Over the decades, “garbage in, garbage out” has been shortened to its acronym, GIGO. In politics, one of the places where you’re most likely to run across the GIGO phenomenon is in the construction of a survey sample. Read more
Jul 242009
Jul 222009
Hank Paulson appeared before the House committee on (Lack of) Oversight and (Prevention of) Government Reform last week to defend his actions in the Bank of America/Merrill Lynch deal. For those of you who haven’t been following along, Bank of America CEO Ken Lewis has accused Ben Bernanke and Hank Paulson of pressuring him to complete the Merill acquisition even after discovering that the losses at Merrill were several orders of magnitude higher than what he thought when the deal was struck. Bernanke and Paulson allegedly told Lewis that he and the entire board would be replaced if he didn’t conceal the losses until the deal was approved by shareholders.
I didn’t think Hammerin’ Hank’s reputation could fall any further but after listening to his arrogant testimony this week, I think I have to revise that. Paulson cast himself as the hero in his testimony:
“Many more Americans would be without their homes, their jobs, their businesses, their savings and their way of life,” he said in written testimony prepared for a hearing Thursday.
While losses have been staggering, “that suffering would have been far more profound and disturbing” had the government not intervened, he will tell the House Oversight and Government Reform Committee.
“Our responses were not perfect … But, having had the benefit of some time to reflect, and to consider views expressed by others, I am confident that our responses were substantially correct and they saved this nation from great peril,” Paulson wrote.
Well, gee, thanks Hank. There is no way to know how things would have turned out if you hadn’t bailed out every firm that acted as a counterparty to your net worth (Goldman Sachs), but it’s nice to know it hasn’t affected your self esteem.
While Bernanke prudently fell back on the “I don’t recall” defense, Paulson, believe it or not, defended his threat to Lewis:
Paulson said he told Lewis that reneging on the promise to purchase Merrill would show “a colossal lack of judgment.” He then pointed out to Lewis that the Fed could remove management at the bank if it saw fit, he said.
“By referring to the Federal Reserve’s supervisory powers, I intended to deliver a strong message reinforcing the view that had been consistently expressed by the Federal Reserve, as Bank of America’s regulator, and shared by the Treasury, that it would be unthinkable for Bank of America to take this destructive action for which there was no reasonable legal basis and which would show a lack of judgment,” Paulson said.
Paulson said he believed his remarks to Lewis were “appropriate.”
Faced with being forced out with only a golden parachute to cushion his fall, Lewis decided that maybe those Merrill losses weren’t really so important that they needed to be disclosed to BAC shareholders prior to voting on the merger. Based on the performance of BAC’s stock price since then, shareholders might disagree, but hey that’s a small price to pay for saving the “system”, right?
The charge that the failure of large financial institutions represents a systemic risk is one that suffers from a lack of evidence. Is the system really better off maintaining Citigroup on life support rather than letting it die a natural death? Is the system really better off by expanding the allegedly already too large to fail Bank of America? Is the system really better off when poorly managed companies are rescued at the expense of those who acted more prudently? Is the system really better off when losses are spread far and wide rather than concentrated with those who took the risks? What message does it send to prudent managers when their imprudent competitors are bailed out? Will they be so prudent next time?
The economic success of the US is not dependent on maintaining the status quo. Capitalism is a system which requires failure to advance. The failure of a few companies is not evidence that capitalism has failed but evidence that it is working. Failure sends a message to other market participants that the practices that caused the failure should be avoided. That message applies not only to private companies but to the government institutions that also failed us in this crisis. Attempting to return to the status quo rather than allowing private company failures and reforming failed government institutions does not advance us as a society. It mires us in mediocrity.
It is Paulson, Bernanke and Bush who showed a colossal lack of judgment. It is the management of Bear Stearns, AIG, Lehman, Merrill Lynch, Fannie Mae and Freddie Mac who showed a colossal lack of judgment. It is Alan Greenspan and all the member of the Federal Reserve who showed a colossal lack of judgment. It is most of Congress that showed a colossal lack of judgment. It is Tim Geithner and President Obama who continue to show a colossal lack of judgment. And it is the American taxpayer who will have to pay the tab for the colossal lack of judgment shown by all of them.
