-connected economist monetize his intelligence?
The real issue with Larry and with too many of Barack's brilliant team is that they are financiers - not industrialists. That's the first half of their problem.
Their fixes for companies and banks are to muck with their balance sheets.
What is needed are jobs. Well-paying. Private-sector (or, at least, at the public-private interphase - like utilities).
Nothing that's being done - other than flooding the economy with money to get people and companies to buy things - is retaining or creating jobs.
The second half of their problem is that they believe they can socially engineer. Green cars. Green energy.
Yet, they deliberately avoid looking at the most successful, economically validated, examples of each - both, actually, in Europe.
France, for nuclear energy.
All of Europe, for a simple gas tax.
Creating, on a large competitive scale, jobs where people make or do things that other people willingly buy and use requires an intelligence akin to - perhaps even beyond - investment banking.
The social engineering? They will figure out what they actually need to do shortly before the 2010 election.
Or shortly after.
— W in the Middle, New York State
All this was predicted and predictable
The insiders are still inside and the present administration policies will increasing reflect their desire to serve their real and future employers. Representation of Americans when it actually happens is just a coincidence or collateral damage to their real representation of themselves and the power elite.
During each and every American war (with the possible exception of the Revolutionary War when the new colonial government was broke) America's entrepreneurs, swindlers, thieves, crooks, connected insiders, elites, politicians and some military leaders did what they really do best: steal ill-gained wealth while America's fighting men and women sacrificed their lives for their economic benefit.
That ill-gained wealth made millionaires out of people who care little about American values, American soldier lives and less about whether America even survives. (A good example of the above is found in Chapter 18, Corruption-Stanton Replaces Cameron, Abraham Lincoln, The War Years, V. 1, Carl Sandburg, Harcourt, Brace & Company 1939.)
But similar information surfaced after WW I, during WW II and then almost continuously as the military-political complex became a major component of our economy. The war in Iraq is just the current version of those in power stealing as America's soldiers have their lives stolen.
So we will see more war cries from this administration (think North Korea and its little Freudian missile)about everything as we have done in the past. But these advisors, insiders, etc. are now double treasonous in that they seek to ensure their own economic advantage while America is at war.
The double treason is based on their their undermining the economic stability for their own self-interest of America as they undermine America's military success by allowing and permitting waste and corruption in the provision of war materials, poor contracting quality and no-bid contracting to favorites and friends.
Senator Henry Charles Van Wyck said during the Civil War:
"The soldier who, bourne down by disease and overcome with fatigue, is found sleeping at his post, you punish with death, while the miscreant who holds his festival at this carnage of blood, you treat with deferential respect. Do you say Government cannot banish treason and punish crime?"
His statement came after a detailed study of multiple cases of fraud, delivery of guns that misfired and blew off thumbs, of delivery of horses that were so sick and diseased that they had to be shot, both examples being sold to the government at above market or any reasonable competitive prices, where no one identified as being part of the fraud, misrepresentation and providers of unacceptable goods was punished. Little of the ill-gained wealth was recovered.
The innocent died and the phony patriots got rich.
Sound familiar? This particualr individual's economic self-interest and future is being guaranteed every day. But instead of a subway pass to get to Wall Street, he gets paid a fabulous salary and the deferential treatment mentioned by Senator Van Wyck.
In the past, America could afford a little inefficiency and waste. Now that pattern is putting the last nails in our coffin. 1% of the population owns over 35% of the total wealth of America and the top 25% owns over 85%. Not much left for the 80% who are losing their homes, jobs, medical care insurance and opportunties to go to college. And yet the greed goes unchecked and America's position falters.
Who is America's Nero? Who can even afford fiddle lessons? How many fires, floods, hurricanes and wars do we need to wake up?
Or do we just roll over and let the thieves have it all?
America's history is replete with commissions, studies and reports of this unpatriotic, immoral, illegal, undemocratic and damning practice during and after each war.
The Civil War was the turning point
— ed g, Warwick, NY
During each and every American war (with the possible exception of the Revolutionary War when the new colonial government was broke) America's entrepreneurs, swindlers, thieves, crooks, connected insiders, elites, politicians and some military leaders did what they really do best: steal ill-gained wealth while America's fighting men and women sacrificed their lives for their economic benefit.
That ill-gained wealth made millionaires out of people who care little about American values, American soldier lives and less about whether America even survives. (A good example of the above is found in Chapter 18, Corruption-Stanton Replaces Cameron, Abraham Lincoln, The War Years, V. 1, Carl Sandburg, Harcourt, Brace & Company 1939.)
But similar information surfaced after WW I, during WW II and then almost continuously as the military-political complex became a major component of our economy. The war in Iraq is just the current version of those in power stealing as America's soldiers have their lives stolen.
So we will see more war cries from this administration (think North Korea and its little Freudian missile)about everything as we have done in the past. But these advisors, insiders, etc. are now double treasonous in that they seek to ensure their own economic advantage while America is at war.
The double treason is based on their their undermining the economic stability for their own self-interest of America as they undermine America's military success by allowing and permitting waste and corruption in the provision of war materials, poor contracting quality and no-bid contracting to favorites and friends.
Senator Henry Charles Van Wyck said during the Civil War:
"The soldier who, bourne down by disease and overcome with fatigue, is found sleeping at his post, you punish with death, while the miscreant who holds his festival at this carnage of blood, you treat with deferential respect. Do you say Government cannot banish treason and punish crime?"
His statement came after a detailed study of multiple cases of fraud, delivery of guns that misfired and blew off thumbs, of delivery of horses that were so sick and diseased that they had to be shot, both examples being sold to the government at above market or any reasonable competitive prices, where no one identified as being part of the fraud, misrepresentation and providers of unacceptable goods was punished. Little of the ill-gained wealth was recovered.
The innocent died and the phony patriots got rich.
Sound familiar? This particualr individual's economic self-interest and future is being guaranteed every day. But instead of a subway pass to get to Wall Street, he gets paid a fabulous salary and the deferential treatment mentioned by Senator Van Wyck.
In the past, America could afford a little inefficiency and waste. Now that pattern is putting the last nails in our coffin. 1% of the population owns over 35% of the total wealth of America and the top 25% owns over 85%. Not much left for the 80% who are losing their homes, jobs, medical care insurance and opportunties to go to college. And yet the greed goes unchecked and America's position falters.
Who is America's Nero? Who can even afford fiddle lessons? How many fires, floods, hurricanes and wars do we need to wake up?
Or do we just roll over and let the thieves have it all?
America's history is replete with commissions, studies and reports of this unpatriotic, immoral, illegal, undemocratic and damning practice during and after each war.
The Civil War was the turning point
— ed g, Warwick, NY
27.3.09
on 401k
The 401Ks are the most painful manifestation of the Bush strategy as directed by wealthy interests in this nation to redistribute wealth back to turn-of-the-twentieth century standards of a bifurcated United States: the Rich and the Rest of Us.
Remember the first initiative of the Bush II regime: “Reform Social Security” - by privatizing it and essentially converting it to Wall Street managed 401 Ks. It failed. But, the chaos that ensued in the days that followed the attack on the World Trade Center allowed the Milton Friedman acolytes who bridged the Treasury (Greenspan) and the White House (Cheney’s cadre) to run the money out the back door by waging a $1Trillion enterprise in Iraq funded with artificially low interest. Sooner or later, the pressure would find its release in a second shock: decreased valuation by 42%. That is what Americans are suffering now in their equity holdings, mostly suffered in 401 Ks.
But, even those who attempted to manage their funds through bank and investment fund pools that advertised safe hedges, such a “Municipal Bond Funds” that were billed as “safer than owning individual bonds with the same tax advantages,” have seen their funds tank while those funds let money out via holding and trading ‘fees’ and pooled - largely unaudited claimed holdings that seem to have been stuck with a disproportionate share of bonds where municipalities are hardest hit by invisible shrinkage and non-enforced compliance reporting.
Meanwhile - the average Joe is being given the privilege of going into a talk-show driven rage over the AIG executive compensation bonuses totaling $65million. That’s a cheap scam considering the Republicans and their fellow tax cheats The Rich have skimmed at least $13 Trillion out of the rest of us.
The Republicans are depending on your continued stupidity in harping on about the ‘deficits for your grand children’ represented by the current propose budget. Those deficits will be their along with wars and misery if you don’t act. Look at the “War with China” story plants coming out of the Pentagon already.
It is time to realize that Murdock is the evil twin of Hearst and represents everything that Hearst was accused of and more. It is the unremitting propaganda that is delivered via Fox News as ‘free’ or ‘basic’ cable news throughout the trailer camp economy of middle America that is driving the ’story of the day’ of Rove politics and which robbed your 401K and then gave you “Joe the Plumber.” If you want to think about what to do about it - shove this budget and a rich tax down the throat of a fat, white, middle aged, millionaire, Republican today who insists that he has your ‘best interests and that of your little unborn granddaughter or son closest to his heart.”
— jwp-nyc
If I could have taken my 401k money when I stopped working and invested it in bigger first home, or a beach house, I’d have doubled my investment. But the laws require that it be “protected” by some custodian like Merrill Lynch or Lehmann Bros or Bernie Madoff or CitiGroup or….
Just as Jack said above, the managers profit, and we pay.
— Deb
401k’s are a basically a government requirement that workers hand over retirement savings to the crooks on Wall Street. The only way most workers can get an employer to contribute to their retirement is through these vehicles. The law MUST be changed to get rid of these things.
— Rob Levine
I clearly remember the days when fixed pensions converted to 401K plans. At the time, I was making about $24,000 a year and would have been fully vested in the company fixed pension scheme in another six years. ERISA meant my pension would have been protected even if my employer disappeared before retirement. The truth is that 401K plans were never set up to benefit workers, rich or otherwise. At the time, employers like the U.S. auto industry were screaming about being uncompetitive with Japan because of the burgeoning liability of fixed pension reserves . Workers like me were handed glossy brochures and told to pick our poison. And the rest is history.
— Retiring on air
Remember the first initiative of the Bush II regime: “Reform Social Security” - by privatizing it and essentially converting it to Wall Street managed 401 Ks. It failed. But, the chaos that ensued in the days that followed the attack on the World Trade Center allowed the Milton Friedman acolytes who bridged the Treasury (Greenspan) and the White House (Cheney’s cadre) to run the money out the back door by waging a $1Trillion enterprise in Iraq funded with artificially low interest. Sooner or later, the pressure would find its release in a second shock: decreased valuation by 42%. That is what Americans are suffering now in their equity holdings, mostly suffered in 401 Ks.
But, even those who attempted to manage their funds through bank and investment fund pools that advertised safe hedges, such a “Municipal Bond Funds” that were billed as “safer than owning individual bonds with the same tax advantages,” have seen their funds tank while those funds let money out via holding and trading ‘fees’ and pooled - largely unaudited claimed holdings that seem to have been stuck with a disproportionate share of bonds where municipalities are hardest hit by invisible shrinkage and non-enforced compliance reporting.
Meanwhile - the average Joe is being given the privilege of going into a talk-show driven rage over the AIG executive compensation bonuses totaling $65million. That’s a cheap scam considering the Republicans and their fellow tax cheats The Rich have skimmed at least $13 Trillion out of the rest of us.
The Republicans are depending on your continued stupidity in harping on about the ‘deficits for your grand children’ represented by the current propose budget. Those deficits will be their along with wars and misery if you don’t act. Look at the “War with China” story plants coming out of the Pentagon already.
It is time to realize that Murdock is the evil twin of Hearst and represents everything that Hearst was accused of and more. It is the unremitting propaganda that is delivered via Fox News as ‘free’ or ‘basic’ cable news throughout the trailer camp economy of middle America that is driving the ’story of the day’ of Rove politics and which robbed your 401K and then gave you “Joe the Plumber.” If you want to think about what to do about it - shove this budget and a rich tax down the throat of a fat, white, middle aged, millionaire, Republican today who insists that he has your ‘best interests and that of your little unborn granddaughter or son closest to his heart.”
— jwp-nyc
If I could have taken my 401k money when I stopped working and invested it in bigger first home, or a beach house, I’d have doubled my investment. But the laws require that it be “protected” by some custodian like Merrill Lynch or Lehmann Bros or Bernie Madoff or CitiGroup or….
Just as Jack said above, the managers profit, and we pay.
— Deb
401k’s are a basically a government requirement that workers hand over retirement savings to the crooks on Wall Street. The only way most workers can get an employer to contribute to their retirement is through these vehicles. The law MUST be changed to get rid of these things.
— Rob Levine
I clearly remember the days when fixed pensions converted to 401K plans. At the time, I was making about $24,000 a year and would have been fully vested in the company fixed pension scheme in another six years. ERISA meant my pension would have been protected even if my employer disappeared before retirement. The truth is that 401K plans were never set up to benefit workers, rich or otherwise. At the time, employers like the U.S. auto industry were screaming about being uncompetitive with Japan because of the burgeoning liability of fixed pension reserves . Workers like me were handed glossy brochures and told to pick our poison. And the rest is history.
— Retiring on air
24.3.09
On Geithner-Obama's plan
1) Obama's housing plan will not stop the avalanche of foreclosures, which means the toxic assets the taxpayers will be on the hook for will become more, not less, toxic. See my op-ed with Professor Geanakoplos, Matters of Principal (NY Times 3/5/09) and Congressional Oversight Panel's finding (3/6/09 p.32) both finding that negative equity --not addressed by Obama housing plan-- is the single best indicator of default. IMF report supports this position too. The data is just irrefutable.
2) Winstar! Both the President's housing plan and this new bank plan are based, not on legislation, but on contracts between the government and private actors.
Winstar is a Supreme Court case, coming out of the savings and loan crisis, which says that when the government enters into a contract with a private party to induce it to do x (here buy these assets), Congress cannot -- when the plan fails -- legislate to adopt a more sensible plan without being potentially liable for HUGE damages to the private parties whose expectations were thwarted. This case, a bad decision but one this conservative Supreme Court will stand by, puts executive agencies (those who write these deals with private parties) above Congress and in effect renders future elections to change policy near meaningless as it allows private contracts made by unelected agency officials to make legislation to change course too expensive to adopt (because it would require paying massive damages to compensate private folks who acted on the basis of the contracts about to be entered into to implement Geithner's plan and the near useless housing plan).
Winstar means that it is not just public bailout fatigue,as Paul Krugman says, that may prevent us from later adopting sensible policy. The costs of sensible policy are likely to become prohibitively high once we walk down this path of inducing private parties to "help" us out of this mess with the Geithner plan to be adopted today (and the housing plan, which also involves private contracts with the big banks, who are the servicers of most subprime mortgages).
A number of years ago, I wrote an article with David Dana, Asooc. Dean of Northwestern Law School, about the anti-democratic nature of Winstar and government policy implemented by private contract instead of legislation. The title was Bargaining in the Shadow of Democracy, published in the University of Pennsylvania Law Review, for anyone interested in learning more about the "tax" that the executive branch can levy on future Congresses by contracts that make future sensible legislation to costly to pass.
Susan P. Koniak, Professor of Law, Boston University
— Susan P. Koniak, Boston University School of Law
-------------------------------------------------------
Treasury puts in $1,000,000,000,000. (Looks bigger and more real when one types it out all the way.) It goes in as this: 12% straight up freebie by handing over the money to the banks in exchange for trash and 85% in low-interest non-rcourse loans.
Private investors put in $309,273,835,050 - 3% of the purchase price.
And what price do they pay for this toxic waste that the 'markets' can not value - or at least 'value' high enough so the banks are willing to sell?
The price will be whatever the PRIVATE investors decide - all by themselves to pay for it! Treasury doesn't have a thing to say about it.
And if it turns out that these mortgages really are toxic waste and the private investors bid too high? (And they will since Treasury wants them to bid as high as possible to get the banks to sell their trash.)
Oh well, not a problem. The loans to them are non-recourse and they can walk away and Treasury can't collect a penny from them and the taxpayers lose 85% of what was paid for the loans; the taxpayers lose thier 15% of direct money (now a grand total of 97% of the purchase price) and the investors are out their 3%.
This is NONSENSE! It is Paulson recyled and disguised to pretend that it is a public-private partnership.
Prof Krugman has frequently quipped that Paulson, Bernanke and Geithner suffer from the delusion that there "are no bad mortgage loans or assets - that there are only misunderstood - and thus undervalued -loans and assets" He is depressingly correct.
The markets have already put a price on these so-called assets - and that price is pennies on the dollar. This whole proposal is nothing more than an thinly veiled effort to hand even more taxpayer money over to insolvent - insolvent, not illiquid - banks and take junk that isn't worth even close to what these banks and the Bernanke/Paulson/Geithner want the value to be.
