The economy
Charles Krauthammer has written regarding the 2008 Wall Street fiasco (emphasis is added):
Interestingly, some of those who did
were hardly on the radar screen of Washington’s elite.
For an excellent collection of such warnings and prognostications,
see this collection of articles
from The American Conservative starting with its founding in 2002.
At least one, published in February 2006,
even uses the punchbowl metaphor wielded by Krauthammer,
and indeed views as causes of future problems the issues that he cited.
But how many of Washington’s anointed elite read The American Conservative?
For an excellent series covering the financial crisis,
but starting only in September 2008 so with the benefit of hindsight,
see the NYT’s The Reckoning.
As of July 2008, in millions and seasonally adjusted,
using horizontally-oriented bar chart format.
Notes:
1. Government includes Federal and local
2. Professional services includes lawyers, management and administrative services
4. Leisure and entertainment includes hotel industry
7. Finance includes banking and real estate
9. Transportation includes airlines and trucking
For the underlying data, see this graphic accompanying the article
“Jobless Rate Hits a High, Dims Hope For Recovery”.
A comment by the author of this blog:
This distribution certainly surprises me.
I would have thought that, aside perhaps from government,
the biggest industrial sectors would be
manufacturing and construction.
To me, that’s what the economy is all about.
Professional services, leisure and entertainment, health care and finance,
although more or less (less in the case of leisure and entertainment) essential,
all seem secondary in importance.
But that reflects, I am sure, my WASP male perspective
(and I have been informed that, even there,
I may well rank on the less “enlightened” part of the scale).
Is it possible that women, and perhaps Jews as well,
have different priorities?
Note also the absence of farming and mining from the top ten
(I’m assuming that they are not included in those listed).
Surely in olden America they would have been high up;
farming might have been number one.
Celebrated Fed Chairman Alan Greenspan’s true legacy is
one of debt and fiscal deceit.
His successor aims to follow.
by Bill Bonner
The American Conservative, 2006-02-13
[This article describes the situation then
and points out the problems to come (I am writing this on 2008-12-01)
with near pinpoint accuracy.
It even uses the “punchbowl” metaphor used by Charles Krauthammer above.
Who in the mainstream media can claim to have diagnosed the problem so acutely,
and pointed out the inevitable consequences so unflinchingly?]
The mortgage crisis is only the beginning ...
By James Howard Kunstler
The American Conservative, 2007-10-08
[This is truly disquieting reading.
Hopefully not all that it projects will come true,
but as of 2008 at least some has.
If you wish an alarming picture of the future, read it,
remembering that it was written circa September 2007,
long before the financial crises of 2008.
An excerpt:]
Bad financial paper, like rust, never sleeps.
The tropical paradise of Hedge Fund Island might seem tranquil for now,
but worms are turning in the dumpsters of securitized alphabet debt
(MBSs, CDOs, CLOs),
and the odor blowing around the world from all this garbage
grows stronger by the day
in places like New York, London, Tokyo, and Shanghai.
Transfusions of loss-cover loans
from the Federal Reserve and other central banks
have enabled the Big Fund Boyz to spend the late summer weekends
rubbing elbows in the Hamptons with transcendent beings like Diddy and Kelly Ripa.
The Boyz gather along the dunes at twilight, bongs in hand,
to gaze at Hedge Fund Island, looming offshore in the gray Atlantic mist,
and they notice something alarming:
the island, which the BFBs built themselves over the past ten years,
seems to be either floating out to sea or perhaps just sinking.
In any case, it’s getting smaller.
The scores of billions of dollars, euros, and other monies
that central banks have recently poured into the sinkhole of losses
will only paper over the essential problem for another few weeks, at most.
The damage to global structured finance has been done,
and there is a widespread, belated recognition that
Now the task of people with power to act in the finance sector—
which itself may be a conceit at this point—
is to manage the rapid dissolution of hallucinated wealth in such a way that
as few people as possible notice that x-trillions in dollar-denominated pixels
have vanished from the hard drives.
Sooner or later, though, millions of shlubs dependent on
pension checks, annuities, or monthly payouts of one kind or another
will notice that something has stopped landing in the mailbox.
...
Terrible shocks are going to rip through the socioeconomic fabric of the U.S....
The fiasco of bad debt won’t be contained.
The choices for those who find themselves financially underwater will be
which translate into Depression (let’s make it a capital “D.”)
By PAUL KRUGMAN
New York Times Op-Ed, 2007-10-26
[An excerpt; emphasis is added.]
[T]he greater tragedy [of the subprime load foreclosures]
is the one facing borrowers
who were offered what they were told were good deals,
only to find themselves in a debt trap.
In his final paper,
Mr. Gramlich stressed the extent to which unregulated lending
is prone to the “abusive lending practices”
he mentioned in his 2004 warning.
The fact is that
many borrowers are ill-equipped to make judgments about “exotic” loans,
like subprime loans that offer a low initial “teaser” rate
that suddenly jumps after two years,
and that include prepayment penalties
preventing the borrowers from undoing their mistakes.
Yet such loans were primarily offered to those least able to evaluate them.
“Why are the most risky loan products
sold to the least sophisticated borrowers?”
Mr. Gramlich asked.
“The question answers itself —
the least sophisticated borrowers
are probably duped into taking these products.”
And “the predictable result was carnage.”
[There is a real underlying social problem being masked here.
How do you prevent unsophisticated people from making mistakes?
Consider the obvious two alternatives:
By William R. Bonner and Lila Rajiva
Washington Post Outlook, 2007-10-28
[The beginning, middle, and end of this wise article; emphasis is added.]
Last summer, the bill started to come due on our debt-fueled economy.
We should have let it -- and let
reckless speculators, subprime lenders and banks
finally get what they had coming.
But instead, the financial authorities let them off the hook.
Rather than simply letting markets be markets,
they bailed out both the fools and the knaves.
We’ll all live to regret it.
...
In the first 25 years after World War II [1946–70],
the average ratio in the U.S. economy
of periods of growth to periods of recession
was only about 5 to 1.
Over the next 25 years [1971–95],
the downturns got softer and even less frequent.
And now, we seem to have rollicked our way
through an expansion longer than any in the preceding era.
[NBER on business cycle dates,
BEA on GDP (see “Percent change from preceding period”)]
Either we are suddenly moving toward the perfection of mankind,
or there’s a large batch of errors we’ve yet to clean up.
And the batch grows by the day.
Never before have so many people owed so much money
in so many different ways.
When you make a mistake with your own money,
you may go broke, you may despair, you may even kill yourself.
Not to sound callous, but the damage rarely goes much further than that.
Make a mistake with borrowed money, on the other hand,
and it sets off a chain reaction of losses.
You lose money, the lender loses money, savers lose money,
and the investors
who bought shaky financial instruments tied up with the original debt
lose money.
...
Instead of wiping out bad decisions,
the Fed’s rate cuts keep the cheap money flowing,
letting errors compound and spread.
Instead of sticking the losses to the people who deserve them,
it redistributes even bigger losses to bystanders:
innocent savers, hapless householders and
dollar-holding, dollar-earning chumps everywhere.
That’s the problem with meddling in markets:
Once you get started, it’s hard to stop.
By MARK LANDLER
New York Times, 2007-11-27
[An excerpt; emphasis is added.]
Referring to television commercials in the United States that
promised loans with no proof of income,
Mr. Müller [a German banking executive] said,
“I do not believe you should lend money
to people whose income you have not properly checked.”
[Various people have been trying to pin responsibility
for America’s subprime loan crisis
on various technical mathematical modeling techniques,
or the misuse thereof (e.g.).
But it seems to me that is disingenuous in the extreme,
when fundamental principles of prudence and responsibility
are ignored, as pointed out above.
If you ignore such fundamentals,
all the sophisticated mathematical models that can ever be developed
won’t help you a whit.]
By David S. Hilzenrath
Washington Post, 2007-12-04
[An excerpt; emphasis is added.]
[T]he missions of Fannie Mae and Freddie Mac have long been muddled,
and their mandates contain built-in conflicts, chief among them
the pressure to make money
as well as serve the public interest.
...
The government expects Fannie Mae and Freddie Mac
to uphold prudent lending standards.
However,
By Steven Pearlstein
Washington Post, 2007-12-05
By PAUL KRUGMAN
New York Times, 2007-12-14
[An excerpt; emphasis is added.]
In past financial crises —
the stock market crash of 1987,
the aftermath of Russia’s default in 1998 —
the Fed has been able to wave its magic wand
and make market turmoil disappear.
But this time the magic isn’t working.
Why not?
Because the problem with the markets isn’t just a lack of liquidity —
there’s also a fundamental problem of solvency.
...
[T]he financial system —
both banks and, probably even more important,
nonbank financial institutions —
made a lot of loans
that are likely to go very, very bad.
It’s easy to get lost in the details of
subprime mortgages, resets, collateralized debt obligations, and so on.
But there are two important facts
that may give you a sense of just how big the problem is.
First, we had an enormous housing bubble in the middle of this decade.
To restore a historically normal ratio of housing prices to rents or incomes,
average home prices would have to fall
about 30 percent from their current levels.
Second, there was a tremendous amount of borrowing into the bubble
[some would say “buying into the bubble”], as
new home buyers purchased houses with little or no money down,
and as
people who already owned houses
refinanced their mortgages as a way of converting rising home prices into cash.
[The problem:
These home buyers, instead of buying low, selling high,
did the reverse: they bought at the top.
Then they made matters worse
by obtaining gimmicky mortgages whose payments were guaranteed to jump up,
even when the underlying home value might be falling.
Finally, many of them had shaky finances and income to start with.]
As home prices come back down to earth,
many of these borrowers will find themselves with negative equity —
owing more than their houses are worth.
Negative equity, in turn,
often leads to foreclosures and big losses for lenders.
And the numbers are huge.
The financial blog Calculated Risk,
using data from First American CoreLogic,
estimates that
if home prices fall 20 percent
there will be 13.7 million homeowners with negative equity.
If prices fall 30 percent,
that number would rise to more than 20 million.
That translates into a lot of losses,
and explains why liquidity has dried up.
What’s going on in the markets isn’t an irrational panic.
It’s a wholly rational panic,
because there’s a lot of bad debt out there,
and
you don’t know how much of that bad debt
is held by the guy who wants to borrow your money.
How will it all end?
Markets won’t start functioning normally
until investors are reasonably sure that they know
where the bodies — I mean, the bad debts — are buried.
And that probably won’t happen until
house prices have finished falling and
financial institutions have come clean about all their losses.
All of this will probably take years.
Meanwhile, anyone who expects the Fed or anyone else
to come up with a plan that makes this financial crisis just go away
will be sorely disappointed.
By George F. Will
Washington Post, 2007-12-16
[An excerpt.]
Although the freeze of adjustable mortgage rates amounts to a revision of perhaps hundreds of thousands of contracts, it will help a relatively small number of people. And it will not help scrupulous borrowers who have scrimped and sacrificed to fulfill the obligations of their contracts. According to Treasury Secretary Hank Paulson, 93 percent of American mortgages are paid on time. At most, 15 percent of recent “resets” -- mortgage rate increases -- have resulted in foreclosures. Alan Reynolds of the Cato Institute says that only about a third of adjustable-rate mortgages are with subprime borrowers and barely half of subprime mortgages have variable rates.
[Hillary] Clinton perhaps regrets that the plan President Bush has enabled and endorsed is voluntary. Today’s liberalism, combining tolerance and statism, cares less what happens than that it be mandatory....
In helping lenders to cooperate with each other in reducing their distress and that of their customers, the government has played only “a convening role,” says Paulson, who adds: “This is a private-sector effort, involving no government money.” But the second half of that statement does not validate the first. The government is now implicated in the making of arbitrary distinctions.
Clinton says the rate freeze should last “until the mortgages have been converted into affordable, fixed-rate loans.” What does “affordable” mean? Paulson says: “Homes in foreclosure can pose costs for whole neighborhoods, as crime goes up and property values decline. Avoiding preventable foreclosures, then, is in the interest of all homeowners.” But all foreclosures are “preventable” if all mortgage contracts can be revised. Regarding “predatory lending,” remember that Congress often operates on the principle “first criminalize, then define.” But did “predatory” lenders expect the borrowers upon whom they supposedly preyed to default?
Speaking ill of lenders began when homo sapiens acquired language, hence it is unsurprising that many people who until recently were criticizing lenders for not making money available to marginally qualified borrowers are now caustic about lenders who complied. Clinton is fluent in the language of liberalism, aka Victimspeak, so, denouncing “Wall Street,” she says families were “lured into risky mortgages” and “led into bad situations” by those who knew better. So, lenders knew their loans would not be fully repaid?
Jesse Jackson speaks of “victims of aggressive mortgage brokers.” But given that foreclosure is usually a net loss for all parties to the transaction, what explains the “aggression”? Who thought it was in their interest to do the luring and leading that Clinton alleges? While granting that “borrowers share responsibility,” her only examples are those “who paid extra fees to avoid documenting their income” and “speculators who were busy buying two, three, four houses to sell for a quick buck.” Everyone else has been victimized.
Paulson has been criticized for saying that some subprime borrowers “will become renters again.” But some borrowers put no money down on their houses, or took mortgages with negligible “teaser” rates, or accepted mortgages requiring them at first to pay only interest, not principal. Such borrowers are effectively renters.
The president says: “The homeowners deserve our help.” But why “deserve”? The principles of “compassionate conservatism” are opaque, but they might involve liberalism’s premise that Americans are so easily victimized they must be regarded as wards of government.
Perhaps Washington’s intervention in the subprime problem reveals the tiny tip of an enormous new entitlement: People who voluntarily run a risk, betting that they will escape unscathed, are entitled to government-organized amelioration when they lose their bets. The costs of this entitlement will include new ambiguities in the concepts of contracts and private property.
By EDMUND L. ANDREWS
New York Times, 2007-12-18
[An excerpt; paragraph numbers and emphasis are added.]
[1]
Until the boom in subprime mortgages turned into a national nightmare this summer, the few people who tried to warn federal banking officials might as well have been talking to themselves.
[2]
John Gamboa and Robert Gnaizda of the Greenlining Institute, a housing advocacy group, warned the Fed in 2004 about unscrupulous lenders.
[3]
Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.
[4]
But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman.
[5]
In 2001, a senior Treasury official, Sheila C. Bair, tried to persuade subprime lenders to adopt a code of “best practices” and to let outside monitors verify their compliance. None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms. Bair recalled recently, soon let them slip.
[6]
And leaders of a housing advocacy group in California, meeting with Mr. Greenspan in 2004, warned that deception was increasing and unscrupulous practices were spreading.
[7]
John C. Gamboa and Robert L. Gnaizda of the Greenlining Institute implored Mr. Greenspan to use his bully pulpit and press for a voluntary code of conduct.
[8]
“He never gave us a good reason, but he didn’t want to do it,” Mr. Gnaizda said last week. “He just wasn’t interested.”
[9]
Today, as the mortgage crisis of 2007 worsens and threatens to tip the economy into a recession, many are asking: where was Washington?
[10]
An examination of regulatory decisions shows that the Federal Reserve and other agencies waited until it was too late before trying to tame the industry’s excesses. Both the Fed and the Bush administration placed a higher priority on promoting “financial innovation” and what President Bush has called the “ownership society.”
[11]
On top of that, many Fed officials counted on the housing boom to prop up the economy after the stock market collapsed in 2000.
[12]
Mr. Greenspan, in an interview, vigorously defended his actions, saying the Fed was poorly equipped to investigate deceptive lending and that it was not to blame for the housing bubble and bust.
[13]
On Tuesday, under a new chairman, the Federal Reserve will try to make up for lost ground by proposing new restrictions on subprime mortgages, invoking its authority under the 13-year-old Home Ownership Equity and Protection Act. Fed officials are expected to demand that lenders document a person’s income and ability to repay the loan, and they may well restrict practices that make it hard for borrowers to see hidden fees or refinance with cheaper mortgages.
[14]
It is an action that people like Mr. Gramlich and Ms. Bair advocated for years with little success. But it will have little impact on many existing subprime lenders, because most have either gone out of business or stopped making subprime loans months ago.
[15]
Before this year, officials here enthusiastically praised subprime lenders for helping millions of families buy homes for the first time. “I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk,” Mr. Greenspan wrote in his recent memoir, “The Age of Turbulence: Adventures in a New World.” “But I believed then, as now, that the benefits of broadened home ownership are worth the risk.”
[16]
As housing prices soared in what became a speculative bubble,
Fed officials took comfort that
foreclosure rates on subprime mortgages remained relatively low.
But
It was not a matter of “if” but “when.”]
[17]
Had officials bothered to look, frightening clues of the coming crisis were available. The Center for Responsible Lending, a nonprofit group based in North Carolina, analyzed records from across the country and found that default rates on subprime loans soared to 20 percent in cities where home prices stopped rising or started to fall.
[18]
“The Federal Reserve could have stopped this problem dead in its tracks,” said Martin Eakes, chief executive of the center. “If the Fed had done its job, we would not have had the abusive lending and we would not have a foreclosure crisis in virtually every community across America.”
By Steven Pearlstein
Washington Post, 2007-12-19
[An excerpt; emphasis is added.]
[I]t may be useful to recall the reasons given by the Fed and other regulators
for rejecting
the same rules that they now consider necessary....
Lesson 1 from the subprime fiasco:
Industry self-regulation almost never works.
Lesson 2:
Disclosure alone won't deter bad behavior.
Lesson 3:
Market discipline can be easily corrupted.
Lesson 4:
Even sophisticated buyers and sellers
cannot always protect themselves,
let alone the safety and soundness of the financial system.
By Steven Pearlstein
Washington Post, 2008-03-28
[An excerpt.]
[1]
Well, isn’t this rich: Max Baucus of Montana and Chuck Grassley of Iowa, chairman and ranking member, respectively, of the Senate Finance Committee are suddenly in a lather that taxpayer funds might be implicated in the Federal Reserve‘s rescue of Bear Stearns.
[2]
Would that be the same Max Baucus and Chuck Grassley who have made careers out of protecting and enhancing the lavish system of import restrictions, price supports and other subsidies that have transformed American farming and ranching into a vast socialist enterprise? You betcha.
[3]
Whatever you want to say about the sharpies on Wall Street, they are pikers compared to Max’s and Chuck’s friends down on the farm when it comes to picking the pockets of taxpayers and consumers, or concocting a system in which the farmers get all the gains while the government assumes most of the risk.
[4]
In case you hadn’t noticed, this last year has been a banner one for farmers, thanks to bountiful harvests and record commodity prices. The average farm household income in 2006 was $77,654, or about 17 percent higher than the average for nonfarm households. And next year, that’s expected to rise to $90,000.
[Note how Pearlstein shines the spotlight on the income of farmers.
But he totally ignores the obscene average income
of investment bankers and hedge fund managers.
What bigotry!
Could it be due to the fact that Pearlstein is, as a matter of fact,
far more ethnically linked
to those who make such obscene wages on Wall Street
than to those farmers?]
[5]
But for Max and Chuck, that’s no reason to cut back on farm socialism. No siree. Farmers are expected to pull in $13 billion in federal subsidies this year. And there will be plenty more once Congress gets around to passing a new five-year farm bill later this spring.
[6]
In fact, the big concern out in farm country these days is that rapidly rising commodity prices are putting the financial squeeze on ethanol plants and grain elevators. It’s probably only a matter of time before Max and Chuck weigh in with “emergency” legislation providing government loans to these cash-strapped operations, just like the Fed is doing with the investment banks. Only unlike the Bear Stearns shareholders, you can be sure that the farmers who own these businesses won’t lose a dime.
[7]
Seriously, folks, this isn’t the time for members of Congress to come sauntering back from another of their vacations and begin second-guessing the battlefield judgments [!!!] of Fed and Treasury officials who have been working day and night to prevent a meltdown in global financial markets.
[Call me a cynic,
but I think this much hyped, and hypothetical,
“meltdown in global financial markets”
may be but a cover story
for what these financial people are really trying to protect:
the income of the financial community.
Added 2008-03-30:
At any rate, the Joe Nocera column below certainly makes a good case
for revising the regulatory system.]
By JOE NOCERA
New York Times, 2008-03-29
[An excerpt; emphasis is added.]
A number of people told me, for instance, that
were ignored.
By Allan Sloan
Washington Post, 2008-04-01
[An excerpt; emphasis is added.]
[In this article] I’ll tell you why I fear that
the Wall Street enablers of the biggest financial mess of my lifetime
will escape with relatively light damage,
leaving the rest of us, and our children and grandchildren,
to pay for their misdeeds.
We’re suffering the aftereffects of the collapse of a Tinker Bell financial market,
one that depended heavily on borrowed money
that has now vanished like pixie dust.
Like Tink, the famous fairy from Peter Pan,
this market could exist
only as long as everyone agreed to believe in it.
So because it was convenient -- and oh, so profitable! --
players embraced fantasies like
U.S. house prices never falling and
cheap short-term money always being available.
...
Academics now feel that
the 1929 slowdown morphed into a Great Depression in large part
because the Fed tightened credit rather than loosening it.
With that precedent in mind,
you can see why Bernanke’s Fed is cutting rates rapidly
and throwing everything but the kitchen sink at today’s problems....
So why hasn’t the cure worked?
The problem is that
vital markets that most people never see --
the constant borrowing and lending and trading among huge institutions --
have been paralyzed by losses, fear and uncertainty.
And you can’t get rid of losses, fear and uncertainty by cutting rates.
Giant institutions are, to use the technical term, scared to death.
They’ve had to come back time after time
and report additional losses on their securities holdings
after telling the market that they had cleaned everything up.
It’s whack-a-mole finance --
the problems keep appearing in unexpected places.
We’ve had problems with
mortgage-backed securities,
collateralized debt obligations,
collateralized loan obligations,
financial insurers,
structured investment vehicles,
asset-backed commercial paper,
auction rate securities,
liquidity puts.
To paraphrase what a top Fednik told me in a moment of candor last fall:
big firms are short of capital because of their losses
(some of which have to do with accounting rules I won’t inflict on you today)
and that
they’re afraid of
not being able to borrow enough short-term money to fund their obligations,
and you can see why credit has dried up.
The fear -- a justifiable one -- is that
if one big financial firm fails,
it will lead to cascading failures throughout the world.
Big firms are so linked with one another and with other market players
that the failure of one large counterparty, as they’re called,
can drag down counterparties all over the globe.
If the counterparties fail, it could drag down the counterparties’ counterparties, and so on.
Meltdown City.
In 1998,
the Fed orchestrated a bailout of the Long-Term Capital Management hedge fund
because it had $1.25 trillion in transactions with other institutions.
These days that’s almost small beer.
Add to that the Wall Street ethos:
[There are, of course, many things to criticize about this,
but here is what really makes me angry.
When people on Wall Street were questioned on
why they were taking such huge profits and fees
out of the money that they were being entrusted to invest wisely,
their answers were that
they were brilliant, smart, and indispensable.
In other words, they were the acme of the much-ballyhooed “meritocracy.”
But now when it looks like they were in fact
fools, scoundrels, charlatans, and swindlers,
who quite literally didn’t even understand their own actions,
there seems no way of recovering
the literally vast profits and fees they extracted from investors.
On Wall Street, as with responsibility for the Iraq War,
is seems like power and accountability have been divorced.]
By FLOYD NORRIS
New York Times, 2008-04-11
[An excerpt.]
Paul Volcker, the former Federal Reserve chairman
whose legacy has not crumbled since he left office,
was right this week when he said
It is striking to realize that
while Mr. Volcker has been gone from the Fed for two decades,
he is, at 80, two years younger than his successor, Alan Greenspan.
Had Mr. Volcker somehow kept the job,
he almost certainly would have been
more skeptical about the new financial architecture —
and less popular on Wall Street —
than Mr. Greenspan was when times were good.
But the bad times we are now entering
might not have become nearly so large a threat.
By PETER S. GOODMAN
New York Times Week in Review, 2008-05-11
[An excerpt; emphasis is added.]
If the United States were any other country,
these would surely be days of panic and austerity in Washington.
