Obama’s Regulatory Reform Isn’t Enough – Clive Crook, Financial Times
Barack Obama’s Regulatory Changes Are Hopeless – John Tamny, Forbes
Jun 242009
Jun 242009
Raised in an individualistic culture, Americans dislike the concept of the “welfare state” and do not use the term. But make no mistake, the United States has a welfare state, and its future is precarious. The true significance of General Motors’ bankruptcy lies more with this welfare state than with the battered condition of American capitalism.
Broadly speaking, the U.S. welfare system divides into two parts — the private, run by firms; and the public, provided by government. Both are besieged: private companies by competitive pressures; government by rising debt and taxes. GM exemplified the large corporation as private welfare state. In contracts with the United Auto Workers, GM promised high wages, lifetime employment, generous pensions and comprehensive health insurance. All this is ancient history: New workers get skimpier benefits.
As metaphor, GM’s bankruptcy marks the passage of this model. Companies still provide welfare benefits to attract and retain skilled workers. But these shelters against insecurity are growing flimsier. Career jobs remain, but lifetime job guarantees — whether formal or informal — are gone. Last year, about 50 percent of male workers ages 50 to 54 had been with the same employer at least 10 years; in 1983, that was 62 percent.
U.S. Can’t Deliver On All Its Promises – Robert Samuelson, Washington Post
Weekly Economic & Financial Commentary – Wachovia Economics
Inflate This – Marc Chandler, Brown Brothers Harriman
Weekly Economic Report – Diana Furchtgott-Roth, Hudson Institute
Is Apple Computer a Buy, Hold or Sell? – Applied Finance Group
Jun 242009
The stock market’s damage has already been done. And if you’re one of those people near or already in retirement, you already know you’re going to have to work longer, save more or spend less.
But what should you do right now with the money you have left? Should you wade back into the stock market, if you bailed out when the market was plunging? Or if you watched your investments drop and then recover a little in the last few months, should you just hold on? What happens if the market doesn’t fully recover for a long time? (That happened in Japan in the ’90s.)
This economic downturn has been steep enough and frightening enough to undermine the idea that the stock market, over time, will always deliver. So a lot of investors have retreated to a more conservative stance.
The wisdom of that move is debatable. The investment industry warns that becoming too defensive is costly in the long run. Its argument goes something like this: People are living longer, retirement may last 25 or 30 years and stocks are supposed to protect you from the ravages of inflation. And since stocks tend to outpace most investments over long periods of time, the industry says, your savings will do all right in the end.
But some people are no longer comfortable with that logic. There’s even a new study that contends holding stocks over long periods of time may be riskier than previously thought. Robert F. Stambaugh, a finance professor at the Wharton School at the University of Pennsylvania and a co-author of the report, said most investment research only accounted for the risk of short-term market swings around the stock market’s average gain over time. It doesn’t factor in the fact, he said, that the average itself is subject to change.
So what should retirees and pre-retirees make of all of this?
“If another decline in the market is going to bankrupt you or put you out of business or destroy your retirement account, you should not go back into the stock market,” said John C. Bogle, the founder of Vanguard and viewed by many as the father of index investing. “It’s not complicated. The stock market can go up and down a lot and nobody really knows how much and when.”
What’s worked for Mr. Bogle may not work for you, but his method isn’t a bad place to start. “I have this threadbare rule that has worked very well for me,” he said in an interview this week. “Your bond position should equal your age.” Mr. Bogle, by the way, is 80 years old.
That’s a rather conservative recommendation, by many financial planners’ standards. In fact, Vanguard itself offers products that are more aggressive. Its target-date funds — whose investment mix grows more conservative as retirement nears — recommend that people retiring in 2010 (generally, people who are 65) should split their savings evenly between stock and bonds.
Charles Schwab, by contrast, has recently reduced the risk for its target-date funds. The company’s 2010 fund will allocate about 40 percent to stock funds next year, down from 50 percent in the past. “It’s a reflection that our clients’ appetite for risk has changed,” said Peter Crawford, a senior vice president at Charles Schwab Investment Management.
But you shouldn’t simply view your investments through the lens of how much you allocate to different investments (though you will need to come up with a plan). Instead, you should work your way backward. First, consider how much you will need to live when you’re retired and then figure out how you’ll pay for it.
Nearing Retirement
Ideally, you should have started to slowly shrink your stock position over your working career. But some financial planners have become more conservative about that. Before the market’s sharp downturn, Warren McIntyre, a financial planner in Troy, Mich., typically reduced his clients’ stock allocations by about 1 percent each year. Now, for older investors, he ratchets down their stocks by 2 percent each year once they reach 60. So a 65-year-old’s investments would be evenly split between stocks and bonds.
Other planners are taking even more defensive positions. “We are still very concerned about the status of the economic recovery and remain quite defensive as a result,” said Chip Addis, a financial planner in Wayne, Pa., who invests his clients’ portfolios in only 40 percent stocks.
Of course, there’s no one formula. Milo Benningfield, a fee-only planner in San Francisco, for instance, said he put a 61-year-old client in a portfolio with 60 percent in diversified stocks and alternatives (like real estate) and 40 percent in fixed-income (largely split among high-quality, short-term and intermediate-term bonds and cash). But this client can afford to take that risk — the client owns a house, rental property and has other holdings outside the portfolio.
The picture may change for pre-retirees who are 61 and close to meeting their savings goals, but can’t afford to lose any money. “We would ask ourselves to what degree, if any, can you afford equities,” Mr. Benningfield said. If inflation was their only concern, he might invest their money across a ladder of Treasury Inflation-Protected Securities, or TIPS, which are backed by the government and keep pace with inflation.