This is more robbery of the taxpayers to prop up walking dead insolvent banks.
Below is the real meaing of all the money that has been thrown at these banks and the financial ssytem:
"The government through bailouts, fiscal stimulus, monetary programs, and every other imaginable bailout has committed over $9 trillion to the cause. You know how many $50,000 a year jobs we can buy with that for one year? 180,000,000. Even with the $1.2 trillion committed by the Fed with the TALF and buying treasuries to lower the interest rate, we could have literally bought 24,000,000 jobs at $50,000 for one year. We could have put everyone back to work for the price of making mortgages go back down to 4% and giving Wall Street another crony capitalist present. "
And now Treasury wants to toss in another $1,000,000,000,000. That would create 20,000,000 jobs paying $50,000 a year!
And in the end, all this propping up of zombie banks won't matter even if they finally start being willing to lend. Aunt Tilly and Uncle Jake out in the real world are broke, busted and flat tapped out. They are in hock to their eyeballs. Household debt (not including mortgages) is now 140% of household income and it hasn't been that high since 1929...... Aunt Tilly and Uncle Jake can not afford to pay the debts they have now let alone borrow more money. And Tilly and Jake don't have a hope of their income increasing as their jobs have been shipped to China and India, their wages cut and their health insurance keeps going up and up. Retraining for a new job is a joke as the wages of college grads have been falling for the past 8 years since there are more college grads then there are jobs that require such education. The jobs in real estate, housing retail suppliers, construction, retail, insurance and finance are gone and are not coming back.
Obama is giving Larry 'Don't regulate the deriviatives market' Summers and Timothy 'I helped create the Paulson palns in '08' Geithner their heads and letting them plow ahead and put into effect the same nonsense proposed by Paulson just dressed up in new trimmings. Welcome to Republican-lite economics.....
We are toast.
— AnnS, MI
11.2.09
"Protectionism did not cause the Great Depression, but it sure helped to make it “Great.” From 1929 to 1934, world trade plunged by more than 60 percent — and we were all worse off." Thomas Friedman, NYTimes columnist and author
Okay lets try some Econ 101. This is an oft-cited refrain BUT it is incorrect if NOT put in context. That is an INCORRECT answer in certain situations where tariffs are beneficial to a country which enacts them.
(1) Trade barriers enacted by a nation that is a CREDITOR nation harm its economy. The nations that owe it money (be it the governments or private business) can not repay the debt owed to it if they can not sell their goods to and in the creditor nation.
(2) Trade barriers enacted by a DEBTOR nation help its internal economy. Such barriers keep the creditor nation(s) to whom it owes money from flooding it with cheap goods and draining it of money.
(3) Trade barriers enacted by a Net-Exporting nation hurt its internal economy as the importing nations who wish to sell their goods in the net-exporting nation retaliate by enacting trade barriers against its goods.
(4) Trade barriers enacted by a Net-Importing nation HELP its internal economy by raising the cost of imported goods which discourages its residents from purchasing imported goods in preference to domestically produced goods and keeps money from flowing out of the Net-Importing nation to the exporting-seller nation.
Okay - you got that now? Fine lets move on.
(5) In 1929, the US was a CREDITOR nation and a NET-EXPORTING nation. Smoot-Hawley was enacted under Hoover which he was pressured into signing. (Republicans of that time were as knee-jerk on tariffs and trade barriers as the current ones are on tax cuts. Those were the Republican panacea and answer to every problem in the early 1/2 of the 20th century & imposed without thought in every situation possible just like tax cuts today.)
See rules #1 & 3 for the results. That made the Great Depression worse because a large number of the bank failures were due to the default on bonds issued on behalf of foriegn governments. (The CDOs and SIVs of their day.)
(6) England in 1929 was a CREDITOR nation and a NET-IMPORTER nation. In about 1930 or so, it enacted tarriffs and trade barriers to all goods that did NOT come from within the Empire. (That means no tariffs on things from Australia etc but tariffs on things from France or the US.)
It WORKED in assisting the British economy to be less damaged from the Great Depression and to recover faster. It stimulated the British economy by encouraging domestic production.
See Rules #2 & 4 above.
(7) This is NOT 1929. The US is NOT a creditor nation. The US is NOT a Net-Exporter nation.
(8) In right now - 2009 - the US is the biggest debtor nation in the world. It is one of the biggest, if not the biggest net-importer nations in the world.
And for those who haven't noticed, we import over 4 times the amount of goods from China than we sell to them. In total we import nearly twice as much as we export. That sucking sound is MONEY flowing out of the US at a faster rate than it is coming in.
If Mr. Friedman is so enamoured of his 'free market global econmy', I suggest he put his money where his mouth is. Gobal economy means a leveling of incomes among the entire world. Add up the populations of the US, China & India; multiply the population of each of those countries by the per capita income of the country in question; then add up how much income there is in all 3 countries; and finally divide that total dollar amount by the total population of all 3. That number you get is what happens when there is an equalization of income through outsourcing, shipping out manufacturing and his precious global economy. To save you all the trouble of looking up the data, the answer is that for incomes to equalize, the US per capita income must fall by 75%.
I hereby nominate Mr. Friedman to be the first reduce his personal per capita income to $9,650. I'm certain he will manage just fine - although he may want to go live in India until the rest of the US falls to the same level.
All this prat from the 'free marketers' about how individuals should be 'self-reliant' gets very tiresome in view of how they find shipping US jobs and manufacturing overseas so wonderful. If individuals should be self-reliant, so should nations and that means having its own industrial and manufacturing base so it does not depend upon other countries or foreign businesses to supply it with the goods needed for survival ranging from clothing to computer chips to building tanks (ie: auto plants in WWII.) A nation needs to be self-reliant for manufactured goods if for no other reason than national security and protection. Just ask Japan and Germany how well WWII turned out for them when they did not have essential materials or plants within their own borders. And yes, Virginia, such a war can happen again and the US could be isolated.
Okay lets try some Econ 101. This is an oft-cited refrain BUT it is incorrect if NOT put in context. That is an INCORRECT answer in certain situations where tariffs are beneficial to a country which enacts them.
(1) Trade barriers enacted by a nation that is a CREDITOR nation harm its economy. The nations that owe it money (be it the governments or private business) can not repay the debt owed to it if they can not sell their goods to and in the creditor nation.
(2) Trade barriers enacted by a DEBTOR nation help its internal economy. Such barriers keep the creditor nation(s) to whom it owes money from flooding it with cheap goods and draining it of money.
(3) Trade barriers enacted by a Net-Exporting nation hurt its internal economy as the importing nations who wish to sell their goods in the net-exporting nation retaliate by enacting trade barriers against its goods.
(4) Trade barriers enacted by a Net-Importing nation HELP its internal economy by raising the cost of imported goods which discourages its residents from purchasing imported goods in preference to domestically produced goods and keeps money from flowing out of the Net-Importing nation to the exporting-seller nation.
Okay - you got that now? Fine lets move on.
(5) In 1929, the US was a CREDITOR nation and a NET-EXPORTING nation. Smoot-Hawley was enacted under Hoover which he was pressured into signing. (Republicans of that time were as knee-jerk on tariffs and trade barriers as the current ones are on tax cuts. Those were the Republican panacea and answer to every problem in the early 1/2 of the 20th century & imposed without thought in every situation possible just like tax cuts today.)
See rules #1 & 3 for the results. That made the Great Depression worse because a large number of the bank failures were due to the default on bonds issued on behalf of foriegn governments. (The CDOs and SIVs of their day.)
(6) England in 1929 was a CREDITOR nation and a NET-IMPORTER nation. In about 1930 or so, it enacted tarriffs and trade barriers to all goods that did NOT come from within the Empire. (That means no tariffs on things from Australia etc but tariffs on things from France or the US.)
It WORKED in assisting the British economy to be less damaged from the Great Depression and to recover faster. It stimulated the British economy by encouraging domestic production.
See Rules #2 & 4 above.
(7) This is NOT 1929. The US is NOT a creditor nation. The US is NOT a Net-Exporter nation.
(8) In right now - 2009 - the US is the biggest debtor nation in the world. It is one of the biggest, if not the biggest net-importer nations in the world.
And for those who haven't noticed, we import over 4 times the amount of goods from China than we sell to them. In total we import nearly twice as much as we export. That sucking sound is MONEY flowing out of the US at a faster rate than it is coming in.
If Mr. Friedman is so enamoured of his 'free market global econmy', I suggest he put his money where his mouth is. Gobal economy means a leveling of incomes among the entire world. Add up the populations of the US, China & India; multiply the population of each of those countries by the per capita income of the country in question; then add up how much income there is in all 3 countries; and finally divide that total dollar amount by the total population of all 3. That number you get is what happens when there is an equalization of income through outsourcing, shipping out manufacturing and his precious global economy. To save you all the trouble of looking up the data, the answer is that for incomes to equalize, the US per capita income must fall by 75%.
I hereby nominate Mr. Friedman to be the first reduce his personal per capita income to $9,650. I'm certain he will manage just fine - although he may want to go live in India until the rest of the US falls to the same level.
All this prat from the 'free marketers' about how individuals should be 'self-reliant' gets very tiresome in view of how they find shipping US jobs and manufacturing overseas so wonderful. If individuals should be self-reliant, so should nations and that means having its own industrial and manufacturing base so it does not depend upon other countries or foreign businesses to supply it with the goods needed for survival ranging from clothing to computer chips to building tanks (ie: auto plants in WWII.) A nation needs to be self-reliant for manufactured goods if for no other reason than national security and protection. Just ask Japan and Germany how well WWII turned out for them when they did not have essential materials or plants within their own borders. And yes, Virginia, such a war can happen again and the US could be isolated.
— AnnS, MI
27.1.09
Pensions were a concept that came into existence during WWII.
401(k) was the darling of the '90s when businesses wanted to get out from having to be responsible for guaranteeing payments to their retirees.
Relying upon the stock market to provide for retirement should have been seen as potentially disasterous for anyone with more sense than a gnat. It has now been shown to be exactly such a disaster - and the future problems for those in their 50s and 60s is troubling.
Before Social Security, retirement DID NOT exist for 90% of the population. They either:
(a) worked until they died; or
(b) if unable to work due to health or age, then they
(i) went to the county poorhouse or
(ii) were supported by their younger relatives.
And that, for all those far right-wingers who blather on about saving for retirement being the sole responisblity of the individual WAS the reality and it meant that unless they were in at least the upper 10% in income (now over $120,000 in household income), they too would never have retired.
Social Security was created to get the older workers out of the workforce and decrease the supply of workers; and to so so in such an manner as to spread the burden of the elderly across all the younger workers rather than leaving it to the immediate family. That solved the problem of one worker trying to support his/her paretns. in-laws, grandparents and a few aunts and uncles while the neighbor on one side only had to support 1 or 2 elderly relatives and the neighbor on the other side had no living elderly relatives.
Telling households to 'save more' is akin to telling someone they really should try to fly off the roof of a 20 story building. FOr most, it simply can NOT be done. The median household income is around $50,000.
Try running the numbers on what households are 'supposed to save' each year according to the talking heads. Households are supposed to save enough each year to pay for their children's college so figure $7000 per child. Then they are suppose to ante up for their healthcare - say $6000 for 50% of the cost of the average family plan. Then they are supposed to spend 31% of the gross income on housing. Then they are supposed to save for emergencies and have an equivalent of 1 year of income set aside. Then they are supposed to save for retirement so call is another $7000 a year and they might end up with $280,000 over 40 year ....
Run the numbers for yourself. Using the 'advice' of the talking heads and taking the usual costs of utilities, car insurance, a car, healthcare, necesities, the median priced house at $180,000 and the required income is in excess of $150,000 - that is about the top 7 1/2% of the US.
So what are the other 92 1/2% supposed to do, eh? They simply do not have the income to save and pay everything they are "supposed' to do.
It may be necessary to completely rethink the idea of privately funding retirement for the vast majority.
401(k) was the darling of the '90s when businesses wanted to get out from having to be responsible for guaranteeing payments to their retirees.
Relying upon the stock market to provide for retirement should have been seen as potentially disasterous for anyone with more sense than a gnat. It has now been shown to be exactly such a disaster - and the future problems for those in their 50s and 60s is troubling.
Before Social Security, retirement DID NOT exist for 90% of the population. They either:
(a) worked until they died; or
(b) if unable to work due to health or age, then they
(i) went to the county poorhouse or
(ii) were supported by their younger relatives.
And that, for all those far right-wingers who blather on about saving for retirement being the sole responisblity of the individual WAS the reality and it meant that unless they were in at least the upper 10% in income (now over $120,000 in household income), they too would never have retired.
Social Security was created to get the older workers out of the workforce and decrease the supply of workers; and to so so in such an manner as to spread the burden of the elderly across all the younger workers rather than leaving it to the immediate family. That solved the problem of one worker trying to support his/her paretns. in-laws, grandparents and a few aunts and uncles while the neighbor on one side only had to support 1 or 2 elderly relatives and the neighbor on the other side had no living elderly relatives.
Telling households to 'save more' is akin to telling someone they really should try to fly off the roof of a 20 story building. FOr most, it simply can NOT be done. The median household income is around $50,000.
Try running the numbers on what households are 'supposed to save' each year according to the talking heads. Households are supposed to save enough each year to pay for their children's college so figure $7000 per child. Then they are suppose to ante up for their healthcare - say $6000 for 50% of the cost of the average family plan. Then they are supposed to spend 31% of the gross income on housing. Then they are supposed to save for emergencies and have an equivalent of 1 year of income set aside. Then they are supposed to save for retirement so call is another $7000 a year and they might end up with $280,000 over 40 year ....
Run the numbers for yourself. Using the 'advice' of the talking heads and taking the usual costs of utilities, car insurance, a car, healthcare, necesities, the median priced house at $180,000 and the required income is in excess of $150,000 - that is about the top 7 1/2% of the US.
So what are the other 92 1/2% supposed to do, eh? They simply do not have the income to save and pay everything they are "supposed' to do.
It may be necessary to completely rethink the idea of privately funding retirement for the vast majority.
— AnnS, MI
25.1.09
on financial regulation
"Financial innovation" means the invention of "devices" by which the members of the investor class can make more money. I'm, of course, not speaking about small-time investors, either. Anyone who believes that small-time investors have a place at Wall Street's table is uninformed and unobservant. Small-time investors are carrying the dirty plates to the kitchen.
"Financial innovation" also means instability, as "creative" MBAs from the Ivy League invent arcane financial devices that are no more than gambling chits. Average citizens and investors can not, and are not supposed to, understand the obscure logic of the financial industry.
Mr. Obama has a very difficult row to hoe. It is faith that has disappeared, and appointing people to power who are themselves partially responsible for the loss of that faith is not a good idea, whether those people are Democrats or Republicans.
Here's the nub. In the financial industry, does it matter whether one is a Democrat or Republican, or are BOTH Democratic and Republican members of the financial class simply trying to maximize their profit at the expense of others?
My suspicion is that "Democrats" such as those mentioned in your editorial are "Democrats" in name only. At heart, they WANTED derivatives--and they still do. They are not the kind of people who would be willing to admit that they were wrong, just like our outgoing President.
Our lleadership has failed. Why should we trust replacements chosen from the same class of leaders? And how can we find leaders outside that class? Does Mr. Obama REALLY have any choice, or must he continue to play the game that has created a recession that is seemingly sliding into a depression, something our financial leaders have been telling us was impossible.
Rubin was wrong. So was Clinton. And the list does not stop there.
_____________________
Regulating the $500 trillion dollar beast of the OTC derivatives market and effectively and efficiently overseeing that activity to ensure compliance would be a gargantuan effort, requiring unprecedented international cooperation by legislative bodies, regulatory agencies and justice departments. Every single country will have to fight battles with their own banks and hedge funds until consistent regulations were established. It's a pipe dream. Where will the money for this effort come from? Even if it were possible, it is many years down the line.
More effective and achievable steps would be to re-impose Glass-Steagall, place a ban on the use of leveraged derivatives instruments, and end the practice of securitization of consumer debt. If you think that's radical, I have these words for you: $7.5 trillion in taxpayer dollars. Great Depression II.
Unfortunately, I see no reason to believe that President-elect Obama or the supplicant members of Congress will find the courage to impose regulations that go against the wishes of their benefactors at financial institutions or the hedge fund world. This past election cycle, for instance, Obama received more money from hedge funds than any other candidate for president. I won't hold my breath waiting for him to truly rein in their gambling.
"It could be that the people whose actions contributed to the mess are best equipped to clean it up," is one of the most preposterous suppositions I have ever read. Following that logic, why not reappoint Greenspan? Madoff knows a lot about how things work, let's put HIM in charge. Or how about those guys that used to run LTCM. They won a Nobel Prize. They must have learned an enormous amount from their mistakes.