The long term consequences of government actions over the last two years will become evident to investors in the coming years, but for now, attention is focused on the immediate situation. And the immediate situation is still improving. The stock market rallied 7% last week as earnings season kicked off with some highly visible positive surprises. Goldman Sachs, JP Morgan, Bank of America and Citigroup all reported better than expected earnings (thanks in large part to the implicit guarantee of the government) and the remainder of the financial sector seems likely to follow suit in the coming weeks. Intel and IBM got the tech sector off to a good start. Next week will see a flood of companies reporting their second quarter results and while there will be a few disappointments such as Google last week, I believe the aggregate numbers will continue to be better than the market expects.
Paulson: A Colossal Lack of Judgment – Joseph Calhoun, Alhambra Inv.
Jul 212009
The stock market is rallying. The economy will recover by year end, and strong profits among big players like Goldman Sachs, IBM and Google will spread to other big corporations. However, many small businesses and working Americans won’t be cheering.
Since December 2007, the private sector has shed 6.6 million jobs-half in manufacturing and construction. Lousy banking practices and a surge in imports, mostly from China, are the main culprits but are not getting fixed.
President Obama’s bank reforms will fix many abusive lending practices. However his reforms hardly touch Wall Street’s increasing aversion to the ordinary business of making sound loans, and its obsession with abusive derivatives trading and the big bonuses that creates.
The Federal Reserve and FDIC have poured $2 trillion in cheap credit into the banks and financial houses, mostly benefiting the biggest players. Hence, Goldman Sachs and J.P. Morgan post record profits and Citigroup and Bank of America survive when they should simply be dismembered in bankruptcy court. Meanwhile, regional banks that rely on Wall Street for credit simply can’t get enough money to make loans or they end up like CIT Financial and others-broke and bankrupt.
Small and medium sized manufacturers, builders and retailers rely on those disenfranchised regional banks and can’t borrow enough money to sustain operations as the economy recovers. New opportunities in the President’s green economy will go to big players like GM and to businesses in China, where the government understands global commerce is played by rules of prison football.
China has more than 100 million rural underemployed workers, who if moved into factories could replace every manufacturing job in the United States, Western Europe and Japan. China lacks the technology to capture all those jobs but Beijing recognizes its huge, growing market provides leverage to impose teach-to-sell conditions on the likes of GM and GE.
Beijing maintains high barriers to imports, requires Western companies to transfer technology to sell in China and subsidizes exports to the tune of at least $500 billion a year.
Beijing requires 70 percent of all green energy hardware sold in China to be manufactured there. Buick is a top-selling brand, but GM can’t export from Michigan but must produce and source parts in China.
Any suggestion to get tough with Chinese mercantilism is naively labeled protectionism by President Obama and his aids.
Hence, the $789 billion stimulus will create some jobs but those will be mostly low-paying government jobs.
The economy will stage a moderate recovery but few jobs will be created that adequately replace lost high paying manufacturing and construction jobs.
Nevertheless, large companies like GE, GM and IBM are well poised to profit, having downsized domestic operations to service a smaller U.S. market and aggressively expanded in China.
President Obama is serving donuts. The big guys will get the cake and working Americans the hole inside.
President Obama’s Donut Economics – Peter Morici, RealClearMarkets
The Peking-Washington connection: is it real?
A Growing List Of One Term Presidents, China and the Treasuries - A Dependency Relationship, Global Trade, Obama's Hypocrisy, The excellent adventures of Ben Bernanke, The Geithner Resignation Watch, The Global Economy, Unindicted Co-Conspiritors, US Trade Imbalance, We Have Become Beggars To The World
No Responses »
Jul 202009
Is there a clandestine understanding between the world’s two most powerful central banks, the Federal Reserve and the People’s Bank of China?
Naturally, no one can talk about it, let alone confirm or deny anything. But it’s not too difficult to make out the broad outlines of how Chinese-American monetary cooperation may be working.
People’s Bank governor Zhou Xiaochuan and other figures in the Chinese leadership seem to use every opportunity to broadcast finely calibrated skepticism over the dollar’s future. Such Jeremiahs feed on and — in turn — feed doubts about potential American inflation caused by the Fed’s quantitative easing and exploding budget deficits.
But both Washington and Beijing appear to recognize — whatever the saber-rattling — that large-scale shifts in the currency composition of Chinese currency reserves are more or less impossible. Roughly two-thirds of Chinese reserves of more than $2 trillion are thought to be held in the greenback.