Your Money: For Older Investors, Old Rules May Not Apply – NY Times
Is Apple Computer a Buy, Hold or Sell? – Applied Finance Group
SANTA MONICA, Calif. (MarketWatch) — There’s a lot of talk about creating millions of new jobs via the “green” economy, one that weans reliance from fossil fuels and invests in alterative energies and technology.
But such a massive shift in labor — figures are for some 5 million new “green-collar” jobs to be created — isn’t likely to happy anytime soon, or anytime at all.
In short, we shouldn’t be betting on job growth from the clean and renewable energy sector, even if it is the fastest-growing segment of the economy right now. That would be a mistake in planning that could stay current policy and keep things relatively inert.
As new jobs are created in alternative energy openings, old jobs in traditional energy companies will be lost. This creates a break-even job scenario. Simply put, a new solar plant creates several hundred new jobs. That energy replaces a coal-fired power plant. The coal plant shutters and hundreds of jobs are lost. Result: no gain.
Moreover, the jobs in the alternative energy sector — beyond construction workers hired temporarily to build or retrofit — need a different set of skills than those who have been working in the traditional energy sector. An oil-rig operator can’t become a wind operator overnight.
This brings me to the real issue at hand: The skill of the U.S. labor force.
A recent study of college graduates shows that for every U.S. student who earns an engineering degree, China graduates five. Never mind those engineers coming out of India, South Korea, and Japan.
The West is losing out on the skilled labor needed for future growth not because we aren’t investing in alternative energy — we are — because we aren’t investing in education.
Sam Newell, a job recruiter for RenewableEnergyJobs.com, writing on the Climate Change Corp. website, says: “Unless the number of students taking science, engineering, technology and math base qualifications in the Western world increases dramatically, this skills shortage will become even more apparent and constraining for businesses.
“It is beginning to look untenable that the new green-collar jobs can be made available only to domestic applicants — in line with [President Barack] Obama’s plans of creating jobs that cannot be outsourced — due to the engineering skills shortage. If we fail to address the lack of available, qualified and appropriately skilled workers, talk of millions of new jobs being filled within the renewable energy sector is likely to remain just talk,” Newell went on to say.
To be sure, I am all for growth in the alternative energy sector. I am all for a clean and green economy. But if this is to be America’s big bet on the future, we have to play our best hand at the world table. And that hand isn’t the green-collar worker.
That’s increasingly looking like a bluff. Our strongest hand is with the graduating student. Yet they don’t seem to be much interested in playing. We have to change that.
Setting our sights on the blue-collar, green-collar or plain old worker is setting them too low. It’s not the collar or the color that matters; it’s the prospect. We should be prospecting for engineers with incentives and investments. Meanwhile, we must get sober about our future.
Otherwise the green economy will pass us by, and the much touted job growth will become more job shrinkage.
Thomas M. Kostigen is the author of “You Are Here; Exposing the Vital Link Between What We Do and What That Does to Our Planet.”
The ‘Green-Collar’ Job Creation Myth – Thomas Kostigen, MarketWatch
Jun 222009
What does it tell you when banks, investment houses, insurance companies and derivatives traders are so pleased with their regulators that they are prepared to pull out all the stops to keep them?
What it tells me is that the current system of financial regulation has been thoroughly captured by the companies it was meant to restrain — and that the only way to put things right is to bring in new rules, a new structure and tough new regulators. Anything short of that, and you can almost guarantee that the inmates will be back in charge of the asylum by the time the next bubble starts to develop.
Judged by that standard, the proposals the Obama administration put forward this week to reform the regulatory apparatus were a bit of a disappointment.
If you have to set up a council of regulators just to harmonize the rules used by different bank regulators, why not bite the bullet and consolidate them into a single agency?
How are safety and soundness of the financial system furthered by allowing regulated banks to run “proprietary trading desks” that are nothing more than in-house hedge funds?
Should oversight of giant markets in financial futures and derivatives continue to be regulated by an agency set up to regulate hog prices and corn futures just because members of the congressional agriculture committees can raise political funds from Wall Street fat cats?
Regulatory Reform That Falls Short – Steven Pearlstein, Washington Post
Also:
Wall Street Fights New Regulations – Editorial, Investor’s Business Daily
Obama’s Regulatory Reform: Our Money In Danger – Peter Morici, NPR
We Need Greater Global Governance – Peter Mandelson, Wall Street Journal
Jun 222009
June 19 (Bloomberg) — President Barack Obama doesn’t need to just overhaul financial regulation. He needs to exorcise the ghost of Alan Greenspan.
For far too long, regulators weren’t willing to regulate, inspired by the view of the former Federal Reserve chairman that too much oversight is a greater threat to markets than too little. That turned out to be a bigger cause of the credit crisis than the particular structure of the agencies overseeing the financial system.
Donald Kohn, the Fed’s vice chairman, summed up the prevailing regulatory attitude in 2005, saying, “The actions of private parties to protect themselves — what chairman Greenspan has called private regulation — are generally quite effective,” while government regulation risks undermining “financial stability itself.”
Unless Obama can change that mindset, which is entrenched in many of the institutions overseeing banks and markets, the details of his 88-page reform plan won’t matter much.
And while there appears to be a newfound appreciation for government oversight, we can’t be certain yet about the intentions of those shaping the Obama plan. Some of them, after all, were one-time advocates of Greenspan’s views, or at least failed to challenge them.
Greenspan’s Disciples
Treasury Secretary Timothy Geithner, one of the architects of the Obama overhaul, was a big promoter of the kind of so- called financial innovation that ultimately helped bring about the crisis.
During a speech in early 2007, Geithner argued that innovative products such as credit default swaps and collateralized debt obligations “should help make markets both more efficient and more resilient.”