Seriously, Obama's choice of Lawrence Summers as economic advisor, and his pending appointments of Gensler(!), Geithner(!), and Schapiro were devastatingly clear messages to financial interests that only surface reforms were in store. Summers is a former hedge fund manager. Geithner has stated very clearly in the past his belief in "self-regulation". At least Alan Greenspan has publically admitted his error, in that regard. Mr. Geithner has yet to do so.
With respect to regulation of hedge fund activity, Geithner, in his keynote address to the 8th Annual Risk Convention in New York in 2007, called the goal of transparency of hedge fund activity "unachievable". He went on to say "We are not likely to ever be in a position where we have the capacity to identify the source and estimate the probability of future financial shocks."
Forgive me, but that's just not acceptable.
This is not a "mess" to be cleaned up. It is a once in a century global financial disaster that has driven the country to the brink of another Great Depression. The people responsible should be driven through the streets in shame, barred from ever working in financial institutions again. Instead, in Bush-like fashion, they are being promoted.
It is depressing beyond belief to have to look that fact in the face.
"Financial innovation" also means instability, as "creative" MBAs from the Ivy League invent arcane financial devices that are no more than gambling chits. Average citizens and investors can not, and are not supposed to, understand the obscure logic of the financial industry.
Mr. Obama has a very difficult row to hoe. It is faith that has disappeared, and appointing people to power who are themselves partially responsible for the loss of that faith is not a good idea, whether those people are Democrats or Republicans.
Here's the nub. In the financial industry, does it matter whether one is a Democrat or Republican, or are BOTH Democratic and Republican members of the financial class simply trying to maximize their profit at the expense of others?
My suspicion is that "Democrats" such as those mentioned in your editorial are "Democrats" in name only. At heart, they WANTED derivatives--and they still do. They are not the kind of people who would be willing to admit that they were wrong, just like our outgoing President.
Our lleadership has failed. Why should we trust replacements chosen from the same class of leaders? And how can we find leaders outside that class? Does Mr. Obama REALLY have any choice, or must he continue to play the game that has created a recession that is seemingly sliding into a depression, something our financial leaders have been telling us was impossible.
Rubin was wrong. So was Clinton. And the list does not stop there.
— marik7, wailiku, hi
_____________________
Regulating the $500 trillion dollar beast of the OTC derivatives market and effectively and efficiently overseeing that activity to ensure compliance would be a gargantuan effort, requiring unprecedented international cooperation by legislative bodies, regulatory agencies and justice departments. Every single country will have to fight battles with their own banks and hedge funds until consistent regulations were established. It's a pipe dream. Where will the money for this effort come from? Even if it were possible, it is many years down the line.
More effective and achievable steps would be to re-impose Glass-Steagall, place a ban on the use of leveraged derivatives instruments, and end the practice of securitization of consumer debt. If you think that's radical, I have these words for you: $7.5 trillion in taxpayer dollars. Great Depression II.
Unfortunately, I see no reason to believe that President-elect Obama or the supplicant members of Congress will find the courage to impose regulations that go against the wishes of their benefactors at financial institutions or the hedge fund world. This past election cycle, for instance, Obama received more money from hedge funds than any other candidate for president. I won't hold my breath waiting for him to truly rein in their gambling.
"It could be that the people whose actions contributed to the mess are best equipped to clean it up," is one of the most preposterous suppositions I have ever read. Following that logic, why not reappoint Greenspan? Madoff knows a lot about how things work, let's put HIM in charge. Or how about those guys that used to run LTCM. They won a Nobel Prize. They must have learned an enormous amount from their mistakes.
Seriously, Obama's choice of Lawrence Summers as economic advisor, and his pending appointments of Gensler(!), Geithner(!), and Schapiro were devastatingly clear messages to financial interests that only surface reforms were in store. Summers is a former hedge fund manager. Geithner has stated very clearly in the past his belief in "self-regulation". At least Alan Greenspan has publically admitted his error, in that regard. Mr. Geithner has yet to do so.
With respect to regulation of hedge fund activity, Geithner, in his keynote address to the 8th Annual Risk Convention in New York in 2007, called the goal of transparency of hedge fund activity "unachievable". He went on to say "We are not likely to ever be in a position where we have the capacity to identify the source and estimate the probability of future financial shocks."
Forgive me, but that's just not acceptable.
This is not a "mess" to be cleaned up. It is a once in a century global financial disaster that has driven the country to the brink of another Great Depression. The people responsible should be driven through the streets in shame, barred from ever working in financial institutions again. Instead, in Bush-like fashion, they are being promoted.
It is depressing beyond belief to have to look that fact in the face.
— joe (new york), New York
________________________________
There are two problems with rules.
1. Since business is complex, rules will necessarily be complex, not simple. Take a rule limiting how much a financial institution can borrow. Well, what is 'borrowing'? Capital structures are complex, and their are many ways to get money, some of which may or may not be classified as borrowing. You would have to read through the 1000-page contract and then consult with numerous lawyers and accountants, and even then it would be a judgment call that would be vigorously disputed by all parties.
2. Outright swindlers like Madoff like rules. They have books that conform to these rules, and present them to auditors with a smile. This regulatory regime makes investors trust the swindlers all the more. But eventually, someone discovers that their beautiful books that have pass the rigorous audit bear no relationship to reality.
— Jonathan, NYC
________________________________
The most important missing person in this scene was Brooksley Born. A Clinton appointee as the chair of CFTC, she foresaw the mess coming in OTC nonregulated derivatives, especially CDS's. Rubin, Summers, Levitt and Greenspan all insisted she was wrong. Rubin and Summers approached Phil Gramm, then chair of Senate Banking, and asked him to derail Born's proposals. He did, with the assistance of Gensler, as you point out. Born resigned. What else could she do? Thus Cassandra was repeated and those who fail to learn from history are doomed to repeat it. The question now is, how many times? You should look at Born's history closely, before, during and after her sojourn at CFTC. You will surprise yourself at what you find. If Obama had the slightest good advice on who to consult on Wall Street's failures this time he would have sought her out long ago.
— john MacFarlane, Denver
________________________________
The only permanent fix would be to prevent all speculation on stocks. I know, speculation has been with us for a long time but it also has caused numerous crashes in the 19th and 20th Centuries. Only the crashes are getting more severe as wily people have found ways to circumvent controls and to speculate without their own money. And of course the government didn't help when it did away with or weakened regulations imposed after the 1929 crash.
One simple rule would do the trick: Permit the purchase of stocks only with your own money, the full amount. If the buyer can borrow the necessary money from a bank, so be it but then he owes the money to the bank and they own the stocks if he cannot repay the loan. The "wealth" generated between the last crash and 2008 was only a bubble, backed by no real values. That's why the government is on the wrong track when it attempts to recover this imaginary wealth.
— R.H. Schumann, Bonn, Germany
_________________________________
The "economy" failed [again] not because of some flaws in the regulatory regime -- indeed it succeeded! The results deemed failure are due to the underlying model - capitalism which is not sustainable in our necessarily socialized 7-Billion Humans world.
Just as anyone who played the game Monopoly knows, there is an inevitable outcome where one and only one player ends up owning all of the utilities, railroads, properties, houses and hotels. Fewer and fewer can afford to traverse the board on a $200 "Pass Go" payday. We can change the "rules" for rolling the dice and banking -- but NOTHING will change the outcome.
Whether a Tragedy of the Commons or the multitude of thought experiments and empirical analyses, the underlying Capitalism principle will fail. Regulation only delays that inevitable outcome. Regulation comes instantly under attack by the forces incentivized for progress -- that is moving faster toward that inevitable result. The "incentive" feature of the capitalist model is at once the sole advantage and certain undoing.
We will again pour in taxpayer debts and reset the board -- but unless we change the fundamental game, the result will be the same.
You can a lead a horse to water, but that won't fix a broken leg -- you still have to shoot the beast (thirsty or not). The "free-market capitalism" leg is broken and unbendable. Do the right thing and shoot.
— freedata, Long Island NY
___________________________
During the campaign, people said that Barack Obama moved to the center from the left. He actually started out in the center and moved to center-right. I voted for him hoping for the best, but now I'm not so sure. I was against Hillary Clinton because she was a big cheer leader for her husband's ill-conceived pushing of NAFTA, and I was afraid that if she became president we would be in for more voodoo economics. (They sure didn't stop with the end of the Reagan presidency.)
Here we go again. Obama has picked almost everyone who led us down the weedy and rutted garden path of deregulation. The powers-that-be in this country won't be happy until we are turned into a feudal state. Just like Clinton before him, he is a conservative Republican in a Democrat's suit.
The American people must start taking back control. One thing that might make the thieves in Washington and Wall St. wake up is if all the small investors (that's most people) take all their money out of the stock market and put in in CDs. Anyone who invests in the stock market these days should have his/her head examined.
I have lost hope in Obama's "change" even before he takes office. I was suspicious of his thought processes when he announced his prescription for universal health care still included the use of insurance companies instead of an expansion of Medicare. There is no way that we can afford universal care using profit-making entities as middlemen.
I now am hoping that the present generation of young people will see the light and lead us into a social democracy. I was hoping for the start of that with the election of Obama, but all I can see now is an administration that will continue to give all the prime rib to those who already have it, and throw a few neck bones to the rest of us hoping we'll be grateful and shut up.
— Carole A. Dunn, Ocean Springs, MS
_________________________________
I'm a 61-year old woman who until recently had saved enough to retire at 62 so I could return home to care for an elderly parent who can no longer live alone. I have relocated to do just that but now face the grim prospect of having to return to work, somehow, and undoubtedly for a fraction of the pay I earned in my previous career. My guess is I will have to work for another 9-10 years, doing God knows what.
Some version of this is nightmare is staring millions of retirees, or the nearly-retired, smack in the face. Think about being in your 60's and having to start over with some kind of career or at least some kind of job, all because an unfathomably corrupt financial system has destroyed the nest eggs of millions of hard-working people who did everything right, living within their means and saving for retirement.
The greatest country on earth? I am furious and ashamed to be an American, given the level of corruption that has finally brought this country to its knees. Will Obama be able to put a dent in this government-sponsored, utterly dishonest system that helps a tiny few achieve mind-boggling wealth?
The appointments are not encouraging. But I suppose we have no choice (other than suicide) but to hold out the hope that American financial corruption will be viewed with honesty for what it is, now that it has brought the country to its knees.
— Mel, Tampa
13.1.09
How ironic that the largest public industrial support system in U.S. history is going, not to railroads, energy, healthcare, or telecommunications, but to the financial industry.
The banks are now the nation's largest public utility. But what exactly is it that they produce? Debt, debt, debt in exciting new designer styles at discount prices. And what service do they provide? Concealing risk. Offloading the risk side of private speculations by the wealthiest citizens onto the taxpayer base, who are legally forced to pay.
In effect, the Global Banker Class are now acting rather like the Imperial Tax Farmers of the Roman Empire. They have received an imperial charter to indirectly collect taxes from the citizens under their official purview, with police and administrative assistance from the government.
Since the Banker Class do not actually seem to provide anything of social value and cannot support themselves in a free market, their industry should either be nationalized or made self-supporting. How self-supporting? We need an expanded version of the FDIC that creates a capital insurance risk pool entirely funded by a tax on all financial trades. If this reduces the volume and speed of trading, good! It would be hard for anyone to argue with a straight face now that high-volume rapid financial trading actually produces an efficient allocation of capital and risk.
If the bankers refuse to be nationalized or taxed on trades, then the government should remove their right to incorporate and make all financial traders personally responsible, in partnership, for their own debts. Perhaps Gitmo could then be reopened as a debtors' prison for anyone whose leveraged capital losses pass the $1 billion mark. After all, such massive losses offloaded onto taxpayers pose a very tangible to our national security.
The banks are now the nation's largest public utility. But what exactly is it that they produce? Debt, debt, debt in exciting new designer styles at discount prices. And what service do they provide? Concealing risk. Offloading the risk side of private speculations by the wealthiest citizens onto the taxpayer base, who are legally forced to pay.
In effect, the Global Banker Class are now acting rather like the Imperial Tax Farmers of the Roman Empire. They have received an imperial charter to indirectly collect taxes from the citizens under their official purview, with police and administrative assistance from the government.
Since the Banker Class do not actually seem to provide anything of social value and cannot support themselves in a free market, their industry should either be nationalized or made self-supporting. How self-supporting? We need an expanded version of the FDIC that creates a capital insurance risk pool entirely funded by a tax on all financial trades. If this reduces the volume and speed of trading, good! It would be hard for anyone to argue with a straight face now that high-volume rapid financial trading actually produces an efficient allocation of capital and risk.
If the bankers refuse to be nationalized or taxed on trades, then the government should remove their right to incorporate and make all financial traders personally responsible, in partnership, for their own debts. Perhaps Gitmo could then be reopened as a debtors' prison for anyone whose leveraged capital losses pass the $1 billion mark. After all, such massive losses offloaded onto taxpayers pose a very tangible to our national security.
— Nelson Alexander, New York City
30.9.08
Fannie and Freddie were the most regulated institutions in the world. They had there own agency devoted to regulating them with several hundred employees. The regulator failed under Clinton just as it did under Bush, so this isn't an issue of politics.
Regulation in not a panacea because the regulators have a massive incentive to become corrupt, or more likely to just look the other way and worry about their personal lives more than their regulatory duties. Think about it, you are a government employee making maybe $70k a year working 40 hours a week and surfing the net all day. You have little or no real responsibilities other to look over the shoulder of a company. If you go with the flow you keep your cushy job with no risk to your well being. Where is the incentive?
The political heads of the various departments have near zero authority over the employment status of the bureaucracy, so they do as they please.
As a career soldier I can call a spade a spade. We have a guy who graduated in the bottom 10 of his Naval class and still went to flight school. Flight school in the military is reserved for the academic best unless your father is an admiral. Flying, with a lack of aptitude most certainly resulted in his POW status. This POW status has been the center piece of his political career. Not his education or his ability, not his judgment nor his integrity, its been his POW status.
We have a gal who received a cash award from being runner up as Ms. Alaska and used the money to go to college earning a degree in journalism. Her popularity in beauty contests later served to get her elected. For those who believe in melding church and state and establishing laws based on the moral values of your religion I can see how Palin could be an attractive choice but I have been to countries where religion rules the government.
What few people ever seem to get is that the problems we are dealing with starts with the front line people making the mortgage loans. Professionally, I am one of these quants from a mortgage investment company that has gone belly-up.
The fact is that with no/low document loans, the entire financial system was relying on those people to feed us loans that had the same relative risk of the loans they had fed us in the past, everything else being equal — credit scores, LTVs, borrower incomes, etc.
But guess what, when mortgage rates started to move up and the prime market started to slow, these guys started to fudge the loans they were making. Want a better rate on your investment property? I'll put down that it will be your primary residence instead, that'll cut 1/2 percent. Need an appraisal at $250,000, when it reasonably should be $200,000? I'll find you the right appraiser — wink, wink, nod, nod. And so on.
I've worked it out with my colleagues. Historically, it takes at least 6-9 months to tell that a mortgage deal is starting off poorly, maybe 12-15 months. The REALLY bad subprime loans started in late 2005. My firm caught on in mid-2006. We started running numbers, looking for the reasons. Months ticked by. It was the end of the year and we had our five culprits. Loan characteristics that never appear on the computer files shared by loan sellers AND SO WERE NEVER IN THE MODELS. We built an add-on to our model for 2007, but too late we were sunk. What we'd already bought in 2006 and the market reaction to S&P and Moody's horrendous management of their rating actions destroyed the market and us.
Wall Street greed? Yes, they (we) were enablers of fraud by the front line mortgage brokers getting their $2000 per loan pumped into the system. But do you expect the head of a street mortgage shop go to his boss in 2005 and say, "Mr. O'Neal/Mr. Fuld/Mr. Whoever, there is too much risk in my business line (although the data doesn't show it yet). Fire my entire mortgage group."
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C'mon people! Wake up, nobody sees the proverbial 800 pound gorilla…
The quants didn't invent these products. They were just asked by mgmt to justify the decision to securitize the loans to housekeepers. These junior (Chinese or Russian) guys are fresh from a math or physics program and have no clue about what a mortgage is and the local economy of CA or FL.
The experienced sales guy who"ll reap the 7-figure bonus knows exactly though what he's doing when he's stuffing the securities to the investors and saying "our quants have used a very conservative 2% default rate and, anyway, two rating agencies say it's AAA".