With debts spiraling higher, a trade deficit exceeding $700 billion a year, and its currency plunging for years, the government would be forced to cut spending and jack up interest rates in a frantic bid to attract investment.
But the United States is not any other country. For more than half a century, Americans have enjoyed a unique privilege in the global economy: The dollar has been the world’s dominant currency, the money used in most transactions and the repository for the national savings of many countries, including China, Japan and Saudi Arabia.
Come what may — a financial crisis here, a military misadventure there — Americans could count on money sloshing up thick on their shores. Virtually limitless demand for American government bonds has supported the dollar’s value, and kept domestic interest rates down. Americans have been emboldened to spend in blissful disregard of their debts, secure that foreigners would always supply finance. And that devil-may-care spending has in turn fueled economic growth around the world.
This dynamic may be so deeply embedded in the workings of the global economy that it could endure for many years to come: The costs of weaning the United States from its credit habit would ripple far and wide.
But what are the chances that a day of reckoning is coming,
when the dollar would be so weak that
America would have to play by the rules that apply to every other country?
[My opinion: 100%.
The question is not if, but when.
And the longer we put off our adjustments, the worse the outcome will be.]
Recent signs do suggest some fraying in the American relationship with its many foreign creditors. The balance of trade has gotten so lopsided and the question marks hovering over the American economy so thick that some foreign governments are beginning to hedge their bets on the dollar.
...
China’s leaders fear anything that threatens to crimp exports;
that would eliminate jobs and send angry peasants back to their villages.
[Note the contrast with the U.S.
In China, the people want jobs,
not bothering about whether they are “good” jobs
or about that all the issues that seem to tie up labor negotiations in America.
But perhaps Chinese management compensation is not so outlandish
as that, say, on Wall Street,
which would certainly reduce labor unrest.]
By FLOYD NORRIS
New York Times, 2008-05-16
[Its beginning.]
Would you invest money — at a very low interest rate —
to finance mortgage loans made to risky borrowers who put no money down?
What if you knew
the company that made most of the loans had gone bankrupt
because so many of its loans had turned bad almost immediately?
Now, no one would do that.
But it was just a year ago that Merrill Lynch
was wrapping up a securitization that met just those criteria.
The securities were snapped up by buyers like the Bond Fund of America,
one of the largest mutual funds.
Now, that mortgage securitization is a candidate for the title of worst ever.
This week, the Merrill securitization had its first anniversary,
an event that brought no celebrations,
and Moody’s forecast that by the time it is wrapped up,
so many of the mortgages will have gone bad that
60 percent of the money lent will not be paid back.
Already some public investors are seeing their money vanish,
and it seems certain that more will follow.
It turns out that so-called piggyback loans are highly vulnerable to homeowners who walk away when property values fall.
[Now, who would have thought that?
I guess that’s why Wall Streeters make so much money.]
In a typical deal, a buyer took two mortgage loans,
one for 80 percent of the purchase price,
and the other to provide the remaining 20 percent.
It is the latter loans that this securitization, and others like it,
now own.
“In light of the pressure on home prices
and limited or negative borrower equity in their homes,
many second liens were simply written off”
after several months of payments were missed, Moody’s said.
With these loans, it turns out, foreclosure is seldom worth the effort,
since all the money would go to the first mortgage holder.
Making the situation worse is
the nature of many of the mortgages in the Merrill securitization.
Fewer than 30 percent of the loans were made to borrowers
who provided full documentation of their income and assets.
Many of the other borrowers probably lied about their income.
Nearly all had borrowed the full appraised value of the home,
either for the purchase or for refinancing,
and it is possible that some appraisals were unreasonably high
even before home prices began to fall.
The loans in this group did not go to solid credits.
Although market interest rates were low when these mortgages were written,
the mortgages had rates averaging 11.2 percent.
Yet investors who put up most of the money
were willing to accept a floating rate
of just 30 basis points — three-tenths of one percentage point —
over the London interbank offered rate.
At the moment, that gives them a yield of 3.2 percent.
If Moody’s is right, those investors will eventually suffer capital losses.
That is quite a combo for a security:
low yield, high risk.
...
By Kathleen Day
Washington Post Outlook, 2008-06-01
[This opinion piece seems pretty good, except on one point:]
In recent months, dozens of news reporters and bloggers
have blamed former Fed chairman Alan Greenspan for the mortgage mess,
saying that he made money too cheap
by keeping interest rates too low for too long from 2003 to 2004.
[Yes, that was certainly the worst period, see the numbers here or here.
But rates were too low beyond that.]
“Those who argue that
you can incrementally increase interest rates to defuse bubbles
ought to try it sometime,”
Greenspan said recently.
He has a point.
[I’m not a professional economist, but I think that is BS.
We all know how low Greenspan kept the fed funds rate,
close to 1 percent for significant periods of time.
Why did it need to be so low?
I can’t see a plausible reason, other than to keep the expansion,
and with it the unsustainable boom in house prices, going.
Here’s a case in point:
A Washington financial institution, I forget which one,
kept running a memorable print aid, encouraging homeowners to refinance,
that featured the line:
“How low can rates go?”
along with some cute graphic showing boats sinking
and other examples of going down.
The point is that that low rates from the Fed
encouraged financial institutions to keep mortgage rates low
which in turn kept the boom going.]
By Steven Pearlstein
Washington Post, 2008-06-04
[An excerpt; emphasis is added.]
The documentary evidence that has emerged so far confirms that
many people in the financial world were aware of
a significant deterioration in underwriting standards
and that they were taking on unusual risks.
But because of the competitive imperative,
once one company demonstrated that
it could boost short-term profit and grab market share
by lowering underwriting standards,
the others felt they had no choice but to follow it right off the cliff.
Why? Certainly pride is a big part of it -- you’d be shocked
by how fixated Wall Street has become with the annual “league tables”
that rank the investment houses on their volume of initial stock offerings, bond issues or collateralized debt obligations (CDOs).
How investors later fare is barely noticed.
Perhaps most significantly, any bank or investment house
that decided to hold the line on underwriting standards
would have run a real risk of quickly losing its top-performing employees,
who are constantly being recruited by rivals.
Once those key players go, so go their clients,
whose loyalties tend to run to individual investment bankers and fund managers
rather than the financial institutions.
This arms race for talent extends to top executives on Wall Street
who, because of their employment contracts,
have a built-in incentive to take undue risks.
These contracts make it impossible
for these top executives to be fired for making bad business judgments,
no matter how costly they may prove.
As a result,
boards of directors are forced to negotiate “voluntary” retirements,
like the one that allowed Stan O’Neal
to walk away from Merrill Lynch with $161.5 million in cash and stock
after presiding over
the loss of tens of billions of dollars of shareholders’ money.
By David Ignatius
Washington Post, 2008-07-16
By PETER S. GOODMAN
New York Times Week in Review, 2008-07-20
By Steven Pearlstein
Washington Post, 2008-08-15
By Robert J. Samuelson
Washington Post, 2008-09-03
By Examiner Newspapers (Editorial), 2008-09-15
By Steven Pearlstein
Washington Post, 2008-09-18
[An excerpt; paragraph numbers and emphasis are added.]
[4]
What we are witnessing may be
the greatest destruction of financial wealth that the world has ever seen --
paper losses measured in the trillions of dollars.
Corporate wealth. Oil wealth. Real estate wealth. Bank wealth.
Private-equity wealth. Hedge fund wealth. Pension wealth.
It’s a painful reminder that,
when you strip away all the complexity and trappings
from the magnificent new global infrastructure,
finance is still a confidence game --
and once the confidence goes,
there’s no telling when the selling will stop.
[5]
But more than psychology is involved here.
What is really going on, at the most fundamental level, is that
the United States is in the process of
being forced by its foreign creditors
to begin living within its means.
[6]
That wasn’t always the case.
In fact, for most of the past decade,
foreigners seemed only too willing to provide
U.S. households, corporations and governments
all the cheap money they wanted --
and Americans were only too happy to take them up on their offer.
Congress is currently being urged to pass immediately a massive bailout for banks and Wall Street firms.
A (perhaps the) key aspect is that the government would buy from those institutions the “toxic” financial instruments which have lost their value.
The need for such action, supposedly, is that without clearing those dead weights from those institutions books, they can no longer play their necessary role in financing ongoing corporate economic activity.
So what is the urgent need?
To keep corporate economic activity vital.
But are those institutions the only route to doing that?
Who knows?
I certainly don’t.
Congress needs to take some time, to let a variety of knowledgeable experts make alternative proposals, and let those proposals be compared.
The following are some comments by the author of this blog.
First, I have no special training or experience in economics or finance.
Nonetheless, I wish to offer my “two cents.”
Please don’t bail out the financial institutions that made this mess.
Let them suffer the consequences of their own decisions.
They are big boys, made fantastic amounts of money when they could,
and constantly bragged about how smart they were.
Both out of justice and
as a signal to those in the future who might be tempted
to behave as irresponsibly as they did,
don’t bail them out.
The problem, of course, is that many others are, it seems,
dependent on them being bailed out.
But there are other ways of handling that.
The Bush administration would have you believe that
the only solution is to rescue the firms that made the mess in the first place.
But there is another way.
Identify those who are innocent victims of Wall Street’s malfeasance, and
help the victims, not the perpetrators.
By Anthony Faiola, Peter Whoriskey and Renae Merle
Washington Post, 2008-09-23
[Paragraph numbers and emphasis are added.]
[1]
The dollar took its steepest one-day drop in years
as the financial crisis
eroded the nation’s basic measure of value,
helping to drive U.S. stocks sharply lower
and the dollar-based prices of oil and gold sharply higher.
[2]
The convergence of negative sentiment came as
investors focused on the uncertainties
in the Bush administration’s emergency plan
for a massive bailout of the financial system,
outlined this weekend.
Indications yesterday that the administration
would need more time to iron out a compromise with Congress
raised questions about what the plan will ultimately look like,
even as investors tried to assess how and whether it would work.
[3]
New concerns also emerged over
the toll the crisis will take on the U.S. economy,
with many analysts saying the slowdown could worsen,
perhaps costing more jobs and hurting consumers.
[4]
The government’s plan to spend up to $700 billion
to take troubled assets off the books of ailing firms
and billions more to guarantee money-market mutual funds
will
force the Treasury to add to the already massive national debt.
It may have to raise that money
by selling more Treasury bills and perhaps even printing more dollars.
[How else can it be raised?]
That, economists said,
could trigger higher inflation and drag down the economy further.
[5]
The dollar yesterday plunged 2.2 percent against the euro --
its biggest one-day fall since January 2001.
Some analysts predicted that if the dollar continues its dramatic tumble,
the Bush administration would seek the assistance of foreign central banks
to prop it up.
[6]
The steep drop was partly behind Monday’s surge in the price of oil --
denominated in the U.S. currency --
its biggest one-day jump ever in dollar terms.
The price of the benchmark crude oil
catapulted to $120.92 a barrel on the New York Mercantile Exchange,
a $16.37 increase. At one point, the price was up $25.55.
[7]
“This is a revaluation of the U.S.,”
said C. Fred Bergsten,
director of the Peterson Institute for International Economics
and a top Treasury Department official during the Carter administration.
“Growth is going to be slower,
the budget deficit higher, but mostly,
the whole U.S. financial system has been thrown into question.
People around the world are looking at this and saying, ‘Holy Toledo.’ ”
[8]
The realization that
the United States may find itself in worsening financial straits
with or without a bailout
sparked a sell-off on Wall Street.
The Dow Jones industrial average fell 372.75 points, or 3.27 percent,
to close at 11,016.
That wiped away Friday’s nearly 400-point rally
that accompanied the initial unveiling of the Bush administration plan.
The technology-heavy Nasdaq composite index fell 94.92, or 4.2 percent,
to close at 2179.
The Standard and Poor’s 500-stock index was down 47.99, or 3.8 percent,
to close at 1207.
[9]
The size of the bailout, analysts said, has focused attention on
just how much debt the United States can handle
without being forced to raise taxes
or make sharp cutbacks in government spending.
Peter Schiff, president of Euro Pacific Capital,
said the fear of inflation provoked by the $700 billion plan --
without figuring out a way to pay for it --
was behind the market’s dramatic movement.
[10]
[11]
He added that the new rules imposed on short selling,
short-term bets that a stock’s price will go down,
caused a flow of money into commodities besides oil, including gold.
“You can’t short stocks anymore, right?
So if you want to bet against the market,
you need to buy commodities: gold, oil,”
he said.
[12]
As the market gyrations left many investors wondering what would happen next,
[13]
“This is arguably a critical question given that
the U.S. Treasury‘s Aaa rating
acts as the cornerstone of risk pricing in the global financial system,”
said Pierre Cailleteau,
managing director of the sovereign risk unit at Moody’s Investors Service
and author of a report issued yesterday on the U.S. credit rating.
[14]
A loss of that status would probably mean that
the United States would have to pay more to those investors,
including foreign governments, that hold U.S. bonds.
But the report said,
“Moody’s continues to view the foundations of the U.S. government rating
as unshaken.”
[15]
Similarly, John Chambers, a managing director at Standard and Poor’s,
said he viewed the United States as stable.
Although some have drawn parallels between the current financial woes
and those in Japan, which lost its AAA credit rating in 2001,
Chambers said
the United States has far greater ability to meet its obligations.
[16]
He noted that before Japan lost its AAA rating,
its general government debt
was more than 100 percent of its gross domestic product.
By contrast, even figuring in “every last nickel” of the proposed U.S. bailouts,
general government debt in the United States
falls below 60 percent of gross domestic product, he said.
[17]
One key question for investors and multilateral lenders is
how the U.S. bailout plan will treat foreign investors
in troubled mortgage-backed securities.
“A substantial amount of these securities are held by non-U.S investors,”
said John Lipsky,
first deputy managing director of the International Monetary Fund.
“Obviously, the disposition of the U.S. [toward these investors]
will be important to determining
future attitudes about investing in the U.S. versus elsewhere.”
[18]
Foreign governments and multilateral lenders
have been offering advice to the U.S. government
as it moved in recent weeks to take over some financial institutions
while allowing others to fail.
The IMF has been subtly calling on the United States
to take a broader approach to the financial crisis,
and officials there applauded the administration’s efforts in recent days
to launch a more comprehensive plan to address core issues.
[19]
“Obviously, these events have been striking and potentially very troublesome,
but the remedial actions being taken, if done right,
will help to restore any confidence that might have been lost,” Lipsky said.
[20]
As investors await final details of the financial rescue plan,
some analysts noted that
it will not address some of the economy’s fundamental weaknesses,
including poor housing prices and growing unemployment figures.
[21]
“With talk of the government buying assets at steep discounts
and of an emphasis on taxpayer protection,
the benefits to bank and thrift capital levels
may be less than the market anticipates,”
Paul J. Miller Jr., an analyst with Friedman, Billings, Ramsey,
said in a research note yesterday.
“At this point, we just do not know.
While the plan will most likely help,
banks and thrifts still need to raise capital.”
[22]
It is also unclear whether the $700 billion will be enough.
Will banks be forced to open their books to their public,
and how will their bad debt be evaluated?
“It’s not clear who is going to be allowed to participate,”
said Joseph Brusuelas, chief U.S. economist at Merk Investments.
“How much will each individual bank be allowed to dump on the public?”
regarding the mortgage crisis and the plan to bailout Wall Street
[From John Cochrane and over two hundred university economists.
The emphasis is added.]
(This letter was sent to Congress on Wed Sept 24 2008
regarding the Treasury plan as outlined on that date.
It does not reflect all signatories views on subsequent plans
or modifications of the bill)
To the Speaker of the House of Representatives
and the President pro tempore of the Senate:
As economists,
we want to express to Congress our great concern
for the plan proposed by Treasury Secretary Paulson
to deal with the financial crisis.
We are well aware of the difficulty of the current financial situation
and we agree with the need for bold action
to ensure that the financial system continues to function.
We see three fatal pitfalls in the currently proposed plan:
For these reasons we ask Congress
Signed (updated at 9/27/2008 6:00PM CT)
[For the signers, see the original;
over two hundred names (231 as of the above date)]
By Neil Irwin and Cecilia Kang
Washington Post, 2008-09-26
[Paragraph numbers and emphasis are added.]
[1]
The Bush administration’s pitch for a sweeping bailout of the financial system
has centered on two simple premises:
[2]
But many of the nation’s top economists
disagree with one or both of those ideas,
even as many top political leaders have swung behind them.
[3]
Wall Street economists
have mostly endorsed Treasury Secretary Henry M. Paulson Jr.’s plan,
or a variation thereof.
[4]
But almost 200 academic economists [as of 09-27, 231] --
who aren’t paid by the institutions that could directly benefit from the plan
but who also may not have recent practical experience in the markets --
have signed a petition organized by a University of Chicago professor
objecting to the plan on the grounds that
brandished that letter yesterday afternoon
as he explained his opposition to the bailout
outside a bipartisan summit at the White House.
The petition did not advocate any specific plan,
including that offered yesterday by House Republicans.
[5]
Economists tend to agree that the nation’s economy is at serious risk
as the flow of credit threatens to freeze.
Just yesterday,
the interest rate at which banks lend to each other rose steeply,
as it has every day this week,
suggesting that lenders are hoarding cash.
History shows that when this happens, a broad economic crisis can follow,
for instance,
the Great Depression and Japan’s decade-long recession in the 1990s.
[6]
“If nothing is done,
the potential for these markets to seize up in a big way is definitely there,”
said Frederic S. Mishkin, an economist at Columbia University
who was a Federal Reserve governor until last month.
“When you look at the history of these crises,
when things spin out of control,
the cost to fix it later goes up exponentially.”
[7]
But many others
with a deep theoretical knowledge of finance and experience in government
are skeptical of the structure of Paulson’s plan --
and the speed with which it has been crafted.
[8]
The critics can be roughly divided into two camps.
[9]
The plan promoted by Paulson and Fed Chairman Ben S. Bernanke
is somewhere in between:
buying up packages of mortgages and hoping that the benefits spread
both up to banks and down to households.
[10]
“The plan is a trickle-down approach from banks to Main Street,”
said Alan S. Blinder, a professor at Princeton University
[how’s that for an understatement?].
“But if you reduce the flood of foreclosures and defaults” --
which he would have the government do by buying loans directly
and then renegotiating the terms --
“it will make mortgage-backed securities worth more.”
[11]
That might help ordinary Americans
but would be extremely difficult to administer.
The government would have to make decisions on
the foreclosure and resale of individual houses all over the country.
Still, many economists with left-of-center political views
favor some variation of this approach
to the plan endorsed by Bush.
[12]
“There is a kind of suggestion in the Paulson proposal that
if only we provide enough money to financial markets,
this problem will disappear,”
said Joseph Stiglitz, a Nobel Prize-winning economist.
“But that
does nothing to address the fundamental problem
of bleeding foreclosures and
the holes in the balance sheets of banks.”
[Well, I certainly am not even qualified to carry Joseph Stiglitz’s shoes,
but it seems to me that
buying those underwater securities from the banks
does indeed fill in some holes in their balance sheets.]
[13]
Coming from the other direction, more conservative economists worry that
by having the government buy mortgage securities,
[14]
In a sign of how the debate over the economy has shifted in recent weeks,
some conservatives,
even as they argue for a relatively limited government role,
are calling on the government to invest public money in private banks.
[15]
“The root of the issue is recapitalizing banks,”
said Glenn Hubbard, dean of Columbia Business School
and a former chairman of President Bush’s Council of Economic Advisers.
“That could be done more efficiently through
the government injection of preferred equity.
Then the market could figure out the prices of the assets.”
[16]
Many of these critics don’t care for
the assumption behind the administration’s plan that
the market is now pricing these mortgage securities incorrectly,
a problem that the government intervention aims to fix.
[17]
“The premise appears to be that the market is irrationally pessimistic,”
wrote Greg Mankiw, a Harvard University economist and another former Bush economic adviser, on his blog this week.
“That might be so.
Nonetheless, one has to be at least a bit skeptical about the idea that
government policymakers gambling with other people’s money
are better at judging the value of complex financial instruments
than are private investors gambling with their own.”
[18]
Some conservatives are now arguing, notably, that
the government should be investing in banks.
[19]
Many economists fault the Bush administration and Congress
for moving so quickly on the bailout package
without allowing more time for debate.
That sentiment was reflected in
the petition organized by John Cochrane of the University of Chicago.
(None of the economists quoted here were signatories.)
[20]
“I totally disagree that this needs to be done this week.
It’s more important to get it right,”
Blinder said.
[21]
Moreover, some economists said
the proposed $700 billion may not be enough
to address all the problems stretching across the financial landscape.
“You only show up if you can win, and this is not that package,”
said Simon Johnson, a professor at Massachusetts Institute of Technology
and former chief economist at the International Monetary Fund.
“This cannot be the ultimate, decisive solution
if you are not addressing the underlying cause.”
[22]
The plan is short on details, instead
giving the Treasury secretary wide latitude to determine
how to execute the purchases of mortgage securities.
[23]
“I’d like to see how they see the evolution of an end game.
There are still many questions,”
said Myron Scholes [of Black-Scholes fame],
a retired professor at Stanford University and Nobel Prize winner.
He said
how long the government holds the assets and how they are later resold
would be the keys to determining whether the plan works.
Some comments from the author of this blog:
I would never, ever, claim to be a financial guru,
but even so have some issues
(presented here in a question and answer format)
with this proposed bailout.
Just whom are we bailing out?
Who owns these “mortgage-backed securities” that are now underwater?
Their owners are, evidently, investment houses on Wall Street,
which are the smartest financial cookies in the whole world,
in their own estimation, that of those who put up their funds,
and that of many others (they’re the Meritocracy, we are told).
Why did they invest in those mortgages?
The expectation of future gain.
They expected housing prices to continue to rise,
and the mortgagees to be able to make the payments.
Both expectations have, of course, been proven wrong.
No financial trend goes on forever, and they made their buys
near the top of a bubble, rather than at the beginning.
They bought high, and face the prospect of selling low.
So the bottom line is: they made some very bad financial bets.
Of course, they are hardly the only ones who have bet wrong.
What are the negative consequences of bailing them out?
In the future, every time there is a bubble,
big players can keep the bubble rising,
with the expectation that if it bursts, they won’t take a bath,
rather, they can just pass their bad investments off on the taxpayers
(actually, onto future generations).
What real problem(s) does this situation cause?
The destruction of trust that these events have caused is a real problem.
Look at some of the lies that have been told:
Many of those who obtained the mortgages did so under false pretenses,
if not outright lies, about their income, assets, and earning potential.
That is not too surprising, that is why credit checks are normally made.
What is surprising is that those making the loans lowered their standards.
Secondly,
evidently some (perhaps many) of those who made and packaged the loans
deceived those who bought the loans
about the creditworthiness of the loan-payers.
For example, mortgage-backed securities were sold to various pension-funds,
claiming to be of much higher grade than they actually were.
That is a matter of business ethics, if not regulations and the law,
which is clearly shameful.
But it would appear that some people in the financial industry
are, in this matter, quite literally shameless.
(To make a vast and perhaps inappropriate generalization,
I think the last fifty years or so have seen a devaluation of
both Christianity and public and private truth-telling,
and believe that that correlation is not coincidental.)
So now the attitude is that suggested by the familiar aphorism:
are not about to be swindled again.
This leads to the credit crunch we are hearing about.
Why should any investor believe what he is being told
by essentially the same people?
So what is the elite’s solution to this problem?
To take all the bad investments
off the hands of those who made the bad investments?
Just how does that help solve the problem of the lack of trust?
The only thing that does is help the financial position
of those who made the bad investments.
Why does the elite wish to help these particular people?
One answer, and one answer only:
Political pull.
The people would be helped by this proposed bailout
have more political power, per capita, than anyone else in America.
They are among, if not at the top of, those who make political contributions.
It is not quite right, but not too far off the mark, to say that
they own both political parties.
Further, through various ties (read into that what you will)
they have great influence over the media.