And Geithner, at least back then, echoed Greenspan’s belief that regulators shouldn’t try to stop bubbles from forming. In the same speech, the then-chief executive of the Federal Reserve Bank of New York also said, “We cannot identify the likely sources of future stress to the system and act preemptively to diffuse them.”
Geithner wasn’t alone in espousing Greenspan’s hands-off approach. His co-pilot on the new Obama plan, National Economic Council Director Lawrence Summers, held similar views.
Summers aligned with Greenspan to kill off attempts to regulate derivatives markets when he worked in Bill Clinton’s administration. That deprived regulators of influence over a key and fast-growing market, an area in which risks to financial institutions would fester.
Regulatory Tension
In unveiling his regulatory plan Wednesday, Obama noted that there is always tension between those who favor the market’s “invisible hand” and those who favor “the guiding hand of government.”
He rightly added that such tension isn’t always a bad thing. Yet in recent years, the invisible hand ruled.
Under Greenspan’s laissez-faire approach, markets would police themselves and risk would be spread far and wide. The theory was that losses would be more easily absorbed if a broad base of investors, rather than a few banks, held risk.
Even as cracks began to gape in the financial system in early 2007, Geithner continued to hew to this view. While acknowledging in his speech at the time that problems with subprime mortgages may signal a gathering storm, he said that credit-market innovations should help ease any pain: “If risk is spread more broadly, shocks should be absorbed with less trauma.”
Hidden Risks
It didn’t work out that way. Rather than dispersing risk, many of the policies espoused during the Greenspan era simply caused risks to regroup out of investors’ and regulators’ sight.
This meant that investors couldn’t know who was holding what types of assets, which ultimately led them to stop trading with one another. Credit markets began to freeze.
Greenspan and his followers also trumpeted financial engineering, hailing the creation of exotic securities that would supposedly help to disperse risk. In the end, much of the innovation — like structured investment vehicles or CDOs — proved ephemeral.
Even those who weren’t Greenspan disciples, such as Fed Chairman Ben Bernanke, failed to challenge the prevailing orthodoxy. Bernanke has been reluctant to abandon the financial- innovation theme promoted by his predecessor.
In a speech this April, Bernanke acknowledged that financial innovation is currently “perceived as the problem.” That said, the Fed chairman rose to its defense, saying that, “Innovation, at its best, has been and will continue to be a tool for making our financial system more efficient and more inclusive.”
Given that so many regulators and political leaders sipped from the Greenspan Kool-Aid cup, it will take time to see if the financial crisis has sobered them up.
If not, Obama can play with regulatory organizational charts all he wants, and it won’t make much difference.
(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)
Greenspan’s Ghouls Stalk Obama’s Finance Plan – David Reilly, Bloomberg
On April 27, Lloyd Blankfein, chairman and chief executive of Goldman Sachs, sat down for a meeting at Goldman headquarters with Gretchen Morgenson, reporter, columnist and senior editor of the New York Times. The Wall Street titan and the Pulitzer Prize winner had never met, but this wasn’t the usual polite getting-to-know-you session between reporter and source.
“I feel like I’ve been waterboarded,” Blankfein told her, according to people familiar with the discussion. Blankfein was being dramatic, but he had reason to feel that way. It was Morgenson, after all, who had written the story this past fall that stripped the veil of secrecy from the most momentous closed-door deal in the annals of US finance: the government rescue of fallen insurance colossus American International Group. The September 28 story, “Behind Insurer’s Crisis, a Blind Eye to a Web of Risk,” was the first article published by a major news organization to reveal that the true beneficiaries of the bailout were the institutions to which AIG owed money, known as counterparties (mainly Wall Street investment banks). The 2,700-word piece said, among other things, that an AIG collapse “threatened to leave a hole of as much as $20 billion in Goldman’s side” and that Blankfein attended a meeting at the Federal Reserve on September 15, the same day decisions were made to let Lehman Brothers fall and to save AIG.
Today this is common knowledge; until this story ran, though, it wasn’t. The article was about as bold and valuable as business stories come and involved no small journalistic risks for the Times. Goldman, for instance, was able to wring a correction on the story and still feels wronged today. Treasury Secretary Timothy Geithner, who was then president of the Federal Reserve Bank of New York, called Morgenson and her editor to question the article’s premise, The Nation has learned. The piece has been the subject of endless parsing on financial blogs and, privately, sniping by Morgenson’s peers. Was Goldman really exposed to AIG? And if so, how? Was it fair to mention Blankfein’s presence at the Fed?
It would be too much to say that the story was all in a day’s work for Morgenson. It was extraordinary. But it does open a window onto what makes Morgenson the most important financial journalist of her generation.
At 53, Morgenson is at the height of her career, read and feared in the corridors of power running from Wall Street to Washington. As a reporter and columnist (a controversial dual role), she is enormously productive. During the period following Lehman’s bankruptcy, her byline appeared on major stories on Henry Cisneros and good housing goals gone bad, Merrill Lynch’s collapse, corrupted rating agencies and Washington Mutual’s boiler-room culture, in addition to the September 28 blockbuster on AIG–not to mention weekly 1,200-word columns on everything from rating-agency hypocrisy (“They’re Shocked, Shocked, About the Mess,” October 26) to a convoluted tax deal that imperiled an Indiana electrical cooperative (“Just Call This Deal Hoosier Baroque,” December 21).
She breaks business-press taboos constantly. Her prose is blunt; some even say crude. (“Everybody knows that executive compensation at many companies has been obscene. What everybody does not know is how obscene obscene is now,” she wrote in February 2006 in a not untypical column.) Morgenson doesn’t just cover subjects but sometimes hammers them into submission, as when she banged out more than three dozen stories on Countrywide in 2007 and 2008 and almost single-handedly made CEO Angelo Mozilo the face of a rogue industry. Not coincidentally, on June 4 the Securities and Exchange Commission charged Mozilo with securities fraud, alleging that he misled investors about the increasing risks Countrywide was taking with loans that Mozilo privately called “toxic.”