The rating agencies are of course accomplice; they have their own clueless quants too and have never changed default assumptions since the 80s but they'll reap the hundred thousands of dollars to rate the bonds of ONE cdo.
The accountants are part of the game too. They'll tell the trader "yeah, you bought the bond and you have also bought insurance against its default from a AAA counterparty, you can therefore book the 20-year profit right now instead of waiting that long — go claim your multimillion bonus and here's our invoice" (so called "negative basis trade").
That's what is at the crux of this mess but how come nobody talking about the gorilla in the room?????
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"I think the underlying current is that these firms and their senior decision makers have had a blind faith in their risk models, the one exception being Goldman Sachs. Clearly, the traders and senior management at Goldman know that computer models designed by PhD grads are still no substitute for experience and sound judgment."
My take-away is somewhat different. The difference at Goldman is that management asked the quants to build models that reflected reality to the best of their ability, while in most cases the staff was required to build models that reflected the business model (illusions) some manager wanted to use, knowing that short-term gains would yield them rich rewards. Search the page for "Goldman" and you'll find this.
This isn't a rocket science event like LTCM. What happened was a long housing price boom fueled the sort of abuses common to such events. Several levels of participants were motivated (by greed) to game the system, canceling the checks that normally prevent you or me from buying a house and defaulting, from a 200K property from getting a 250K mortgage, from a B security being sold as AA and so on. At higher levels it was more abstract and the information less clear. But the fraud at street level wasn't secret; it was encouraged, perhaps indirectly created by the next level up and so forth, because the securities were meant to be held briefly and passed along. It was a multiplayer virtual reality version of the old pyramid scheme.
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Three short observations:
1. It makes no sense to ridicule the intelligence of people who walked away from this debacle with billions of dollars.
2. For at least 20 years, responsible economists and journalists have bemoaned the level of US debt; be it personal, governmental or foreign exchange. And yet the solution to every financial hiccup has been to encourage even more debt though lower interest rates, and other mechanisms.
3. BearStearns, Freddie and Fannie, AIG, etc were deemed "too large to be allowed to fail". But the solutions so far have mostly encouraged the formation of even larger entities that are by definition "too large to be allowed to fail". It seems to me that the opinion expressed by the Economist magazine makes more sense. If a monster company must be bailed out with tax payers money, then that company should be outright nationalized;
its debt and assets should be rationalized, and then it should be broken into smaller pieces (which are not too big to be allowed to fail) and sold back to the private sector, to recover some of the tax payer money. Also, perhaps in the name of national security, no merger or acquisition should be allowed if the resulting entity would be deemed "too large to be allowed to fail".
------------------------------
Well, folks, fundamentally speaking, the pen is mightier than elbow grease. We now live in a world where no productivity is needed to justify creation of currency units, ie money! Ah, money…a unit of exchange, of storage, of value, etc..The intellectual basis for this crisis is that we have decided to prioritize the symbolic aspect of money, thereby eliminating the need for real production to back up the creation of new value. It used to take a buck's skin to make a dollar. Now, we just need a dollar. Long on dollars? Go short, make up to two out of one! Garbage ideas in the minds of garbage persons yields resplendent garbage. Has anyone figured out what Jeb Bush's role over at the Lehmann Brothers Estate sale is to be, and how much he is being paid for his alleged expertise?
"Isn't it strange that these 100 year events seem to be occurring every 10 years."
I have also been in the situation of voicing an unpopular conclusion to a very bullish management team (incidentally of a firm that dabbles in commercial mortgages). Initially they were thankful for the heads-up when they were only minor problems that could be fixed within the quarter. As larger and larger issues piled up that would affect our annual guidance, I was sidelined more and more and ultimately ignored for asking very reasonable questions and voicing legitimate concerns. I was also shocked by our board of directors at their lack of curiosity in all of this. We just went with more (ridiculous) optimistic assumptions to get to where management thought we should be. Ultimately I have been proven correct but will of course not receive the credit. There isn't a whole lot anyone can do when the management team is stubborn, and will not listen to reason, risk models, or anyone else.
The point being, management teams are not stupid, they know exactly what they are doing. They have every incentive of taking outsized risks because they know they will be lavishly rewarded in the short-run, and still well-taken care of in the long-run (through golden parachutes, or just the next lucrative offer elsewhere) regardless of the outcome. For most companies that just go belly-up, it's the employees and shareholders that suffer, but at least the damage is contained, they all at least had an idea of their exposure to incompetence.
But for the really BIG screw-ups that get bailed out (AIG, Fannie, Freddie, LTCM), the management teams should all face serious jail time for financial fraud on a massive scale. No exaggeration, that is exactly what they were doing, they knew it all along and didn't care, and should face the consequences, especially now that public funds are being used to support their fraudulent behavior. NOT FINES, they have more than enough money to pay their way out of this, but actual time in a federal prison, that is the only way to scare them straight, so that others won't take those same sorts of risks in the future.
------------------------------There are two large, unmentioned elephants in this discussion.
1. Mathematical models really can't fully encompass, explain, and more or less predict reality;
2. When the broad markets use roughly the same mathematical premises as the basis of their proprietary models, the behavior of the market participants becomes positively correlated, not diversified, as a result of which the markets move in unison; thus, when the sell lights go on, they go on in more or less every trading room, there's a rush to the exits, and eventually a big pile of bodies at the door.
What really happened here is that 12-15 years ago, the financial world bought a bunch of magic beans–various models, chiefly Value at Risk–that they believed could so accurately measure risk that they could take more chances, reserve less against losses, and make more money.
The problem: These were models–not reality–and models can only anticipate a finite number of events, while reality has a nasty habit of surprising you with the unexpected. The financiers were told the models should be used as only one input to decision-making–not the decision-making process itself–but nobody listened; over time, the verdict of the models became god-like.
VaR's fundamental mistake: It's based on the idea of perfect liquidity–anything can be sold at some price– whereas when markets freeze up, there is no liquidity. And since most risk management models are built on VaR, they all reacted the same way last August to the plunge in sub-prime-related bonds–they all flashed sell signals. But since everybody was selling, there was no liquidity–only that pile of bodies at the exits.
This reminded everybody about all the weak models in their own shops, and likewise reminded them that there was nothing special about their shops, or their portfolios: That most shops' portfolios had similarly weak models, and most everybody's portfolios were salted with the results.
Since everybody knew they now had no idea of what their own portfolios were worth, it was reasonable to conclude nobody else did, either. This meant there was no more guarantee their counterparties could perform in a pinch, than there was that they themselves could perform, considering the reality that no shop knew what their own portfolios were worth.
It also reminded them that pretty much every financial asset, worldwide, had been priced off VaR-based models since it took such deep root in the markets. And that while they didn't know what these assets were worth, it was only common sense that they were worth less than the risk-adjusted price at which they'd been bought.
Ergo, no market confidence, evaporated liquidity, and frozen credit markets–and today's headlines.
And need I mention that most of the derivatives market falls into this description?
The worst part of all this is that while no one knows what anything is worth, what follows close behind is that virtually all financial assets, world wide, need to be re-priced downwards, and that there is no mechanism available to any central bank to manage an event like that: It just has to wash through the system, with the logical results.
And who's to blame for all this? Nobody. Pogo said it best: "We have met the enemy, and he is us." This is one case where everybody is to blame. And we're all going to have to pay for believing in magic beans.
Cheery prospect, ain't it?
------------------------------
The Private Securities Litigation Reform Act, while not a major cause, is something I have not seen mentioned anywhere. The corporate political machine convinced everybody that securities fraud plaintiffs lawyers were fleecing investors and that legislature should raise the pleading standards for securities class actions - as a result, it became much harder to bring successfully leverage a bona fide class action complaint into a meritorious settlement. The number of filings and the average settlements went down. The government did just stop enforcing the securities laws; it decommissioned the private attorney generals out there who were doing a great job of making it very expensive to defraud the American people.
------------------------------
"McCain voted in favor of this deregulation. Joe Biden and every other democratic senator voted against it."
1. Actually, McCain did not vote for Gramm-Leach-Bliley (GLB), he was on the campaign trail at the time of the vote, so we will never know his position.
2. Joe Biden did vote for GLB, as did Harry Ried, who is also out claiming that GLB is the heart of the problem.
3. Leach, the L in GLB, is an advisor to the Obama campaign.
4. In any case GLB passed 90-8 in the Senate on 11/4/1999, the House passed it 362-57, and Bill Clinton signed it into law.
If GLB has anything to do with today's problems, and I know of no evidence to support the theory, it is a bipartisan creation.
------------------------
I think the reasons for mass failures of financial institutions in developed world are:
1. Agency issues:
a. Rewarding somebody immediately for creating a long-term liability for an institution. In ideal world, the reward payout plan should reflect the term of liability.
b. BIS II regime, which allows banks to calculate their own capital requirement
2. Regulator Failures
a. Investment Banks have an incentive to create new markets (read CDS and other derivatives) and keep those markets away from public regulation. It is a job of a regulator to bring transperancy and efficient "entity neutral" price finding and settlement systems in a new every market which finds wide acceptance
b. Unified regulation of entities playing across multiple traditional roles of commercial banks, investment banks and insurers
c. All financial market regulators needed to be subservient to the monetary policy (Central Banking) authority
3. Lack of Financial Planning
a. If one has short-term funding, one needs to have short-term assets of equivalent maturity, currency and size. An institution which hopes to create wealth by riding yield curve is doomed to fail
b. Control on Leverage. The leverage of institution should be such that the instition should have capital remaining after a synchronized adverse 6-sigma movement in its entire portfolio. (If we can achieve 6-sigma quality in physical world, why we cannot create financial institutions with 6-sigma survival chances, and still make money)
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September 30, 1999
Fannie Mae Eases Credit To Aid Mortgage Lending
By STEVEN A. HOLMES
In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.
The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.
Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.
''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''
Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.
In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.
''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''
Under Fannie Mae's pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000 -- a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped.
Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.
Fannie Mae officials stress that the new mortgages will be extended to all potential borrowers who can qualify for a mortgage. But they add that the move is intended in part to increase the number of minority and low income home owners who tend to have worse credit ratings than non-Hispanic whites.
Home ownership has, in fact, exploded among minorities during the economic boom of the 1990's. The number of mortgages extended to Hispanic applicants jumped by 87.2 per cent from 1993 to 1998, according to Harvard University's Joint Center for Housing Studies. During that same period the number of African Americans who got mortgages to buy a home increased by 71.9 per cent and the number of Asian Americans by 46.3 per cent.
In contrast, the number of non-Hispanic whites who received loans for homes increased by 31.2 per cent.
Despite these gains, home ownership rates for minorities continue to lag behind non-Hispanic whites, in part because blacks and Hispanics in particular tend to have on average worse credit ratings.
In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups.
The change in policy also comes at the same time that HUD is investigating allegations of racial discrimination in the automated underwriting systems used by Fannie Mae and Freddie Mac to determine the credit-worthiness of credit applicants.
Bailout or Not, Credit Will Be Crunched
By SANDRA WARD
Special Report: Where to Put Your Money Now - Don't exhale yet: The credit crunch has only just begun.
THE GOVERNMENT'S SWEEPING FINANCIAL BAILOUT plan may have cheered Wall Street -- but it will take a lot more to lift spirits on Main Street.
The bailout could go a long way in stemming the freefall of financial asset prices, helping to stabilize banks and Wall Street firms. Unfortunately, that won't be enough to truly stoke lending or ease the economic vise that's squeezing American businesses and consumers.
[pic]
Scott Pollack for Barron's
Taking the Economy's Measure: Bank capital remains scarce, businesses are apt to contract, and consumers face both rising unemployment and falling wages.
Bank capital will likely remain scarce, businesses will find it tougher to get financing at the same time demand for their wares fades, and consumers are coming under the twin pressures of rising unemployment and falling wages just as their net worths are declining and their ability to borrow is being crimped.
"The risk is increasing for the state of the economy as we move forward because of the substantial stresses," says A. Marshall Acuff Jr., chairman of the investment committee of Richmond, Va.-based Cary Street Partners, and formerly U.S. equity strategist at Smith Barney. "There'll be slow growth in the world; it won't be the end of the world but it will be slow. There'll be no quick fix."
The crumbling of some of the biggest and best known financial institutions in the world in a matter of days is causing jitters throughout American industry. That was clear last week during a conference call arranged by the principals of a $140 billion investment-management firm. One caller, from Boeing, wanted to know how to explain to management what the federal bailout of AIG, once the world's largest insurance company, meant for the giant aerospace company. He was told that Boeing should minimize its own counterparty risk, keep liquidity high and preserve cash flow, especially as the fourth quarter approaches and projections call for record losses at financial institutions.
Another caller, from consulting firm Mercer, wondered about the implications of a long and deep recession. He was told U.S. credit growth could fall as low as 2%, the minimum needed for sustainable economic growth and a level only seen in one decade in the last century: 1930-39.
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The current crisis is as much one of confidence as it is of credit. That prompted moves late last week by the U.S. government to restore order, bolster security and alleviate the stresses in the system by announcing a comprehensive plan to safeguard the banking system, instead of waiting to deal with individual cases on the brink of collapse. Meanwhile, the Federal Reserve and major central banks around the world made billions available to ailing commercial financial institutions aiming to free up credit.
All the same, the growth of world economies is slowing sharply. International Strategy and Investment Group in Manhattan is forecasting 1% growth in U.S. gross domestic product through the first quarter of 2010. Germany is on the edge of a severe recession; a wage price spiral is unfolding in Eastern Europe; Asian economies are slowing; and declining commodity prices and deteriorating growth in developed markets are pressuring growth in emerging economies.
Yes, there have been some upbeat signs. The outlook for inflation has improved, the manufacturing sector has picked up, mortgage rates have fallen and energy prices are lower (See story on oil prices). The problem is, it's not enough.
"This is not the end of the credit crunch -- the credit crunch is just beginning," asserts Larry Jeddeloh, publisher of the Market Intelligence Report and founder and chief investment officer of Minneapolis-based TIS Group, an independent research service. "What we have seen thus far are just the first signs of deleveraging at the banks, the consumer level and among corporations. Savings are in. Consumption based on leverage is going out of favor." And he adds: "If you think Wal-Mart and the Dollar Menu at McDonald's rule the roost now, wait a few years... Saving and reducing debt and value shopping are the new trends."
ALREADY, YEAR-OVER-YEAR growth in nonfinancial credit-market debt collapsed to a 3.5% seasonally adjusted annual rate in the second quarter from 9.1% in the third-quarter of 2007, according to the calculations of economists John Ryding and Conrad DeQuadros, founders of RDQ Economics.
Household credit growth is at its lowest level since 1970 and the rate of growth of household liabilities slowed to 3.9%, the lowest growth rate since the fourth quarter of 1970. Yet, as a share of net worth, household liabilities rose to a record high of 25.9%, according to Ryding and DeQuadros.
"It's the consumer's turn to go through a restructuring," says Nancy Lazar, vice chairwoman and economist at Manhattan's ISI Group. "The lack of credit availability combined with a decline in net worth and cyclical forces are creating the beginnings of a sustained slowdown in the U.S. consumer."
That, in turn, will have severe implications for emerging economies, which have become the world's suppliers of consumer goods.
Lazar expects the consumer savings rate to rise sharply, a development that hasn't occurred in 17 years and will likely trigger a significant and prolonged slump in consumer spending, which represents two-thirds of the U.S. economy.
Lazar expects the consequences of this to be most severe for retailers -- we are potentially "overretailed" and "internationally oversupplied," she says. And she is most concerned about non-durable, heavily discretionary areas such as travel, entertainment, casinos and luxury goods because durable goods, such as autos and furniture, have already been hit hard.
"We're on the downside of the credit boom," says Jeremy Grantham, co-founder and chairman of Boston-based investment manager GMO with $120 billion under management. "Acquiring leverage for any purpose will be made harder."
For the first time, he points out, a global credit crisis has coincided with asset prices that have been overpriced around the world and that will exacerbate the problem.
"There'll be a material slowdown in global growth," he says, and "this is going to echo around for a long time."
Real-estate prices have peaked, energy and commodity prices have peaked, and financial assets have peaked.
The Bottom Line
U.S. gross domestic product may grow by just 1% through the first quarter of 2010, by one estimate. Germany is on the edge of recession and Asian economies are slowing.
One notable exception has been the art market. Indeed, in a two-day period last week, as some of the world's mightiest financial firms fell by the wayside, Sotheby's held a record-shattering, single-artist auction of 223 works done in the past two years by London's Damien Hirst.
The auction, titled Beautiful Inside My Head Forever, brought $200.7 million, well above the auction house's high estimate of $177.6 million. While Americans were missing from the bidding, the Russians were out in force as were collectors from the Middle East and Asia.