Heavy Chinese sales, or even a deliberate policy of diverting export proceeds into Euro or yen by re-dominating sales contracts, would depress the U.S. currency and lower the value of Chinese reserves. It’s the well-known Beijing dollar trap. And it has to be said: the Chinese have maneuvered themselves into it of their own volition, and in full knowledge of the potential problem.
So Governor Zhou’s strictures are, to a certain extent, shadow boxing. However, in return for a tacit standstill agreement on the currency composition of reserves, the Americans have to acknowledge that the renminbi’s value will rise only moderately.
If the Chinese continue taking in dollars, logic tells us the Chinese currency can hardly revalue strongly. A signal of the U.S. authorities’ acceptance of this state of affairs is that the word “manipulation” for Chinese currency management now clearly is banned.
There is another, still more intriguing, side to Chinese currency pronouncements. The doubts voiced from Beijing on the dollar’s stability, far from unsettling the U.S. monetary authorities, are actually manna from heaven for the Federal Reserve. The Obama administration hardly can go in for years of reckless deficit spending when the country’s largest creditor is emitting so many warning signals.
More importantly, the Fed is getting a certain amount of cover from Beijing for its eventual “exit strategy” — a reversal of quantitative easing and a rise in interest rates as soon as economic recovery gets under way.
The Chinese even are giving a strong tailwind to Fed Chairman Ben Bernanke’s bid for re-nomination after his initial four-year term ends in January. The reason? With the Chinese appearing to turn the knife through gloom-laden dollar prognostications, President Obama knows that appointing a heavily political successor to Bernanke would be fraught with great risks.
Any Fed chairman who looks less than squeaky-clean on currency stability is likely to send dollar holders heading for the exits — and could spark the full-scale currency collapse that Wall Street bears have been growling about for months.
So, if Obama wishes to replace Bernanke, he can do so only by bringing in a full-scale monetary hawk — a step that he must rule out on domestic political grounds. The conclusion is that the Chinese maneuverings leave Obama with no choice but to re-appoint Bernanke, whatever the doubts about his stewardship that have arisen in recent months.
When Bernanke a little later this year eventually is confirmed in a second term of office, what’s the betting that a laconic red-rimmed telegram from Governor Zhou will turn up in his in-tray?
The missive and its contents, of course, will remain secret. We can only guess at the possibility that the two men, just for a moment, will share the opportunity for a modicum of discreet self-congratulation.
David Marsh is chairman of London and Oxford Capital Markets. The Marsh on Monday column appears in German in the newspaper Handelsblatt.
A Deal Between the Fed and Bank of China? – David Marsh, MarketWatch
Obama’s Economic Box
A Growing List Of One Term Presidents, A State of Distress, Coming Social Unrest, Death of the Dollar, Deflation-Inflation-Stagflation, Deleveraging, IMF Issues - Discussion, Let's Call What It Is - DEPRESSION, Obama's Hypocrisy, Our phony middle class, Patience is a virtue...Delusion is a vice, Political Chaos, The End of American Capitalism As We Know It? - Discuss, The excellent adventures of Ben Bernanke, The Global Economy, The Importance of Strategic Planning, Truth In Charity, Unemployment Catastrophe, Unindicted Co-Conspiritors, We Have Become Beggars To The World, Who Guarantees the Guarantor?-You Do!
No Responses »
Jul 152009
Despite the administration’s aggressive and costly economic policy initiatives, there is trouble all around.
Barely six months in office, President Obama already finds himself in an economic box. For despite his aggressive and costly economic policy initiatives, the jobs market shows no sign of healing. At the same time, the housing market foreclosure crisis continues apace, while renewed questions are again surfacing about the soundness of the U.S. banking system. To complicate matters, financial markets are now starting to fret about the longer-run inflationary consequences of the unusually large budget deficits in prospect for as far as the eye can see.
In January 2009, on presenting its $780 billion fiscal stimulus package, the Obama administration assured the public that because of that stimulus package U.S. unemployment would not exceed 8 percent. Yet already by June 2009, unemployment had risen to 9.5 percent; including part-time workers, who would prefer to be working full time, unemployment rose to a staggering post-war high of over 16 percent. Worse still, the jobs market shows every sign of being far from bottoming out.
The degree to which unemployment has exceeded the administration’s forecasts has to raise basic questions about the appropriateness and coherence of President Obama’s economic policy approach.