At this point, it is almost impossible for business reporters and editors not to have an opinion about Morgenson. Supporters cheer her tell-it-like-it-is style; detractors call her simplistic and agenda-driven. In certain Wall Street and business circles, she is flatly detested.
“She rules,” says Aaron Elstein, a senior writer who covers Wall Street for Crain’s New York. “She grasped that the game was rigged way before it was fashionable to do so.” (He was talking about bogus accounting practices, but the remark holds more generally.)
“Unreadable,” snaps a business journalism peer. “She writes like an Escalade running into a concrete barrier. And her relentless and repetitious pounding of simplistic issues is maddening.”
“The consensus view of her among actual business people I know is pure contempt,” says Jim McCarthy of CounterPoint Strategies, a public relations firm that has represented high-profile business-press targets. “Her work has a sort of drive-by, potshot quality to it that leads to habitual mistakes and ideological laziness. She is reflexively opposed to free markets and assumes bad faith in almost every subject or person she examines.”
What both sides miss, and what sets Morgenson apart, is that she combines the blunt writing style with a prodigious fact-gathering ability and an accountability mindset all too rare in the business-press culture. This allows her to go beyond merely reporting and commenting on the public agenda. She helps to set it.
Why Gretchen Morgenson Is So Important – Dean Starkman, The Nation
A Senate energy bill was voted out of committee yesterday, but not before losing the support of two Democrats and a dozen leading environmental organizations.
The measure would be the third energy bill in four years — not counting the huge energy provisions in this year’s economic stimulus bill. Like the others, it is rife with controversy over new offshore drilling plans near Florida, the sharing of federal offshore oil and gas royalties, and a mandate for renewable energy that alternative-energy executives and environmentalists say is too weak. It would require 15 percent of electricity to come from renewable sources by 2021, but would allow exemptions that would diminish that target.
The proposed bill would also create a new “clean energy” financing agency that would extend subsidized loans and loan guarantees to a variety of projects, including nuclear plants. While it would set tough energy-efficiency standards for new buildings, it would also ease restrictions on the federal government’s use of petroleum from Canadian tar sands, whose energy-intensive production generates more greenhouse gases than conventional oil. The bill would also create a 30 billion-barrel strategic reserve for refined petroleum products; the current reserve contains only crude oil.
Senate Energy and Natural Resources Committee Chairman Jeff Bingaman (D-N.M.) said the bill would “help shift our country to cleaner sources of energy, and more secure sources as well.” He won the support of the committee’s ranking Republican, Sen. Lisa Murkowski (R-Alaska), who said she would press for additional nuclear-energy provisions on the Senate floor.
But a dozen environmental groups yesterday said they opposed it. In a joint letter to the committee, they called the renewable-electricity standard too lax because it allows noncompliance fees to go back to companies, exempts new nuclear plants and certain new coal plants from baseline calculations, and allows energy-efficiency savings to substitute for renewable energy.
Expansive Energy Bill Advances In Congress – Washington Post
Richard Perry/The New York Times
President Obama met Wednesday with regulators at the White House. At right are Ben S. Bernanke, chairman of the Federal Reserve, and Sheila C. Bair, chairwoman of the F.D.I.C.
WASHINGTON — No sooner had President Obama proposed a new regulatory road map for the country’s financial system on Wednesday than senior lawmakers expressed reservations about one of the plan’s central elements — to broadly expand the reach of the Federal Reserve to regulate financial risk across the entire system.
Some Lawmakers Question Expanded Reach for the Fed – New York Times
Economic Competition: Competitive Advantage Period – Applied Finance
The Two Sides of the Inflation Debate – Richard Berner, Morgan Stanley
Jun 192009
The blunt fact is that the economic recoveries that have been rapid and seen fast growth in employment are those that ended when a central bank, following strongly restrictionary policies to fight inflation, eased off and significantly lowered interest rates. No such lowering of interest rates is possible this time—interest rates are already as low as they can possibly go. So I can see no reason to anticipate a rapid recovery and rising employment when the cliff-diving stops. And I do not understand why the Obama administration is following policies that presume such a rapid recovery—a V rather than an L for the shape of the recession—is not just possible but probable.
How Far We’ve Come from Last December – Brad DeLong, Free Exchange
Jun 192009
A string of new polls seems to show that America’s belief in the wonder-working power of Obamanomics has begun to fade. A Pew poll found President Obama’s economic approval rating has fallen to 52 percent from 60 percent in April. A Wall Street Journal poll found 53 percent disapprove of his handling of GM and Chrysler vs. 39 who approve. And the New York Times found that 60 percent don’t think Obama has a “clear plan” to deal with the monstrous budget deficit.
Okay, here’s the thing: Obama took a tremendous economic and political gamble last January. The new president had the option of putting forward a stimulus plan that would attempt to reverse or significantly dampen America’s terrible economic downturn ASAP. The quickest and most effective approach would have been a big cut in payroll taxes. For $800 billion, combined Social Security and Medicare taxes could have been slashed by 6 percentage points, or 40 percent. That would have put $1,500 in worker paychecks and, according to one credible study, increased employment by 4 million jobs in 2009.
Instead, Obama chose to listen to Rahm “Never let a crisis to go waste” Emanuel and put forward an $800 billion plan that advanced his healthcare, energy and education policy goals — but pretty much neglected the economy in 2009. Team Obama had to fully understand this. Indeed, a study from the Congressional Budget Office study — when led by current Obama budget chief Peter Orszag — concluded that an Obama-like economic stimulus package would be “totally impractical” because it would take so long to implement. (True enough, only seven percent of the American Recovery and Reinvestment Act has been doled out so far.)