But, don't be surprised if the auction proves to be the peak in the art market, says Grantham, just as Sam Zell's sale of Equity Office Properties in early 2007 to Blackstone Group marked the top of the real-estate market and Blackstone Group's subsequent initial public offering was the beginning of the end for the private-equity boom.
The Hirst auction, notes Grantham, in retrospect might become known as "the Hirst peak," in which the price paid for the works will, indeed, be beautiful only to Hirst and Sotheby's.
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The Pain of Deleveraging Will Be Deep and Wide
Felix Zulauf, Founder, Zulauf Asset Management
By LAWRENCE C. STRAUSS
AN INTERVIEW WITH FELIX ZULAUF: A bleak long-term view on stocks.
AS THE CREDIT CRISIS INTENSIFIED LAST WEEK, radically altering the Wall Street landscape and the government's role in stabilizing the financial system, Barron's sought out Switzerland-based Felix Zulauf for a global macro perspective. A longtime member of Barron's Roundtable, the founder of Zulauf Asset Management is now equity-averse -- he prefers gold and government bonds -- but further out, sees untapped growth potential in emerging-markets.
[pic]
Gary Spector
Barron's: It's been an unprecedented time in the financial markets, with Lehman filing for bankruptcy protection, Merrill Lynch being bought by Bank of America and AIG getting rescued by the U.S. government. What's the fallout going to be?
Zulauf: The leveraging-up in this cycle is reversing, and we are now deleveraging. When a huge system -- that is, the global credit system dominated by the investment-bank giants that have been the major creators of credit in the last cycle -- turns down, the fallout is going to be terrible.
Deleveraging is a very painful process, and will run longer and deeper than anybody can imagine. I've been fearful of this.
So far, what we're seeing is the pain in the financial system. Later on, we'll see the echo effect of the pain in the real economy. I can't understand economists talking about no recession or mild recession. This is the worst financial crisis since the 1930s. It's different than the '30s, but is the worst since then, and the consequences will be very, very painful for virtually everybody in our economies.
So it's a global downturn?
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That's right. It started out in the U.S., but it is a global event, led by the [excessive lending practices that grew up in the] housing boom in the U.S. But we also had housing booms in some of the European countries, and in some of the emerging countries. People are already talking about a glut of unsold homes in China.
How will these countries fight this severe downturn?
Governments, particularly those in the industrialized economies, will use fiscal stimuli to prop up the system and prevent them from collapsing. Usually, those stimuli are a little too small to really have a lasting impact, which is usually spent after two to three quarters. So we could have a pop in the market in '09 and the economy into 2010, and then it disappears again; then there is the next fiscal program, and so on. That can go on for a long time.
By issuing more debt, all of these governments are trying to stimulate deteriorating economies. But what do you see as some of the other consequences of all that additional debt?
Government debt is going to rise dramatically over the next five to 10 years. Government debt is at 300% of [gross domestic product] in most industrialized countries, if you calculate correctly. That can increase to 400% and 500%, but at some point the government-bond market will not take this without any consequences. That will lead to rising long-term interest rates. But because the economy is not on solid footing yet, short-term rates will stay low for a long time. So you will have a very steep yield curve for many, many years, and this is bearish for bonds since their prices keep falling.
What's your take on the inflation outlook?
Most governments and central bankers are still concerned about the inflation rate. I think for cyclical reasons that inflation will probably drop sharply into '09, partly due to lower commodity prices. But what's more important thereafter is that there will be a secular rise of the inflation rate, because governments and central bankers will be forced to reflate these economies in a big, big way, and this will be bad for nominal assets, whose value decreases because of less purchasing power. But it will be good for real assets at some point of time in the future. For example, companies can adjust by raising their prices and growing their incomes.
What does all of this deleveraging, in which firms try to get various forms of debt off their balance sheet, mean for those involved?
When the deleveraging starts due to declining asset prices, there is no one there to reverse it. I cannot see the private sector stopping this and turning it around. It has to be the government, together with the central banks, and they are starting to do that.
What's your assessment of the steps Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Henry Paulson have taken to stem these problems?
It's a challenging job. Bernanke and his team and Treasury are doing the utmost, but doing the utmost means they're always one step behind. So far, it seems that the Fed is constrained by not being able to expand its balance sheet. It has replaced a lot of Treasury paper with other paper of lower quality, and the level of Treasury paper on the Fed's balance sheet has now reached such a low point that it cannot expand more without really monetizing debt.
You can't stop this [downturn] or turn it around without going to monetization, a step the central bank hesitates to take. But eventually the developments will force the Fed to do it.
What's your reaction to Friday's announcement that Paulson is crafting a plan for the federal government to buy illiquid assets from various financial firms?
Treasury, together with the Fed, is taking a big step forward to keep the system from melting down. It will work, but it has to be at least $1 trillion in size and the Fed has to help by cutting rates. The idea is good; now the Treasury has to make it solid and the Fed has to lend its support. This is probably the beginning of a medium-term bottom. Usually a good bottom, even medium term, doesn't stand on one leg. In the coming three or four weeks, the low will be tested, but from there we have a chance for a good medium-term rally.
Could you elaborate?
What the Fed has to do is buy paper in the asset market, including Treasuries and corporate bonds, and create new money in the financial system -- because the deflationary process created by the deleveraging is at work. Deflationary power is growing dramatically, and the Fed has to replace the dollars that have disappeared into a black hole. The private credit system cannot do that anymore. The Fed and government are really the lenders of last resort.
From your vantage point, what do you see happening to the Eurozone's economy?
Short term, it will probably get a little bit worse in Europe, because we have a different policy mix than in the U.S. Your central bank has cut rates. They've been aware of the problem. The fiscal situation is expansive already, whereas in Europe we have tightening fiscal policy, and we have still a restrictive central bank that's looking at holding the value of the euro. So Europe could get hurt a little more than the U.S. in the short term, but I think it will do better over the medium term.
Why is that?
First of all, Europe can finance itself, meaning it's not dependent on outside money. It runs a slight current-account surplus and, net-net, it is not indebted to the rest of the world. The U.S. is indebted to the rest of the world; that's a major difference. Also, Eurozone households [collectively] run a financial surplus, while U.S. households have deficits. So when you look at the large European economies such as those in Germany or France, the consumer is in much better shape and the banks are probably in a little bit better shape than in the U.S., although some internationally active banks and investment banks are like their U.S. competitors.
What about emerging-market economies?
Even emerging economies are getting hurt. We have seen how real-estate prices in some emerging economies, from the Baltic States to some Asian countries, are coming down. But these countries have a better situation from a very, very long-term point of view because of demographics. They are much younger nations. They are much lower in their standard of living, they are going up the ladder, and they are competitive.
Another thing to consider is that current-account and trade deficits will shrink. So what used to be a big stimulus for emerging economies will be curtailed and it will hurt those economies in the short run much more than the markets assume.
What do you see ahead for the U.S. economy and elsewhere?
The U.S. economy goes flat for several years, and from time to time there probably will be major fiscal programs, each one bigger than the previous one, to help the economy. Europe will be similar; its potential growth is relatively low, with a stagnating population.
The emerging economies have much higher potential growth rates. They are going through a down-cycle, but they will come up again in the next cycle and have higher growth rates. But it is going to be a very tough 2009, a global recession. Whoever gets elected president in November will come through with a fiscal program. Monetary policy is really ineffective in this situation. When you have a balance-sheet recession and everybody is deleveraging, monetary policy cannot do the trick. It doesn't work because there is no one willing to leverage up their own balance sheet.
Around these parts there has been a lot of focus on Merrill, Lehman and AIG, not to mention Fannie Mae and Freddie Mac, which the U.S. government bailed out recently. What does the future hold for financial firms globally?
Bankers have to learn that banking is an industry like any other industry. The financial sector has grown dramatically over recent decades, and I think it has grown to a level that is too big in proportion to total GDP.
Global financial-sector debt has gone up fivefold in the last 25 years relative to GDP. So what you now see is a reversal back to the mean. That means that the financial sector as a profit generator, as an employer and as a provider of services will shrink over many years -- back to a level that is more normal than in recent years. The financial-services industry has been treated extremely well for a long time and people made a lot of money and created careers, etc. But it is going to be much, much tougher in the next 10 years globally.
Do you see any industries that look promising at the macro level?
First, we go through a down-cycle, and it will affect virtually every industry. After that down-cycle is over, particularly in the emerging economies that have higher growth potential, it will turn up again. It could again be infrastructure-related assets or commodity-related assets that will perform very well. If I'm right in this scenario, what will happen is we will create a stimulus to grow in the future. And those who grow the best in a world of stimuli will be those that have the highest growth potential, namely the emerging economies. And then we will see rising bond yields. They will go in cycles, of course, and they will not shoot up straight. But they will go up.
What investments look interesting to you?
In this environment, those who do not lose win. For the average guy, I'd say go into the most defensive position. I'm not really interested in any longs in equities. I'm holding a lot of government bonds on the long side. I suggest that American investors stick to shorter-term Treasuries with maturities of up to two years.
Any other suggestions for equity holdings?
If you have extra money left and want to be more aggressive, you can play the markets short-term. There are going to be a lot of runs up and down in a declining market.
This is all sounds very bleak, Felix.
I'm not interested in any longs in equities. If you are an optimist by nature and if you want to be long, the one area that you should look at is daily necessities, notably consumer staples. Companies like Procter & Gamble [ticker: PG], General Mills [GIS] and maybe Johnson & Johnson [JNJ]. Those are the defensive names. But I have absolutely no interest in investing on the long side in anything that is cyclical in nature, because this cycle could last longer on the downside and go deeper than most investors assume.
Thanks very much.
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The Broken Buck Stops Here -- or Does It?
By TOM SULLIVAN
Not-so-safe money funds.
WALL STREET TOLD US AUCTION-RATE SECURITIES WERE just like money-market funds but with bigger yields. They also told us money-market funds were just like cash. What's next? The check's in the mail?
Well, sort of, but it's from the federal government, not the Street.
Treasury Secretary Henry Paulson on Friday played the role of white knight for the $3.4 trillion money-market-fund industry, which was looking like the next financial domino to fall. As part of a broad plan to ease the credit-crisis contagion, he announced a temporary guaranty program for the U.S. money-market mutual-fund industry, the gold standard for bond investors wanting safety, liquidity and yield.
The industry was rocked earlier in the week after the then-$62 billion Reserve Primary Fund said its net asset value fell below the all-important $1-per-share level, hurt by the now bankrupt Lehman Brothers debt it owns. That's called breaking the buck. Investors are getting 97 cents a share.
"It was a seminal event because the fund was so big and it breaks a solemn pledge that owning shares of a money- market fund is as good as cash," says Don Phillips, managing director at Morningstar.
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Ironically, the Reserve Fund's manager is veteran Bruce Bent, the creator of money-market funds and critic of many of his peers for taking on too much risk. He didn't return Barron's call.
His many peers wasted little time assuring clients their investments were safe. Fidelity, Vanguard, BlackRock and others posted notes on their Websites saying their money funds have no exposure to Lehman. But Putnam closed and will distribute the assets of the $12.3 billion institutional Putnam Prime Money Market Fund because of a surge in redemptions. And, oddly, it said it has no exposure to Lehman, AIG (ticker: AIG) or Washington Mutual (WM).
In all, money-fund assets fell by a record $89.38 billion in the week through last Tuesday, with institutions withdrawing $93.57 billion while individual investors added $4.19 billion, according to the Money Fund Report, published by iMoneyNet. Institutional investors are very nimble and quick on the trigger while individual investors are a bit slower to respond, said Connie Bugbee, managing editor at iMoneyNet.
"Money funds are only as safe as people think they are," says Lance Pan, director of credit research at Capital Advisors Group. "If people believe they're unsafe, they'll pull out, creating a cascading effect," he adds.
Paulson has put his finger in the dike.
The actions "will go a long way toward...building investor confidence after a period of extraordinary turmoil that has affected money market mutual funds" and others, said Paul Schott Stevens, CEO of Investment Company Institute, a mutual fund trade group, in a news release.
What's next? Congress has to pass on the rescue package. And, yes, Wall Street will still respect you in the morning.
[cash]
Whipsawed Money: Equity funds' net inflows averaged a weekly $753 million for the four weeks ended Wednesday, reports AMG. Money funds had net outflows averaging $33 billion. Taxable bond funds drew a weekly $1.56 billion. Muni funds averaged $692 million in inflows.
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Week of the Living Dead
By THOMAS G. DONLAN
Is the rescue "Bernanke's Blunder" in the making?
SOME ARE BORN TO MANAGE AMERICAN FINANCIAL COMPANIES; some achieve management of American financial companies; some have the entire industry thrust upon them. Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson must see themselves in the third category this weekend after taking over responsibility for a trillion dollars or so of bad debts.
Actually, the amount of liabilities are unknown, possibly unknowable. The pack of banks and private-capital firms that turned on American International Group last week could attest to that. In only a couple of days of free access to the books, they found unfunded liabilities mismatched with unpriced assets for a vulnerability reaching nobody-knew-how-far beyond $80 billion. They wouldn't risk their capital against AIG's liabilities, knowing that the books of many other financial firms, possibly including their own, would look no better.
Only the federal government could perform a rescue, and it stepped up last week. But should the Federal Reserve, the Treasury and the Securities and Exchange Commission insure everyone in Wall Street?
Certainly not. The federal government is usurping the legitimate functions of its own bankruptcy judges. If financial companies are insolvent, let the creditors fight over the corpses in court.
Unknowable Unknowns
The dangers, as Bernanke and Paulson see them, are in the liabilities. Who knows where they might lead? They include AIG's obligations to pay off credit-default swaps -- private contracts in which AIG promised to support billions of dollars of bonds if their issuers defaulted. These were developed to comfort speculators and make them believe they were investing.
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It was a delusion: At the worst, credit-default swaps on Lehman Brothers Holding still were quoted at about 5% of the face value of the bonds being protected less than five days before the firm went under. It was like selling flood insurance on Galveston Island, while Hurricane Ike was in the Gulf of Mexico.
Credit-default swaps created a nation of speculators who don't want to take their losses. The financial establishment has been afraid to start unwinding these swaps. They know that when you pull on a loose bit of yarn dangling from a sweater, you never know how much sweater you will have left at the end. So the government is buying the sweater. As President Bush declared in the Rose Garden Friday, "These are risks America cannot afford to take." Too bad. The risks have already been taken. Now: Can America afford to cover its bets?
Federal Resuscitation Board
Bernanke is sometimes described as the world's leading expert on the mistakes that the Fed made after October 1929. He is determined not to make those mistakes, so much so that he vowed years ago to distribute $100 bills by helicopter if it would avert deflation. The weeks just past prove that he will make his own mistakes.
Consider AIG: The Fed has given AIG an $85 billion line of credit, and AIG has supplied the Fed with collateral in the form of newly printed stock warrants. AIG is a zombie walking among the living. Shareholders are reduced to shadows of their former selves.
No sooner done for AIG than done for the rest of the world: The Fed also increased the supply of dollars for foreign markets and central banks. The message: The Fed and its fellow central banks will print money until the cows come home. No big borrower will be left in pain, no big lender left unsaved.
Then Friday, the SEC ordered an end to pessimism: No one may sell the financial system short until further notice -- which will not be given until the storm clouds pass, if ever. No one should profit from falling stock prices and that's supposed to help them rise.
Finally, the Treasury restored confidence by guaranteeing money-market mutual funds and ordaining a happy ending to the mortgage mess. It told Fannie Mae and Freddie Mac to buy more mortgages -- as if they don't have too many now. The Treasury, meanwhile, will purchase mortgage-backed securities, including those backed by mortgages well on the way to default. Even worse paper, which existing safety regulations would prohibit any agency or bank from holding, will be snarfed up by a new agency.
Unfortunately, this is how we got into this mess. Banks lent more money than they should have to people who were borrowing more money than they should have, mostly on the strength of the idea that real estate would appreciate enough to cover up any problems.
As it came to pass that everyone who could afford a house already had one, or more than one, so it may turn out that everyone who wants dollars already has more than enough of them.
The Worst Kind of Help
Listen carefully to the cries of "chaos" on Wall Street: Some of those shouting loudest are trying to make others pay for bankers' and borrowers' mistakes. Finding no others willing to step up, the Fed and Treasury are becoming the nation's stand-in speculators.
The Treasury will borrow to buy mortgages and the Fed will print money to buy Treasuries. The danger is that they are igniting a great inflation to stave off a great depression. If so, this week will enshrine President Bush with President Carter, and Ben Bernanke with G. William Miller.