This makes sure that the downside to the bailout,
and the alternative solutions the the underlying problem
(keeping credit available to deserving borrowers)
do not receive the attention that they should,
until it is too late (after the bailout is passed).
Then, after the bailout is passed, all the problems with it,
and the alternative approaches that were not considered,
can be discussed ad infinitum (cf. Iraq).
But then they can be blamed on the stupid politicians who passed the bill,
and the role the media played (or did not play) in presenting a fair picture
can be ignored.
Isn’t democracy wonderful?
By Binyamin Appelbaum, David Cho and Neil Irwin
Washington Post, 2008-09-29
[An excerpt; emphasis is added.]
“We need confidence, and this is about confidence,”
Paulson said.
[Glad he admitted that.
It’s sure not about fundamentals.
On second thought,
I think both Paulson and I are wrong.
It is about fundamentals:
The fundamental problem that
so many loans were made on, basically,
the assumption that the economy would keep doing well in the future,
in other words, on the once-famous “rosy scenario.”]
In a practical sense,
the government is trying to revive the markets
because
buying up all the troubled assets would require far more than $700 billion.
Twenty of the nation’s largest financial institutions
owned a combined total of $2.3 trillion in mortgages as of June 30.
They owned another $1.2 trillion of mortgage-backed securities.
And they reported selling another $1.2 trillion in mortgage-related investments
on which they retained hundreds of billions of dollars in potential liability,
according to filings the firms made with regulatory agencies.
The numbers do not include investments derived from mortgages
in more complicated ways, such as collateralized debt obligations.
Experts say the Treasury plan could do more harm than good.
If the Treasury pushes to buy troubled assets at bargain-basement prices,
many banks that hold similar assets
would be forced to mark down their holdings.
Such losses could push some institutions over the edge.
If the Treasury overpays, taxpayers could lose massive sums.
“There are more questions of doing this and the consequence of doing it poorly
than anything else,”
said Richard H. Baker, a former Congressman
and the chief executive of the Managed Funds Association,
which lobbies for hedge funds.
...
The bill also forces a re-evaluation of “mark to market” accounting rules,
under which
banks and other financial institutions must adjust the value of their assets
to reflect current market prices,
even if they intend to hold the assets for the long term.
Bank executives have blamed these rules in part for their troubles,
saying that distressed sellers have pushed market prices below actual values,
forcing unreasonable write-downs.
The Securities and Exchange Commission already
has the power to overrule the board that sets those accounting rules,
the Financial Accounting Standards Board,
but the bill restates that the SEC had authority to change mark-to-market rules.
It also orders a study be conducted on
the role mark-to-market rules played in the current crisis.
Lynn E. Turner, a former chief accountant at the SEC, criticized the provision,
which he said was designed to help bend the commission to the banks’ will.
“What they’ve done here is say
let’s study whether banks should be allowed to lie,”
he said.
“Regardless of whether you had mark-to-market accounting,
you would have this problem, which is banks running out of cash.
And they’re running out of cash
because they made loans to people who aren’t paying them back.”
[There are, in fact, several explanations offered for why banks are low on cash:
By Steven Pearlstein
Washington Post, 2008-09-30
[An excerpt; emphasis is added.]
Oy vey.
[Yes, that is how Pearlstein began his column.]
...
[Leaders] will come around, reluctantly, to the understanding that the only way to get out of these situations is to have governments all around the world borrow gobs of money and effectively nationalize large swaths of the financial system so it can be restructured, recapitalized, reformed and returned to private ownership once the crisis has passed and the economy has gotten back on its feet.
[In response to Mr. Rickards’ op-ed, the following letter to the editor appeared in the Post on 10-08:] See-No-Risk Analyses In his Oct. 2 op-ed, “A Mountain, Overlooked,” James Rickards correctly explained why “random walk” risk models, apparently widely used on Wall Street, vastly underestimate the probability of catastrophic collapses. Mathematicians and physicists have understood this for decades, and they have developed much better methods for estimating the probability of extreme events in complex systems. Many of the pioneers in this field were interested in markets and clearly pointed out that risks can be thousands of times larger than what comes out of random walk models. For at least 20 years, Wall Street has been hiring some of the best young theoretical physicists to do risk analysis for them. All of these physicists know that random walk models are inappropriate and unreliable for market analysis of extreme events. If the people who run banks and hedge funds, and the agencies that regulate them, didn’t know that, it is because they didn’t want to. MARTIN LAMPE University Park
James Grant is the editor of Grant’s Interest Rate Observer and author of the forthcoming book “Mr. Market Miscalculates: The Bubble Years and Beyond.”
The writer, who was economic adviser for Ron Paul’s 2008 presidential campaign, is president of Euro Pacific Capital. He is the author of “The Little Book of Bull Moves in Bear Markets.”
Charles Morris, a lawyer and former banker, is the author of The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash.
By FRANCIS FUKUYAMA
New York Times Book Review,2011-05-06
by Peter Dreier
commondreams.org, 2011-05-09
The ideas of Friedrich Hayek (1899-1992) are making a comeback, in large part due to Glenn Beck, who has touted the libertarian economist and philosopher’s views on his TV show. The essence of Hayek’s views -- spelled out in his most well-known book, The Road to Serfdom -- is that government stifles freedom and liberty. With a few exceptions, he viewed almost any governmental intervention in economic affairs as a slippery slope toward totalitarian socialism. No wonder that Beck has been hawking Hayek. Now comes Francis Fukuyama, the neoconservative political scientist, who uses the pages of the New York Times Book Review to hawk his own version of government-bashing. Unfortunately, Fukuyama, who claims to be something of a student of Hayek’s ideas, hasn’t done his homework. In his review of the new edition of Hayek’s The Constitution of Liberty, published in the Review on Sunday (May 8), Fukuyama off-handedly comments that three of Hayek’s ideas “have become broadly accepted by economists.” But it so happens that economists don’t agree on these three ideas. Moreover, the policy conclusions that Fukuyama draws happen to be untrue. First, Fukuyama claims that “labor unions create a privileged labor sector at the expense of the nonunionized.” It is true that unionized employees earn better wages and benefits than their nonunion counterparts, even those with comparable experience and education. But economists know that it is also true that unions raise wages and benefits for nonunionized workers. The higher the “density” of union workers in an industry or area, the more likely it is that employers will increase the wages and benefits of nonunion employees in order to stave off a union drive. Thus, unions lift the floor for everyone, not just union members, contrary to Hayek. Second, Fukuyama claims that economists agree with Hayek that “rent control reduces the supply of housing.” Economists differ on the wisdom of price controls in general, but it helps to test economist theories in the real world. There is absolutely no empirical evidence for the statement that rent control -- which some cities use to maintain a supply of affordable housing -- reduces the housing supply in general or even rental housing in particular. Every study of rent control in U.S. cities (except those funded by the real estate industry) -- including those that compare similar cities with and without rent control -- shows that rent control has no impact on either the level of new housing construction or the level of housing abandonment. Local rent control laws exempt new construction and allow landlords to raise rents annually based on expenses. Cities with various forms of rent control are often in “hot” markets in which developers want to build rental and other forms of housing. The evidence is clear that rent control does not dampen private investment. Finally, Fukuyama claims that economists agree that “agricultural subsidies lower the general welfare and create a bonanza for politicians.” Again, there is no evidence for this statement. The impact of farm subsidies depends on who gets them, what they are used for, and the general economic condition of the period. During the Depression, subsidies saved many family farmers from going under, helped stabilize prices, and kept entire farm communities, and the nonfarm jobs that depended on agriculture, alive. Today, the vast majority of federal farm subsidies go to large agribusiness conglomerates like Archer Daniels Midland and Cargill that don’t need them rather than small family farmers. President Obama campaigned on a pledge to limit individual farm payments to $250,000 to ensure family farms and not “corporate agribusiness” got the money. This is still a good idea. But food stamps, which are an indirect subsidy to farmers, clearly improve the general welfare by dramatically reducing the incidence of hunger and malnutrition. ...
by Steven Pearlstein
Washington Post, 2011-10-30
by Robert J. Samuelson
Washington Post, 2018-03-05
Tight labor markets might well raise wage increases,
and these in turn might stimulate higher price increases —
and we are then off on a wage-price spiral reminiscent of the ’60s and ’70s.
This, of course, won’t be the end of it.
The prospect of higher inflation means that
“the Fed and the [Trump] administration are on a collision course”
The mob is agitated but hardly blameless.Few, perhaps, but some did.
While the punch bowl --
Alan Greenspan’s extremely low post-Sept. 11 interest rates --
was being held out,
few complained about cheap loans and doubling home values.
Now all of a sudden everything is the fault of Wall Street malfeasance.
Interestingly, some of those who did
were hardly on the radar screen of Washington’s elite.
For an excellent collection of such warnings and prognostications,
see this collection of articles
from The American Conservative starting with its founding in 2002.
At least one, published in February 2006,
even uses the punchbowl metaphor wielded by Krauthammer,
and indeed views as causes of future problems the issues that he cited.
But how many of Washington’s anointed elite read The American Conservative?
For an excellent series covering the financial crisis,
but starting only in September 2008 so with the benefit of hindsight,
see the NYT’s The Reckoning.
U.S. 2008 Employment by Industry Sector
As of July 2008, in millions and seasonally adjusted,
using horizontally-oriented bar chart format.
1 Government 12345678901234567890123 2 Professional Services 123456789012345678 3 Retail 123456789012345 4 Leisure and Entertainment 12345678901234 5 Manufacturing 1234567890123 6 Health Care 1234567890123 7 Finance 12345678 8 Construction 1234567 9 Transportation 12345 10 Education 123
Notes:
1. Government includes Federal and local
2. Professional services includes lawyers, management and administrative services
4. Leisure and entertainment includes hotel industry
7. Finance includes banking and real estate
9. Transportation includes airlines and trucking
For the underlying data, see this graphic accompanying the article
“Jobless Rate Hits a High, Dims Hope For Recovery”.
A comment by the author of this blog:
This distribution certainly surprises me.
I would have thought that, aside perhaps from government,
the biggest industrial sectors would be
manufacturing and construction.
To me, that’s what the economy is all about.
Professional services, leisure and entertainment, health care and finance,
although more or less (less in the case of leisure and entertainment) essential,
all seem secondary in importance.
But that reflects, I am sure, my WASP male perspective
(and I have been informed that, even there,
I may well rank on the less “enlightened” part of the scale).
Is it possible that women, and perhaps Jews as well,
have different priorities?
Note also the absence of farming and mining from the top ten
(I’m assuming that they are not included in those listed).
Surely in olden America they would have been high up;
farming might have been number one.
Miscellaneous Articles
2006
2006-02-13-TAC-Bonner
Eat, Drink, and Buy MerrilyCelebrated Fed Chairman Alan Greenspan’s true legacy is
one of debt and fiscal deceit.
His successor aims to follow.
by Bill Bonner
The American Conservative, 2006-02-13
[This article describes the situation then
and points out the problems to come (I am writing this on 2008-12-01)
with near pinpoint accuracy.
It even uses the “punchbowl” metaphor used by Charles Krauthammer above.
Who in the mainstream media can claim to have diagnosed the problem so acutely,
and pointed out the inevitable consequences so unflinchingly?]
2007
2007-10-08-Kuntsler
Slip Sliding AwayThe mortgage crisis is only the beginning ...
By James Howard Kunstler
The American Conservative, 2007-10-08
[This is truly disquieting reading.
Hopefully not all that it projects will come true,
but as of 2008 at least some has.
If you wish an alarming picture of the future, read it,
remembering that it was written circa September 2007,
long before the financial crises of 2008.
An excerpt:]
Bad financial paper, like rust, never sleeps.
The tropical paradise of Hedge Fund Island might seem tranquil for now,
but worms are turning in the dumpsters of securitized alphabet debt
(MBSs, CDOs, CLOs),
and the odor blowing around the world from all this garbage
grows stronger by the day
in places like New York, London, Tokyo, and Shanghai.
Transfusions of loss-cover loans
from the Federal Reserve and other central banks
have enabled the Big Fund Boyz to spend the late summer weekends
rubbing elbows in the Hamptons with transcendent beings like Diddy and Kelly Ripa.
The Boyz gather along the dunes at twilight, bongs in hand,
to gaze at Hedge Fund Island, looming offshore in the gray Atlantic mist,
and they notice something alarming:
the island, which the BFBs built themselves over the past ten years,
seems to be either floating out to sea or perhaps just sinking.
In any case, it’s getting smaller.
The scores of billions of dollars, euros, and other monies
that central banks have recently poured into the sinkhole of losses
will only paper over the essential problem for another few weeks, at most.
The damage to global structured finance has been done,
and there is a widespread, belated recognition that
it’s not possible to get something for nothing after all.
When you hold a lot of paper that represents nothing
and put it up for sale,
nothing will be offered for it.
Now the task of people with power to act in the finance sector—
which itself may be a conceit at this point—
is to manage the rapid dissolution of hallucinated wealth in such a way that
as few people as possible notice that x-trillions in dollar-denominated pixels
have vanished from the hard drives.
Sooner or later, though, millions of shlubs dependent on
pension checks, annuities, or monthly payouts of one kind or another
will notice that something has stopped landing in the mailbox.
...
Terrible shocks are going to rip through the socioeconomic fabric of the U.S....
The fiasco of bad debt won’t be contained.
The choices for those who find themselves financially underwater will be
- liquidation,
- bankruptcy, or
- destroying whatever remains of confidence in the U.S. dollar
in order to erase debt by hyperinflation.
which translate into Depression (let’s make it a capital “D.”)
2007-10-26-Krugman
A Catastrophe ForetoldBy PAUL KRUGMAN
New York Times Op-Ed, 2007-10-26
[An excerpt; emphasis is added.]
[T]he greater tragedy [of the subprime load foreclosures]
is the one facing borrowers
who were offered what they were told were good deals,
only to find themselves in a debt trap.
In his final paper,
Mr. Gramlich stressed the extent to which unregulated lending
is prone to the “abusive lending practices”
he mentioned in his 2004 warning.
The fact is that
many borrowers are ill-equipped to make judgments about “exotic” loans,
like subprime loans that offer a low initial “teaser” rate
that suddenly jumps after two years,
and that include prepayment penalties
preventing the borrowers from undoing their mistakes.
Yet such loans were primarily offered to those least able to evaluate them.
“Why are the most risky loan products
sold to the least sophisticated borrowers?”
Mr. Gramlich asked.
“The question answers itself —
the least sophisticated borrowers
are probably duped into taking these products.”
And “the predictable result was carnage.”
[There is a real underlying social problem being masked here.
How do you prevent unsophisticated people from making mistakes?
Consider the obvious two alternatives:
- Explain carefully the risks in writing.
Make them sign a statement that they have read the warnings
before they get the loan.
But are unsophisticated borrowers going to understand the warnings? - Simply do not offer substandard borrowers the subprime loans.
But many of such potential borrowers are likely to be minorities.
How do you guard against the charge that they are being denied the loans simply because they are minorities?
2007-10-28-Bonner+Rajiva
Is Bailing Out Reckless Investors Wise? Don't Bank on It.By William R. Bonner and Lila Rajiva
Washington Post Outlook, 2007-10-28
[The beginning, middle, and end of this wise article; emphasis is added.]
Last summer, the bill started to come due on our debt-fueled economy.
We should have let it -- and let
reckless speculators, subprime lenders and banks
finally get what they had coming.
But instead, the financial authorities let them off the hook.
Rather than simply letting markets be markets,
they bailed out both the fools and the knaves.
We’ll all live to regret it.
...
In the first 25 years after World War II [1946–70],
the average ratio in the U.S. economy
of periods of growth to periods of recession
was only about 5 to 1.
Over the next 25 years [1971–95],
the downturns got softer and even less frequent.
And now, we seem to have rollicked our way
through an expansion longer than any in the preceding era.
[NBER on business cycle dates,
BEA on GDP (see “Percent change from preceding period”)]
Either we are suddenly moving toward the perfection of mankind,
or there’s a large batch of errors we’ve yet to clean up.
And the batch grows by the day.
Never before have so many people owed so much money
in so many different ways.
When you make a mistake with your own money,
you may go broke, you may despair, you may even kill yourself.
Not to sound callous, but the damage rarely goes much further than that.
Make a mistake with borrowed money, on the other hand,
and it sets off a chain reaction of losses.
You lose money, the lender loses money, savers lose money,
and the investors
who bought shaky financial instruments tied up with the original debt
lose money.
...
Instead of wiping out bad decisions,
the Fed’s rate cuts keep the cheap money flowing,
letting errors compound and spread.
Instead of sticking the losses to the people who deserve them,
it redistributes even bigger losses to bystanders:
innocent savers, hapless householders and
dollar-holding, dollar-earning chumps everywhere.
That’s the problem with meddling in markets:
Once you get started, it’s hard to stop.
2007-11-27-NYT
A Banker in Germany Says Trouble Is Not OverBy MARK LANDLER
New York Times, 2007-11-27
[An excerpt; emphasis is added.]
Referring to television commercials in the United States that
promised loans with no proof of income,
Mr. Müller [a German banking executive] said,
“I do not believe you should lend money
to people whose income you have not properly checked.”
[Various people have been trying to pin responsibility
for America’s subprime loan crisis
on various technical mathematical modeling techniques,
or the misuse thereof (e.g.).
But it seems to me that is disingenuous in the extreme,
when fundamental principles of prudence and responsibility
are ignored, as pointed out above.
If you ignore such fundamentals,
all the sophisticated mathematical models that can ever be developed
won’t help you a whit.]
2007-12-04-Hilzenrath
Fannie, Freddie Face Conflicting DemandsBy David S. Hilzenrath
Washington Post, 2007-12-04
[An excerpt; emphasis is added.]
[T]he missions of Fannie Mae and Freddie Mac have long been muddled,
and their mandates contain built-in conflicts, chief among them
the pressure to make money
as well as serve the public interest.
...
The government expects Fannie Mae and Freddie Mac
to uphold prudent lending standards.
However,
it has dictated that
they help low-income populations buy homes
by meeting a complicated set of
affordable housing goals or quotas.
Those requirements helped prompt the companies
to invest billions of dollars in subprime loans,
contributing to the popularity of the mortgages.
2007-12-05-Pearlstein
It's Not 1929, but It's the Biggest Mess SinceBy Steven Pearlstein
Washington Post, 2007-12-05
2007-12-14-Krugman
After the Money’s GoneBy PAUL KRUGMAN
New York Times, 2007-12-14
[An excerpt; emphasis is added.]
In past financial crises —
the stock market crash of 1987,
the aftermath of Russia’s default in 1998 —
the Fed has been able to wave its magic wand
and make market turmoil disappear.
But this time the magic isn’t working.
Why not?
Because the problem with the markets isn’t just a lack of liquidity —
there’s also a fundamental problem of solvency.
...
[T]he financial system —
both banks and, probably even more important,
nonbank financial institutions —
made a lot of loans
that are likely to go very, very bad.
It’s easy to get lost in the details of
subprime mortgages, resets, collateralized debt obligations, and so on.
But there are two important facts
that may give you a sense of just how big the problem is.
First, we had an enormous housing bubble in the middle of this decade.
To restore a historically normal ratio of housing prices to rents or incomes,
average home prices would have to fall
about 30 percent from their current levels.
Second, there was a tremendous amount of borrowing into the bubble
[some would say “buying into the bubble”], as
new home buyers purchased houses with little or no money down,
and as
people who already owned houses
refinanced their mortgages as a way of converting rising home prices into cash.
[The problem:
These home buyers, instead of buying low, selling high,
did the reverse: they bought at the top.
Then they made matters worse
by obtaining gimmicky mortgages whose payments were guaranteed to jump up,
even when the underlying home value might be falling.
Finally, many of them had shaky finances and income to start with.]
As home prices come back down to earth,
many of these borrowers will find themselves with negative equity —
owing more than their houses are worth.
Negative equity, in turn,
often leads to foreclosures and big losses for lenders.
And the numbers are huge.
The financial blog Calculated Risk,
using data from First American CoreLogic,
estimates that
if home prices fall 20 percent
there will be 13.7 million homeowners with negative equity.
If prices fall 30 percent,
that number would rise to more than 20 million.
That translates into a lot of losses,
and explains why liquidity has dried up.
What’s going on in the markets isn’t an irrational panic.
It’s a wholly rational panic,
because there’s a lot of bad debt out there,
and
you don’t know how much of that bad debt
is held by the guy who wants to borrow your money.
How will it all end?
Markets won’t start functioning normally
until investors are reasonably sure that they know
where the bodies — I mean, the bad debts — are buried.
And that probably won’t happen until
house prices have finished falling and
financial institutions have come clean about all their losses.
All of this will probably take years.
Meanwhile, anyone who expects the Fed or anyone else
to come up with a plan that makes this financial crisis just go away
will be sorely disappointed.
2007-12-16-Will
The New EntitlementBy George F. Will
Washington Post, 2007-12-16
[An excerpt.]
Although the freeze of adjustable mortgage rates amounts to a revision of perhaps hundreds of thousands of contracts, it will help a relatively small number of people. And it will not help scrupulous borrowers who have scrimped and sacrificed to fulfill the obligations of their contracts. According to Treasury Secretary Hank Paulson, 93 percent of American mortgages are paid on time. At most, 15 percent of recent “resets” -- mortgage rate increases -- have resulted in foreclosures. Alan Reynolds of the Cato Institute says that only about a third of adjustable-rate mortgages are with subprime borrowers and barely half of subprime mortgages have variable rates.
[Hillary] Clinton perhaps regrets that the plan President Bush has enabled and endorsed is voluntary. Today’s liberalism, combining tolerance and statism, cares less what happens than that it be mandatory....
In helping lenders to cooperate with each other in reducing their distress and that of their customers, the government has played only “a convening role,” says Paulson, who adds: “This is a private-sector effort, involving no government money.” But the second half of that statement does not validate the first. The government is now implicated in the making of arbitrary distinctions.
Clinton says the rate freeze should last “until the mortgages have been converted into affordable, fixed-rate loans.” What does “affordable” mean? Paulson says: “Homes in foreclosure can pose costs for whole neighborhoods, as crime goes up and property values decline. Avoiding preventable foreclosures, then, is in the interest of all homeowners.” But all foreclosures are “preventable” if all mortgage contracts can be revised. Regarding “predatory lending,” remember that Congress often operates on the principle “first criminalize, then define.” But did “predatory” lenders expect the borrowers upon whom they supposedly preyed to default?
Speaking ill of lenders began when homo sapiens acquired language, hence it is unsurprising that many people who until recently were criticizing lenders for not making money available to marginally qualified borrowers are now caustic about lenders who complied. Clinton is fluent in the language of liberalism, aka Victimspeak, so, denouncing “Wall Street,” she says families were “lured into risky mortgages” and “led into bad situations” by those who knew better. So, lenders knew their loans would not be fully repaid?
Jesse Jackson speaks of “victims of aggressive mortgage brokers.” But given that foreclosure is usually a net loss for all parties to the transaction, what explains the “aggression”? Who thought it was in their interest to do the luring and leading that Clinton alleges? While granting that “borrowers share responsibility,” her only examples are those “who paid extra fees to avoid documenting their income” and “speculators who were busy buying two, three, four houses to sell for a quick buck.” Everyone else has been victimized.
Paulson has been criticized for saying that some subprime borrowers “will become renters again.” But some borrowers put no money down on their houses, or took mortgages with negligible “teaser” rates, or accepted mortgages requiring them at first to pay only interest, not principal. Such borrowers are effectively renters.
The president says: “The homeowners deserve our help.” But why “deserve”? The principles of “compassionate conservatism” are opaque, but they might involve liberalism’s premise that Americans are so easily victimized they must be regarded as wards of government.
Perhaps Washington’s intervention in the subprime problem reveals the tiny tip of an enormous new entitlement: People who voluntarily run a risk, betting that they will escape unscathed, are entitled to government-organized amelioration when they lose their bets. The costs of this entitlement will include new ambiguities in the concepts of contracts and private property.
2007-12-18-NYT-Andrews
Fed Shrugged as Subprime Crisis SpreadBy EDMUND L. ANDREWS
New York Times, 2007-12-18
[An excerpt; paragraph numbers and emphasis are added.]