The degree to which unemployment has exceeded the administration’s forecasts has to raise basic questions about the appropriateness and coherence of President Obama’s economic policy approach. These questions pertain not simply to the very poor design of the fiscal stimulus package. Rather they pertain to the adequacy of the measures aimed at stabilizing the housing market and at resolving the country’s most wrenching credit crisis in the post-war period.
At the most basic level, one has to question how much sense it made for President Obama to allow the fiscal package to become excessively back-loaded at time when the economy needed immediate large scale support. If a large fiscal stimulus was indeed needed, why has only $60 billion of that package been dribbled out by June? And why is less than a third of the package scheduled to come into effect in 2009, the year when the package is most sorely needed?
Similarly one has to wonder about the heavy price that the Obama administration paid for effectively outsourcing the package’s design to House Speaker Nancy Pelosi and the rest of the Democratic congressional leadership. Should it really have come as a surprise to us that the resulting stimulus package would be laden with pork and with expenditures that are going to be very difficult to roll back? Or should we now be shocked that the package fell sadly short of including fast acting and effective fiscal stimulus measures that might have gotten the most bang for the buck?
Perhaps the most troubling aspect of the Obama fiscal stimulus package is the serious way in which it compromises the country’s long-run public finances and fans long-run inflationary expectations. The nonpartisan Congressional Budget Office estimates that the Obama budget not only implies unusually large budget deficits over the next two years but it implies that, even when the economy eventually fully recovers, the deficit will remain in the region of between 4 and 6 percentage points of GDP. As a result, over the next decade, the public debt will rise in a manner that has never occurred before in peacetime, from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.
Over the next decade, the public debt will rise in a manner that has never occurred before in peacetime from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.
The rising tide of unemployment must also raise questions about the Obama administration’s efforts to stabilize the housing market, which the administration correctly views as a necessary condition for producing a meaningful economic recovery. One has to expect that a weaker job market will only exacerbate the country’s present foreclosure crisis, which is adding supply to an already glutted housing market. The Center for Responsible Lending estimates that 2.4 million homes could be in foreclosure in 2009 and as many as 8.1 million homes over the next four years. Yet, the Obama administration’s loan modification program announced earlier this year has to date only resulted in 190,000 offers at mortgage loan modification.
Rising unemployment also has to raise questions about whether the Obama administration is not being overly sanguine about the health of the U.S. banking system. For it would seem that unemployment will now well exceed the worst-case scenario in the bank stress test presented by the administration earlier this year. Yet, despite a weakening unemployment outlook that is sure to boost bank losses, the Obama administration is now cavalierly backing away from its earlier initiatives to reduce the toxic assets that remain on the banks’ balance sheets.
Less than six months into his term, President Obama already faces difficult economic policy choices. He can choose, as he now seems to be doing, to counsel patience and assure us that all is well at considerable cost to his credibility on economic policy management. Or he can own up to the facts that he misread the economy in January and that his economic team now needs to go back to the drawing board. For the sake of the U.S. economy, one has to hope that he has the courage to review the overall coherence of his policy approach before it is too late.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was managing director and chief emerging market economic strategist at Salomon Smith Barney and a deputy director in the International Monetary Fund’s policy and review department.
FURTHER READING: Lachman wrote “Does Bernanke Really Deserve a Second Term?” and “Despite the Doubters, It’s Still Top Dollar” on the likelihood that the Chinese renminbi will eventually replace the U.S. dollar as the world’s preeminent international reserve currency. He also penned “Can the IMF Really Save the World Economy?” and “The World Economy’s Europe Problem.” His article “Don’t Repeat Japan’s Mistakes” warns against the policies Japanese authorities followed during their financial crisis in the early 1990s.
Obama Is Stuck In an Economic Box – Desmond Lachman, The American
Washington’s enormous expansion of the government’s spending share of GDP to over 40 percent — including Bailout Nation, TARP, and government takeovers in numerous industries — is eerily reminiscent of Old Europe’s old policies. In a twist of irony, Europe seems to be moving toward a lower-tax-and-spend-and-regulate, Ronald Reagan–type approach, while we in the U.S. are regressing to the failed socialist model of Old Europe. This makes no sense.
Here’s the clincher: Year-to-date, Dow Jones stocks are off 7 percent, while China stocks are up 71 percent. The world index is up 4 percent. Emerging markets are up 25 percent. They’re all beating us. None of this is good.
We’re going the wrong way. That’s why stock markets are not voting for the United States anymore.