Presidential gamble. In short, Obama wagered that the deluge of money coming from the Federal Reserve would do the heavy lifting as far as stabilizing the financial sector and keeping the already apparent recession from turning into a real disaster. Voters would, thus, continue to support his policies to assert more government control over healthcare, heavily regulate energy through a costly cap-and-trade program and further intervene into the financial industry.
The gamble appears to have failed miserably, both economically and politically. The terrible tale of the tape: a) the current downturn is arguably the worse since the Great Depression; b) household wealth has fallen by $14 trillion during the past two years, including the first quarter of 2009; c) while the economy may not shrink as much this quarter as it did in the previous three months (-5.7 percent) or the final quarter of 2008 (-6.3 percent), unemployment is soaring; d) Obama himself said the jobless rate will hit 10 percent this year; d) even worse, the Federal Reserve sees it approaching 11 percent next year. (Recall, that the original White House economic analysis of the Obama economic plan never saw unemployment exceeding 8 percent if Obamanomics was passed by Congress.)
Falling public support. So now many Americans are rightfully wondering just what they are getting for that $800 billion, as well as massive budget deficits as far as the eye can see. And it goes beyond the mercurial world of polling. Pricey plans to deal with perceived climate change and healthcare are also appear on the ropes or are being scaled back as voters view them as lower priorities than job creation and taming out-of-control spending.
Green shoots? Oh there are some to be sure. Just yesterday, the Conference Board said its index of leading economic indicators rose by its biggest monthly amount in five years And the stock market is up nearly 40 percent from its lows as depression fears ebb. Gluskin Sheff economist David Rosenberg, by contrast, declares that the “era of the green shoots is over.” He points out that 1) bellwether FedEx described the economy as “extremely difficult” when it reported disappointing earnings , 2) United Airlines said second quarter traffic fell as much at 10.5 percent, 3) commercial real estate loan concerns led S&P to cut ratings on 22 non-”too big too fail” regional banks; 4) incomes are being pinched by rising gas prices, and 5) surging interest rates are refreezing the housing market.
Too little, too late. Then, of course, there is rising unemployment, which is either a lagging indicator of an economy slowly on the mend or a forward indicator of a possible double-dip recession. Either way, it takes a long time for economic perceptions to change after a nasty downturn. Just ask all those congressional Democrats who lost their jobs in 1994. Even though the economy had then been growing for 14 straight quarters since the 1990-91 recession and the unemployment rate was down to 5.8 percent from a high of 7.8 percent, 72 percent of Americans still thought the economy was “fair” or “poor” and 66 percent though the nation was headed in the wrong direction. What do you think the national mood will be like on Election Day 2010 if unemployment is over 10 percent, gas prices near $4.00 a gallon and homes prices moribund? Certainly by then, the effectiveness of the “Blame Bush” mantra will have hit its expiration date for Obama and the rest of the Democratic Party.
Why Obama’s Economic Gamble Is Failing – James Pethokoukis, Reuters
Simon Johnson, a senior fellow at the Peterson Institute for International Economics, is the former chief economist at the International Monetary Fund.
There is much to worry about in President Obama’s financial regulation proposal, officially unveiled on Wednesday. It’s a long wish list, but intense and nontransparent financial sector lobbying already ensured that four out of the five sets of measures are unlikely to have any lasting positive impact.
“In the last two weeks alone, the administration has heard from top executives from Goldman Sachs, MetLife, Allstate, JPMorgan Chase, Credit Suisse, Citigroup, Barclays, UBS, Deutsche Bank, Morgan Stanley, Travelers, Prudential and Wells Fargo, among others. Administration officials also discussed the president’s plan with the top lobbyists at major financial trade associations in Washington.”
What is the outcome of all this behind-the-scenes maneuvering to get the financial sector fully on board? Not much change that we can really believe in.
For example, take the points that President Obama himself stresses (e.g., in this interview). First and foremost, he says the Federal Reserve will become the official “system risk regulator” (section 1 of his proposal). But in principle the Fed had exactly this kind of leadership role before — and under both Alan Greenspan and Ben Bernanke it was a reckless cheerleader and facilitator for the unsustainable real estate boom.
If the Fed had been stronger before, the crisis now would be worse.
Hedge funds and other private pools of capital have to register with the Securities and Exchange Commission, also in section 1. But the once-proud S.E.C. has fallen on hard times, effectively just as much captured by the intellectual bubble of Wall Street as all our other regulators.
Originators of securitized products will be required to retain some stake in what they issue (section 2). But the major shock of early 2008 was when we learned that Bear Stearns, Lehman Brothers, and others had done exactly that. There is no serious attempt here to recognize that our leading financial firms have completely failed in their efforts to measure and control risks.
In addition, the administration will now seek a “resolution authority” that makes it easier to take over and shut down large financial companies (section 4 in the proposal). But effectively they had this power before — Continental Illinois, for example, was handled as a negotiated conservatorship in the 1980s, and Citigroup could have been taken over at various points in the past nine months. The government blinked in the face of financial sector complexity and scale. “Too big to fail” is “too big to exist,” but the president’s document goes nowhere near this fundamental principle.
And while the proposal is no doubt right to emphasize the need for international cooperation in re-regulation, section 5 is so vague as to be meaningless.
There is, however, one interesting piece — the creation of a Consumer Financial Protection Agency (section 3). The president himself seems to recognize that previous consumer protection was scattered and ineffectual. A strong agency could help protect us all both in boom times and during crises.
But protecting consumers is not the same thing as protecting investors and taxpayers. Major financial players will once again be able to float bubbles, creating the illusion of growth and the reality of further expensive bailouts.