[1]
Until the boom in subprime mortgages turned into a national nightmare this summer, the few people who tried to warn federal banking officials might as well have been talking to themselves.
[2]
John Gamboa and Robert Gnaizda of the Greenlining Institute, a housing advocacy group, warned the Fed in 2004 about unscrupulous lenders.
[3]
Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.
[4]
But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman.
[5]
In 2001, a senior Treasury official, Sheila C. Bair, tried to persuade subprime lenders to adopt a code of “best practices” and to let outside monitors verify their compliance. None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms. Bair recalled recently, soon let them slip.
[6]
And leaders of a housing advocacy group in California, meeting with Mr. Greenspan in 2004, warned that deception was increasing and unscrupulous practices were spreading.
[7]
John C. Gamboa and Robert L. Gnaizda of the Greenlining Institute implored Mr. Greenspan to use his bully pulpit and press for a voluntary code of conduct.
[8]
“He never gave us a good reason, but he didn’t want to do it,” Mr. Gnaizda said last week. “He just wasn’t interested.”
[9]
Today, as the mortgage crisis of 2007 worsens and threatens to tip the economy into a recession, many are asking: where was Washington?
[10]
An examination of regulatory decisions shows that the Federal Reserve and other agencies waited until it was too late before trying to tame the industry’s excesses. Both the Fed and the Bush administration placed a higher priority on promoting “financial innovation” and what President Bush has called the “ownership society.”
[11]
On top of that, many Fed officials counted on the housing boom to prop up the economy after the stock market collapsed in 2000.
[12]
Mr. Greenspan, in an interview, vigorously defended his actions, saying the Fed was poorly equipped to investigate deceptive lending and that it was not to blame for the housing bubble and bust.
[13]
On Tuesday, under a new chairman, the Federal Reserve will try to make up for lost ground by proposing new restrictions on subprime mortgages, invoking its authority under the 13-year-old Home Ownership Equity and Protection Act. Fed officials are expected to demand that lenders document a person’s income and ability to repay the loan, and they may well restrict practices that make it hard for borrowers to see hidden fees or refinance with cheaper mortgages.
[14]
It is an action that people like Mr. Gramlich and Ms. Bair advocated for years with little success. But it will have little impact on many existing subprime lenders, because most have either gone out of business or stopped making subprime loans months ago.
[15]
Before this year, officials here enthusiastically praised subprime lenders for helping millions of families buy homes for the first time. “I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk,” Mr. Greenspan wrote in his recent memoir, “The Age of Turbulence: Adventures in a New World.” “But I believed then, as now, that the benefits of broadened home ownership are worth the risk.”
[16]
As housing prices soared in what became a speculative bubble,
Fed officials took comfort that
foreclosure rates on subprime mortgages remained relatively low.
But
neither the Fed nor any other regulatory agency in Washington
examined what might happen
if housing prices flattened out or declined.
It was not a matter of “if” but “when.”]
[17]
Had officials bothered to look, frightening clues of the coming crisis were available. The Center for Responsible Lending, a nonprofit group based in North Carolina, analyzed records from across the country and found that default rates on subprime loans soared to 20 percent in cities where home prices stopped rising or started to fall.
[18]
“The Federal Reserve could have stopped this problem dead in its tracks,” said Martin Eakes, chief executive of the center. “If the Fed had done its job, we would not have had the abusive lending and we would not have a foreclosure crisis in virtually every community across America.”
2007-12-19-Pearlstein
A $500 Billion CorrectionBy Steven Pearlstein
Washington Post, 2007-12-19
[An excerpt; emphasis is added.]
[I]t may be useful to recall the reasons given by the Fed and other regulators
for rejecting
the same rules that they now consider necessary....
Lesson 1 from the subprime fiasco:
Industry self-regulation almost never works.
Lesson 2:
Disclosure alone won't deter bad behavior.
Lesson 3:
Market discipline can be easily corrupted.
Lesson 4:
Even sophisticated buyers and sellers
cannot always protect themselves,
let alone the safety and soundness of the financial system.
2008
2008-03-28-Pearlstein
Hypocrisy That's Hard to BearBy Steven Pearlstein
Washington Post, 2008-03-28
[An excerpt.]
[1]
Well, isn’t this rich: Max Baucus of Montana and Chuck Grassley of Iowa, chairman and ranking member, respectively, of the Senate Finance Committee are suddenly in a lather that taxpayer funds might be implicated in the Federal Reserve‘s rescue of Bear Stearns.
[2]
Would that be the same Max Baucus and Chuck Grassley who have made careers out of protecting and enhancing the lavish system of import restrictions, price supports and other subsidies that have transformed American farming and ranching into a vast socialist enterprise? You betcha.
[3]
Whatever you want to say about the sharpies on Wall Street, they are pikers compared to Max’s and Chuck’s friends down on the farm when it comes to picking the pockets of taxpayers and consumers, or concocting a system in which the farmers get all the gains while the government assumes most of the risk.
[4]
In case you hadn’t noticed, this last year has been a banner one for farmers, thanks to bountiful harvests and record commodity prices. The average farm household income in 2006 was $77,654, or about 17 percent higher than the average for nonfarm households. And next year, that’s expected to rise to $90,000.
[Note how Pearlstein shines the spotlight on the income of farmers.
But he totally ignores the obscene average income
of investment bankers and hedge fund managers.
What bigotry!
Could it be due to the fact that Pearlstein is, as a matter of fact,
far more ethnically linked
to those who make such obscene wages on Wall Street
than to those farmers?]
[5]
But for Max and Chuck, that’s no reason to cut back on farm socialism. No siree. Farmers are expected to pull in $13 billion in federal subsidies this year. And there will be plenty more once Congress gets around to passing a new five-year farm bill later this spring.
[6]
In fact, the big concern out in farm country these days is that rapidly rising commodity prices are putting the financial squeeze on ethanol plants and grain elevators. It’s probably only a matter of time before Max and Chuck weigh in with “emergency” legislation providing government loans to these cash-strapped operations, just like the Fed is doing with the investment banks. Only unlike the Bear Stearns shareholders, you can be sure that the farmers who own these businesses won’t lose a dime.
[7]
Seriously, folks, this isn’t the time for members of Congress to come sauntering back from another of their vacations and begin second-guessing the battlefield judgments [!!!] of Fed and Treasury officials who have been working day and night to prevent a meltdown in global financial markets.
[Call me a cynic,
but I think this much hyped, and hypothetical,
“meltdown in global financial markets”
may be but a cover story
for what these financial people are really trying to protect:
the income of the financial community.
Added 2008-03-30:
At any rate, the Joe Nocera column below certainly makes a good case
for revising the regulatory system.]
2008-03-29-Nocera
A System Overdue for ReformBy JOE NOCERA
New York Times, 2008-03-29
[An excerpt; emphasis is added.]
A number of people told me, for instance, that
the Fed could have reined in mortgage lenders if it had wanted to,
or cracked down on subprime loans.
But the Fed chairman then, Alan Greenspan,
was really quite hostile to
the notion that he should be wading into the subprime market.
Indeed, he thought the benefits of broader homeownership
were worth the risks
that subprime loans entailed.
were ignored.
2008-04-01-Sloan
Dreams End With Collapse of Tinker Bell MarketBy Allan Sloan
Washington Post, 2008-04-01
[An excerpt; emphasis is added.]
[In this article] I’ll tell you why I fear that
the Wall Street enablers of the biggest financial mess of my lifetime
will escape with relatively light damage,
leaving the rest of us, and our children and grandchildren,
to pay for their misdeeds.
We’re suffering the aftereffects of the collapse of a Tinker Bell financial market,
one that depended heavily on borrowed money
that has now vanished like pixie dust.
Like Tink, the famous fairy from Peter Pan,
this market could exist
only as long as everyone agreed to believe in it.
So because it was convenient -- and oh, so profitable! --
players embraced fantasies like
U.S. house prices never falling and
cheap short-term money always being available.
They created, bought, and sold, for huge profits,
securities that almost no one understood.
And
they goosed their returns
by borrowing vast amounts of money.
[I.e., leverage.]
...
Academics now feel that
the 1929 slowdown morphed into a Great Depression in large part
because the Fed tightened credit rather than loosening it.
With that precedent in mind,
you can see why Bernanke’s Fed is cutting rates rapidly
and throwing everything but the kitchen sink at today’s problems....
So why hasn’t the cure worked?
The problem is that
vital markets that most people never see --
the constant borrowing and lending and trading among huge institutions --
have been paralyzed by losses, fear and uncertainty.
And you can’t get rid of losses, fear and uncertainty by cutting rates.
Giant institutions are, to use the technical term, scared to death.
They’ve had to come back time after time
and report additional losses on their securities holdings
after telling the market that they had cleaned everything up.
It’s whack-a-mole finance --
the problems keep appearing in unexpected places.
We’ve had problems with
mortgage-backed securities,
collateralized debt obligations,
collateralized loan obligations,
financial insurers,
structured investment vehicles,
asset-backed commercial paper,
auction rate securities,
liquidity puts.
To paraphrase what a top Fednik told me in a moment of candor last fall:
You realize that
you don’t know what’s in your own portfolio,
so how can you know what’s in the portfolio
of people who want to borrow from you?
big firms are short of capital because of their losses
(some of which have to do with accounting rules I won’t inflict on you today)
and that
they’re afraid of
not being able to borrow enough short-term money to fund their obligations,
and you can see why credit has dried up.
The fear -- a justifiable one -- is that
if one big financial firm fails,
it will lead to cascading failures throughout the world.
Big firms are so linked with one another and with other market players
that the failure of one large counterparty, as they’re called,
can drag down counterparties all over the globe.
If the counterparties fail, it could drag down the counterparties’ counterparties, and so on.
Meltdown City.
In 1998,
the Fed orchestrated a bailout of the Long-Term Capital Management hedge fund
because it had $1.25 trillion in transactions with other institutions.
These days that’s almost small beer.
Add to that the Wall Street ethos:
If you take big, even reckless, bets and win,
you have a great year and you get a great bonus --
or in the case of hedge funds, 20 percent of the profits.
If you lose money the following year,
you lose your investors’ money rather than your own,
and you don’t have to give back last year’s bonus.
Heads, you win; tails, you lose someone else’s money.
[There are, of course, many things to criticize about this,
but here is what really makes me angry.
When people on Wall Street were questioned on
why they were taking such huge profits and fees
out of the money that they were being entrusted to invest wisely,
their answers were that
they were brilliant, smart, and indispensable.
In other words, they were the acme of the much-ballyhooed “meritocracy.”
But now when it looks like they were in fact
fools, scoundrels, charlatans, and swindlers,
who quite literally didn’t even understand their own actions,
there seems no way of recovering
the literally vast profits and fees they extracted from investors.
On Wall Street, as with responsibility for the Iraq War,
is seems like power and accountability have been divorced.]
2008-04-11-Norris-Volcker
It’s a Crisis, and Ideas Are ScarceBy FLOYD NORRIS
New York Times, 2008-04-11
[An excerpt.]
Paul Volcker, the former Federal Reserve chairman
whose legacy has not crumbled since he left office,
was right this week when he said
the financial engineers had created
“a demonstrably fragile financial system
that has produced unimaginable wealth for some,
while repeatedly risking a cascading breakdown of the system as a whole.”
It is striking to realize that
while Mr. Volcker has been gone from the Fed for two decades,
he is, at 80, two years younger than his successor, Alan Greenspan.
Had Mr. Volcker somehow kept the job,
he almost certainly would have been
more skeptical about the new financial architecture —
and less popular on Wall Street —
than Mr. Greenspan was when times were good.
But the bad times we are now entering
might not have become nearly so large a threat.
2008-05-11-NYT-Dollar
The Dollar: Shrinkable but (So Far) UnsinkableBy PETER S. GOODMAN
New York Times Week in Review, 2008-05-11
[An excerpt; emphasis is added.]
If the United States were any other country,
these would surely be days of panic and austerity in Washington.
With debts spiraling higher, a trade deficit exceeding $700 billion a year, and its currency plunging for years, the government would be forced to cut spending and jack up interest rates in a frantic bid to attract investment.
But the United States is not any other country. For more than half a century, Americans have enjoyed a unique privilege in the global economy: The dollar has been the world’s dominant currency, the money used in most transactions and the repository for the national savings of many countries, including China, Japan and Saudi Arabia.
Come what may — a financial crisis here, a military misadventure there — Americans could count on money sloshing up thick on their shores. Virtually limitless demand for American government bonds has supported the dollar’s value, and kept domestic interest rates down. Americans have been emboldened to spend in blissful disregard of their debts, secure that foreigners would always supply finance. And that devil-may-care spending has in turn fueled economic growth around the world.
This dynamic may be so deeply embedded in the workings of the global economy that it could endure for many years to come: The costs of weaning the United States from its credit habit would ripple far and wide.
But what are the chances that a day of reckoning is coming,
when the dollar would be so weak that
America would have to play by the rules that apply to every other country?
[My opinion: 100%.
The question is not if, but when.
And the longer we put off our adjustments, the worse the outcome will be.]
Recent signs do suggest some fraying in the American relationship with its many foreign creditors. The balance of trade has gotten so lopsided and the question marks hovering over the American economy so thick that some foreign governments are beginning to hedge their bets on the dollar.
...
China’s leaders fear anything that threatens to crimp exports;
that would eliminate jobs and send angry peasants back to their villages.
[Note the contrast with the U.S.
In China, the people want jobs,
not bothering about whether they are “good” jobs
or about that all the issues that seem to tie up labor negotiations in America.
But perhaps Chinese management compensation is not so outlandish
as that, say, on Wall Street,
which would certainly reduce labor unrest.]
2008-05-16-NYT-Norris
Color-Blind Merrill in a Sea of Red FlagsBy FLOYD NORRIS
New York Times, 2008-05-16
[Its beginning.]
Would you invest money — at a very low interest rate —
to finance mortgage loans made to risky borrowers who put no money down?
What if you knew
the company that made most of the loans had gone bankrupt
because so many of its loans had turned bad almost immediately?
Now, no one would do that.
But it was just a year ago that Merrill Lynch
was wrapping up a securitization that met just those criteria.
The securities were snapped up by buyers like the Bond Fund of America,
one of the largest mutual funds.
Now, that mortgage securitization is a candidate for the title of worst ever.
This week, the Merrill securitization had its first anniversary,
an event that brought no celebrations,
and Moody’s forecast that by the time it is wrapped up,
so many of the mortgages will have gone bad that
60 percent of the money lent will not be paid back.
Already some public investors are seeing their money vanish,
and it seems certain that more will follow.
It turns out that so-called piggyback loans are highly vulnerable to homeowners who walk away when property values fall.
[Now, who would have thought that?
I guess that’s why Wall Streeters make so much money.]
In a typical deal, a buyer took two mortgage loans,
one for 80 percent of the purchase price,
and the other to provide the remaining 20 percent.
It is the latter loans that this securitization, and others like it,
now own.
“In light of the pressure on home prices
and limited or negative borrower equity in their homes,
many second liens were simply written off”
after several months of payments were missed, Moody’s said.
With these loans, it turns out, foreclosure is seldom worth the effort,
since all the money would go to the first mortgage holder.
Making the situation worse is
the nature of many of the mortgages in the Merrill securitization.
Fewer than 30 percent of the loans were made to borrowers
who provided full documentation of their income and assets.
Many of the other borrowers probably lied about their income.
Nearly all had borrowed the full appraised value of the home,
either for the purchase or for refinancing,
and it is possible that some appraisals were unreasonably high
even before home prices began to fall.
The loans in this group did not go to solid credits.
Although market interest rates were low when these mortgages were written,
the mortgages had rates averaging 11.2 percent.
Yet investors who put up most of the money
were willing to accept a floating rate
of just 30 basis points — three-tenths of one percentage point —
over the London interbank offered rate.
At the moment, that gives them a yield of 3.2 percent.
If Moody’s is right, those investors will eventually suffer capital losses.
That is quite a combo for a security:
low yield, high risk.
...
2008-06-01-WP-Day
Villains in the Mortgage Mess? Start at Wall Street. Keep Going.By Kathleen Day
Washington Post Outlook, 2008-06-01
[This opinion piece seems pretty good, except on one point:]
In recent months, dozens of news reporters and bloggers
have blamed former Fed chairman Alan Greenspan for the mortgage mess,
saying that he made money too cheap
by keeping interest rates too low for too long from 2003 to 2004.
[Yes, that was certainly the worst period, see the numbers here or here.
But rates were too low beyond that.]
“Those who argue that
you can incrementally increase interest rates to defuse bubbles
ought to try it sometime,”
Greenspan said recently.
He has a point.
[I’m not a professional economist, but I think that is BS.
We all know how low Greenspan kept the fed funds rate,
close to 1 percent for significant periods of time.
Why did it need to be so low?
I can’t see a plausible reason, other than to keep the expansion,
and with it the unsustainable boom in house prices, going.
Here’s a case in point:
A Washington financial institution, I forget which one,
kept running a memorable print aid, encouraging homeowners to refinance,
that featured the line:
“How low can rates go?”
along with some cute graphic showing boats sinking
and other examples of going down.
The point is that that low rates from the Fed
encouraged financial institutions to keep mortgage rates low
which in turn kept the boom going.]
2008-06-04-WP-Pearlstein
Bubbles, Arms Races and an End to the Spin CycleBy Steven Pearlstein
Washington Post, 2008-06-04
[An excerpt; emphasis is added.]
The documentary evidence that has emerged so far confirms that
many people in the financial world were aware of
a significant deterioration in underwriting standards
and that they were taking on unusual risks.
But because of the competitive imperative,
once one company demonstrated that
it could boost short-term profit and grab market share
by lowering underwriting standards,
the others felt they had no choice but to follow it right off the cliff.
Why? Certainly pride is a big part of it -- you’d be shocked
by how fixated Wall Street has become with the annual “league tables”
that rank the investment houses on their volume of initial stock offerings, bond issues or collateralized debt obligations (CDOs).
How investors later fare is barely noticed.
Perhaps most significantly, any bank or investment house
that decided to hold the line on underwriting standards
would have run a real risk of quickly losing its top-performing employees,
who are constantly being recruited by rivals.
Once those key players go, so go their clients,
whose loyalties tend to run to individual investment bankers and fund managers
rather than the financial institutions.
This arms race for talent extends to top executives on Wall Street
who, because of their employment contracts,
have a built-in incentive to take undue risks.
These contracts make it impossible
for these top executives to be fired for making bad business judgments,
no matter how costly they may prove.
As a result,
boards of directors are forced to negotiate “voluntary” retirements,
like the one that allowed Stan O’Neal
to walk away from Merrill Lynch with $161.5 million in cash and stock
after presiding over
the loss of tens of billions of dollars of shareholders’ money.
2008-07-16-Ignatius
Bailing Hard and Getting SoakedBy David Ignatius
Washington Post, 2008-07-16
2008-07-20-NYT-Goodman
Too Big to Fail?By PETER S. GOODMAN
New York Times Week in Review, 2008-07-20
2008-08-15-WP-Pearlstein
Sir Alan's Follies [Alan Greenspan, of course]By Steven Pearlstein
Washington Post, 2008-08-15
2008-09-03-WP-Samuelson
The Real Economic ScorecardBy Robert J. Samuelson
Washington Post, 2008-09-03
2008-09-15-DCExaminer
Roots of financial crisis in Clinton housing policyBy Examiner Newspapers (Editorial), 2008-09-15
2008-09-18-Pearlstein
Scrambling to Clean Up After A Category 4 Financial StormBy Steven Pearlstein
Washington Post, 2008-09-18
[An excerpt; paragraph numbers and emphasis are added.]
[4]
What we are witnessing may be
the greatest destruction of financial wealth that the world has ever seen --
paper losses measured in the trillions of dollars.
Corporate wealth. Oil wealth. Real estate wealth. Bank wealth.
Private-equity wealth. Hedge fund wealth. Pension wealth.
It’s a painful reminder that,
when you strip away all the complexity and trappings
from the magnificent new global infrastructure,
finance is still a confidence game --
and once the confidence goes,
there’s no telling when the selling will stop.
[5]
But more than psychology is involved here.
What is really going on, at the most fundamental level, is that
the United States is in the process of
being forced by its foreign creditors
to begin living within its means.
[6]
That wasn’t always the case.
In fact, for most of the past decade,
foreigners seemed only too willing to provide
U.S. households, corporations and governments
all the cheap money they wanted --
and Americans were only too happy to take them up on their offer.
2008-09-22-Harbaugh-don't-rush
Congress is currently being urged to pass immediately a massive bailout for banks and Wall Street firms.
A (perhaps the) key aspect is that the government would buy from those institutions the “toxic” financial instruments which have lost their value.
The need for such action, supposedly, is that without clearing those dead weights from those institutions books, they can no longer play their necessary role in financing ongoing corporate economic activity.
So what is the urgent need?
To keep corporate economic activity vital.
But are those institutions the only route to doing that?
Who knows?
I certainly don’t.
Congress needs to take some time, to let a variety of knowledgeable experts make alternative proposals, and let those proposals be compared.
2008-09-23-Harbaugh-don't-bailout-Wall-Street
The following are some comments by the author of this blog.
First, I have no special training or experience in economics or finance.
Nonetheless, I wish to offer my “two cents.”
Please don’t bail out the financial institutions that made this mess.
Let them suffer the consequences of their own decisions.
They are big boys, made fantastic amounts of money when they could,
and constantly bragged about how smart they were.
Both out of justice and
as a signal to those in the future who might be tempted
to behave as irresponsibly as they did,
don’t bail them out.
The problem, of course, is that many others are, it seems,
dependent on them being bailed out.
But there are other ways of handling that.
The Bush administration would have you believe that
the only solution is to rescue the firms that made the mess in the first place.
But there is another way.
Identify those who are innocent victims of Wall Street’s malfeasance, and
help the victims, not the perpetrators.
2008-09-23-WP-Problems
Currency’s Dive Points to Further PainBy Anthony Faiola, Peter Whoriskey and Renae Merle
Washington Post, 2008-09-23
[Paragraph numbers and emphasis are added.]
[1]
The dollar took its steepest one-day drop in years
as the financial crisis
eroded the nation’s basic measure of value,
helping to drive U.S. stocks sharply lower
and the dollar-based prices of oil and gold sharply higher.
[2]
The convergence of negative sentiment came as
investors focused on the uncertainties
in the Bush administration’s emergency plan
for a massive bailout of the financial system,
outlined this weekend.
Indications yesterday that the administration
would need more time to iron out a compromise with Congress
raised questions about what the plan will ultimately look like,
even as investors tried to assess how and whether it would work.
[3]
New concerns also emerged over
the toll the crisis will take on the U.S. economy,
with many analysts saying the slowdown could worsen,
perhaps costing more jobs and hurting consumers.
[4]
The government’s plan to spend up to $700 billion
to take troubled assets off the books of ailing firms
and billions more to guarantee money-market mutual funds
will
force the Treasury to add to the already massive national debt.
It may have to raise that money
by selling more Treasury bills and perhaps even printing more dollars.
[How else can it be raised?]
That, economists said,
could trigger higher inflation and drag down the economy further.
[5]
The dollar yesterday plunged 2.2 percent against the euro --
its biggest one-day fall since January 2001.
Some analysts predicted that if the dollar continues its dramatic tumble,
the Bush administration would seek the assistance of foreign central banks
to prop it up.
[6]
The steep drop was partly behind Monday’s surge in the price of oil --
denominated in the U.S. currency --
its biggest one-day jump ever in dollar terms.
The price of the benchmark crude oil
catapulted to $120.92 a barrel on the New York Mercantile Exchange,
a $16.37 increase. At one point, the price was up $25.55.
[7]
“This is a revaluation of the U.S.,”
said C. Fred Bergsten,
director of the Peterson Institute for International Economics
and a top Treasury Department official during the Carter administration.
“Growth is going to be slower,
the budget deficit higher, but mostly,
the whole U.S. financial system has been thrown into question.