Just as the Weimar Republic printed money to pay war reparations that the Germans couldn't afford, the United States of America is putting its full faith and credit -- until neither remains -- behind mortgages that its citizens can't afford. All investors can do is hope that the ultimate sacrifice of capital destruction won't be necessary.
To avert further capital destruction, it's important to take an audit of the capital that remains. By regulation, by law or by the reasonable demand of investors seeking information, companies should open their books to continuous public scrutiny. Every weekly or daily financial report that would go to the CEO or the CFO also should go out to investors on the company Website.
Shareholders don't get to decide how companies are run, but they should know the results of management and mismanagement as quickly as the managers do. Without such information, they lack the knowledge to help them navigate away from storms.
Editorial Page Editor THOMAS G. DONLAN receives e-mail at tg.donlan@barrons.com.
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--------------------------------
By SANDRA WARD
Special Report: Where to Put Your Money Now - Don't exhale yet: The credit crunch has only just begun.
THE GOVERNMENT'S SWEEPING FINANCIAL BAILOUT plan may have cheered Wall Street -- but it will take a lot more to lift spirits on Main Street.
The bailout could go a long way in stemming the freefall of financial asset prices, helping to stabilize banks and Wall Street firms. Unfortunately, that won't be enough to truly stoke lending or ease the economic vise that's squeezing American businesses and consumers.
[pic]
Scott Pollack for Barron's
Taking the Economy's Measure: Bank capital remains scarce, businesses are apt to contract, and consumers face both rising unemployment and falling wages.
Bank capital will likely remain scarce, businesses will find it tougher to get financing at the same time demand for their wares fades, and consumers are coming under the twin pressures of rising unemployment and falling wages just as their net worths are declining and their ability to borrow is being crimped.
"The risk is increasing for the state of the economy as we move forward because of the substantial stresses," says A. Marshall Acuff Jr., chairman of the investment committee of Richmond, Va.-based Cary Street Partners, and formerly U.S. equity strategist at Smith Barney. "There'll be slow growth in the world; it won't be the end of the world but it will be slow. There'll be no quick fix."
The crumbling of some of the biggest and best known financial institutions in the world in a matter of days is causing jitters throughout American industry. That was clear last week during a conference call arranged by the principals of a $140 billion investment-management firm. One caller, from Boeing, wanted to know how to explain to management what the federal bailout of AIG, once the world's largest insurance company, meant for the giant aerospace company. He was told that Boeing should minimize its own counterparty risk, keep liquidity high and preserve cash flow, especially as the fourth quarter approaches and projections call for record losses at financial institutions.
Another caller, from consulting firm Mercer, wondered about the implications of a long and deep recession. He was told U.S. credit growth could fall as low as 2%, the minimum needed for sustainable economic growth and a level only seen in one decade in the last century: 1930-39.
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The current crisis is as much one of confidence as it is of credit. That prompted moves late last week by the U.S. government to restore order, bolster security and alleviate the stresses in the system by announcing a comprehensive plan to safeguard the banking system, instead of waiting to deal with individual cases on the brink of collapse. Meanwhile, the Federal Reserve and major central banks around the world made billions available to ailing commercial financial institutions aiming to free up credit.
All the same, the growth of world economies is slowing sharply. International Strategy and Investment Group in Manhattan is forecasting 1% growth in U.S. gross domestic product through the first quarter of 2010. Germany is on the edge of a severe recession; a wage price spiral is unfolding in Eastern Europe; Asian economies are slowing; and declining commodity prices and deteriorating growth in developed markets are pressuring growth in emerging economies.
Yes, there have been some upbeat signs. The outlook for inflation has improved, the manufacturing sector has picked up, mortgage rates have fallen and energy prices are lower (See story on oil prices). The problem is, it's not enough.
"This is not the end of the credit crunch -- the credit crunch is just beginning," asserts Larry Jeddeloh, publisher of the Market Intelligence Report and founder and chief investment officer of Minneapolis-based TIS Group, an independent research service. "What we have seen thus far are just the first signs of deleveraging at the banks, the consumer level and among corporations. Savings are in. Consumption based on leverage is going out of favor." And he adds: "If you think Wal-Mart and the Dollar Menu at McDonald's rule the roost now, wait a few years... Saving and reducing debt and value shopping are the new trends."
ALREADY, YEAR-OVER-YEAR growth in nonfinancial credit-market debt collapsed to a 3.5% seasonally adjusted annual rate in the second quarter from 9.1% in the third-quarter of 2007, according to the calculations of economists John Ryding and Conrad DeQuadros, founders of RDQ Economics.
Household credit growth is at its lowest level since 1970 and the rate of growth of household liabilities slowed to 3.9%, the lowest growth rate since the fourth quarter of 1970. Yet, as a share of net worth, household liabilities rose to a record high of 25.9%, according to Ryding and DeQuadros.
"It's the consumer's turn to go through a restructuring," says Nancy Lazar, vice chairwoman and economist at Manhattan's ISI Group. "The lack of credit availability combined with a decline in net worth and cyclical forces are creating the beginnings of a sustained slowdown in the U.S. consumer."
That, in turn, will have severe implications for emerging economies, which have become the world's suppliers of consumer goods.
Lazar expects the consumer savings rate to rise sharply, a development that hasn't occurred in 17 years and will likely trigger a significant and prolonged slump in consumer spending, which represents two-thirds of the U.S. economy.
Lazar expects the consequences of this to be most severe for retailers -- we are potentially "overretailed" and "internationally oversupplied," she says. And she is most concerned about non-durable, heavily discretionary areas such as travel, entertainment, casinos and luxury goods because durable goods, such as autos and furniture, have already been hit hard.
"We're on the downside of the credit boom," says Jeremy Grantham, co-founder and chairman of Boston-based investment manager GMO with $120 billion under management. "Acquiring leverage for any purpose will be made harder."
For the first time, he points out, a global credit crisis has coincided with asset prices that have been overpriced around the world and that will exacerbate the problem.
"There'll be a material slowdown in global growth," he says, and "this is going to echo around for a long time."
Real-estate prices have peaked, energy and commodity prices have peaked, and financial assets have peaked.
The Bottom Line
U.S. gross domestic product may grow by just 1% through the first quarter of 2010, by one estimate. Germany is on the edge of recession and Asian economies are slowing.
One notable exception has been the art market. Indeed, in a two-day period last week, as some of the world's mightiest financial firms fell by the wayside, Sotheby's held a record-shattering, single-artist auction of 223 works done in the past two years by London's Damien Hirst.
The auction, titled Beautiful Inside My Head Forever, brought $200.7 million, well above the auction house's high estimate of $177.6 million. While Americans were missing from the bidding, the Russians were out in force as were collectors from the Middle East and Asia.
But, don't be surprised if the auction proves to be the peak in the art market, says Grantham, just as Sam Zell's sale of Equity Office Properties in early 2007 to Blackstone Group marked the top of the real-estate market and Blackstone Group's subsequent initial public offering was the beginning of the end for the private-equity boom.
The Hirst auction, notes Grantham, in retrospect might become known as "the Hirst peak," in which the price paid for the works will, indeed, be beautiful only to Hirst and Sotheby's.
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The Pain of Deleveraging Will Be Deep and Wide
Felix Zulauf, Founder, Zulauf Asset Management
By LAWRENCE C. STRAUSS
AN INTERVIEW WITH FELIX ZULAUF: A bleak long-term view on stocks.
AS THE CREDIT CRISIS INTENSIFIED LAST WEEK, radically altering the Wall Street landscape and the government's role in stabilizing the financial system, Barron's sought out Switzerland-based Felix Zulauf for a global macro perspective. A longtime member of Barron's Roundtable, the founder of Zulauf Asset Management is now equity-averse -- he prefers gold and government bonds -- but further out, sees untapped growth potential in emerging-markets.
[pic]
Gary Spector
Barron's: It's been an unprecedented time in the financial markets, with Lehman filing for bankruptcy protection, Merrill Lynch being bought by Bank of America and AIG getting rescued by the U.S. government. What's the fallout going to be?
Zulauf: The leveraging-up in this cycle is reversing, and we are now deleveraging. When a huge system -- that is, the global credit system dominated by the investment-bank giants that have been the major creators of credit in the last cycle -- turns down, the fallout is going to be terrible.
Deleveraging is a very painful process, and will run longer and deeper than anybody can imagine. I've been fearful of this.
So far, what we're seeing is the pain in the financial system. Later on, we'll see the echo effect of the pain in the real economy. I can't understand economists talking about no recession or mild recession. This is the worst financial crisis since the 1930s. It's different than the '30s, but is the worst since then, and the consequences will be very, very painful for virtually everybody in our economies.
So it's a global downturn?
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That's right. It started out in the U.S., but it is a global event, led by the [excessive lending practices that grew up in the] housing boom in the U.S. But we also had housing booms in some of the European countries, and in some of the emerging countries. People are already talking about a glut of unsold homes in China.
How will these countries fight this severe downturn?
Governments, particularly those in the industrialized economies, will use fiscal stimuli to prop up the system and prevent them from collapsing. Usually, those stimuli are a little too small to really have a lasting impact, which is usually spent after two to three quarters. So we could have a pop in the market in '09 and the economy into 2010, and then it disappears again; then there is the next fiscal program, and so on. That can go on for a long time.
By issuing more debt, all of these governments are trying to stimulate deteriorating economies. But what do you see as some of the other consequences of all that additional debt?
Government debt is going to rise dramatically over the next five to 10 years. Government debt is at 300% of [gross domestic product] in most industrialized countries, if you calculate correctly. That can increase to 400% and 500%, but at some point the government-bond market will not take this without any consequences. That will lead to rising long-term interest rates. But because the economy is not on solid footing yet, short-term rates will stay low for a long time. So you will have a very steep yield curve for many, many years, and this is bearish for bonds since their prices keep falling.
What's your take on the inflation outlook?
Most governments and central bankers are still concerned about the inflation rate. I think for cyclical reasons that inflation will probably drop sharply into '09, partly due to lower commodity prices. But what's more important thereafter is that there will be a secular rise of the inflation rate, because governments and central bankers will be forced to reflate these economies in a big, big way, and this will be bad for nominal assets, whose value decreases because of less purchasing power. But it will be good for real assets at some point of time in the future. For example, companies can adjust by raising their prices and growing their incomes.
What does all of this deleveraging, in which firms try to get various forms of debt off their balance sheet, mean for those involved?
When the deleveraging starts due to declining asset prices, there is no one there to reverse it. I cannot see the private sector stopping this and turning it around. It has to be the government, together with the central banks, and they are starting to do that.
What's your assessment of the steps Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Henry Paulson have taken to stem these problems?
It's a challenging job. Bernanke and his team and Treasury are doing the utmost, but doing the utmost means they're always one step behind. So far, it seems that the Fed is constrained by not being able to expand its balance sheet. It has replaced a lot of Treasury paper with other paper of lower quality, and the level of Treasury paper on the Fed's balance sheet has now reached such a low point that it cannot expand more without really monetizing debt.
You can't stop this [downturn] or turn it around without going to monetization, a step the central bank hesitates to take. But eventually the developments will force the Fed to do it.
What's your reaction to Friday's announcement that Paulson is crafting a plan for the federal government to buy illiquid assets from various financial firms?
Treasury, together with the Fed, is taking a big step forward to keep the system from melting down. It will work, but it has to be at least $1 trillion in size and the Fed has to help by cutting rates. The idea is good; now the Treasury has to make it solid and the Fed has to lend its support. This is probably the beginning of a medium-term bottom. Usually a good bottom, even medium term, doesn't stand on one leg. In the coming three or four weeks, the low will be tested, but from there we have a chance for a good medium-term rally.
Could you elaborate?
What the Fed has to do is buy paper in the asset market, including Treasuries and corporate bonds, and create new money in the financial system -- because the deflationary process created by the deleveraging is at work. Deflationary power is growing dramatically, and the Fed has to replace the dollars that have disappeared into a black hole. The private credit system cannot do that anymore. The Fed and government are really the lenders of last resort.
From your vantage point, what do you see happening to the Eurozone's economy?
Short term, it will probably get a little bit worse in Europe, because we have a different policy mix than in the U.S. Your central bank has cut rates. They've been aware of the problem. The fiscal situation is expansive already, whereas in Europe we have tightening fiscal policy, and we have still a restrictive central bank that's looking at holding the value of the euro. So Europe could get hurt a little more than the U.S. in the short term, but I think it will do better over the medium term.
Why is that?
First of all, Europe can finance itself, meaning it's not dependent on outside money. It runs a slight current-account surplus and, net-net, it is not indebted to the rest of the world. The U.S. is indebted to the rest of the world; that's a major difference. Also, Eurozone households [collectively] run a financial surplus, while U.S. households have deficits. So when you look at the large European economies such as those in Germany or France, the consumer is in much better shape and the banks are probably in a little bit better shape than in the U.S., although some internationally active banks and investment banks are like their U.S. competitors.
What about emerging-market economies?
Even emerging economies are getting hurt. We have seen how real-estate prices in some emerging economies, from the Baltic States to some Asian countries, are coming down. But these countries have a better situation from a very, very long-term point of view because of demographics. They are much younger nations. They are much lower in their standard of living, they are going up the ladder, and they are competitive.
Another thing to consider is that current-account and trade deficits will shrink. So what used to be a big stimulus for emerging economies will be curtailed and it will hurt those economies in the short run much more than the markets assume.
What do you see ahead for the U.S. economy and elsewhere?
The U.S. economy goes flat for several years, and from time to time there probably will be major fiscal programs, each one bigger than the previous one, to help the economy. Europe will be similar; its potential growth is relatively low, with a stagnating population.
The emerging economies have much higher potential growth rates. They are going through a down-cycle, but they will come up again in the next cycle and have higher growth rates. But it is going to be a very tough 2009, a global recession. Whoever gets elected president in November will come through with a fiscal program. Monetary policy is really ineffective in this situation. When you have a balance-sheet recession and everybody is deleveraging, monetary policy cannot do the trick. It doesn't work because there is no one willing to leverage up their own balance sheet.
Around these parts there has been a lot of focus on Merrill, Lehman and AIG, not to mention Fannie Mae and Freddie Mac, which the U.S. government bailed out recently. What does the future hold for financial firms globally?
Bankers have to learn that banking is an industry like any other industry. The financial sector has grown dramatically over recent decades, and I think it has grown to a level that is too big in proportion to total GDP.
Global financial-sector debt has gone up fivefold in the last 25 years relative to GDP. So what you now see is a reversal back to the mean. That means that the financial sector as a profit generator, as an employer and as a provider of services will shrink over many years -- back to a level that is more normal than in recent years. The financial-services industry has been treated extremely well for a long time and people made a lot of money and created careers, etc. But it is going to be much, much tougher in the next 10 years globally.
Do you see any industries that look promising at the macro level?
First, we go through a down-cycle, and it will affect virtually every industry. After that down-cycle is over, particularly in the emerging economies that have higher growth potential, it will turn up again. It could again be infrastructure-related assets or commodity-related assets that will perform very well. If I'm right in this scenario, what will happen is we will create a stimulus to grow in the future. And those who grow the best in a world of stimuli will be those that have the highest growth potential, namely the emerging economies. And then we will see rising bond yields. They will go in cycles, of course, and they will not shoot up straight. But they will go up.
What investments look interesting to you?
In this environment, those who do not lose win. For the average guy, I'd say go into the most defensive position. I'm not really interested in any longs in equities. I'm holding a lot of government bonds on the long side. I suggest that American investors stick to shorter-term Treasuries with maturities of up to two years.
Any other suggestions for equity holdings?
If you have extra money left and want to be more aggressive, you can play the markets short-term. There are going to be a lot of runs up and down in a declining market.
This is all sounds very bleak, Felix.
I'm not interested in any longs in equities. If you are an optimist by nature and if you want to be long, the one area that you should look at is daily necessities, notably consumer staples. Companies like Procter & Gamble [ticker: PG], General Mills [GIS] and maybe Johnson & Johnson [JNJ]. Those are the defensive names. But I have absolutely no interest in investing on the long side in anything that is cyclical in nature, because this cycle could last longer on the downside and go deeper than most investors assume.
Thanks very much.
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The Broken Buck Stops Here -- or Does It?
By TOM SULLIVAN
Not-so-safe money funds.
WALL STREET TOLD US AUCTION-RATE SECURITIES WERE just like money-market funds but with bigger yields. They also told us money-market funds were just like cash. What's next? The check's in the mail?
Well, sort of, but it's from the federal government, not the Street.
Treasury Secretary Henry Paulson on Friday played the role of white knight for the $3.4 trillion money-market-fund industry, which was looking like the next financial domino to fall. As part of a broad plan to ease the credit-crisis contagion, he announced a temporary guaranty program for the U.S. money-market mutual-fund industry, the gold standard for bond investors wanting safety, liquidity and yield.