Our financial sector has become very powerful politically — and these proposals are a further sad reminder of that fact.
The Defanging of Obama’s Regulation Plan – Simon Johnson, Economix
By Stephen Grocer
So Bank of America is paying bonuses to lure new talent and retain the talent that is left.
Among the bankers to receive bonuses were Fares Noujaim and Harry McMahon, the New York Post reports. Noujaim, a former Bear banker who was recently named vice chairman of corporate and investment banking, is said to have received roughly $15 million over two years, according to the Post. Both were offered guarantees not to leave the company.
A BofA spokeswoman told the Post it had to pay bonuses to hold on to the bankers and that “any reference to [a] specific associate’s compensation in this story is inaccurate.”
The BofA-Merrill situation raises an interesting question: How many top bankers and brokers can a Wall Street firm lose before its business is significantly impacted. Since BofA’s $50 billion acquisition of Merrill closed early this year, Merrill employees have been fleeing the beleaguered bank in droves. And it turns out the Merrill employees did have someplace to go. Boutiques and large overseas banks such as Deutsche Bank and Credit Suisse Group moved quickly to scoop up Merrill bankers, traders. In some cases, whole teams fled.
The options for BofA-Merrill employees are likely to expand. J.P. Morgan Chase, Goldman Sachs Group and Morgan Stanley paid their TARP funds back Wednesday, freeing them to pay employees how they see fit. BofA and Citigroup, meanwhile, will both remain under the government thumb for the foreseeable future. Remember, earlier this year Citigroup sought Treasury Secretary Timothy Geithner’s approval to pay out bonuses. (Ironically as shareholders in two banks, it is perhaps in the best interest of taxpayers that the banks hold on to their best employees.) That puts both at a competitive disadvantage in recruiting and retaining top talent. Today, long-time Merrill M&A banker William Rifkin fled Merrill for J.P. Morgan.
All this highlights the numerous pitfalls in regulating Wall Street pay. The fear was that if Washington clamped down on compensation for all of Wall Street it would put the industry at a disadvantage globally. But by not regulating compensation for all of Wall Street, the Obama administration seems to be hoping that the banks that paid back TARP would follow the “best practices” the TARP banks are required to follow.
That seems highly unlikely.
Also, there are plenty that believe as William Cohan writes in the Daily Beast today that until compensation is fixed on Wall Street: “We will all just be biding our time until the next bubble is inflated and bursts anew.”
BofA’s Paying Bonuses to Keep Top Talent? Shocking! – Deal Journal
Jun 192009
Bankruptcy Epitaphs 2009–And We’re Only In June! – Reformed Broker
Jun 192009
Everybody’s got an opinion on the dollar, ranging from its aesthetics (for the most part, people think greenbacks lack that) to its utility (we hear a lot from folks bemoaning its use as a fiat currency).
Voices were raised in recent months in favor of doing away with the dollar as a reserve currency, the most strident emanating from exporters of dollar-denominated commodities, such as Russia, and nations like China that hold large swatches of U.S. government paper.
So, what’s a reserve currency and why should the buck get the boot?
A reserve currency is a simply a store of value, held by a central bank and denominated in the legal tender of another nation, that facilitates international trade and foreign exchange. The modern notion of a reserve currency came about in the late 19th century along with the emergence of the international gold standard.
The U.S. dollar is the most widely held reserve currency, representing about two-thirds (10-year weighted average: 65.9%) of central bank foreign exchange holdings. The hegemony enjoyed by the greenback makes it easier for the U.S. to run and maintain high trade deficits, a consequence of the nation’s debt-financed consumerism and low savings rate. The greenback’s preeminence is eroding, though. Its allocation in central bank reserves has been chipped away at a rate of 70 basis points (0.7%) a year over the past decade.
Dollar Ain’t Perfect, but What’s Better? – Brad Zigler, Hard Asset Investor
Jun 182009
Old habits die hard—especially bad ones, and especially when they’re backed by well-heeled lobbyists and a powerful congressional committee chairman.
It was hard not to draw that conclusion over the past week, as Wall Street and Washington alike prepared for President Barack Obama’s much-anticipated June 17 speech outlining the Administration’s proposals to overhaul financial regulations. Despite the promise of tough reforms from the President and his top economic officials, the Administration—in its decision to put off tough political battles over regulatory turf and reining in executive pay—appeared to be backing away from the stiffest moves that were on the table.
With the worst of the crisis appearing to recede, the political will to take on those tough constituencies appeared to be fading as well. With it may go a once-in-a-generation opportunity to aggressively tackle some badly needed changes in the U.S. financial system.
“Is the drive for reform losing steam? Yes, absolutely,” says Daniel Clifton, a Washington-based policy analyst at institutional broker Strategas Research Partners. With Congress signaling that it is unlikely to act on the President’s financial-system reforms until the fall, Clifton and other observers warn that this week’s regulatory plan could be highly vulnerable to attack for five months. Short of an unexpectedly sharp return of crisis in the financial sector, which would force the Administration and Congress to conclude that the costs of retaining much of the status quo intact are too high, Clifton believes the push for reform “will lose a lot more momentum by October.”
The aim of the Administration’s regulatory plan, largely developed by Treasury Secretary Timothy Geithner, is to create a more effective and powerful regulatory structure that would have a better chance of preventing the sort of unseen and out-of-control financial excesses that brought about the current global crisis. In an op ed article in the June 15 Washington Post, Geithner and Lawrence Summers, director of the National Economic Council, said their goal is “to create a more stable regulatory regime that is flexible and effective; that is able to secure the benefits of financial innovation while guarding the system against its own excess.” The plan will try to rein in systemic risk by “raising capital and liquidity requirements for all institutions, with more stringent requirements for the largest and most interconnected firms.” It will give the Federal Reserve the power to unwind financial holding companies whose failure could threaten the world’s economy. And it will try to strengthen consumer and investor protections on products ranging from “credit cards to annuities.”