People around the world are looking at this and saying, ‘Holy Toledo.’ ”
[8]
The realization that
the United States may find itself in worsening financial straits
with or without a bailout
sparked a sell-off on Wall Street.
The Dow Jones industrial average fell 372.75 points, or 3.27 percent,
to close at 11,016.
That wiped away Friday’s nearly 400-point rally
that accompanied the initial unveiling of the Bush administration plan.
The technology-heavy Nasdaq composite index fell 94.92, or 4.2 percent,
to close at 2179.
The Standard and Poor’s 500-stock index was down 47.99, or 3.8 percent,
to close at 1207.
[9]
The size of the bailout, analysts said, has focused attention on
just how much debt the United States can handle
without being forced to raise taxes
or make sharp cutbacks in government spending.
Peter Schiff, president of Euro Pacific Capital,
said the fear of inflation provoked by the $700 billion plan --
without figuring out a way to pay for it --
was behind the market’s dramatic movement.
[10]
“Where’s the tax increase to fund this bailout?
Where is the cut in programs?
The government’s not doing either --
they’re just going to print money,” he said.
“And if you think inflation is the answer,
take a trip to Zimbabwe and see how it’s working for them.”
[11]
He added that the new rules imposed on short selling,
short-term bets that a stock’s price will go down,
caused a flow of money into commodities besides oil, including gold.
“You can’t short stocks anymore, right?
So if you want to bet against the market,
you need to buy commodities: gold, oil,”
he said.
[12]
As the market gyrations left many investors wondering what would happen next,
major credit-rating agencies issued statements rejecting the notion that
the AAA rating of the U.S. government might be immediate danger.
Yet analysts acknowledged it was a valid question.
[13]
“This is arguably a critical question given that
the U.S. Treasury‘s Aaa rating
acts as the cornerstone of risk pricing in the global financial system,”
said Pierre Cailleteau,
managing director of the sovereign risk unit at Moody’s Investors Service
and author of a report issued yesterday on the U.S. credit rating.
[14]
A loss of that status would probably mean that
the United States would have to pay more to those investors,
including foreign governments, that hold U.S. bonds.
But the report said,
“Moody’s continues to view the foundations of the U.S. government rating
as unshaken.”
[15]
Similarly, John Chambers, a managing director at Standard and Poor’s,
said he viewed the United States as stable.
Although some have drawn parallels between the current financial woes
and those in Japan, which lost its AAA credit rating in 2001,
Chambers said
the United States has far greater ability to meet its obligations.
[16]
He noted that before Japan lost its AAA rating,
its general government debt
was more than 100 percent of its gross domestic product.
By contrast, even figuring in “every last nickel” of the proposed U.S. bailouts,
general government debt in the United States
falls below 60 percent of gross domestic product, he said.
[17]
One key question for investors and multilateral lenders is
how the U.S. bailout plan will treat foreign investors
in troubled mortgage-backed securities.
“A substantial amount of these securities are held by non-U.S investors,”
said John Lipsky,
first deputy managing director of the International Monetary Fund.
“Obviously, the disposition of the U.S. [toward these investors]
will be important to determining
future attitudes about investing in the U.S. versus elsewhere.”
[18]
Foreign governments and multilateral lenders
have been offering advice to the U.S. government
as it moved in recent weeks to take over some financial institutions
while allowing others to fail.
The IMF has been subtly calling on the United States
to take a broader approach to the financial crisis,
and officials there applauded the administration’s efforts in recent days
to launch a more comprehensive plan to address core issues.
[19]
“Obviously, these events have been striking and potentially very troublesome,
but the remedial actions being taken, if done right,
will help to restore any confidence that might have been lost,” Lipsky said.
[20]
As investors await final details of the financial rescue plan,
some analysts noted that
it will not address some of the economy’s fundamental weaknesses,
including poor housing prices and growing unemployment figures.
[21]
“With talk of the government buying assets at steep discounts
and of an emphasis on taxpayer protection,
the benefits to bank and thrift capital levels
may be less than the market anticipates,”
Paul J. Miller Jr., an analyst with Friedman, Billings, Ramsey,
said in a research note yesterday.
“At this point, we just do not know.
While the plan will most likely help,
banks and thrifts still need to raise capital.”
[22]
It is also unclear whether the $700 billion will be enough.
Will banks be forced to open their books to their public,
and how will their bad debt be evaluated?
“It’s not clear who is going to be allowed to participate,”
said Joseph Brusuelas, chief U.S. economist at Merk Investments.
“How much will each individual bank be allowed to dump on the public?”
2008-09-24-Cochrane-economists-letter-to-Congress
The petition from John Cochrane and over two hundred economists to Congressregarding the mortgage crisis and the plan to bailout Wall Street
[From John Cochrane and over two hundred university economists.
The emphasis is added.]
(This letter was sent to Congress on Wed Sept 24 2008
regarding the Treasury plan as outlined on that date.
It does not reflect all signatories views on subsequent plans
or modifications of the bill)
To the Speaker of the House of Representatives
and the President pro tempore of the Senate:
As economists,
we want to express to Congress our great concern
for the plan proposed by Treasury Secretary Paulson
to deal with the financial crisis.
We are well aware of the difficulty of the current financial situation
and we agree with the need for bold action
to ensure that the financial system continues to function.
We see three fatal pitfalls in the currently proposed plan:
- Its fairness.
The plan is a subsidy to investors at taxpayers’ expense.
Investors who took risks to earn profits must also bear the losses.
Not every business failure carries systemic risk.
The government can ensure a well-functioning financial industry,
able to make new loans to creditworthy borrowers,
without bailing out particular investors and institutions
whose choices proved unwise. - Its ambiguity.
Neither the mission of the new agency nor its oversight are clear.
If taxpayers are to buy illiquid and opaque assets from troubled sellers,
the terms, occasions, and methods of such purchases
must be crystal clear ahead of time and carefully monitored afterwards. - Its long-term effects.
If the plan is enacted, its effects will be with us for a generation.
For all their recent troubles,
America’s dynamic and innovative private capital markets
have brought the nation unparalleled prosperity.
Fundamentally weakening those markets
in order to calm short-run disruptions
is desperately short-sighted.
For these reasons we ask Congress
- not to rush,
- to hold appropriate hearings, and
- to carefully consider the right course of action, and
- to wisely determine
the future of the financial industry and the U.S. economy
for years to come.
Signed (updated at 9/27/2008 6:00PM CT)
[For the signers, see the original;
over two hundred names (231 as of the above date)]
2008-09-26-WP-Economists
Away from Wall Street, Economists Question Basis of Paulson's PlanBy Neil Irwin and Cecilia Kang
Washington Post, 2008-09-26
[Paragraph numbers and emphasis are added.]
[1]
The Bush administration’s pitch for a sweeping bailout of the financial system
has centered on two simple premises:
- the economy could suffer a crippling downturn
if action is not taken very quickly
and - this action should consist of
the government buying troubled mortgage securities
from banks and other institutions.
[2]
But many of the nation’s top economists
disagree with one or both of those ideas,
even as many top political leaders have swung behind them.
[3]
Wall Street economists
have mostly endorsed Treasury Secretary Henry M. Paulson Jr.’s plan,
or a variation thereof.
[4]
But almost 200 academic economists [as of 09-27, 231] --
who aren’t paid by the institutions that could directly benefit from the plan
but who also may not have recent practical experience in the markets --
have signed a petition organized by a University of Chicago professor
objecting to the plan on the grounds that
- it could create perverse incentives,
- it is too vague, and
- its long-run effects are unclear.
brandished that letter yesterday afternoon
as he explained his opposition to the bailout
outside a bipartisan summit at the White House.
The petition did not advocate any specific plan,
including that offered yesterday by House Republicans.
[5]
Economists tend to agree that the nation’s economy is at serious risk
as the flow of credit threatens to freeze.
Just yesterday,
the interest rate at which banks lend to each other rose steeply,
as it has every day this week,
suggesting that lenders are hoarding cash.
History shows that when this happens, a broad economic crisis can follow,
for instance,
the Great Depression and Japan’s decade-long recession in the 1990s.
[6]
“If nothing is done,
the potential for these markets to seize up in a big way is definitely there,”
said Frederic S. Mishkin, an economist at Columbia University
who was a Federal Reserve governor until last month.
“When you look at the history of these crises,
when things spin out of control,
the cost to fix it later goes up exponentially.”
[7]
But many others
with a deep theoretical knowledge of finance and experience in government
are skeptical of the structure of Paulson’s plan --
and the speed with which it has been crafted.
[8]
The critics can be roughly divided into two camps.
- One group thinks money should be directly infused into banks,
which should allow it to trickle down through the financial system
to borrowers. - A second group thinks the government should buy individual mortgages,
thus helping ordinary Americans more directly,
with the benefits trickling up to the banks.
[9]
The plan promoted by Paulson and Fed Chairman Ben S. Bernanke
is somewhere in between:
buying up packages of mortgages and hoping that the benefits spread
both up to banks and down to households.
[10]
“The plan is a trickle-down approach from banks to Main Street,”
said Alan S. Blinder, a professor at Princeton University
[how’s that for an understatement?].
“But if you reduce the flood of foreclosures and defaults” --
which he would have the government do by buying loans directly
and then renegotiating the terms --
“it will make mortgage-backed securities worth more.”
[11]
That might help ordinary Americans
but would be extremely difficult to administer.
The government would have to make decisions on
the foreclosure and resale of individual houses all over the country.
Still, many economists with left-of-center political views
favor some variation of this approach
to the plan endorsed by Bush.
[12]
“There is a kind of suggestion in the Paulson proposal that
if only we provide enough money to financial markets,
this problem will disappear,”
said Joseph Stiglitz, a Nobel Prize-winning economist.
“But that
does nothing to address the fundamental problem
of bleeding foreclosures and
the holes in the balance sheets of banks.”
[Well, I certainly am not even qualified to carry Joseph Stiglitz’s shoes,
but it seems to me that
buying those underwater securities from the banks
does indeed fill in some holes in their balance sheets.]
[13]
Coming from the other direction, more conservative economists worry that
by having the government buy mortgage securities,
the Paulson plan would manipulate prices in that market
without getting at the nub of the problem:
that banks do not have enough capital and
are having difficulty raising any on private markets.
[14]
In a sign of how the debate over the economy has shifted in recent weeks,
some conservatives,
even as they argue for a relatively limited government role,
are calling on the government to invest public money in private banks.
[15]
“The root of the issue is recapitalizing banks,”
said Glenn Hubbard, dean of Columbia Business School
and a former chairman of President Bush’s Council of Economic Advisers.
“That could be done more efficiently through
the government injection of preferred equity.
Then the market could figure out the prices of the assets.”
[16]
Many of these critics don’t care for
the assumption behind the administration’s plan that
the market is now pricing these mortgage securities incorrectly,
a problem that the government intervention aims to fix.
[17]
“The premise appears to be that the market is irrationally pessimistic,”
wrote Greg Mankiw, a Harvard University economist and another former Bush economic adviser, on his blog this week.
“That might be so.
Nonetheless, one has to be at least a bit skeptical about the idea that
government policymakers gambling with other people’s money
are better at judging the value of complex financial instruments
than are private investors gambling with their own.”
[18]
Some conservatives are now arguing, notably, that
the government should be investing in banks.
[19]
Many economists fault the Bush administration and Congress
for moving so quickly on the bailout package
without allowing more time for debate.
That sentiment was reflected in
the petition organized by John Cochrane of the University of Chicago.
(None of the economists quoted here were signatories.)
[20]
“I totally disagree that this needs to be done this week.
It’s more important to get it right,”
Blinder said.
[21]
Moreover, some economists said
the proposed $700 billion may not be enough
to address all the problems stretching across the financial landscape.
“You only show up if you can win, and this is not that package,”
said Simon Johnson, a professor at Massachusetts Institute of Technology
and former chief economist at the International Monetary Fund.
“This cannot be the ultimate, decisive solution
if you are not addressing the underlying cause.”
[22]
The plan is short on details, instead
giving the Treasury secretary wide latitude to determine
how to execute the purchases of mortgage securities.
[23]
“I’d like to see how they see the evolution of an end game.
There are still many questions,”
said Myron Scholes [of Black-Scholes fame],
a retired professor at Stanford University and Nobel Prize winner.
He said
how long the government holds the assets and how they are later resold
would be the keys to determining whether the plan works.
2008-09-26-Harbaugh-bailing-out-whom?
Some comments from the author of this blog:
I would never, ever, claim to be a financial guru,
but even so have some issues
(presented here in a question and answer format)
with this proposed bailout.
Just whom are we bailing out?
Who owns these “mortgage-backed securities” that are now underwater?
Their owners are, evidently, investment houses on Wall Street,
which are the smartest financial cookies in the whole world,
in their own estimation, that of those who put up their funds,
and that of many others (they’re the Meritocracy, we are told).
Why did they invest in those mortgages?
The expectation of future gain.
They expected housing prices to continue to rise,
and the mortgagees to be able to make the payments.
Both expectations have, of course, been proven wrong.
No financial trend goes on forever, and they made their buys
near the top of a bubble, rather than at the beginning.
They bought high, and face the prospect of selling low.
So the bottom line is: they made some very bad financial bets.
Of course, they are hardly the only ones who have bet wrong.
What are the negative consequences of bailing them out?
In the future, every time there is a bubble,
big players can keep the bubble rising,
with the expectation that if it bursts, they won’t take a bath,
rather, they can just pass their bad investments off on the taxpayers
(actually, onto future generations).
What real problem(s) does this situation cause?
The destruction of trust that these events have caused is a real problem.
Look at some of the lies that have been told:
Many of those who obtained the mortgages did so under false pretenses,
if not outright lies, about their income, assets, and earning potential.
That is not too surprising, that is why credit checks are normally made.
What is surprising is that those making the loans lowered their standards.
Secondly,
evidently some (perhaps many) of those who made and packaged the loans
deceived those who bought the loans
about the creditworthiness of the loan-payers.
For example, mortgage-backed securities were sold to various pension-funds,
claiming to be of much higher grade than they actually were.
That is a matter of business ethics, if not regulations and the law,
which is clearly shameful.
But it would appear that some people in the financial industry
are, in this matter, quite literally shameless.
(To make a vast and perhaps inappropriate generalization,
I think the last fifty years or so have seen a devaluation of
both Christianity and public and private truth-telling,
and believe that that correlation is not coincidental.)
So now the attitude is that suggested by the familiar aphorism:
Fool me once, shame on you.
Fool me twice, shame on me.
are not about to be swindled again.
This leads to the credit crunch we are hearing about.
Why should any investor believe what he is being told
by essentially the same people?
So what is the elite’s solution to this problem?
To take all the bad investments
off the hands of those who made the bad investments?
Just how does that help solve the problem of the lack of trust?
The only thing that does is help the financial position
of those who made the bad investments.
Why does the elite wish to help these particular people?
One answer, and one answer only:
Political pull.
The people would be helped by this proposed bailout
have more political power, per capita, than anyone else in America.
They are among, if not at the top of, those who make political contributions.
It is not quite right, but not too far off the mark, to say that
they own both political parties.
Further, through various ties (read into that what you will)
they have great influence over the media.
This makes sure that the downside to the bailout,
and the alternative solutions the the underlying problem
(keeping credit available to deserving borrowers)
do not receive the attention that they should,
until it is too late (after the bailout is passed).
Then, after the bailout is passed, all the problems with it,
and the alternative approaches that were not considered,
can be discussed ad infinitum (cf. Iraq).
But then they can be blamed on the stupid politicians who passed the bill,
and the role the media played (or did not play) in presenting a fair picture
can be ignored.
Isn’t democracy wonderful?
2008-09-29-WP-Bailout-Problems
Broad Authority, Lots of Money And UncertaintyBy Binyamin Appelbaum, David Cho and Neil Irwin
Washington Post, 2008-09-29
[An excerpt; emphasis is added.]
“We need confidence, and this is about confidence,”
Paulson said.
[Glad he admitted that.
It’s sure not about fundamentals.
On second thought,
I think both Paulson and I are wrong.
It is about fundamentals:
The fundamental problem that
so many loans were made on, basically,
the assumption that the economy would keep doing well in the future,
in other words, on the once-famous “rosy scenario.”]
In a practical sense,
the government is trying to revive the markets
because
buying up all the troubled assets would require far more than $700 billion.
Twenty of the nation’s largest financial institutions
owned a combined total of $2.3 trillion in mortgages as of June 30.
They owned another $1.2 trillion of mortgage-backed securities.
And they reported selling another $1.2 trillion in mortgage-related investments
on which they retained hundreds of billions of dollars in potential liability,
according to filings the firms made with regulatory agencies.
The numbers do not include investments derived from mortgages
in more complicated ways, such as collateralized debt obligations.
Experts say the Treasury plan could do more harm than good.
If the Treasury pushes to buy troubled assets at bargain-basement prices,
many banks that hold similar assets
would be forced to mark down their holdings.
Such losses could push some institutions over the edge.
If the Treasury overpays, taxpayers could lose massive sums.
“There are more questions of doing this and the consequence of doing it poorly
than anything else,”
said Richard H. Baker, a former Congressman
and the chief executive of the Managed Funds Association,
which lobbies for hedge funds.
...
The bill also forces a re-evaluation of “mark to market” accounting rules,
under which
banks and other financial institutions must adjust the value of their assets
to reflect current market prices,
even if they intend to hold the assets for the long term.
Bank executives have blamed these rules in part for their troubles,
saying that distressed sellers have pushed market prices below actual values,
forcing unreasonable write-downs.
The Securities and Exchange Commission already
has the power to overrule the board that sets those accounting rules,
the Financial Accounting Standards Board,
but the bill restates that the SEC had authority to change mark-to-market rules.
It also orders a study be conducted on
the role mark-to-market rules played in the current crisis.
Lynn E. Turner, a former chief accountant at the SEC, criticized the provision,
which he said was designed to help bend the commission to the banks’ will.
“What they’ve done here is say
let’s study whether banks should be allowed to lie,”
he said.
“Regardless of whether you had mark-to-market accounting,
you would have this problem, which is banks running out of cash.
And they’re running out of cash
because they made loans to people who aren’t paying them back.”
[There are, in fact, several explanations offered for why banks are low on cash:
- Their borrowers aren’t repaying their loans.
- Banks are not willing to loan to other banks
because of the fear of hidden insolvency
(i.e., they won’t get their money back). - Outside investors are leery of putting money into banks for the same reason.
2008-09-30-Pearlstein
They Just Don't Get ItBy Steven Pearlstein
Washington Post, 2008-09-30
[An excerpt; emphasis is added.]
Oy vey.
[Yes, that is how Pearlstein began his column.]
...
[Leaders] will come around, reluctantly, to the understanding that the only way to get out of these situations is to have governments all around the world borrow gobs of money and effectively nationalize large swaths of the financial system so it can be restructured, recapitalized, reformed and returned to private ownership once the crisis has passed and the economy has gotten back on its feet.
2008-10-01-Crisis
Most Voters Worry About Economy By Dan Balz and Jon Cohen Washington Post, 2008-10-01 Majority Consider Situation a Crisis Some comments by the author of this blog: The above boldface line is the subtitle of the article. But why do voters consider the situation a crisis? At least in part, because the Washington Post has told them so. See the WP editorials of 09-25 and 09-27 here. These describe the economic situation, without a bailout, as (these are all direct quotes, but of course the color is added):- economic disaster
- financial collapse
- [t]he stakes could not be higher
- a scenario not contemplated since 1929
- catastrophe
- financial Armageddon
- grave economic peril
- a credit market collapse
- the house is on fire
- crisis
- meltdown
- this terrible situation
- The Post tells its readers that there is a crisis.
- The Post polls its readers and finds they see a crisis.
- The Post now runs an editorial telling Congress:
the public sees a crisis,
therefore you should act, in response to public concern
(neatly leaving out its own role in defining the situation as a crisis,
and practically ignoring
the letter from university economists to Congress).
2008-10-02-Harbaugh-high-risk-high-reward
Some comments from the author of this blog: Before the current turmoil on Wall Street began, back when the masters of the universe were flying high, when questions arose about why compensation on Wall Street was so astronomically high, the almost universal response was: “High risk, high reward.” As at the time everything seemed smooth on the surface, the subtext was: “We are so smart, so adept at risk management and finding opportunities which would evade less brilliant financiers, that we deserve these astronomical compensation packages.” Well, now it turns out that they overlooked two of the most basic lessons in Investment 101:- Diversify your investments.
- No financial trend goes on forever.
2008-10-02-NYT-Climactic-Days
As Credit Crisis Spiraled, Alarm Led to Action By JOE NOCERA New York Times, 2008-10-02 This article was reported by Andrew Ross Sorkin, Diana B. Henriques, Edmund L. Andrews and Joe Nocera. It was written by Mr. Nocera. [This long (3600-word) article gives an account of the climactic period and events which led to the decision of Paulson and Bernake to propose their $700 billion government intervention in the financial system. I certainly do not have the background to either fully understand or judge the gravity of the situations they describe. But I will say this: I think that it is a crime (not legally, but intellectually) that the system that was devised by America’s “greatest financial minds” was so vulnerable to factors which, in the words of the article, were so heavily psychological (“fear”) rather than based on issues of substance. From the article:] It was fear, not greed, that was driving everyone’s actions. [But of course, that is surely only a simplification of the reality.]2008-10-02-WP-Rickards-risk-analysis
A Mountain, Overlooked How Risk Models Failed Wall St. and Washington By James G. Rickards Washington Post, 2008-10-02 The writer was general counsel of Long-Term Capital Management from 1994 to 1999.[In response to Mr. Rickards’ op-ed, the following letter to the editor appeared in the Post on 10-08:] See-No-Risk Analyses In his Oct. 2 op-ed, “A Mountain, Overlooked,” James Rickards correctly explained why “random walk” risk models, apparently widely used on Wall Street, vastly underestimate the probability of catastrophic collapses. Mathematicians and physicists have understood this for decades, and they have developed much better methods for estimating the probability of extreme events in complex systems. Many of the pioneers in this field were interested in markets and clearly pointed out that risks can be thousands of times larger than what comes out of random walk models. For at least 20 years, Wall Street has been hiring some of the best young theoretical physicists to do risk analysis for them. All of these physicists know that random walk models are inappropriate and unreliable for market analysis of extreme events. If the people who run banks and hedge funds, and the agencies that regulate them, didn’t know that, it is because they didn’t want to. MARTIN LAMPE University Park
2008-10-03-NYT-Labaton-SEC
Agency’s ’04 Rule Let Banks Pile Up New Debt By STEPHEN LABATON New York Times, 2008-10-03 [This clears up a critical point, identifying a rules change at the SEC which allowed the big investment banks to take vastly greater (and, in the event, disastrous) risks. Here is an excerpt; paragraph numbers and emphasis are added.] [0.6] Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis since the 1930s. But decisions made at a brief meeting [of the SEC] on April 28, 2004, explain why the problems could spin out of control. The agency’s failure to follow through on those decisions also explains why Washington regulators did not see what was coming. [0.7] On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks. [0.8]They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.