The industry was rocked earlier in the week after the then-$62 billion Reserve Primary Fund said its net asset value fell below the all-important $1-per-share level, hurt by the now bankrupt Lehman Brothers debt it owns. That's called breaking the buck. Investors are getting 97 cents a share.
"It was a seminal event because the fund was so big and it breaks a solemn pledge that owning shares of a money- market fund is as good as cash," says Don Phillips, managing director at Morningstar.
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Ironically, the Reserve Fund's manager is veteran Bruce Bent, the creator of money-market funds and critic of many of his peers for taking on too much risk. He didn't return Barron's call.
His many peers wasted little time assuring clients their investments were safe. Fidelity, Vanguard, BlackRock and others posted notes on their Websites saying their money funds have no exposure to Lehman. But Putnam closed and will distribute the assets of the $12.3 billion institutional Putnam Prime Money Market Fund because of a surge in redemptions. And, oddly, it said it has no exposure to Lehman, AIG (ticker: AIG) or Washington Mutual (WM).
In all, money-fund assets fell by a record $89.38 billion in the week through last Tuesday, with institutions withdrawing $93.57 billion while individual investors added $4.19 billion, according to the Money Fund Report, published by iMoneyNet. Institutional investors are very nimble and quick on the trigger while individual investors are a bit slower to respond, said Connie Bugbee, managing editor at iMoneyNet.
"Money funds are only as safe as people think they are," says Lance Pan, director of credit research at Capital Advisors Group. "If people believe they're unsafe, they'll pull out, creating a cascading effect," he adds.
Paulson has put his finger in the dike.
The actions "will go a long way toward...building investor confidence after a period of extraordinary turmoil that has affected money market mutual funds" and others, said Paul Schott Stevens, CEO of Investment Company Institute, a mutual fund trade group, in a news release.
What's next? Congress has to pass on the rescue package. And, yes, Wall Street will still respect you in the morning.
[cash]
Whipsawed Money: Equity funds' net inflows averaged a weekly $753 million for the four weeks ended Wednesday, reports AMG. Money funds had net outflows averaging $33 billion. Taxable bond funds drew a weekly $1.56 billion. Muni funds averaged $692 million in inflows.
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Week of the Living Dead
By THOMAS G. DONLAN
Is the rescue "Bernanke's Blunder" in the making?
SOME ARE BORN TO MANAGE AMERICAN FINANCIAL COMPANIES; some achieve management of American financial companies; some have the entire industry thrust upon them. Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson must see themselves in the third category this weekend after taking over responsibility for a trillion dollars or so of bad debts.
Actually, the amount of liabilities are unknown, possibly unknowable. The pack of banks and private-capital firms that turned on American International Group last week could attest to that. In only a couple of days of free access to the books, they found unfunded liabilities mismatched with unpriced assets for a vulnerability reaching nobody-knew-how-far beyond $80 billion. They wouldn't risk their capital against AIG's liabilities, knowing that the books of many other financial firms, possibly including their own, would look no better.
Only the federal government could perform a rescue, and it stepped up last week. But should the Federal Reserve, the Treasury and the Securities and Exchange Commission insure everyone in Wall Street?
Certainly not. The federal government is usurping the legitimate functions of its own bankruptcy judges. If financial companies are insolvent, let the creditors fight over the corpses in court.
Unknowable Unknowns
The dangers, as Bernanke and Paulson see them, are in the liabilities. Who knows where they might lead? They include AIG's obligations to pay off credit-default swaps -- private contracts in which AIG promised to support billions of dollars of bonds if their issuers defaulted. These were developed to comfort speculators and make them believe they were investing.
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It was a delusion: At the worst, credit-default swaps on Lehman Brothers Holding still were quoted at about 5% of the face value of the bonds being protected less than five days before the firm went under. It was like selling flood insurance on Galveston Island, while Hurricane Ike was in the Gulf of Mexico.
Credit-default swaps created a nation of speculators who don't want to take their losses. The financial establishment has been afraid to start unwinding these swaps. They know that when you pull on a loose bit of yarn dangling from a sweater, you never know how much sweater you will have left at the end. So the government is buying the sweater. As President Bush declared in the Rose Garden Friday, "These are risks America cannot afford to take." Too bad. The risks have already been taken. Now: Can America afford to cover its bets?
Federal Resuscitation Board
Bernanke is sometimes described as the world's leading expert on the mistakes that the Fed made after October 1929. He is determined not to make those mistakes, so much so that he vowed years ago to distribute $100 bills by helicopter if it would avert deflation. The weeks just past prove that he will make his own mistakes.
Consider AIG: The Fed has given AIG an $85 billion line of credit, and AIG has supplied the Fed with collateral in the form of newly printed stock warrants. AIG is a zombie walking among the living. Shareholders are reduced to shadows of their former selves.
No sooner done for AIG than done for the rest of the world: The Fed also increased the supply of dollars for foreign markets and central banks. The message: The Fed and its fellow central banks will print money until the cows come home. No big borrower will be left in pain, no big lender left unsaved.
Then Friday, the SEC ordered an end to pessimism: No one may sell the financial system short until further notice -- which will not be given until the storm clouds pass, if ever. No one should profit from falling stock prices and that's supposed to help them rise.
Finally, the Treasury restored confidence by guaranteeing money-market mutual funds and ordaining a happy ending to the mortgage mess. It told Fannie Mae and Freddie Mac to buy more mortgages -- as if they don't have too many now. The Treasury, meanwhile, will purchase mortgage-backed securities, including those backed by mortgages well on the way to default. Even worse paper, which existing safety regulations would prohibit any agency or bank from holding, will be snarfed up by a new agency.
Unfortunately, this is how we got into this mess. Banks lent more money than they should have to people who were borrowing more money than they should have, mostly on the strength of the idea that real estate would appreciate enough to cover up any problems.
As it came to pass that everyone who could afford a house already had one, or more than one, so it may turn out that everyone who wants dollars already has more than enough of them.
The Worst Kind of Help
Listen carefully to the cries of "chaos" on Wall Street: Some of those shouting loudest are trying to make others pay for bankers' and borrowers' mistakes. Finding no others willing to step up, the Fed and Treasury are becoming the nation's stand-in speculators.
The Treasury will borrow to buy mortgages and the Fed will print money to buy Treasuries. The danger is that they are igniting a great inflation to stave off a great depression. If so, this week will enshrine President Bush with President Carter, and Ben Bernanke with G. William Miller.
Just as the Weimar Republic printed money to pay war reparations that the Germans couldn't afford, the United States of America is putting its full faith and credit -- until neither remains -- behind mortgages that its citizens can't afford. All investors can do is hope that the ultimate sacrifice of capital destruction won't be necessary.
To avert further capital destruction, it's important to take an audit of the capital that remains. By regulation, by law or by the reasonable demand of investors seeking information, companies should open their books to continuous public scrutiny. Every weekly or daily financial report that would go to the CEO or the CFO also should go out to investors on the company Website.
Shareholders don't get to decide how companies are run, but they should know the results of management and mismanagement as quickly as the managers do. Without such information, they lack the knowledge to help them navigate away from storms.
Editorial Page Editor THOMAS G. DONLAN receives e-mail at tg.donlan@barrons.com.
URL for this article:
http://online.barrons.com/
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Diamond and Kashyap on the Recent Financial Upheavals
As an economist, I am supposed to have something intelligent to say about the current financial crisis. To be honest, however, I haven't got the foggiest idea what this all means. So I did what I always do when something related to banking arises: I knocked on the doors of my colleagues Doug Diamond and Anil Kashyap, and asked them for the answers. What they told me was so interesting and insightful that I begged them to write their explanations down for a broader audience. They were kind enough to take the time to do so. In what follows, they discuss what has happened in the financial sector in the last few days, why it happened, and what it means for everyday people.
The F.A.Q.'s of Lehman and A.I.G.
By Douglas W. Diamond and Anil K. Kashyap
A Guest Post
For most of the last 20 years we have been studying banks, monetary policy, and financial crises. So for us the events of the last year have been especially fascinating.
The last 10 days have been the most remarkable period of government intervention into the financial system since the Great Depression. In talking with reporters and our noneconomist friends, we have been besieged with questions about several aspects of these events. Here are a few of the most frequently asked questions with our best answers.
1) What has happened that is so remarkable?
This episode started when the Treasury nationalized Fannie Mae and Freddie Mac on September 8. Their combined assets are over $5 trillion. These firms help guarantee most of the mortgages in the United States. The Treasury only got authority from Congress to take this action in July, and in seeking the authority had insisted that no intervention would be needed.
The Treasury has replaced the management of both companies and will presumably oversee their operation. This decision marked an acknowledgment by the government that the mortgage market and the institutions to make it operate in the U.S. are broken.
On Monday, the largest bankruptcy filing in U.S. history was made by Lehman Brothers. Lehman had over $600 billion in assets and 25,000 employees. (The largest previous filing was WorldCom, whose assets just prior to bankruptcy were just over $100 billion.)
On Tuesday, the Federal Reserve made a bridge loan to A.I.G., the largest insurance company in the world; perhaps best known to most of the world as the shirt sponsor of Manchester United soccer club, A.I.G. has assets of over $1 trillion and over 100,000 employees worldwide. The Fed has the option to purchase up to 80 percent of the shares of A.I.G., is replacing A.I.G.'s management, and is nearly wiping out A.I.G.'s existing shareholders. A.I.G. is to be wound down by selling its assets over the next two years. (Don't worry, Man U will be fine.) The Fed has never asserted its authority to intervene on this scale, in this form, or in a firm so far removed from its own supervisory authority.
2) Why did these things happen?
The common denominator in all three cases was the inability of the firms to retain financing. The reasons, though, differed in each case.
The Fannie and Freddie situation was a result of their unique roles in the economy. They had been set up to support the housing market. They helped guarantee mortgages (provided they met certain standards), and were able to fund these guarantees by issuing their own debt, which was in turn tacitly backed by the government. The government guarantees allowed Fannie and Freddie to take on far more debt than a normal company. In principle, they were also supposed to use the government guarantee to reduce the mortgage cost to the homeowners, but the Fed and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits and squeeze the private sector out of the "conforming" mortgage market. Regardless, many firms and foreign governments considered the debt of Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly.
Fannie and Freddie were weakly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities which were backed by pools of mortgages that did not meet their usual standards. Over the last year, it became clear that their thin capital was not enough to cover the losses on these subprime mortgages. The massive amount of diffusely held debt would have caused collapses everywhere if it was defaulted upon; so the Treasury announced that it would explicitly guarantee the debt.
But once the debt was guaranteed to be secure (and the government would wipe out shareholders if it carried through with the guarantee), no self-interested investor was willing to supply more equity to help buffer the losses. Hence, the Treasury ended up taking them over.
Lehman's demise came when it could not even keep borrowing. Lehman was rolling over at least $100 billion a month to finance its investments in real estate, bonds, stocks, and financial assets. When it is hard for lenders to monitor their investments and borrowers can rapidly change the risk on their balance sheets, lenders opt for short-term lending. Compared to legal or other channels, their threat to refuse to roll over funding is the most effective option to keep the borrower in line.
This was especially relevant for Lehman, because as an investment bank, it could transform its risk characteristics very easily by using derivatives and by churning its trading portfolio. So for Lehman (and all investment banks), the short-term financing is not an accident; it is inevitable.
Why did the financing dry up? For months, short-sellers were convinced that Lehman's real-estate losses were bigger than it had acknowledged. As more bad news about the real estate market emerged, including the losses at Freddie Mac and Fannie Mae, this view spread.
Lehman's costs of borrowing rose and its share price fell. With an impending downgrade to its credit rating looming, legal restrictions were going to prevent certain firms from continuing to lend to Lehman. Other counterparties that might have been able to lend, even if Lehman's credit rating was impaired, simply decided that the chance of default in the near future was too high, partly because they feared that future credit conditions would get even tighter and force Lehman and others to default at that time.
A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments. While its core insurance businesses and other subsidiaries (such as its large aircraft-leasing operation) were doing fine, these contracts, called credit default swaps (C.D.S.'s), were hemorrhaging.
Furthermore, the possibility of further losses loomed if the housing market continued to deteriorate. The credit-rating agencies looking at the potential losses downgraded A.I.G.'s debt on Monday. With its lower credit ratings, A.I.G.'s insurance contracts required A.I.G. to demonstrate that it had collateral to service the contracts; estimates suggested that it needed roughly $15 billion in immediate collateral.
A second problem A.I.G. faced is that if it failed to post the collateral, it would be considered to have defaulted on the C.D.S.'s. Were A.I.G. to default on C.D.S.'s, some other A.I.G. contracts (tied to losses on other financial securities) contain clauses saying that its other contractual partners could insist on prepayment of their claims. These cross-default clauses are present so that resources from one part of the business do not get diverted to plug a hole in another part. A.I.G. had another $380 billion of these other insurance contracts outstanding. No private investors were willing to step into this situation and loan A.I.G. the money it needed to post the collateral.
In the scramble to make good on the C.D.S.'s, A.I.G.'s ability to service its own debt would come into question. A.I.G. had $160 billion in bonds that were held all over the world: nowhere near as widely as the Fannie and Freddie bonds, but still dispersed widely.
In addition, other large financial firms — including Pacific Investment Management Company (Pimco), the largest bond-investment fund in the world — had guaranteed A.I.G.'s bonds by writing C.D.S. contracts.
Given the huge size of the contracts and the number of parties intertwined, the Federal Reserve decided that a default by A.I.G. would wreak havoc on the financial system and cause contagious failures. There was an immediate need to get A.I.G. the collateral to honor its contracts, so the Fed loaned A.I.G. $85 billion.
3) Why did the Treasury and Fed let Lehman fail but rescue Bear Stearns, Fannie Mae, Freddie Mac, and A.I.G.?
We have already explained why Fannie, Freddie, and A.I.G. were supported. In March, Bear Stearns lost its access to credit in almost the same fashion as Lehman; yet Bear was rescued and Lehman was not.
Bear Stearns was bailed out for two reasons. One was that the Fed had very imperfect information about what was going on at Bear. The Fed was not Bear's regulator, the amount of publicly available information was limited, and its staff was not versed in all of the ways in which Bear might have been connected to other parts of the financial system.
The second problem was that Bear's counterparties in many transactions were not prepared for the sudden demise of Bear. A Bear bankruptcy might have triggered a wave of forced selling of collateral that Bear would have given its counterparties. Given the potential chaos that would have resulted from Bear Stearns filing for bankruptcy, the Fed had little choice but to engineer a rescue. In doing so, the Fed argued that the rescue was a rare, perhaps once-in-a-generation, event.
When Bear was rescued, the Fed created a new lending facility to help provide bridge financing to other investment banks. The new lending arrangement was proposed precisely because there were concerns that Lehman and other banks were at risk for a Bear-like run. Since March, the Fed had also studied what to do if this were to happen again; it concluded that if it modified its lending facility slightly, it could withstand a bankruptcy; it made these changes to the lending facility on Sunday night.
Once the Fed had made these changes and determined that it and the others in the market had an understanding of the indirect or "collateral damage" effects of a bankruptcy, it could rely on the protections of the bankruptcy code to stop the run on Lehman, and to sell its operating assets separately from its toxic mortgage-backed assets.
Against this backdrop, if the government had rescued Lehman, it would have repudiated the claim that the Bear rescue was extraordinary; it would have also conceded that in the six months since Bear failed, neither the new facility that it set up nor the other steps to make markets more robust were reliable. Essentially, the Fed and the Treasury would have been admitting that they had lied or were incompetent in stabilizing the financial system — or both.
It was not surprising that they drew the line at helping Lehman. Based on all the publicly available information, this was clearly the right thing to do.
4) I do not work at Lehman or A.I.G. and do not own much stock; why should I care?
The concern for the man on Main Street is not the bankruptcy of Lehman, per se. Rather, it is the collective inability of major financial institutions to find funding.
As their own funding dries up, the remaining financial firms will be much more cautious in extending credit to normal firms and individuals. So even for people whose own circumstances have not much changed, the cost of the credit is going to rise. For an individual or business that falls behind on payments or needs an increase in short-term credit because of the slowing economy, credit will be much harder to obtain than in recent years.
This is going to slow growth. We have not seen this much stress in the financial system since the Great Depression, so we do not have any recent history to rely upon in quantifying the magnitude of the slowdown. A recent educated guess by Jan Hatzius of Goldman Sachs suggests that G.D.P. growth will be just about 2 percentage points lower in 2008 and 2009. But as he explains, extrapolations of this sort are highly uncertain.