Is Obama Flubbing the Financial Fix? – Jane Sasseen, BusinessWeek
Jun 182009
Last week was a milestone for US treasury secretary Tim Geithner. He finally got to play the hero. The morning of June 9, Treasury notified 10 financial institutions, including JPMorgan Chase, Goldman Sachs, Morgan Stanley, US Bancorp, and Capital One Financial, that they were “eligible to complete the repayment process” for the capital they received under the Troubled Assets Relief Program (TARP). In other words, they would be allowed to pay back $68.3 billion. Even though they really owe $229.7 billion. That we know of. But Geithner didn’t mention that last bit. Instead, he professed that “these repayments are an encouraging sign of financial repair,” with the caveat that “we still have work to do.”
The “we” he refers to is himself and Wall Street, both of whom are getting a good deal out of this fractional payback scheme. The agreement frees the banks from restrictions on executive pay or, worse, their general practices, but it still allows them to keep the cash they’ve received through non-TARP venues like the FDIC Temporary Liquidity Guarantee Program— or the massive sums the banks recovered from AIG (thanks to its own federal bailout) to cover their losses on credit derivatives. Not to mention any cash provided by the mother of all cheap loan programs—the Federal Reserve.
Geithner, for his part, gets to convey the message that things are looking up. “These repayments follow a period in which many banks have successfully raised equity capital from private investors,” stated the press release. “Also, for the first time in many months, these banks have issued long-term debt that is not guaranteed by the government.”
Well, of course certain banks have raised some money on their own: Firms have a tendency to look a whole lot better when they’re backed by government capital and have cheap federal loans sitting on their books. Private investors notice that sort of thing. But more troubling than the misplaced praise is the fine print that accompanied the announcement: “These repayments,” the department noted, “help to reduce Treasury’s borrowing and national debt. The repayments also increase Treasury’s cushion to respond to any future financial instability that might otherwise jeopardize economic recovery.”
This statement belies some accounting sleight of hand.
The Big Bank Bailout Payback Bamboozle – Nomi Pins, Mother Jones
Valuation Update: We estimate that the S&P 500 is currently priced to deliver total returns over the next decade in the range of 6.5-9.0%, centered at an expected total return of about 7.8% annually. Stocks are modestly overvalued here, except on metrics that assume a permanent recovery to 2007′s record profit margins (which were about 50% above the historical norm).
On normalized profit margins, sustainable S&P 500 earnings are slightly above $60 on the index. That’s certainly higher than the 7 bucks of net earnings that companies in the index have reported over the past 52 weeks, but unfortunately, even at current prices, the S&P 500 is near 16 times normalized earnings.
The Outlook Is Not Up, But Very Widely Sideways – Hussman Funds
Jun 182009
Irving Fisher lives on in American economic history mainly as a laughingstock. He was, after all, the ninny who declared on Oct. 15, 1929, that stock prices had reached “what looks like a permanently high plateau.” Two weeks later, stocks plunged off that plateau–not to return to their 1929 level for a quarter-century.
There was more to Fisher than those infamous words. The longtime Yale professor was a successful entrepreneur (he devised and marketed a precursor to the Rolodex), the author of a best-selling textbook on personal hygiene, one of the most prominent backers of Prohibition and a leading eugenicist (that is, he believed the human race could be improved through the weeding out of “degenerates”).
More to the point, Fisher was the country’s first great economist, a pioneer of the mathematical approach that came to dominate the discipline after his death. Fisher saw the behavior of the market in rational, mathematical terms. He wasn’t completely doctrinaire about this–earlier in his career, he had allowed that investors sometimes behaved like sheep. But in the 1920s, convinced that skilled monetary management at the Federal Reserve and the rise of new, professionally run investment trusts had reduced the riskiness of markets, he lulled himself into believing that the prices prevailing on Wall Street were a reflection of economic reality and not of investor mania or a credit bubble.
Does this sound familiar? The financial history of the past decade is replete with echoes of Fisher’s colossal 1929 miscalculation. A brilliant Fed chairman was credited with banishing panics and ushering in what economists called the Great Moderation. An explosion of financial innovation was deemed to have provided investors, corporations and banks with new ways of managing risk. Prices of stocks, houses and other assets rose to levels that were high by historical standards–but who was to say the market was wrong in fixing those high values?
In the 1990s and 2000s, in fact, this myth of the rational market was embraced with a fervor that even Irving Fisher never mustered. Financial markets knew best, the thinking went. They spread risk. They gathered and dispersed information. They regulated global economic affairs with a swiftness and decisiveness that governments couldn’t match. And then, as debt markets began to freeze up in 2007, suddenly markets didn’t do any of these things. “The whole intellectual edifice collapsed in the summer of last year,” former Fed chairman Alan Greenspan said at a congressional hearing in October.
Well, maybe not the whole edifice. For all its flaws, Fisher’s economic approach delivered genuinely important insights. He proposed in 1911 that the government issue inflation-linked bonds; in 1997, the Treasury Department finally got around to doing so. If anybody in power in Washington had been willing to follow his advice in 1930 or ’31 (which essentially amounted to “Print more money”), the Great Depression might not have been so great. For the past two years, the Federal Reserve has been working right out of the Fisher playbook, and while the results haven’t been perfect, they’ve been a lot better than those of the early 1930s. The economics that Fisher espoused–reborn after his death in 1947–should not be discarded. But clearly, there are some issues with it.