[0.9] The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary. [0.10] A lone dissenter — a software consultant and expert on risk management — weighed in from Indiana with a two-page letter to warn the commission that the move was a grave mistake. He never heard back from Washington. [0.11] One commissioner, Harvey J. Goldschmid, questioned the staff about the consequences of the proposed exemption. It would only be available for the largest firms, he was reassuringly told — those with assets greater than $5 billion. [0.12] “We’ve said these are the big guys,” Mr. Goldschmid said, provoking nervous laughter, “but that means if anything goes wrong, it’s going to be an awfully big mess.” [0.13] Mr. Goldschmid, an authority on securities law from Columbia, was a behind-the-scenes adviser in 2002 to Senator Paul S. Sarbanes when he rewrote the nation’s corporate laws after a wave of accounting scandals. “Do we feel secure if there are these drops in capital we really will have investor protection?” Mr. Goldschmid asked. A senior staff member said the commission would hire the best minds, including people with strong quantitative skills to parse the banks’ balance sheets. [0.14] Annette L. Nazareth, the head of market regulation, reassured the commission that under the new rules, the companies for the first time could be restricted by the commission from excessively risky activity. She was later appointed a commissioner and served until January 2008. [0.15] “I’m very happy to support it,” said Commissioner Roel C. Campos, a former federal prosecutor and owner of a small radio broadcasting company from Houston, who then deadpanned: “And I keep my fingers crossed for the future.” [0.16] The proceeding was sparsely attended. None of the major media outlets, including The New York Times, covered it. [0.17] After 55 minutes of discussion, which can now be heard on the Web sites of the agency and The Times, the chairman, William H. Donaldson, a veteran Wall Street executive, called for a vote. It was unanimous. The decision, changing what was known as the net capital rule, was completed and published in The Federal Register a few months later. [0.18] With that, the five big independent investment firms were unleashed. [0.19] In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the agency also decided to rely on the firms’ own computer models for determining the riskiness of investments, essentially outsourcing the job of monitoring risk to the banks themselves. [0.20] Over the following months and years, each of the firms would take advantage of the looser rules. At Bear Stearns, the leverage ratio — a measurement of how much the firm was borrowing compared to its total assets — rose sharply, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt. The ratios at the other firms also rose significantly. [0.21] The 2004 decision for the first time gave the S.E.C. a window on the banks’ increasingly risky investments in mortgage-related securities. [0.22] But the agency never took true advantage of that part of the bargain. The supervisory program under [Christopher] Cox, who arrived at the agency a year later, was a low priority. [0.23] The commission assigned seven people to examine the parent companies — which last year controlled financial empires with combined assets of more than $4 trillion. Since March 2007, the office has not had a director. And as of last month, the office had not completed a single inspection since it was reshuffled by Mr. Cox more than a year and a half ago. [0.24] The few problems the examiners preliminarily uncovered about the riskiness of the firms’ investments and their increased reliance on debt — clear signs of trouble — were all but ignored. [0.25] The commission’s division of trading and markets “became aware of numerous potential red flags prior to Bear Stearns’s collapse, regarding its concentration of mortgage securities, high leverage, shortcomings of risk management in mortgage-backed securities and lack of compliance with the spirit of certain” capital standards, said an inspector general’s report issued last Friday. But the division “did not take actions to limit these risk factors.” ...Congress-2008-$700G-Bailout-Vote
| House | Senate | |||
|---|---|---|---|---|
| For | Against | For | Against | |
| Republicans | 91 | 108 | 34 | 15 |
| Democrats | 172 | 63 | 39 | 9 |
| Independents | 1 | 1 | ||
| Total | 263 | 171 | 74 | 25 |
2008-10-04-WP-No-Plan-B
With No Plan B, House Reluctantly Passes Politically Risky Measure By Jonathan Weisman, David Cho and Paul Kane Washington Post, 2008-10-04 [Its beginning; emphasis is added.] [1] Henry M. Paulson Jr. was in his corner office in the Treasury Department on Monday afternoon, too nervous to turn on his television, when his chief of staff poked his head into the Treasury secretary’s office to tell him the stunning news playing out on Capitol Hill: The House had just defeated the Wall Street rescue plan that Paulson had helped craft. [2] Within minutes, Paulson was on his way across the street to the White House, his senior staff hustling to keep up, for a meeting in the Roosevelt Room with the administration’s economic team. There was no time for pleasantries, and before everyone had taken their seats, the former Goldman Sachs chief began firing off options. [3] Should they push for an immediate vote in the Senate? Should the Democratic leaders be flashed a green light to put together a bill that they could pass on their own, without Republicans? Should they make small changes to win over the dozen or so votes they would need on a second try in the House? [4] Forty-five minutes into the meeting, they were joined by President Bush, who asked the one question no one had considered: If his plan is not working, what is Plan B? [5] Paulson looked at his boss, then delivered the answer he did not want to hear:There is no Plan B. The Treasury Department and the Federal Reserve had stretched their authorities to the limits, employing obscure powers never before used to keep their fingers in the dikes.
The rescue package had to pass. [I don’t want to make too much of it, because the reporters may have misconstrued what was actually said, or some clarifying context may have been omitted, but Paulson’s statement, as reported, on face value seems to be untrue, or at the very least misleading. Compare, for example, the events reported in this four-days-later 2008-10-08 Washington Post story, especially this statement.]2008-10-05-WP-Grant
Bad Medicine By James Grant Washington Post Op-Ed, 2008-10-05 [Paragraph numbers and emphasis are added.] [1] Low interest rates, easy money and malleable accounting rules are what plunged Wall Street into crisis. Yet it is low interest rates, easy money and malleable accounting rules that top the list of federal fixes. The unifying theme of the new bailout bill, all 451 pages of it, is the hair of the dog that bit you. [2] The unblinkable fact is that Americans own too much house. We overpaid and overborrowed, and many of us are “upside down,” as the car dealers say. What to do? Recognize the losses and write them off. What not to do? Inflate the currency and debase accounting standards. [3] But inflation and debasement are the very policies being put in place. The Federal Reserve, not waiting for Congress, embarked last month on a radical program of money-printing. Reserve Bank credit -- the raw material of bank lending -- is growing at the year-over-year rate of 61 percent. [4] Credit creation is the Fed’s signature crisis-management policy: Let a bubble inflate, then watch it burst; clean up with lots of dollar bills. After the stock market broke in 2000, then-Fed Chairman Alan Greenspan set about easing policy. In company with Fed Governor Ben S. Bernanke, the man who wound up succeeding him, Greenspan warned against “deflation.” He vowed that this country would not sleepwalk through a decade of falling prices, as Japan had done. Rather, the Fed would push interest rates low enough to jolt the U.S. economy back into prosperity. [5] So it pushed the “federal funds rate” -- the interest rate that the Fed directly controls -- to 1 percent in mid-2003 and kept it there for a full 12 months. Here was a curious chapter in modern monetary history: Too little inflation was the problem, not too much, Greenspan and Bernanke insisted. Easy money and low interest rates were the answer. American consumers pinched themselves. Could they really borrow more than 100 percent of the price of a house at an unimaginably low teaser rate without so much as presenting proof of employment? Indeed, they could. House prices went up and up. [6] When, in 2006, the roof began to fall in, Wall Street was in a quandary. It held outsize volumes of triple-A-rated mortgage-backed securities (MBSs). That they were not, in fact, triple-A, had become painfully obvious. Curious analysts consulted the financial statements of the top mortgage dealers, including Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley, for clarification. [7] Readers, however, found no clarification and no foreshadowing of the troubles to come. Neither in Bear’s year-end 2006 report (10K, in Securities and Exchange Commission jargon) nor in its March 31, 2007, quarterly filing was there a meaningful word of warning about the sagging prices of the MBSs that did so much to pull Bear down. Those seeking to learn Merrill’s exposure to the mortgage contraptions called collateralized debt obligations, or CDOs, were similarly stymied. Although Merrill was to write off $23 billion worth of CDOs in 2007, the phrase “collateralized debt obligation” did not appear once in its 2006 10K. [8] Because there was often no market for these idiosyncratic securities, Wall Street did not have to value them at market prices. Rather, it marked them “to model.” That is, it assigned them prices at which they would trade, according to one mathematical construct or another, if they could trade. Of course, these mathematical constructs tended to cast things in a cheerful, management-approved way. Only later did a telltale plunge in the value of traded mortgage indices open the eyes of the market to the full extent of the troubles. [9] Prices can be unwelcome pieces of information. When an especially unwelcome batch wells up after a financial collapse, governments try to quash it. So it is today. The SEC has suppressed short selling. The bailout bill will open the door to the suspension of market-value accounting. The Fed is moving heaven and earth to cheapen the value of the dollar. [10] Long after the crisis burst into the open, the Fed and Treasury downplayed it. It was, they insisted, “contained.” Last week they asserted that, unless the House voted “yea,” the wheels would come off this $14 trillion economy. President Bush himself has broadly hinted that the nation is on the cusp of disaster. [11] How can they be so sure? And how can they know that the unintended consequences of the radical policies they are pushing through won’t be worse than the panic that they themselves are helping to foment? When the Fed insists it has no choice but to print up hundreds of billions of new dollars and when the keepers of accounting standards bend in the face of criticism that market prices hurt, what they are really saying is the that financial truth is too awful to bear. Heaven help us all if they’re right.James Grant is the editor of Grant’s Interest Rate Observer and author of the forthcoming book “Mr. Market Miscalculates: The Bubble Years and Beyond.”
2008-10-05-NYT-Duhigg-FMFM
Pressured to Take More Risk, Fannie Reached Tipping Point By CHARLES DUHIGG New York Times, 2008-10-10“Almost no one expected what was coming. It’s not fair to blame us for not predicting the unthinkable.”
— Daniel H. Mudd, former chief executive, Fannie Mae
2008-10-06-WP-Kurtz-media
Press May Own a Share in Financial Mess By Howard Kurtz Washington Post, 2008-10-06 [This is basically an exploration of whether the media could (or should) perhaps have provided more warning to the general public of the problems in the financial sector. Here is its conclusion; paragraph numbers and emphasis are added.] [16] In February, Times columnist Gretchen Morgenson wrote thatthe market for “unregulated” credit swaps had ballooned from $900 billion to $45 trillion-- twice the size of the U.S. stock market -- and a market hiccup “could set off a chain reaction of losses at financial institutions”
that would make it even harder for borrowers to get loans. [17] Even in the 401(k) age, hard-core business coverage tends to be ghettoized. Subjects that directly affect a broad audience, such as housing prices, are covered obsessively. But the arcana of credit default swaps and collateralized debt obligations -- limited to financial pages and financial TV shows -- is what caused the system to buckle. [18] “It wasn’t for lack of courage that the media didn’t pursue this stuff,” [Marcus Brauchli, The Washington Post's new executive editor, who was the Journal's top editor until this past spring], says. “Ultimately, it’s not we who are charged with taking away the punch bowl.” [19] But journalists are reluctant to target those who are guzzling the punch: the overstretched folks who bought houses they couldn’t afford and second homes they wanted to flip, all based on the presumption of endlessly rising prices. “ ‘Blame the people’ is a harder story to write,” [Fortune Managing Editor Andy Serwer] says. “There’s plenty of greed to go around. Everyone’s complicit.” [20] Financial journalists face a difficult balancing act. Penetrating the finances of corrupt companies, such as Enron, and crooked accountants, such as Arthur Andersen, is daunting enough. If these journalists shout too loudly, they can be accused of scaremongering and blamed for torpedoing the stock of outwardly healthy companies. [21] But does the problem run deeper than that? Gasparino recalls interviewing for a financial magazine job and having the editor warn him that he couldn’t sell magazines “with a bucket of crap on the cover.” [22] “People like when the stock market goes up,” Gasparino says. “There is a mind-set at newspapers and magazines that shies away from negative coverage.”2008-10-07-WP-Sloan
How to Borrow $700 Billion By Allan Sloan Washington Post, 2008-10-07 [An excerpt; emphasis is added.] The reason I’m so skeptical of the bailout plan is that it doesn’t directly attack the real problem -- the lack of confidence that lenders have in themselves, their borrowers and other institutions... [I would say the real problem(s) are the bad loans themselves -- the fact that the world has relied far too much on debt, sometimes unlikely to be repaid, to fuel its economy.] ... The bailout plan offers cash for trash. But a shortage of cash -- or to use the fancy word, liquidity -- isn’t the problem. Banks can get all the cash they need by borrowing for about 2 percent from the Federal Reserve Board by posting their troubled securities as collateral. What banks need is to build up their capital, a fancy term for net worth. If the Treasury let me run the bailout show, I’d concentrate on buying common or preferred stock from banks, restoring their capital position. In theory, each dollar of capital could generate $10 of loans. Recapitalizing lenders would not only restore confidence, but it would also give them enough of a cushion to spin off their out-of-favor securities under what’s called a good-bank, bad-bank plan, or do whatever else they see fit, including waiting out the market to see whether it recovers. Better them than us. Besides, buying stock rather than illiquid securities of uncertain value would give us taxpayers a nice, fat upside. Treasury Secretary Henry Paulson‘s bailout plan talks about taxpayers getting an ownership stake in return for buying toxic securities. Negotiating that type of deal isn’t any less complicated than negotiating a straight-up capital infusion.2008-10-07-WP-Pearlstein
With Bubbles Popping Worldwide, No Wonder the Economy's Gone Flat By Steven Pearlstein Washington Post, 2008-10-07 [An excerpt; paragraph numbers and emphasis are added.] [1] Up to now, it’s been a financial crisis. This is a meltdown -- an uncontrolled and largely uncontrollable financial chain reaction that threatens serious harm to the broader economy. [2] The immediate problem is that the institutions that have most of the world’s free cash -- banks, money-market funds, hedge funds, pension funds and major corporations -- are hoarding it and won’t do the normal thing of lending to one another. [3] One reason is that many have taken on too much debt, lost too much money and are under pressure to use any spare cash to pay down debt and rebuild their reserves. [4] The other reason is that they feel unsure about what they know about the financial health of other institutions and are afraid that some of them will fail. [5] So what we’ve got is a liquidity crisis that is bigger than anyone has ever seen, on top of an insolvency crisis that is bigger than anyone has ever seen. And thanks to the explosion of cross-border trade and investment, the crisis has not only gone global but now threatens to take most of the global economy into recession. [6] “World on the edge,” is how the Economist magazine summed things up on its cover this week. And that is certainly how things felt during yesterday’s wild ride on stock and money markets. [7] What we now have is a set of economic and financial bubbles bursting at roughly the same time. [8] Here in the United States, the bursting of the residential real estate bubble punctured the first hole in the credit bubble, which in time brought an end to the corporate takeover bubble, the commercial real estate bubble and the commodities bubble. Because of those bubbles, Americans became convinced that they were wealthier than they really were, leading to a consumption binge that created mini-bubbles in autos, vacation travel and retail sales. Now those have burst as well. [9] The symbiotic twin of the giant consumption bubble in the United States was the giant export bubble in China and the rest of Asia. That export bubble, in turn, created stock market and real estate bubbles all across Asia and fed a global commodities bubble as well. Now that the air is coming out of the export bubble, shares on the Chinese stock market have declined 60 percent, while real estate prices in key Indian cities are in free-fall.2008-10-08-NYT-Leonhardt
Ignoring Reality Has a Price By DAVID LEONHARDT New York Times, 2008-10-08 [Its beginning; paragraph numbers and emphasis are added.] WASHINGTON [1] Thirty billion dollars to keep Bear Stearns from collapsing. Another $85 billion for A.I.G. Hundreds of billions, here and there, lent to banks. [2] All told, the Federal Reserve has pumped $800 billion into the financial system, Ben Bernanke, its chairman, estimated on Tuesday. That figure doesn’t include the untold sum that the Fed now plans to spend buying short-term debt so that companies can continue to pay for their daily operations. And it doesn’t include any of the money the Treasury Department is laying out, like the $700 billion bailout fund or the $200 billion that could be spent propping up Fannie Mae and Freddie Mac. [3] After 14 months of crisis, the federal government — meaning you and me — has put serious money on the line. As a point of comparison, the entire annual federal budget is about $3 trillion. [4] Just how are we going to pay for all this? ...2008-10-08-WP-Irwin
Moves by Fed, Europeans Fail To Calm Investors Dow Falls 5% Despite Hint at Rate Cut, Massive Efforts to Loosen Credit By Neil Irwin Washington Post, 2008-10-08 [An excerpt; paragraph numbers and emphasis are added.] [8] The troubling signs came despite a morning announcement that the Fed will buy up commercial paper, the short-term debt that funds the daily operations of banks and ordinary businesses. In a bold new attempt to jump-start the lending that is the lifeblood of American business, the central bank said it would create a special entity to purchase this short-term debt. [9] The investors that normally snap up those relatively low-risk investments, such as college endowments and money-market mutual funds, aren’t doing so. That is causing stresses throughout the financial system that are damaging the overall economy. So the Fed has moved to essentially funnel cash to companies -- up to the entire universe of $1.3 trillion of high-quality commercial paper that has been issued. [10]“The central bank is finally starting to get aggressive,” said Drew Matus, a senior economist at Merrill Lynch. “Now they’re trying to keep things functioning until the Treasury plan starts up,”
he said, referring to the $700 billion fund to buy up troubled assets from financial firms. [11] Yesterday’s action by the Fed could even lay the groundwork for future interventions in credit markets, should the troubles deepen. [12] “It could be expanded for different types of securities,” said Michael J. Feroli, a U.S. economist at J.P. Morgan Chase. “Today Bernanke said they’re going to continue to be aggressive and innovative, and I don’t expect that to slow down anytime soon.” ... [21] [The above statement seems to explicitly contradict this statement, attributed to Treasury Secretary Paulson, in the 2008-10-05 Post story “With No Plan B ...”.] It used that authority two other times this year -- to rescue Bear Stearns and take over American International Group. This time, for the commercial paper program, the Treasury Department will help provide funding. [22] In previous lending programs this year, the Fed has loaned only against strong collateral. But now the Fed will even take on “unsecured” debt, or that which is backed only by the faith of the company borrowing money. It will require insurance fees on companies borrowing money with unsecured debt to protect against losses.2008-10-09-NYT-Goodman-Greenspan
Taking Hard New Look at a Greenspan Legacy By PETER S. GOODMAN New York Times, 2008-10-09 [Its beginning; paragraph numbers and emphasis are added.]“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.”
— Alan Greenspan in 2004
[0.1] George Soros, the prominent financier, avoids using the financial contracts known as derivatives “because we don’t really understand how they work.” Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential “hydrogen bombs.” And Warren E. Buffett presciently observed five years ago that derivatives were “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” [0.2] One prominent financial figure, however, has long thought otherwise. And his views held the greatest sway in debates about the regulation and use of derivatives — exotic contracts that promised to protect investors from losses, thereby stimulating riskier practices that led to the financial crisis. For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. [0.3] “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” Mr. Greenspan told the Senate Banking Committee in 2003. “We think it would be a mistake” to more deeply regulate the contracts, he added. [0.4] Today, with the world caught in an economic tempest that Mr. Greenspan recently described as “the type of wrenching financial crisis that comes along only once in a century,” his faith in derivatives remains unshaken. [0.5] The problem is not that the contracts failed, he says. Rather, the people using them got greedy. A lack of integrity spawned the crisis, he argued in a speech a week ago at Georgetown University, intimating that those peddling derivatives were not as reliable as “the pharmacist who fills the prescription ordered by our physician.” [0.6] But others hold a starkly different view of how global markets unwound, and the role that Mr. Greenspan played in setting up this unrest. [0.7] “Clearly, derivatives are a centerpiece of the crisis, and he was the leading proponent of the deregulation of derivatives,” said Frank Partnoy, a law professor at the University of San Diego and an expert on financial regulation. [0.8] The derivatives market is $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago. Theoretically intended to limit risk and ward off financial problems, the contracts instead have stoked uncertainty and actually spread risk amid doubts about how companies value them. [0.9] If Mr. Greenspan had acted differently during his tenure as Federal Reserve chairman from 1987 to 2006, many economists say, the current crisis might have been averted or muted. [0.10] Over the years, Mr. Greenspan helped enable an ambitious American experiment in letting market forces run free. Now, the nation is confronting the consequences. ...2008-10-10-NYT-Norris
Plan B: Flood Banks With Cash By FLOYD NORRIS New York Times, 2008-10-102008-10-15-WP-Deregulation
What Went Wrong By Anthony Faiola, Ellen Nakashima and Jill Drew Washington Post, 2008-10-15 How did the world’s markets come to the brink of collapse? Some say regulators failed. Others claim deregulation left them handcuffed. Who’s right? Both are. This is the story of how Washington didn’t catch up to Wall Street. [This is a long report, emphasizing the role of Brooksley E. Born.]2008-10-15-WP-Resistance
Smaller Banks Resist Federal Cash Infusions By Binyamin Appelbaum Washington Post, 2008-10-15 [Its beginning; paragraph numbers and emphasis are added.] [1] Community banking executives around the country responded with anger yesterday to the Bush administration’s strategy of investing $250 billion in financial firms, saying they- don’t need the money,
- resent the intrusion, and
- feel it’s unfair to rescue companies from their own mistakes.
2008-10-15-WP-Pearlstein
Buckle Up -- We Haven't Reached Bottom Yet By Steven Pearlstein Washington Post, 2008-10-15 [An excerpt; paragraph numbers and emphasis are added.] [9] [W]e didn’t just have a housing bubble and a corporate takeover bubble and a consumer credit bubble and a commodities bubble. In time, those asset bubbles led to the creation of a bubble economy, with too many airplanes and restaurant seats and hotel rooms, too many office buildings and shopping centers, too many investment banks and media outlets dependent on advertising revenue from car companies producing too many cars and home builders producing too many houses. Shrinking all that back to the right size is what the coming recession is all about. [Actually, I think shrinking people’s expectations is the greatest and most important requirement.] ... [12] The next shoe to drop will be the hedge funds, which are posting worst-ever losses from investments that have led to record withdrawals. By one estimate, as many as 1,000 hedge funds could close their doors before the shakeout is over, with negative implications for the Wall Street banks that lent them money. [13] Then comes commercial real estate, where values are already plummeting, vacancy rates are rising and permanent financing is difficult to find. A collapse in this sector would be particularly bad news for regional banks and insurance companies. [14] And let’s not forget all those otherwise sound companies taken over by private-equity firms and management teams that proceeded to load them up with debt. A prolonged recession is almost certain to cause a larger-than-expected increase in the default rates on the “leveraged loans” and junk bonds used to finance those deals, and that will be another direct hit on the major Wall Street banks.2008-10-15-NYT-market-investers-fundamental-problems
Despite Big Rally, Grim Outlook on Profits and Jobs By VIKAS BAJAJ New York Times, 2008-10-15 [An excerpt; paragraph numbers and emphasis are added.] [1] The euphoria that swept Wall Street on Monday gave way to a sober reality on Tuesday: a recession, perhaps the deepest one in decades, may be unavoidable. [2] A day after the stock market staged one of its biggest rallies in history, buoyed by the government’s plan to rescue banks, investors retreated once again. Worries about the economy came to the fore. Many people fear that corporations — and by extension their workers and shareholders — will face harder times in the months ahead. [3] “Everything the government has done is not going to prevent further deterioration in the economy,” said Stuart Hoffman, chief economist at PNC Bank. “At the end of all this, what matters is what the economy does.” [Does that mean that the government (the Fed and the Treasury) has just wasted around two trillion dollars?]2008-10-16-NYT-market-investers-fundamental-problems
Markets Suffer as Investors Weigh Relentless Trouble By PETER S. GOODMAN New York Times, 2008-10-16 [An excerpt; paragraph numbers and emphasis are added.] [2] The government’s rescue of the banks has been widely embraced, but the frenzied selling, which pushed the Dow Jones industrial average down 733 points, underscored how the economy’s troubles are too broad to be fixed by the bailout of the financial system. [3] Investors are recognizing thatthe financial crisis is not the fundamental problem. It has merely amplified economic ailments that are now intensifying: vanishing paychecks, falling home prices and diminished spending.