5) What does it mean for the Fed and Treasury going ahead?
A reasonable reading of the recent bailouts suggests a simple rule: if a firm is on the verge of collapse and its ties to the financial system will lead to a cascade of chaos, the firm will be saved. A bankruptcy will be permitted only if the failure can be contained.
Assuming the level of chaos is sufficiently high, this dichotomy is probably consistent with the mandate of the Federal Reserve. The rescue of A.I.G., however, raises some major challenges.
One is where to draw the line. A.I.G. was an insurance company, not a bank or a broker dealer, so the Fed had no special relationship with A.I.G. Presumably, if a very large airline or automaker had been involved in the C.D.S. market, the same reasoning that led to the rescue would apply.
A second challenge comes with defining the acceptable level of chaos. We will never be able to find out what would have happened if A.I.G. had been allowed to fail. Furthermore, there are some reasons to believe that even if A.I.G. continues to operate, the fundamental stress in the financial system will remain. If the rescue does not mark a turning point, the bailout may be viewed quite differently down the road.
Should the government intervene if it merely postpones an inevitable adjustment? Creditor runs can make adjustment too fast; blanket bailouts can make adjustment too slow. Has the Fed found the speed that is just right?
Third, now that A.I.G. has been lent to, how will regulation have to be adjusted? Surely the Fed cannot be called upon to provide backstop financing whenever a large member of the financial system runs into trouble. How does it prevent a replay of this scenario, and can it be done without stifling innovation?
6) What does this mean for the markets going ahead?
Letting Lehman go means that the remaining large financial services firms now must understand that they need to manage their own risks more carefully. This includes both securing adequate funding and being prudent about which counterparties to rely upon. Both of these developments are welcome.
If the remaining investment banks, Goldman Sachs and Morgan Stanley, do not get more secure funding in place, they may be acquired or subject to a run too. In the current environment, relying almost exclusively on short-term debt is hazardous, even if a firm or bank has nothing wrong with it.
7) When will the turmoil end?
The inability to secure short-term funding fundamentally comes from having insufficient capital. There are many indicators that the largest financial institutions are collectively short of capital.
One signal is that there were apparently only two bidders for Lehman, when the ongoing value from operating most of the bank was surely far above the $3.60 share price from Friday. Another is the elevated cost of borrowing that banks are charging each other. A third indicator is the reluctance to take on certain types of risk, such as jumbo mortgages, so that the cost of this type of borrowing is unusually high.
The fear of being the next Lehman ought to convince many of the large institutions that, despite however much they already raised, more is needed. It may be expensive to attract more equity financing, but the choice may be bankruptcy or sale. The decision by the Federal Reserve to not cut interest rates suggests the Fed also recognizes that the short-term interest rate is a very inefficient way to address this problem.
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Cash for Trash
By PAUL KRUGMAN
Some skeptics are calling Henry Paulson's $700 billion rescue plan for the U.S. financial system "cash for trash." Others are calling the proposed legislation the Authorization for Use of Financial Force, after the Authorization for Use of Military Force, the infamous bill that gave the Bush administration the green light to invade Iraq.
There's justice in the gibes. Everyone agrees that something major must be done. But Mr. Paulson is demanding extraordinary power for himself — and for his successor — to deploy taxpayers' money on behalf of a plan that, as far as I can see, doesn't make sense.
Some are saying that we should simply trust Mr. Paulson, because he's a smart guy who knows what he's doing. But that's only half true: he is a smart guy, but what, exactly, in the experience of the past year and a half — a period during which Mr. Paulson repeatedly declared the financial crisis "contained," and then offered a series of unsuccessful fixes — justifies the belief that he knows what he's doing? He's making it up as he goes along, just like the rest of us.
So let's try to think this through for ourselves. I have a four-step view of the financial crisis:
1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.
2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.
3. Because financial institutions have too little capital relative to their debt, they haven't been able or willing to provide the credit the economy needs.
4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the "paradox of deleveraging."
The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets, mainly mortgage-backed securities. How does this resolve the crisis?
Well, it might — might — break the vicious circle of deleveraging, step 4 in my capsule description. Even that isn't clear: the prices of many assets, not just those the Treasury proposes to buy, are under pressure. And even if the vicious circle is limited, the financial system will still be crippled by inadequate capital.
Or rather, it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense. Did I mention that I'm not happy with this plan?
The logic of the crisis seems to call for an intervention, not at step 4, but at step 2: the financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don't go to the people who made the mess in the first place.
That's what happened in the savings and loan crisis: the feds took over ownership of the bad banks, not just their bad assets. It's also what happened with Fannie and Freddie. (And by the way, that rescue has done what it was supposed to. Mortgage interest rates have come down sharply since the federal takeover.)
But Mr. Paulson insists that he wants a "clean" plan. "Clean," in this context, means a taxpayer-financed bailout with no strings attached — no quid pro quo on the part of those being bailed out. Why is that a good thing? Add to this the fact that Mr. Paulson is also demanding dictatorial authority, plus immunity from review "by any court of law or any administrative agency," and this adds up to an unacceptable proposal.
I'm aware that Congress is under enormous pressure to agree to the Paulson plan in the next few days, with at most a few modifications that make it slightly less bad. Basically, after having spent a year and a half telling everyone that things were under control, the Bush administration says that the sky is falling, and that to save the world we have to do exactly what it says now now now.
But I'd urge Congress to pause for a minute, take a deep breath, and try to seriously rework the structure of the plan, making it a plan that addresses the real problem. Don't let yourself be railroaded — if this plan goes through in anything like its current form, we'll all be very sorry in the not-too-distant future.
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In a SPIEGEL interview, Harvard academic and former International Monetary Fund chief economist Kenneth Rogoff, 55, discusses Wall Street's never-ending crisis. The New York Stock Exchange: "You just can't make money out of think air like this." Kenneth Rogoff: It's the worst financial crisis since World War II -- there's really no hyperbole anymore. At the same time, it had to happen. The US financial system was bloated and overgrown and reckless to some extent. Now it is being reigned in. SPIEGEL: What went wrong? Rogoff: In 2006, the financial sector accounted for a third of corporate profits in the US, although it only represents 2 or 3 percent of total gross domestic product. Goldman Sachs alone distributed $16.5 billion in bonuses to its 26,000 employees. I'm sorry, I think it's unbelievable. You can't just make money out of thin air like this, and underlaying this there were enormous risks being taken. SPIEGEL: What do you think willl happen now? Rogoff: What we're seeing is a shrinking industry -- perhaps by 20 or 25 percent and in some segments perhaps as much as 50 percent. But these finance products based on fancy rocket science and derivatives just aren't coming back, and that's very painful. The industry is not going to make the same profits in the future as it did in the past. And this isn't just about subprime and mortgage losses. Investors are starting to realize that the profit model these investment banks were running on has been trimmed. Former IMF chief economist Rogoff: "There are so many people to blame for what happened." Rogoff: If the system just continues to implode, it's going to be very difficult for the Fed to step back and let all the banks go under. They're clearly going to have to throw taxpayer dollars in -- even if there's long been a debate about the fairness of that. I wouldn't be surprised if, at the end of the day, we see the US taypayer out $1 trillion. SPIEGEL: What would that mean for the US economy as a whole? Rogoff: All the evidence shows that when you have a recession accompanied by a financial crisis, it takes much longer to dig your way out of it. The economy is going to grow very slowly in 2009, perhaps by only 1 percent. SPIEGEL: At the end of the day, who bears responsibility for the debacle? Rogoff: There are so many people to blame for what happened. It would be like the title credits at the end of a movie if you were to name them all. But the people most to blame are President George W. Bush and the US Congress. The political system has willfully ignored this problem and at many points pressed the regulators to do nothing. Interview conducted by Frank Hornig. ------------------------------ IMAGINE, if you will, that a man who had much to do with creating the present credit crisis now says he is the man to fix this giant problem, and that his work is so important that he will need a trillion dollars or so of your money. Then add that this man thinks he is so indispensable that he wants Congress to forbid any judicial or administrative questioning of anything he does with your dollars. You might think of a latter-day Lenin or Fidel Castro, but you would be far afield. Instead, you should be thinking of Treasury Secretary Henry M. Paulson Jr. and the rapidly disintegrating United States of America, right here and now. But I am getting ahead of myself. First, I am furious at what the traders, speculators, hedge funds and the government have done to everyone who is saving and investing for retirement and future security. Millions of us did nothing wrong, according to the accepted wisdom of the age. We saved. We put a large part of our money into the stock market, as we were urged to do. Because the market wasn't at ridiculously high levels, it seemed prudent to invest in broad indexes, foreign indexes and small- and large-cap indexes. Now we have had the rug pulled out from under us. Our retirements have been put into severe jeopardy. The "earnings" part of those price-to-earnings ratios turns out to have been fiction for some financial companies, which normally account for a big part of total corporate earnings. In fact, earnings of giant finance players were often wildly negative, creating a situation rarely seen since the Great Depression, when the aggregate earnings of the Dow 30 were negative. The current negativity occurred because of wild, casino-type operations of big finance players, creating liabilities way beyond anything we could have reasonably expected. This looks a lot like theft on a spectacular scale — of our wallets, our peace of mind, our futures. Second, according to what I hear from my betters in the world of finance, the most serious problems are not with the bundles of subprime mortgages themselves — a large but not lethal quantum as far as I can tell — but with derivatives contracts tied to subprime and other dicey debt. These contracts are superficially an attempt to "insure" against risks of default, hence the name "credit-default swaps." In fact, they are an immense wager — which anyone with lots of money or borrowing ability can enter — about how mortgage-backed bonds, leveraged loan bonds, student loan bonds, credit card bonds and the like will perform. These wagers entail amounts many times larger than the total of subprime loans. In fact, there are roughly $62 trillion in credit-default swap derivatives out there, compared with about $1 trillion of subprime mortgages. These derivatives are "weapons of financial mass destruction," in the prophetic words of Warren E. Buffett. (Apparently believing that the worst is over, at least for one big investment bank, Mr. Buffett is now investing in Goldman Sachs.) The swaps market has been unregulated. It has been just a lot of people making bets with one another. Some of them made incredibly fortunate payoff wagers against the mortgage bonds, using credit-default swaps as their wagering vehicle. I am not sure who the big winners are, but they are out there, and the gains were big enough to cripple the part of Wall Street on the losing side of the bets. Almost no one (except Mr. Buffett) saw this coming, at least not on this scale. But let's get back to the man of the hour. Why didn't Mr. Paulson, the Treasury secretary, see it? He was once the head of Goldman Sachs, an immense player in the swaps world. Didn't people at Treasury have a clue? If they didn't, what was going on in their heads? If they did, why didn't they do something about it a year ago, when saving the world would have been a lot cheaper? If Mr. Paulson and Ben S. Bernanke, the chairman of the Federal Reserve, didn't see this train coming, what else have they missed? What other freight train is barreling down the track at us? All of this would be bad enough. But by far the most terrifying item I read in my morning paper last week was this: Mr. Paulson demanded that Congress forbid judicial review of his decisions on use of the money in the mortgage bailout. This would amount to an abrogation of the Constitution. Not only would his decisions be sacrosanct and above the law, but so would the actions of his pals in the banking world in connection with this bailout. The people whose conduct got us into this catastrophe have not only taken our money, hopes and peace of mind, but they apparently also want a trillion or so more dollars to put into their Wall Street Buddy System Fund. This may be the most dangerous attack on the law in my lifetime. What anarchists even dared consider this plan? Thank heaven that minds more devoted to the Constitution on Capitol Hill are questioning this shocking request. By the way, if we are actually thinking about tossing the Constitution out the window, why not simply annul these credit-default swap contracts? With that done, the incomprehensibly large liability of the banks would cease, and we wouldn't need this staggering bailout. Shouldn't we consider making the speculators pay some of the price? WE have survived housing-price corrections before. Why is this one causing so much anguish? It must be the side bets, the credit-default swap bets, multiplying the effect of the housing downturn many times over. Maybe we should just get rid of these exotic bets and start again without them. "Insurance" on market moves is always a bad idea, because it does not tamp down market disruptions but instead greatly magnifies them — as in the disastrous effect of "portfolio insurance" in the 1987 crash. Then there was Mr. Paulson's insistence that there be no compensation caps for executives of companies being bailed out by the factory workers, the farmers, the schoolteachers and the medical doctors. He told a skeptical Congress on Tuesday that if these caps were put into place, bank executives simply wouldn't participate in the bailout or sell us suckers their debts. Fine with me. If the banks are in good enough shape so that petulant executives can simply opt out rather than live on a few million a year, maybe we don't need the bailout at all. Maybe we would be better off if those executives simply bailed out and were replaced by people with more sense and more patriotism. One final little thought bubbles into my mind: Maybe the bailout should not be of the banks at all, but of homeowners themselves. Maybe if we make the government the buyer of last resort of homes, we will stabilize the markets, stabilize the debt associated with the markets and take the gain out of the credit-default swaps for the speculators. Yes, price would be a huge issue, but so it is for Mr. Paulson's plan for buying debt from banks. Why not? We do it for farmers. Why not for the individual homeowner? Oh, right. Because Treasury secretaries don't know any of those people. Ben Stein is a lawyer, writer, actor and economist. E-mail: ebiz@nytimes.com. Banks Won't Be as Profitable in Future
SPIEGEL: Last week, the United States government rescued mortgage finance companies Fannie Mae and Freddie Mac, and only a few days later investment bank Lehman Brothers was forced to file for bankruptcy protection. Is there any end to this debacle on Wall Street?
APSPIEGEL: The US Federal Reserve Bank is intervening ever more often and ever more massively.
In Financial Food Chains, Little Guys Can't Win
By BEN STEIN
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Newspapers vs. Google vs. Newspapers… Back when I was a journalism student in college park (umd), Dr. Petrick told us someday we would get our newspapers over the tube and could even talk back to it. (!!!) The loss of a physical newspaper was expected. Good things about it, right upfront. No more black ink on your fingers, no more trees going down, no more gas used to deliver it.
Of course, it’s so much more than that. We lose editors. Editors who shape content, as in what gets on the frontpage (say, 911) and what gets buried (say, the holocaust through the early 1940’s). In full health, a big strapping paper was a big strapping news gathering machine, reporters stationed in far-flung places who knew the area they covered, the culture, and how it all might fit into the grand puzzle. But those types of correspondents have been drying up for at least the last decade, boiling down to the few hardboiled, the few embedded glams.
Worse, wire services have been bought up, shamelessly spun. UPI, now a Rev. Moonie operation. But et tu, AP? Faxes from the far right have been feeding Congress since the 90’s, posing and accepted as gospel. Rupert Murdoch’s Faux News now owns The Wall Street Journal. So the crud has been eating away at journalism in a big MRSA way. And, as science warns us, corporate pork farming is dangerous to humans.
Radio: deliberately dominated by the far right. Clearchannel bought up the majority of stations and the FCC changed the rules that protected us from such vultures. Who listens to it? Truck drivers, night watchmen… The ones who turn on FOX news when they get couch-wise with a brew.
And then we have THE INTERNET. Shiny! Ruled by their own thirst and hunger, individuals used it to sort through the dark wall of the Bush years. We got it right on 13 Myths because we could search and connect directly to sources. Some even connected to us. Sure, the Free Republic has its few, ready and eager to be part of the disinformed, willing to turn from truth and fair and good just so Jaysus might return to save them (and annihilate you)… But there’s also Talking Points Memo, which brought down Gonzo and helped George Allen bring his own veryself to ruin. Buzzflash has been tireless. Wateringholes formed from e-mailers who formed into e-lists… Because folks began checking things out.
Thank the gods, Google was there to search. But those searches, imho, have been harder to negotiate, less able to help penetrate the wall of late. Interested parties buy up search words, saturate and drown information. And — the biggest potential for suffocation — who chooses what stories go up on the google news page? That’s the power google is capable of having over news. The power of an editor.
Thus we become our own editor. And just at the time that the good old liberal arts education — which is what it takes to even begin to see your way to how things might connect; to begin to understand how much there might be involved in knowing, and in knowing that you can never begin to know all of it; the humility such knowing of your own limits which that necessary enlightenment might bring — our students have been taking business degrees. MBA’s. Pure tech…
I remember reading Reader’s Digest in a doc’s waiting room, a story about a insightful man in an ER who made a casual poetical comment — something from the Bard or maybe Moby Dick or Robbie Burns — to the tech who was taking his vitals. Next thing he knew, the psychiatric staff descended on him. Ignorant of his casual insightful aside, they thought he was suicidal.
Interesting turn of plot, all this. Who will write the history? Will any of it have existed at all?
— deborah conner