Fisher fell on hard times after the 1929 crash–getting by thanks only to the generosity of a wealthy sister-in-law and his employer, Yale–and so did the myth of the rational market. For a few decades, financial markets were seen as unruly beasts that had to be tamed with tight regulation to help protect the hard-earned savings of regular Americans. But memories of the 1930s eventually faded, and in the 1950s, the idea that markets knew best began its comeback. This was part ideological reaction to the antimarket conventions of the day, part scientific progress. It was the combination of the two, in fact, that made the idea so powerful.
A key figure in the revival was the University of Chicago’s Milton Friedman–and his libertarian ideological bent was certainly a factor. Friedman never believed markets were perfectly rational, but he thought they were more rational than governments. Friedman saw the Depression as the product of a Fed screwup–not a market disaster–and convinced himself and other economists (without much evidence) that speculators tended to stabilize markets rather than unbalance them.
But Friedman was a scientist too. During World War II, he used his mathematical and statistical skills to help determine the optimal degree of fragmentation of artillery shells. Officers flew back to the U.S. in the middle of the Battle of the Bulge to get his advice on the trade-off between the likelihood of hitting the target (the more fragments, the better) and the likelihood of doing serious damage (the fewer and bigger the fragments, the better).
Emboldened by this work, economists began to apply their number-crunching skills to the postwar market. Chicago graduate student Harry Markowitz devised a model for picking stocks that was, in Friedman’s estimation, “identical” to his artillery-shell-fragmentation trade-off. And in the late 1950s, scholars at Chicago and the Massachusetts Institute of Technology became enamored of the idea that stock-market movements were, like many physical phenomena, random.
The two strands of statistics and pro-market ideology came together in the mid-1960s. It was the great MIT economist Paul Samuelson who made the case mathematically that a rational market would be a random one. But Samuelson didn’t share Friedman’s political views, and he never claimed that actual markets met this ideal. It was at Chicago that a group of students and young faculty members influenced by Friedman’s ideas began to make the case that the U.S. stock market, at least, was what they called “efficient.”
Their evidence? Mutual-fund managers failed as a group to outsmart the market, and studies showed that new information was quickly incorporated into prices. Eugene Fama, a young professor at Chicago’s business school, tied all this together in 1969 into what he dubbed the efficient-market hypothesis. “A market in which prices always ‘fully reflect’ available information is called ‘efficient,’” he wrote–and the evidence that such conditions prevailed in the U.S. stock market was “extensive, and (somewhat uniquely in economics) contradictory evidence is sparse.”
Upon that basis, economists and finance scholars cleared the way in the 1970s for a new approach to investing and risk management that included index funds, risk-weighted portfolio allocation and mathematical models to price options and other derivatives. A lot of this was, as with Fisher’s economics, useful. But a basic assumption underlying much of it–that prices were reliable reflections of economic reality–was problematic.
It didn’t take long for a new generation of scholars, many with roots at Samuelson’s MIT, to start pointing out the problems. Samuelson protégé Joseph Stiglitz showed that a perfectly efficient market was impossible, because in such a market, nobody would have any incentive to gather the information needed to make markets efficient. Another Samuelson student, Robert Shiller, documented that stock prices jumped around a lot more than corporate fundamentals did. Samuelson’s nephew Lawrence Summers demonstrated that it was impossible (without a thousand years of data) to tell a rationally random market from an irrational one.
Shiller and Summers in particular came to revel in tweaking the rational-market establishment. Shiller declared in 1984 that the logical leap from observing that markets were unpredictable to concluding that prices were right was “one of the most remarkable errors in the history of economic thought.” Summers described how financial markets were often dominated by “idiots” (he later dubbed them “noise traders” and co-authored a series of academic papers showing how their errors could move prices) and lamented at the 1984 meeting of the American Finance Association that “virtually no mainstream research in the field of finance in the past decade has attempted to account for the stock-market boom of the 1960s or the spectacular decline in real stock prices during the mid-1970s.”
The 1987 stock-market crash gave Shiller and Summers all the ammunition they needed. “If anyone did seriously believe that price movements are determined by changes in information about economic fundamentals,” Summers said just after the crash, “they’ve got to be disabused of that notion by Monday’s 500-point movement.” The crash also demonstrated that prices didn’t follow the statistical model of a random walk–if they did, a 20% one-day market drop like that of 1987 should happen only once in billions upon billions of years.
Subsequent years saw more challenges to the core assumptions of the rational market. Even Fama retested his 1969 efficient-market hypothesis and found it wanting. But the strong performance of the U.S. stock market and economy tended to silence doubts about the wisdom of the market both on campus and where it really mattered–in Washington and on Wall Street. Shiller warned repeatedly of irrational exuberance in stocks in the late 1990s and in housing in the early 2000s. He was largely ignored both times–until he turned out to be right. Unwillingness to countenance the possibility that market prices might be wildly wrong defined the behavior of regulators, corporate executives and most Wall Streeters during both the tech-stock and real estate bubbles.
The issue isn’t whether financial markets are useful–they are–or whether the prices of stocks or bonds or collateralized debt obligations convey information–they do. There’s also much to be said for the insight at the heart of efficient-market theory: markets are hard to outsmart. But when we give up second-guessing the market, we suspend our judgment. And without participants’ exercising judgment–applying research, heeding a broker’s opinion–markets stand no chance of ever getting prices right.
Based on Fox’s book The Myth of the Rational Market, published this month by HarperBusin
- Find this article at:
- http://www.time.com/time/magazine/article/0,9171,1904153,00.htm
Exploring The Myth of the Rational Market – Justin Fox, TIME
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The Ultimate Mutual Fund Portfolio – Eugenia Levenson, Fortune
How the bailout bashed the banks
Two good ones:
How the Bailouts Ultimately Bashed the Banks – Nina Easton, Fortune
It’s Time to End the Grotesque Bailouts – Liam Halligan, Daily Telegraph