And there is no relief in sight.2008-10-16-WP-Schiff
Don’t Blame Capitalism By Peter Schiff Washington Post Op-Ed, 2008-10-16 [Paragraph numbers and emphasis are added.] [1] Amid the chaos of recent days, as the federal government has taken gargantuan steps to stabilize the financial markets, realigning the U.S. economic system in the process, comes a nearly universal consensus: This crisis resulted from government reluctance to regulate the unbridled greed of Wall Street. Many economists and market participants who were formerly averse to government interference agree that a more robust regulatory framework must be constructed to cage the destructive forces of capitalism. [2] For the political left, which has long championed the need for such limits, this crisis is the opportunity of a lifetime. [3] Absent from such conclusions is the central role the government played in creating the crisis. Yes, many Wall Street leaders were irresponsible, and they should pay. But they were playing the distorted hand dealt them by government policies. Our leaders irrationally promoted home-buying, discouraged savings, and recklessly encouraged borrowing and lending, which together undermined our markets. [4] Just as prices in a free market are set by supply and demand, financial and real estate markets are governed by the opposing tension between greed and fear. Everyone wants to make money, but everyone is also afraid of losing what he has. Although few would ascribe their desire for prosperity to greed, it is simply a rose by another name. Greed is the elemental motivation for the economic risk-taking and hard work that are essential to a vibrant economy. [I would propose an alternative motivation: ] [5] But over the past generation, government has removed the necessary counterbalance of fear from the equation. Policies enacted by the Federal Reserve, the Federal Housing Administration, Fannie Mae and Freddie Mac (which were always government entities in disguise), and others created advantages for home-buying and selling and removed disincentives for lending and borrowing. The result was a credit and real estate bubble that could only grow -- until it could grow no more. [6] Prominent among these wrongheaded advantages are the mortgage interest tax deduction and the exemption of real estate capital gains from taxable income. These policies create unnatural demand for home purchases and a (tax-free) incentive to speculate in real estate. [7] Similarly, the FHA, Fannie and Freddie were created to encourage lending by allowing primary lenders to turn their long-term risk over to the government. Absent this implicit guarantee, lenders would probably have been much more conservative in approving borrowers and setting interest terms, and in requiring documentation of incomes and higher down payments. Market forces would have kept out unqualified buyers and prevented home-price appreciation from exceeding the growth in household income. [8] Interest rates contributed the most to creating the housing boom. After the dot-com crash and the slowdown following the attacks of Sept. 11, 2001, the Federal Reserve took extraordinary steps to prevent a shallow recession from deepening. By slashing interest rates to 1 percent and holding them below the rate of inflation for years, the government discouraged savings and practically distributed free money. [9] Artificially low interest rates invigorated the market for adjustable-rate mortgages and gave birth to the teaser rate, which made overpriced homes appear affordable. Alan Greenspan himself actively encouraged home buyers to avail themselves of these seeming benefits. As monetary policy caused houses to become more expensive, it also temporarily provided buyers with the means to overpay. Cheap money gave rise to subprime mortgages and the resulting securitization wave that made these loans appear safe for investors. [10] And even today, as market forces deflate the credit bubble, the government is stepping in to re-inflate it. First came the Treasury’s $700 billion plan to purchase mortgage assets that no one in the private sector would buy. Now it has recapitalized banks to the tune of $250 billion, guaranteeing loans between banks and fully insuring non-interest-bearing accounts. Policymakers say that absent these steps, banks would not be able to extend loans.But given our already staggering debt burden, perhaps more loans are not the answer.
[All they do is transfer income from future generations to the present generation.] That’s what the free market is telling us. But the government cannot abide solutions that ask for consumer sacrifice. [11] Real credit can be supplied only by savings, so artificial steps to stimulate lending will only produce inflation. By refusing to allow market forces to- rein in excess spending,
- liquidate bad investments,
- replenish depleted savings,
- fund capital investment and
- help workers transition from the service sector
to the manufacturing sector,
The writer, who was economic adviser for Ron Paul’s 2008 presidential campaign, is president of Euro Pacific Capital. He is the author of “The Little Book of Bull Moves in Bear Markets.”
2008-10-17-NYT-banks-hoard-cash
Banks Are Likely to Hold Tight to Bailout Money By LOUISE STORY and ERIC DASH New York Times, 2008-10-17 [Its beginning; paragraph numbers and emphasis are added.] [1] Even as the government moves to plug holes in the nation’s banks, new gaps keep appearing. [2] As two financial giants, Citigroup and Merrill Lynch, reported fresh multibillion-dollar losses on Thursday, the industry passed a grim milestone: All of the combined profits that major banks earned in recent years have vanished. [3] Since mid-2007, when the credit crisis erupted, the country’s nine largest banks have written down the value of their troubled assets by a combined $323 billion. With a recession looming, the pain is unlikely to end there. The problems that began with home mortgages, analysts say, are migrating to auto, credit card and commercial real estate loans. [4] The deepening red ink underscores a crucial question about the government’s plan: Will lenders deploy their new-found capital quickly, as the Treasury hopes, and unlock the flow of credit through the economy? Or will they hoard the money to protect themselves? [5] John A. Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view. [6] “We will have the opportunity to redeploy that,” Mr. Thain said of the new capital on a telephone call with analysts. “But at least for the next quarter, it’s just going to be a cushion." [7] Granted, the banks are in a deep hole. For every dollar the banks earned during the industry’s most prosperous years, they have now wiped out $1.06. [8] Even with the capital from the government, analysts say, the banking industry still needs to raise around $275 billion in light of the looming losses. [9] But Treasury Secretary Henry M. Paulson Jr. is urging them to use their new capital soon. On Monday, Mr. Paulson unveiled plans to provide $125 billion to nine banks on terms that were more favorable than they would have received in the marketplace. The government, however, has offered no written requirements about how or when the banks must use the money.2008-10-17-Norris-trust
Banks Fail, and So Can Bailouts By FLOYD NORRIS New York Times, 2008-10-17 [Its beginning; paragraph numbers and emphasis are added.] [1] Trust is a precious thing, and the banks still don’t have much of it. Not from the public, and not from one another. [2] The government’s latest bailout plan — to invest $250 billion in banks with few strings attached — could help restore that trust. But it will succeed only if the government is able to make it clear that those investments confer a sort of “Good Bookkeeping” seal of approval. [3] That will depend on whether the government makes sure that the cash goes only to banks that are in decent shape, or at least will be after they get the cash. [If a bank is in “decent shape,” then why does it need the government’s money?] [4] By committing half the money to nine large banks, the Treasury Department presumably has taken care of most, if not all, of the banks whose failure would threaten the system. Now it has the chance to carefully go over the books of banks that apply to join the bailout club. [5] The signs of possible distress that the government should look for go far beyond toxic mortgage securities and credit-default swaps. Many smaller banks were not invited to those parties, and therefore suffer no hangover from them. But real estate construction loans, both for homes and commercial buildings, were far more prevalent in banks all around the country. Credit card losses are looming as unemployment rises. [6] It will take weeks, if not months, for the government to prove that it will invest the money wisely. But so far, it has not even made clear that it is determined to leave out the bad banks. [7] Treasury officials say they have not made any decisions on what criteria will be used to decide which banks are allowed into the program, other than to consult with regulators. That is probably true; the government’s frantic efforts to halt the slide in recent weeks have had a “ready, fire, aim” feel to them.2008-10-19-WP-ripple-effects
Financial Rescues Can Set Off New Problems By Peter Whoriskey and Zachary A. Goldfarb Washington Post, 2008-10-19 [Its conclusion.] Further into the future, some economists predict even more profound consequences from today’s interventions.By fostering the belief the government will rush to the rescue whenever a major financial institution begins to falter, federal officials may be creating what many economists call a “moral hazard.”
That is, those institutions may be more willing to undertake risky investments. “It’s all very Rube Goldberg-esque,” said William O’Donnell, the head of U.S. interest rate strategy at UBS, referring to the cartoonist famed for devices that work in indirect and convoluted means. “You’re never quite sure what any one action will do.”2008-10-19-WP-sideline-527-donors
Economic Downturn Sidelines Donors to '527' Groups By Matthew Mosk Washington Post, 2008-10-192008-10-19-NYT-Bubble-Keeps-Deflating
The Bubble Keeps On Deflating New York Times Editorial, 2008-10-19 [Its first half; emphasis is added.] [1] By now everyone knows that reckless and even predatory mortgage lending provoked the financial meltdown. But bad lending did not stop there. The easy money also fed a corporate buyout binge, with private equity firms borrowing huge sums to buy up public companies and pay themselves big dividends. [In general terms, this sort of corporate buccaneering is hardly a new development: it has been very prominent since at least the 1980s. However maybe the loose bank practices described below are new.] [2] The process was much like a homeowner who borrowed big for a house and then refinanced to pull out cash. In corporate buyouts, however, the newly private company was left with the fat loan, while the private equity partners got the cash. [3] In keeping with the mania of the era [That characterization is entirely too airy and unspecific. The causes of these phenomenon deserve far closer examination.], banks lowered their lending standards as they competed fiercely to make buyout loans. Lenders also did not worry much about being repaid, because they made money by slicing and dicing the buyout loans and selling them off in pieces to investors. [4] All of this means that the country needs to brace for yet another round of trouble: a potentially sharp increase in corporate bankruptcies. This time, government officials and Congress must not be taken by surprise. [5] So far relatively few companies have gone bust. But that is not necessarily a hopeful sign. Instead, loose lending has very likely allowed many troubled companies to postpone a day of reckoning — but not forever. [6] Under the lax terms of many buyout loans (deemed “covenant lite”), borrowers could delay payments, say, by issuing i.o.u.’s in lieu of payment or adding the interest to the loan balance rather than paying it. But when the loans come due and need to be repaid or refinanced, terms will no longer be so easy. The likely result will be defaults and bankruptcies. [7] A rash of corporate bankruptcies would obviously be very bad news for employees and lenders, and for stockholders at troubled public companies, like the carmakers. It could also rock the financial system anew. [8] As with mortgages, huge side bets have been placed on the performance of corporate debt via derivative securities, like credit default swaps. Derivatives are unregulated, so no one can be sure how widely a big or unexpected default would reverberate through the system. [9] Various measures indicate elevated default risk at a range of businesses, including retailers, media companies, restaurants and manufacturers. A survey released this month by the Federal Reserve and other regulators is especially sobering. [10] It looked at $2.8 trillion in large syndicated corporate loans held by American banks at the end of June. Compared with a year earlier, the share of loans rated as problematic had risen from 5 percent to 13.4 percent. ...2008-10-20-WP-unregulated
Unregulated Market Faces Test as Corporate Defaults Pile Up By Heather Landy Washington Post, 2008-10-202008-10-20-NYT-deficit
Deficit Rises, and Consensus Is to Let It Grow By LOUIS UCHITELLE and ROBERT PEAR New York Times, 2008-10-20 [An excerpt; emphasis is added.] Confronted with a hugely expensive economic crisis, Democratic and Republican lawmakers alike have elected to pay the bill mainly by borrowing money rather than cutting spending or raising taxes. But while the borrowing is relatively inexpensive for the government in a weak economy, the cost will become a bigger burden as growth returns and interest rates rise. In addition, outlays for Medicare and Social Security are expected to balloon as the first baby boomers reach full retirement age in the next three years. “The next president will inherit a fiscal and economic mess of historic proportions,” said Senator Kent Conrad, Democrat of North Dakota and chairman of the Senate Budget Committee. “It will take years to dig our way out.”2008-10-23-WP-Paley-Credit-Rating-Firms
Credit-Rating Firms Grilled Over Conflicts Risks Were Known, Documents Show By Amit R. Paley Washington Post, 2008-10-23 [This presents a remarkable, disturbing, picture; here it is in its entirety; emphasis is added.] Executives at the country’s leading credit-rating companies, whose optimistic assessments of risky investments helped fuel the financial meltdown, have privately acknowledged for more than a year that conflicts of interest contributed to the industry’s failures, according to internal company documents released yesterday. The disclosures emerged at a heated congressional hearing where lawmakers grilled the heads of the three major rating companies, accusing them of betraying the public by letting corporate greed trump their responsibility to provide unbiased appraisals for investors. “The story of the credit-rating agencies is the story of a colossal failure,” said Rep. Henry A. Waxman (D-Calif.), chairman of the House Oversight and Government Reform Committee. “Millions of investors rely on them for independent, objective assessments. The ratings agencies broke this bond of trust, and federal regulators ignored the warning signs.” In one of the confidential documents obtained by the committee, Raymond W. McDaniel, chief executive of ratings firm Moody’s, said analysts and executives are “continually ‘pitched’ by bankers, issuers, investors . . . whose views can color credit judgment.” “we ‘drink the kool-aid,’ “ he wrote in a Oct. 21, 2007, memo to the board. “Unchecked, competition on this basis can place the entire financial system at risk.” The three major credit-rating companies -- Standard & Poor’s, Moody’s and Fitch -- assigned some of their highest ratings to mortgage-backed securities whose risks were grossly underestimated. As homeowners began defaulting on subprime mortgages, it became clear that many of those securities were overvalued. The companies finally downgraded thousands of those securities over the past year, contributing to the collapse of major firms and heightening the economic crisis. Lawmakers are looking at whether the business model of these companies was a key factor in their failure to accurately predict the risk of the securities. The big credit-raters are paid by the issuers of the securities they evaluate, creating what executives acknowledge is an inherent conflict of interest. Some industry critics advocated banning the practice \and replacing it with a model in which companies are paid by investors. “When the referee is being paid by the players, no one should be surprised when the game spins out of control,” said Rep. Christopher Shays (R-Conn.), reflecting the committee’s unanimous bipartisan criticism of the industry. “You have so screwed up the ratings as to not be believable.” All three executives acknowledged their firms had badly erred in assessing the mortgage-backed securities and said those mistakes had contributed to the financial meltdown. But they said the errors were not intentional or malicious, adding that they had made their procedures more transparent and implemented safeguards to prevent additional mistakes. “We have to earn our credibility back,” said Deven Sharma, president of Standard & Poor’s. Before the firm chiefs testified, the committee heard from two former high-ranking credit-rating executives who described their frustrations in dealing with conflicts of interest and pressure on analysts to gloss over problems. Frank L. Raiter, who had been head of residential mortgage-backed securities ratings at Standard & Poor’s for 10 years, said that he developed a new model for better assessing loan performance in 2001 but that it was not implemented because of budgetary constraints. “Profits were running the show,” he said. Sharma said that the model was not adopted because Raiter’s colleagues thought it was not effective and that models have been repeatedly updated since Raiter left the company in 2005. Raiter also clashed with colleagues at Standard & Poor’s when he was asked to rate a security by Richard Gugliada, an S&P managing director. After Raiter asked for detailed loan information to assess the creditworthiness of the security, Gugliada refused. “Any request for loan level tapes is TOTALLY UNREASONABLE!!!” Gugliada wrote in 2001. “It is your responsibility to provide those credit estimates and your responsibility to devise some method for doing so.” Raiter responded: “This is the most amazing memo I have ever received in my business career.” He told the lawmakers that he never rated the security. Gugliada said in an interview that he was following company policy and that Raiter’s department was the only one that refused to provide ratings without the detailed data. Other internal documents suggested that analysts knew they were overrating the securities. In an April 2007 instant-message exchange between two S&P analysts, one wrote, “that deal is ridiculous.” “i know right . . . model def does not capture half of the . . . risk,” responded the other. “we should not be rating it,” the first replied. “we rate every deal,” the second wrote. “it could be structured by cows and we would rate it.” Standard & Poor’s said the deal discussed by the employees was later restructured and then rated by the firm. The company said the rating has held up and that the exchange did not reflect the firm’s professional standards. One high-ranking executive at Moody’s expressed concern about the morality of its policies in September 2007. “We had blinders on and never questioned the information we were given,” the unnamed managing director said. “These errors make us look either incompetent at credit analysis, or like we sold our soul to the devil for revenue, or a little bit of both.” Other credit-raters took a more whimsical tone in describing the risks of mortgage-backed securities. “Let’s hope we are all wealthy and retired by the time this house of cards falters,” a high-ranking official at Standard and Poor’s wrote in December 2006. The sentence concludes with a smiley face.2008-10-26-NYT-Morgenson-Shocked-Shocked
They’re Shocked, Shocked, About the Mess By GRETCHEN MORGENSON New York Times, 2008-10-26 [In its entirety; emphasis is added.] MY hypocrisy meter konked out last week. It started acting up on Wednesday, spinning wildly as executives from the nation’s leading credit-rating agencies testified before Congress about their nonroles in the credit crisis. Leaders from Moody’s, Standard & Poor’s and Fitch all said that their firms’ inability to see problems in toxic mortgages was an honest mistake. The woefully inaccurate ratings that have cost investors billions were not, mind you, a result of issuers paying ratings agencies handsomely for their rosy opinions. Still, there were those pesky e-mail messages cited by the House Committee on Oversight and Government Reform that showed two analysts at S.& P. speaking frankly about a deal they were being asked to examine. “Btw — that deal is ridiculous,” one wrote. “We should not be rating it.” “We rate every deal,” came the response. “It could be structured by cows and we would rate it.” Asked to explain the cow reference, Deven Sharma, S.& P.’s president, told the committee: “The unfortunate and inappropriate language used in these e-mails does not reflect the core culture of the organization I am committed to leading.” Maybe so, but that was a lot for my malarkey meter to absorb. Then, on Thursday, my meter sputtered as Alan Greenspan, former “Maestro” of the Federal Reserve, testified before the same Congressional questioners. He defended years of regulatory inaction in the face of predatory lending and said he was “in a state of shocked disbelief” that financial institutions did not rein themselves in when there were billions to be made by relaxing their lending practices and trafficking in exotic derivatives. Mr. Greenspan was shocked, shocked to find that there was gambling going on in the casino. MY poor, overtaxed, smoke-and-mirrors meter gave out altogether when Christopher Cox, chairman of the Securities and Exchange Commission, took his turn on the committee’s hot seat. His agency had allowed Wall Street firms to load up on leverage without increasing its oversight of them. But he said on Thursday that the credit crisis highlights “the need for a strong S.E.C., which is unique in its arm’s-length independence from the institutions and persons it regulates.” He said that with a straight face, too. There was more. Mr. Cox went on to suggest that his hapless agency should begin regulating credit-default swaps. This, recall, is that $55 trillion market at the heart of almost every big corporate failure and near-collapse of recent months. Trading in these swaps, which offer insurance against debt defaults, exploded in recent years. As the market for the swaps grew, so did the risks — and the interconnectedness — among the firms that traded them. During the years when these risks were ramping up unregulated, Mr. Cox and his crew were silent on the swaps beat. How exasperating. After all the time and taxpayer money spent trying to resolve the financial crisis, we’re still in the middle of the maelstrom. The S.& P. 500-stock index was down 40.3 percent for the year at Friday’s close. Yes, the problems are global, and made more complex by Wall Street’s financial engineers. And a titanic deleveraging process like the one we are in, where both consumers and companies must cut their debt loads, is never fun or over fast. Still, as the stock market continues to grind lower, something more may be at work. And that something centers on trust and credibility, which have been lacking in corporate and government leadership in recent years. Like the boy who cried wolf,corporate and regulatory officials have issued a lot of hogwash over the years.
Until recently, investors were willing to believe it. Now they may not be so easily gulled. Companies, even those in cyclical businesses, routinely told investors that the reason they so regularly beat their earnings forecasts was honest hard work — and not cookie-jar accounting. They were believed. Politicians proclaiming that the economy was strong and that the crisis would not spread kept our trust. Brokerage firms insisting that auction-rate securities were as good as cash won over investors — and, as we all know now, that market froze up. Wall Street dealmakers were fawned over like all-knowing superstars, their comings and goings celebrated. No one doubted them. Banks engaging in anything-goes lending practices assured shareholders that safety and soundness was their mantra. They, too, got a pass. Directors who didn’t begin to understand the operational complexities of the companies they were charged with overseeing told stockholders that they were vigilant fiduciaries. Investors suspended their disbelief. And regulators, asserting that they were policing the markets, convinced investors that there was a level playing field. Is it any surprise that virulent mistrust seems to own the markets now? Janet Tavakoli, a finance industry consultant who is president of Tavakoli Structured Finance, said the stock market’s gyrations are a result of a severe lack of confidence in the very officials who are charged with cleaning up the nation’s mess. “It is not enough to throw money at a problem; you also have to use honesty and common sense,” Ms. Tavakoli said. “In fact, if you leave out the last two, you are wasting taxpayers’ money.” What Ms. Tavakoli means by common sense is a plan that will force institutions to get a fix on what their holdings are actually worth. “If you are going to hand out capital, you have to first revalue the assets or take over so that you can force a mark to market,” she said.“Force restructurings, mark down the assets to defensible levels and let the market clear.”