Washington Is Going the Wrong Way – Larry Kudlow, CNBC
Jul 092009
A few weeks back, at the dawn of the Obama Administration, I was at dinner with a very bright woman of middle years who called herself an independent. She found the new president very engaging, but she was alarmed by the music in the air: a government takeover of Detroit, a $700 billion government bailout of the banks, a $787 billion stimulus bill, a cap and trade bill that will add perhaps $800-$2,000 to every family’s tax bill, a massive healthcare reform now estimated to cost $1 trillion over the next decade. For the past thirty years, most of them good economic years, the federal bite into our GDP has been just under 20%. Calculating the cost of Obama’s spending it will be 28.1% this fiscal year, a peacetime record!
My dinner companion was alarmed. She was not simply alarmed by the bills our president and his Democratic colleagues were ringing up on the Hill. My friend, the independent, was alarmed by something much more important, the cost to our freedoms. As I believe she put it, “the question here is our liberty.” Increasingly, thoughtful Americans understand the Obama era in these terms. With the government suddenly looming so large in the life of every American, it is time for us to consider what is a singularly American possession, individual liberty. The Founding Fathers created a government that was uniquely solicitous about individual liberty. With the federal government so deeply involved in our healthcare, our banking, our manufacturing, and the many targets of its $787 billion stimulus program, it is time to think about your liberty vis-a-vis the government bureaucrats who are about to minister to you.
Ronald Reagan’s modern conservative movement began thinking about the loss of individual liberty to government encroachment half a century ago thanks in part to the wake up call from Friedrich Hayek, delivered in his indispensable book The Road to Serfdom. Hayek believed government was a threat to freedom, enterprise, and the rule of law. Later another vigilant advocate of personal liberty, Frank Meyer, came along and became a major figure for American conservatives, propounding the exhilarating argument that freedom is essential to mankind. Freedom, he wrote, is the “essence of [man's] being,” for without it a citizen cannot be moral, by which he meant cannot choose good over evil. Meyer believed freedom was at our essence because God put it there. God gave us freedom to choose, good over evil, art over schlock, a knee replacement over a Botox treatment.
Personal liberty makes each American citizen a creature of dignity. Obama overlooks this. Though in presenting Congress a $3.9 trillion budget on February 24 he insisted that “I’m not” for big government, he is. Consider the vastness of the budget, its far-reaching domestic policies, and much of his background as a community organizer. Clearly he is a big government guy. No other American president has been so committed to big government.
Historically most of our experiences with big government have been unhappy. Big government is expensive, inefficient, and once corrupted very difficult to clean up. Moreover, once a government bureaucracy has made its judgment on you, whom do you appeal to? With Obamacare, government will decide when and if you can get that knee replacement. From the clear utterances of the president’s healthcare advisers, namely, Drs. Ezekiel Emanuel and David Blumenthal, that knee replacement will depend on such factors as your age and your overall health. If you are too old or decrepit, government will have a more economical place to spend its money. In other words, your health will not be decided by what you want to pay for it but by government policy. That test you wanted for colon cancer might be denied. You might just be too old. Such decisions are made by the nationalized British system all the time.
Almost any service the government provides can be more efficiently and effectively provided by private enterprise. The most striking example is the inefficiency of the money-losing U.S. Postal Service that has been swept aside by the internet and by such private carriers as UPS and FedEx. Government is not even very effective in its efforts at regulation. Consider the recent failures of Fannie Mae and Freddie Mac and at the Securities and Exchange Commission.
There is another unappreciated failing of government. It politicizes everything that it touches, including the simplest human relations. Agreements that ought to be arrived at voluntarily or through the rule of law are arrived at by lobbyists or thanks to the political power of your group — ethnic, economic, or otherwise.
One of the little noted projects of the government healthcare reforms being considered on Capitol Hill today is the channeling of healthcare money away from the elderly and toward community services and drug or alcohol rehabilitation. Equal rights before the law is all well and good, but it is political favor and political power that matter when big government is making your decisions for you.
That is why so many Americans have opted for freedom from government. We recognize that the free society is the most humane…and the most productive.
Obama is Costing Us More than Money – Emmett Tyrell, American Spectator
The blunt truth is that even if we had had President Obama’s financial regulatory “reforms” in place four years ago–reforms designed to prevent another financial meltdown–we would still have experienced a horrific economic disaster. In other words, the Administration’s prescriptions deal with the symptoms–and those badly–not the underlying causes.