She also suggests that financial regulators impose a form of martial law, allowing them to rewrite derivatives contracts that bind counterparties to terms they may not even comprehend. “If I were queen of the world, I would wade in there with a small army of people and just start straightening out these books,” she said. “Start stripping them down and simplifying contracts so people can start to understand what they own. It would be unprecedented, but so is everything else we are doing.” THAT move, which would begin the much-needed healing process for investors, would be unprecedented in another way. It might get the people who run our companies and our regulatory agencies into the business of telling the truth. Naïve, I know. But something to wish for — I’d like to give my hypocrisy meter a breather.2008-10-28-Sloan-MTM
Don't Blame Mark-to-Market Accounting By Allan Sloan Washington Post, 2008-10-282008-10-29-Pearlstein
A Detroit Bankruptcy Beats a Bailout By Steven Pearlstein Washington Post, 2008-10-29 [This makes a good case, in my opinion, for why bankruptcy for automakers, rather than putting them permanently out of business, rather allows them to clear off some of the encumbrances that have prevented profitability.]2008-10-29-WP-bonuses
Waxman Seeks Bank Data On Use of Bailout Funds By Amit R. Paley and Binyamin Appelbaum Washington Post, 2008-10-29 [An excerpt; emphasis is added.] [1] Congressional investigators yesterday demanded that the nation’s nine largest banks prove they are not using an emergency infusion of $125 billion in taxpayer funds to lavish their executives with wealthy bonuses. [2] Rep. Henry A. Waxman (D-Calif.), chairman of the House Committee on Oversight and Government Reform, noted that before the infusion, the banks had spent or allocated $108 billion on employee compensation and bonuses for the first nine months of 2008, nearly the same amount as last year. [3] “I question the appropriateness of depleting the capital that taxpayers just injected into the banks through the payment of billions of dollars in bonuses, especially after one of the financial industry’s worst years on record,” Waxman wrote in a letter to the banks. [4] Lawmakers across the political spectrum want to ensure that the government’s bailout program results in increased lending, not bigger paydays for executives. [5] Banking industry officials said they fully intend to use money from the government’s bailout program to make loans and increase liquidity. They noted that bonuses are a normal part of compensation packages. The fact that the allocations on compensation so far in 2008 are identical to last year suggests that the bailout money will be not used to boost bonuses, they said. [6] “Waxman’s barking up the wrong tree,” said Scott E. Talbott, senior vice president of government affairs for the Financial Services Roundtable, which represents the nation’s most powerful banks, brokerages and insurers. “We reject his basic premise. The institutions fully intend to use the money to start making loans.” [7] But a new study suggests that financiers are still bullish about their bonuses. More than two-thirds of Wall Street professionals are expecting a bonus this year, and 36 percent are anticipating a larger bonus than last year, according to a survey by eFinancialCareers, a career networking company. [8] “Some experts have suggested that a significant percentage of this compensation could come in year-end bonuses [Why be so wishy-washy about this? That is a well-known and -established fact. Why present reality as hypothesis?] and that the size of the bonuses will be significantly enhanced as a result of the infusion of taxpayer funds,” Waxman said.2008-10-31-Pearlstein
Hank Paulson's $125 Billion Mistake By Steven Pearlstein Washington Post, 2008-10-31 [Pearlstein doesn’t like Paulson’s current approach of investing in banks:] Sprinkling money around a highly fragmented banking system when markets were panicked and everyone was scrambling to reduce leverage was always akin to shoveling sand against the tide. [Pearlstein’s recommended solution (emphasis added):] Paulson’s first mistake was in allowing himself to be diverted from his original strategy, which stood a good chance of establishing reasonable and credible market prices for asset-backed securities -- a necessary first step in attracting other buyers back into those frozen markets. [Wrong, wrong, wrong! How can government mandarins “establish reasonable and credible market prices for asset-backed securities”? That seems like a contradiction in terms. The government is not the market. The only credible way of establishing “market prices” is the market, by definition. Or is that too simple and straight-forward for those who desire to rule America? Part of what is wrong with America these days, in my opinion, is this sort of flim-flam and swindle, taking things constructed by Wall Street sharpies and persuading hapless investors that they are worth far more than they are, appealing to governmental fiat and taxpayer dollars to support the case as necessary. Meanwhile, leading elements in our society keep calling for “change” as if the problem isn’t too much change from tried and true ways of conducting both economic and social life already.]2008-10-30-Ignatius
Alphas in Their Bunkers By David Ignatius Washington Post, 2008-10-302008-11-13-WP-Treasury-redefines
Treasury Redefines Its Rescue Program Plan to Buy Distressed Assets Is Abandoned In Favor of Aid to Loosen Consumer Credit By Peter Whoriskey, David Cho and Binyamin Appelbaum Washington Post, 2008-11-13 [Ready, Fire, Aim]2008-11-13-WP-Lacks-oversight
Bailout Lacks Oversight Despite Billions Pledged Watchdog Panel Is Empty; Report Is Unfinished By Amit R. Paley Washington Post, 2008-11-132008-11-15-Morris
A Recession Can Clear The Air By Charles Morris Washington Post Outlook, 2008-11-15 [This is a great article, one whose sentiments I really agree with (but bear in mind that I have no professional training or experience in economics). Here is its full contents.] [1] Virtually all of America’s financial and political artillery has been dragooned into the great task of heading off a recession. This is exactly the wrong way to go. As painful as it will be in the short run, a recession is just what we need. [2] Our economic model is broken, and trying to restart it will just dig us deeper into a hole. The massive changes that are required can be made only through the violent rejiggering that takes place during recessions. That may sound coldhearted, but there’s a precedent. [3] From 1979 to 1981, then-Federal Reserve Chairman Paul Volcker masterminded a nasty slowdown that broke stagflation -- the noxious combination of rising prices and no growth. Among other moves, Volcker pushed the yield on three-month Treasury bills up to an unheard-of 20 percent, stopping the economy in its tracks. Millions lost their jobs; Volcker was burned in effigy on the Capitol steps. [4] But when Volcker finally broke inflation’s back in 1983, healthy growth resumed almost immediately, and Ronald Reagan rode the result to a landslide victory in 1984 -- a little fact that people worried about a one-term presidency for Barack Obama should note. [5] The arithmetic of our current problem is pretty simple: From 2000 through 2007, U.S. households borrowed $6.2 trillion, nearly doubling their debt. Most of it was borrowed against houses, and about two-thirds was spent on things other than another house or paying down mortgage debt -- including SUVs, flat-screen TVs and all the other consumer baubles of an American lifestyle. But when house prices collapsed, the home-equity cash spigot shut tight. U.S. consumer spending has fallen off the cliff, devastating car companies and shuttering factories throughout China. [6] The Treasury Department and the Federal Reserve have responded with pyrotechnics. The Treasury has infused hundreds of billions in cash into banks and other financial players. Even more remarkably, the Fed has distributed more than $1 trillion in new loans and credits to a broad range of financial and non-financial companies. The automobile manufacturers have now joined the queue, and President-elect Obama has signaled that he’d like them to be included in the bailout. [7] So far, none of this has worked very well. Banks continue to tighten credit and lending standards. Even interbank lending came close to freezing up last month -- a level of disruption not seen since the 1970s. [8] All these frenzied attempts at staving off recession seem to be aimed merely at jump-starting the consumer borrowing-spending binge that underpinned the ersatz growth of the 2000s. But the real need is to shift to a more balanced system that’s less addicted to high-leverage finance. [9] Pouring money from the Fed into the banks just delays the day when banks -- and now we taxpayers -- will have to tally up our losses. The Fed is exchanging Treasury bonds for bundles of subprime mortgages at 98 cents on the dollar. But in the real world, those bundles could barely fetch 30 to 50 cents on the dollar. Does the Fed seriously believe that subprime mortgages are going to recover their value? The Japanese tried papering over bad assets during their 1990s credit crunch, and their economy has barely budged in 20 years. [10] At the same time, Congress and Treasury Secretary Henry M. Paulson Jr. are insisting that banks increase lending. To whom? House prices are still falling at double-digit rates. Credit-card defaults are spiraling upward. Companies are weak. Banks know how fast their loans books are deteriorating, and they desperately need cash to build up their reserves against all the bad loans they’ve made. Forcing them to ratchet up lending now is just pushing them back into the quicksand they’re struggling to climb out of. It’s financial folly. It would also be political folly for the new Obama administration. [11] For years now, even Democrats have been drinking the free-market Kool-Aid that the best economy is whatever markets decree it should be. So for most of the past two decades, the U.S. economy has been driven by whatever Wall Street is best at financing -- mostly bigger houses, fancier cars and more electronic toys from Asia. We have become a nation where people struggle to make payments on four-bedroom houses with faux-marble bathrooms and two SUVs in the driveway even as they worry about their lousy health insurance, evaporating pensions, shaky Social Security benefits and tapped-out 401(k)s. [12] Wall Street, meanwhile, prospered mightily. Financial-sector profits, which typically average about 10 to 15 percent of corporate profits, had leapt to 40 percent by 2007. Total corporate profits also soared, nearly doubling as a share of national income. But instead of triggering an investment boom, the gains were mostly distributed to shareholders. Exxon brags that it has invested $90 billion in exploration and new plants since 2003, but it has distributed even more -- nearly $120 billion -- to shareholders. The cash incomes of the top 1 percent hit an all-time high in 2006, just a tad higher than the previous record in 1929. That’s the cash that fed the hedge funds, private-equity funds and the other yield-chasers that inflated the decade’s asset bubble. [13] The scale of that bubble is reminiscent of the price-inflation bubble that bedeviled President Jimmy Carter. So are the policies being used to deal with it. Carter and his hapless Fed chairman, G. William Miller, flooded the economy with dollars even as consumer price inflation spiraled out of control. Volcker took over the Fed in 1979 and, by previous standards, moved aggressively his first year in office. But he made little headway. Finally, in late 1980, he cracked down hard and significantly raised interest rates. [14] Unemployment soared from 5.8 percent to 9.7 percent. Inflation stubbornly held on but finally broke in 1983. For the next several years, Volcker continued to crack down at the slightest hint of price buoyancy, until the markets took for granted that the United States was a low-inflation economy. [15] The 2008 analogue to the Volcker strategy would be to force a harsh, fast marking-down of all bank assets to real values. A one- to two-year bloodbath is far preferable to a decade of death by a thousand cuts. Many banks will fail and will have to be re-equitized by the government -- the terms should be neither punitive nor excessively generous -- but the weakest and the most irresponsible should simply be let go. [16] The banking system that emerges should be dull -- one where credit analysis trumps financial engineering and where everything is on the balance sheet. The big Canadian banks, RBC and TD Bank, have been determinedly dull in the 2000s and have turned in superb profits, far outperforming their supposedly brilliant American cousins. [17] Shrinking the banking sector will curtail bubble-style lending and force the share of GDP represented by consumer spending back down from its current 70 percent to a more sustainable 65-66 percent. It will be very painful, putting many companies in jeopardy, but it is the only way to engineer a transition to a world in which we spend less on houses and TVs and more on infrastructure and health care. Interest rates will be higher to encourage savings and taxes will go up, but debt should go down and the bottom half of the population should be more secure. It will also be very important to shore up our tattered social safety net to cushion the recession’s impact on that lower half. [18] Democrats should seriously study the 1979-84 period. The political lesson is that Reagan backed Volcker all the way, even when the Republican Party was calling for Volcker’s head. The deep recession cost the Republicans seats in the 1982 midterm elections. But when inflation suddenly cleared and growth resumed, Reagan won the 1984 election in a landslide. The dollar was once more the world’s strongest currency, and the Reagan era had been launched. [19] If Democrats insist on piling on the palliatives, as the party’s congressional leaders seem to be advocating, and the country hobbles along at 0 to 1 percent annual growth, they may get through the midterms, but they may also ensure that President Obama gets an early release from the burdens of office.Charles Morris, a lawyer and former banker, is the author of The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash.
2008-11-17-Deneen-economy-and-culture
Full Faith and Bad Credit By Patrick J. Deneen The American Conservative, 2008-11-17 [An excerpt; paragraph numbers and emphasis are added.] [9] The longer story obscured by this year’s dramatic collapse is the gradual but intentional abandonment of a functioning American economy and its replacement by a counterfeit [or synthetic] kind of economic health based on borrowed money, cheap goods and services made with inexpensive exported and imported labor, and reliance on foreign resources. The creation of this shell of an economy required the transformation of our workforce from one that produced goods to one that consumed products made elsewhere— effectively, the replacement of workers by consumers. The immediate reward of everyday low prices was more instantly palpable to Americans than the slow but steady loss of jobs and the tacit acquiescence to cheap labor by free markets that required the opening of all borders. [10] American workers have gradually become accustomed to perpetual anxiety, assuming this to be an ordinary condition of advanced economic man. As a pleasant distraction—if not an opiate— the economy came to be defined by entertainment and consumption: two-thirds of economic activity consisted of buying and selling. [Cf.] This perverse system was sustained by stagnant wages and borrowed money. Older virtues like thrift and moderation were shelved as the broader culture encouraged immediate gratification without concern for consequences. [Cf. hedonism.] Just do it! [11] Blame Bush—but not just Bush. Elite ambitions for mobile capital combined seamlessly with messages from the popular culture that encouraged license and the loosening of traditional bonds. Economic experts and social, educational, and political leaders spared no effort in persuading the public that an ungovernable process called “globalization” required this transformation. The benefits of worldwide economic integration were largely directed at consumers, and the costs would be felt by workers— as if the two were distinct. A main aim of globalization was to dislodge particular loyalties and patterns of life and replace them with an ethic of individual autonomy, a libertarian worldview, and a financial system in which the consequences of economic actions were difficult to discern. Mortgages were thus made available to almost any borrower so that financial institutions could later repackage and sell the debt to numerous other parties, wholly diffusing responsibility. [12] In this environment, party affiliation— even so-called “liberal” or “conservative” leanings— mattered less than whether a person possessed mobile skills. Riches were available to those who abandoned scruples and loyalties, who eagerly joined an economy in which efficiency and profit were the solvent that melted traditional patterns of restraint and virtue. What was most necessary was to foster what market capitalism excels at producing: short-term thinking. Gratitude to the past and obligations to the future were shorn in the name of present returns. The idea of trusteeship was rejected for the quarterly report or even the daily stock price as reported in minute and dramatic detail on CNBC. We were promised a golden future based on 10 percent (or better) annual market returns, when the real economy grew at a quarter of that rate. Greed, speculation, and spendthrift ways were actively inculcated in the wider culture and easily found a home amid a populace bereft of the old mainstays of culture.2008-11-19-Romney-Detroit-bankruptcy
Let Detroit Go Bankrupt By MITT ROMNEY New York Times Op-Ed, 2008-11-192008-12-14-WP-Moore
5 Myths About Our Sputtering Economy By James P. Moore Jr. Washington Post Outlook, 2008-12-14 [This is one of a genre of MSM articles which, it seems to me, have a fundamentally irresponsible view of the economy. Consider this excerpt (the bold emphasis is added):] 4. The United States is no longer the economic engine of world trade. Not true. For three decades now, we have amassed staggering trade deficits, amounting to several trillion dollars (and growing), but U.S. consumers have still helped add substantially to the growth of most countries around the world. When it comes to imports, of course, the United States buys far more products from overseas than either China or Germany. But in terms of exports, all three countries are closely bunched together, at just over $1 trillion each. There is simply no country, now or in the immediate future, that can replace the United States’ sheer global buying power. [That’s supposed to be good? That America has unmatched “buying power”? Based on what? On the debt that America accumulates, for which the day of reckoning will inevitably come, no matter how much the “elite” tries to avoid discussing that fact, presumably because it will come “after their watch.” I find that indifference to the mounting debt burden, combined with gloating over America’s unmatched “buying power”, which represents consumption rather than production, to be downright craven.]2009
2009-02-13-NYT-Lohr-banks
Ailing Banks May Require More Aid to Keep Solvent By STEVE LOHR New York Times, 2009-02-13 [An excerpt; emphasis is added.] Some of the nation’s large banks, according to economists and other finance experts, are like dead men walking. A sober assessment of the growing mountain of losses from bad bets, measured in today’s marketplace, would overwhelm the value of the banks’ assets, they say. The banks, in their view, are insolvent. ... Nouriel Roubini, a professor of economics at the Stern School of Business at New York University, has been both pessimistic and prescient about the gathering credit problems. In a new report, Mr. Roubini estimates that total losses on loans by American financial firms and the fall in the market value of the assets they hold will reach $3.6 trillion, up from his previous estimate of $2 trillion. Of the total, he calculates that American banks face half that risk, or $1.8 trillion, with the rest borne by other financial institutions in the United States and abroad. “The United States banking system is effectively insolvent,” Mr. Roubini said. ... Raghuram G. Rajan, a professor of finance and an economist at the University of Chicago graduate business school, draws the distinction between “liquidation values” and those of calmer times, or “going concern values.” In a troubled time for banks, Mr. Rajan said, analysts are constantly scrutinizing current and potential losses at the banks, but that is not the norm. “If they had to sell these securities today, the losses would be far beyond their capital at this point,” he said. “But if the prices of these assets will recover over the next year or so, if they don’t have to sell at distress prices, the banks could have a new lease on life by giving them some time.” That sort of breathing room is known as regulatory forbearance, essentially a bet by regulators that time will help heal banking troubles. It has worked before.2009-03-05-FP-Rothkopf
Will Obama steer the international system toward the abyss?: A Crisis of Confidence is Coming by David Rothkopf Foreign Policy Blog, 2009-03-052009-03-15-NYT-looking-for-the-bottom-three-indicators-pe-homes-consumer-spending
Looking for the Bottom: Three Indicators New York Times Week in Review graphic, 2009-03-15 The three indicators are: price-to-earnings ratio for stocks (1890s to present) prices for existing homes (1890s to present) consumer spending (1930s to present).2009-05-01-NYT-Chrysler-lenders
The Lenders Obama Decided to Blame By ZACHERY KOUWE New York Times, 2009-05-01 [An excerpt; emphasis is added.] As Chrysler’s fate hung in the balance Wednesday night, this group [of lenders] refused to bend to the Obama administration and accept steep losses on their investments while more junior investors, including the United Automobile Workers union, were offered favorable terms.2009-05-19-Sloan-Nader-GM
Ralph Nader's Unlikely Soapbox By Allan Sloan Washington Post, 2009-05-19 You know something strange is going on when Ralph Nader calls me to complain that General Motors shareholders are being treated unfairly by the federal government. ... But the shareholders’ travails are only part of what bothers Nader. His major worry is that President Obama’s autos task force is determining GM’s fate and the fates of workers, dealers, communities and investors without meaningful input from Congress or the public. “I care about the consumers and the workers and the communities that are going to be hurt,” Nader said. “All of these issues should be discussed publicly. It’s elementary political science.” ... But he’s asking a good question. Do we as a country care about having a U.S. auto industry, or do we care about having U.S. auto companies? They aren’t necessarily the same thing. For example, GM’s plan calls for closing U.S. manufacturing facilities and replacing their output by importing vehicles made in GM plants overseas. That probably makes good business sense. But does it make good sense for the country? “I’ve been against transplants -- because their profits get shipped outside the country,” he said. Transplants, of course, are U.S. production facilities owned by foreign-based companies. But he’d rather have a transplant produce cars here, creating at least some assembly and supplier jobs, than have GM import foreign-made vehicles. And that brings him to China, GM’s most lucrative market. Nader thinks GM is planning to reorganize around its Chinese operation and move as much of its U.S. production there as quickly as it can, eventually using Chinese-made vehicles to supply much of the U.S. market. That sounds more than a little conspirational, which is somewhat off-putting. But I sure got the creeps when I saw that GM plans to begin selling Chinese-made vehicles in the United States in 2011. I tried to get GM to discuss Nader’s points (and a few of my own), but my call wasn’t returned. I’m not suggesting that Congress subject GM and the autos task force folks to an AIG-like abusefest or bog down everything with endless yammering. But we should talk about some big-picture questions, given that we taxpayers are funding GM’s plan. When Ralph Nader -- Ralph Nader -- makes more of a fuss about GM’s investors and dealers than Congress does, it makes you stop and think. Or at least, it should.2009-11-09-NYT-Uchitelle-econometrics-error
Economists Seek to Fix a Defect in Data That Overstates the Nation’s Vigor By LOUIS UCHITELLE New York Times, 2009-11-09 WASHINGTON — [1]A widening gap between data and reality is distorting the government’s picture of the country’s economic health, overstating growth and productivity in ways that could affect the political debate on issues like trade, wages and job creation.
... [3] The fundamental shortcoming is in the way imports are accounted for. A carburetor bought for $50 in China as a component of an American-made car, for example, more often than not shows up in the statistics as if it were the American-made version valued at, say, $100. The failure to distinguish adequately between what is made in America and what is made abroad falsely inflates the gross domestic product, which sums up all value added within the country. ...2009-12-17-WP-Meyerson
America's decade of dread By Harold Meyerson Washington Post Op-Ed, 2009-12-17 ... The dread in the land today isn’t just a fear of losing your job -- or of your spouse, sister, father or child losing his or hers. It’s a fear that America has been hollowed out, that we don’t have a sustainable path back to mass prosperity, let alone to economic preeminence.... Such fears can only be intensified by public policies that fail to champion America’s national interests by fostering the flight of investment abroad. ...The problem is that America’s economic elites have thrived on the financialization and globalization of the economy that have caused the incomes of the vast majority of their fellow Americans to stagnate or decline. The insecurity that haunts their compatriots is alien to them. Fully 85 percent of Americans in that [Council on Foreign Relations]-sponsored poll said that protecting U.S. jobs should be a top foreign policy priority, but when the pollsters asked that question of the council’s own members, just 21 percent said that protecting American jobs should be a top concern.
...2010
2010-01-29-Samuelson
Now confirmed, Bernanke must rebuild confidence By Robert J. Samuelson Washington Post Op-Ed, 2010-01-29 [1] Now that the Senate has confirmed him for a second term as chairman of the Federal Reserve, Ben Bernanke has, or ought to have, a very simple agenda: improve confidence. This isn’t his job alone, of course. President Obama and Treasury Secretary Timothy Geithner are hardly bit players. But what Bernanke does and says -- how he projects himself and the Fed -- matters a great deal, and he faces an exacting challenge. [2] There is a supposition among academic economists (the tribe from which Bernanke comes) that “economic policy” consists of making decisions about interest rates, taxes, government spending and regulations that translate, almost mechanically, into actions by firms and consumers to hire or fire, spend or save, invest or hoard. By now, Bernanke surely recognizes that this economic model is at best a half-truth. [3] The famous British economist John Maynard Keynes (1883-1946) coined the phrase “animal spirits.” Less elegantly, we say “emotions.” Whatever the vocabulary, the lesson is the same: Psychology matters. Booms proceed from overconfidence; busts inspire great fear. Recoveries require increasing optimism. Otherwise, despondent consumers confine buying to necessities, and businesses delay hiring and expansion. ... [I find much to agree with in most columns by Samuelson (especially his frequent warnings about the dangers of cost growth in entitlements and health care spending), but not this one. The biggest problems the American economy has are not of psychology, of (lack of) confidence by consumers and decision-makers, but are the fundamentals. To name a few, the trade deficit, the budget deficits at all levels of government, the crushing load that current patterns of entitlement growth will put on future workers, the emphasis in the economy on consumption rather than investment, the disastrous shift of the American economy from production and manufacturing into service and consumption. More happy talk from politicians, media figures (like Samuelson) and academic experts is the last thing we need. What we do need are, not teary stories about how some 20-year-old with a rare form of cancer has only run up nearly two million dollars in treatment costs over his young life, and now those mean bean-counters are threatening to say “enough is enough” with his treatment and cut it off, but rather a whole raft of stories about the dangers of over-spending, debt growth, and the almost inevitable hyperinflation that results. The editorial boards (and Paul Kludgeman), if they possessed the responsibility and foresight one might expect, would stop warning us about the “danger” of emulating Japan’s “lost decade” and start warning us about the dangers of repeating the various example of hyperinflation. If they want examples, they will find plenty here. And yes, it can happen here.]2011
2011-05-06-NYT-Fukuyama-hayek-big-government-skeptic
Friedrich A. Hayek, Big-Government SkepticBy FRANCIS FUKUYAMA
New York Times Book Review,2011-05-06
011-05-09-Drier-on-Fukuyama-on-Hayek
How Do Wrong Economic Ideas Become Conventional Wisdom?by Peter Dreier
commondreams.org, 2011-05-09
The ideas of Friedrich Hayek (1899-1992) are making a comeback, in large part due to Glenn Beck, who has touted the libertarian economist and philosopher’s views on his TV show. The essence of Hayek’s views -- spelled out in his most well-known book, The Road to Serfdom -- is that government stifles freedom and liberty. With a few exceptions, he viewed almost any governmental intervention in economic affairs as a slippery slope toward totalitarian socialism. No wonder that Beck has been hawking Hayek. Now comes Francis Fukuyama, the neoconservative political scientist, who uses the pages of the New York Times Book Review to hawk his own version of government-bashing. Unfortunately, Fukuyama, who claims to be something of a student of Hayek’s ideas, hasn’t done his homework. In his review of the new edition of Hayek’s The Constitution of Liberty, published in the Review on Sunday (May 8), Fukuyama off-handedly comments that three of Hayek’s ideas “have become broadly accepted by economists.” But it so happens that economists don’t agree on these three ideas. Moreover, the policy conclusions that Fukuyama draws happen to be untrue. First, Fukuyama claims that “labor unions create a privileged labor sector at the expense of the nonunionized.” It is true that unionized employees earn better wages and benefits than their nonunion counterparts, even those with comparable experience and education. But economists know that it is also true that unions raise wages and benefits for nonunionized workers. The higher the “density” of union workers in an industry or area, the more likely it is that employers will increase the wages and benefits of nonunion employees in order to stave off a union drive. Thus, unions lift the floor for everyone, not just union members, contrary to Hayek. Second, Fukuyama claims that economists agree with Hayek that “rent control reduces the supply of housing.” Economists differ on the wisdom of price controls in general, but it helps to test economist theories in the real world. There is absolutely no empirical evidence for the statement that rent control -- which some cities use to maintain a supply of affordable housing -- reduces the housing supply in general or even rental housing in particular. Every study of rent control in U.S. cities (except those funded by the real estate industry) -- including those that compare similar cities with and without rent control -- shows that rent control has no impact on either the level of new housing construction or the level of housing abandonment. Local rent control laws exempt new construction and allow landlords to raise rents annually based on expenses. Cities with various forms of rent control are often in “hot” markets in which developers want to build rental and other forms of housing. The evidence is clear that rent control does not dampen private investment. Finally, Fukuyama claims that economists agree that “agricultural subsidies lower the general welfare and create a bonanza for politicians.” Again, there is no evidence for this statement. The impact of farm subsidies depends on who gets them, what they are used for, and the general economic condition of the period. During the Depression, subsidies saved many family farmers from going under, helped stabilize prices, and kept entire farm communities, and the nonfarm jobs that depended on agriculture, alive. Today, the vast majority of federal farm subsidies go to large agribusiness conglomerates like Archer Daniels Midland and Cargill that don’t need them rather than small family farmers. President Obama campaigned on a pledge to limit individual farm payments to $250,000 to ensure family farms and not “corporate agribusiness” got the money. This is still a good idea. But food stamps, which are an indirect subsidy to farmers, clearly improve the general welfare by dramatically reducing the incidence of hunger and malnutrition. ...
2011-10-30-Pearlstein-EPI
25 years of EPI speaking up for the 99%by Steven Pearlstein
Washington Post, 2011-10-30
2018
2018-03-05-WP-Samuelson-the-coming-trump-inflation
The coming Trump inflation?by Robert J. Samuelson
Washington Post, 2018-03-05
Tight labor markets might well raise wage increases,
and these in turn might stimulate higher price increases —
and we are then off on a wage-price spiral reminiscent of the ’60s and ’70s.
This, of course, won’t be the end of it.
The prospect of higher inflation means that
“the Fed and the [Trump] administration are on a collision course”
Labels: economy
posted by KHarbaugh at 20:00
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