The astonishing housing bubble could not have happened without the Federal Reserve’s easy-money policy, which got under way in late 2003. If not for the excess liquidity created, there would not have been sufficient fuel to distort the housing market and ultimately the financial system. Yet President Obama has remained mum regarding the need for a strong and stable dollar. Without such a policy it’s guaranteed we’ll continue to experience financial turmoil.
The Fed’s punishment for its wretched doings is that Congress will likely give it more regulatory powers. That’s the thing about government: The more it fails, the more power it accrues.
Obama’s Financial Overhaul Is Largely Useless – Steve Forbes, Forbes
Responding to the almost monolithically positive coverage of the Obama administration by the national press, Phil Bronstein, editor-at-large for the Hearst Newspapers, observed recently that the Administration and the reporters covering it should “get a room.” And while USA Today’s account of Barack and Michelle Obama’s “United We Serve” initiative appeared after Bronstein’s quip, its coverage of same serves as yet another example of a media apparently unwilling to show even the remotest amount of skepticism about an Administration and program that deserve a great deal of it.
As USA Today’s Andrea Stone wrote, “First Lady Michelle Obama will launch a summer of service” that the “White House hopes will help the economy recover through the work of individuals.” This is not a joke, and this is also not a parody of slavish White House reportage from the Onion. Stone was serious.
But back to reality, and taking nothing away from either charitable work or volunteerism, neither has anything to do with economic growth. If anything, for drawing potential workers away from the wage economy, volunteerism detracts from economic activity.
Nothing Stimulative About Obama’s Volunteerism – John Tamny, RCM
Joe Nocera has said his peace with respect to Obama’s proposed overhaul of the financial system. And in doing so, he expressed disappointment with several aspects of the proposal. In particular, he is displeased that the proposal “doesn’t attempt to diminish the use of … bespoke derivatives.” That certainly sounds ominous. But it’s also not true.
The proposal calls for increased capital charges on bespoke trades, which is a strong incentive away from them. But frankly, I’m sick of writing about the proposal. So rather than regurgitate and parse the administration’s plans for financial regulation, I’d like to take a moment to get familiar with some of the key concepts at play in the proposal, so that you can read it and come to your own conclusions. The two core areas I focus on here are derivatives and regulatory capital. With an understanding of these two areas, you should be able to get a grasp on what the administration is thinking and what effects the proposal will have in practice.
Obama’s Financial Overhaul: What You Need to Know – The Atlantic
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
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
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
Better to suffer now than in the long-term
Last week saw the publication of some of the scariest numbers so far in this recession. Britain suffered its worst quarterly fall in GDP since 1958: a year when Harold Macmillan was prime minister and the Soviet Union was launching Sputnik satellites into space. The 2.4% fall in the first quarter of 2009 was equivalent to about 10% at an annual rate.
In America the unemployment rate hit its highest level since 1983: when the American embassy in Beirut was bombed and Michael Jackson first performed the “Moonwalk”. Paul Krugman, a Nobel prize-winning economist, has estimated America has lost 6.5m jobs since the start of this recession.
To make matters worse Arnold Schwarzenegger, the governor of the state of California, declared a state of fiscal emergency in his state. The fiscal plight of the American states adds to the ballooning of federal debt discussed in this week’s cover story.
Under such circumstances it is not surprising that Stuart Thomson, the economist at Ignis, talks of a “WWW recovery”. He is not referring to the internet but to the pattern of apparent recovery followed by a decline back into the mire.
After nine months of severe pain it should be apparent to all that the recovery, when it comes, will not be easy. The economies of the developed world are in a dire state.
With the benefit of hindsight it would have been better to take some pain in the short term, rather than the sustained torture by a thousand cuts. For example, letting some large banks and auto makers go under would no doubt have been unpleasant. But if the destruction of old business helped pave the way for the generation of new ones, the longer-term effect could be beneficial.
Of course, it makes sense to minimise the extent of human suffering. Those who lose their jobs should, as far as possible, get help in finding work in new or expanding economic sectors.
In any case, the current recession is hardly painless. As Greg Mankiw, a professor of economics at Harvard, points out in his blog the level of American unemployment now is much higher than the Obama administration forecasted in January. This is despite its huge stimulus plan.
Better to take misery in the short run than face a protracted period of unpleasantness.
Better to Face Our Economic Pain Now – Daniel Ben-Ami, Fund Strategy