Posts Tagged: Bernanke

American Society / Business / The Federal Reserve — 0 Comments
10
Mar 11

Single Malt Scotch Index Redux

Occasionally I visit Warehouse Wines & Spirits in New York City.  No, I am not a paid booster for this store.  But clearly, it has become a must for aficionados searching for premium single malts at discount prices. (Note – there are other good single malt shops in the city such as Park Avenue Liquors and Skyview Wine and Spirits).  Besides indulging in the eternal quest for the perfect single malt, I view my pilgrimages as windows into what is happening in the economy.  Single malt is a pursuit of the upper middle class (or those aspiring to be) and a relatively small luxury item, compared to cars, furs, mansions and private jets.

Observations from the Warehouse Battlefield

First, gone is the variety of single malts available for sale.  For example, Warehouse used to carry four or more expressions of Laphroaig; now it carries two. The same reduction has occurred in its Talisker line.  Second, on the remaining lines, significant discounts have largely disappeared.  On some items prices have been increased from $5 to $10 per bottle.  Third, the most promoted single malt has been Lagavulin 16-year-old.  As I have mentioned in previous blogs, this particular bottling reached a low price of $47.99.  It has since experienced two price increases to the current $54.99.  This is still quite a bargain compared to prices across the river in New Jersey where it sells for as much as $95 per bottle.

Why Is This Important?

While it appears trite or silly to discuss single malt scotch, it is a good indicator of what is happening in the upscale import market.  Single malt is priced in Euros (I was surprised as I thought it would be in British pounds).  The price increases in this market reflect price increases in imports generally.  It also demonstrates that at least in the upscale New York City beverage market, demand has picked up somewhat and importers and retailers have some pricing power.    Even at this discounter, prices have increased 10-20%.  The era of single malt deflation is at an end, as my Single Malts I Like Ever (“SMILE”) has risen.  See Update on Deflation

One has to wonder how much prices have risen for more other necessary, important and basic commodities.  Further, it is interesting that our choices are beginning to contract.  My guess is that down the road Americans, who heavily rely on imports, will be “treated” to further diminishing choices, and higher prices on less desirable merchandise.

Thank you, Dr. Bernanke and Mr. Geithner, for trashing the dollar.  I will not be drinking to you.

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American Society / Banking / Financial / Political / The Federal Reserve — 0 Comments
1
Dec 10

Perception is Reality

One of my more difficult tasks in corporate life was explaining to my employee-attorneys that perception was reality.  What did I mean?  An attorney could be the smartest and most hardworking, but if he was rude, late, sloppy or arrogant, all that intelligence and hard work were useless.  The reality for clients was that he was an ineffective attorney.

Attorneys love to argue, and employees generally react defensively to criticism.  So, conveying the “perception is reality” message was always a challenge.   Many a time I heard detailed factual rebuttal citing brilliant legal arguments, an excellent memo or brief, or a creative idea.  In each case the attorney missed the point.  All of those counterexamples might have been true, but irrelevant.  Once perceived as ineffective or a poor performer, that became reality.

Missing New Realities

It is clear now that government has favored Wall Street and the large money center banks over taxpayers, savers, and the unemployed.  QE2 has now captured the public’s attention and criticism.  In fact, a video critical of QE2 and the Fed has had close to three million viewers.

The video suggests that the Fed is printing money, causing inflation, and buying Treasury securities at premium prices from Goldman Sachs.  Further, it blames the Fed for the internet boom and bust and the housing crash.

Richard Alford, a former Fed economist, parses the video. See “Quantitative Easing Explained” and its Critics. He has inconsistencies in his argument, and he suggests that the Fed avoid defensive and legalistic responses to its mistakes.  His advice to the Fed is to simply get its message out.  Like my employee-attorneys,  Mr. Alford misses the point, and his reasoning is fatally flawed.   The video resonates because its message is true and the Fed cannot muster much of a response without sounding defensive. So much for Mr. Alford’s suggested public relations campaign.  For my purpose here, however, a quote from Mr. Alford works.  A part of his article accurately captures the public’s mood, describing the reality of growing political anger:

…The video is a general protest against the role the Fed has played in transferring wealth from savers and taxpayers to Goldman Sachs and other Wall Street firms. The Fed is seen as picking winners and losers: Wall Street is seen as the winner and savers and the taxpayers are seen as the losers…

The American people care deeply about fairness, but the Fed is perceived to care more about the health of Wall Street than fairness.  Instead of addressing the underlying issue of fairness and the efficiency of the bailouts, the Fed defenders focus on a narrow legal prohibition. “Quantitative Easing Explained” and its Critics.

The Reality of Numbers

In a democracy, economic interventions spill over into the political realm.  The political backlash is on display in the latest Rasmussen survey of likely voters (thanks to Zero Hedge) See Many Say Government Operating Outside the Constitution:

  • 44% believe that the government is operating outside the limits of the US Constitution.
  • 65% are either somewhat or very angry at the policies of the federal government. 65% prefer a smaller government.
  • 70% believe that government and big business collude against the interests of investors and consumers.
  • Only 20% feel that the government has the consent of the governed (previous survey).

Back to Reality

The public gets it.  We understand that the government has rewarded the folks who have wrecked the economy and punished the average citizen.  Again we are back to “perception is reality.”  While academically elegant, theoretical explanations of Fed policy may play well at Princeton lectures, the American public does not want to hear how Dr. Bernanke studied the Great Depression and intends to save us from another one.

Our reality is high unemployment, diminishing savings, declining house prices, diminishing net worth and arbitrary and unfair governmental actions.  Failure to assert political leadership and reign in the Fed has gone on way too long.   Clearly, reality has deteriorated enough that almost half of our average citizens question whether the government is operating outside the Constitution, that is, illegally.

If the underlying message of the elite is that  “we need to destroy the Constitution to save it”  we are heading down a very dangerous path.

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American Society / International Finance / law / The Federal Reserve — 0 Comments
28
Nov 10

How Many Branches of Government?

“The Federal Reserve is an example not just of run-of-the-mill hubris but of the far more profound Pathology of Power.

The rule of law has been supplanted in the U.S. by self-serving propaganda campaigns serving State and financial Elites: this is the Pathology of Power.”  The Federal Reserve and the Pathology of Power

Ben Bernanke is out of control.  “Out of control” is an oft-used phrase, but in this case the term describes an important actor with a limited statutory role who is usurping the power of both the legislative and executive branch.

Back in school we learned that we had three branches of government, the legislative, the executive and the judicial.   Each had checks and balances to ensure that power was not abused.  We now have a fourth branch, the imperial Federal Reserve.  Without our permission, this rogue branch is dictating economic policy for the United States.  Mission creep is taking the Fed from its dual mandates of employment and stable prices to its own self-proclaimed mandate: economic stimulation (in direct contravention of the views of the newly elected Congress and the American public) and dollar devaluation.   In QE2 it also has taken on the role of guardian of stock market prices. See Who Elected Ben Bernanke?

By law the Federal Reserve has two economic mandated goals:  full employment and stable prices.  The US Treasury, part of the executive branch, has a separate and distinct role, and is responsible for maintaining the value of the dollar and debt issuance.  Venturing into the world of quantitative easing the Federal Reserve is usurping the role of the Treasury through debt issuance and the Congressional role of fiscal policy through back door economic stimulus.

Crossing a New Line

Michael Shedlock has long maintained that the Federal Reserve was the least competent part of government.  Dr. Bernanke never saw the economic crisis; however, he maintained that past folly would not stop the Fed from grabbing even more power and bungling any economic recovery.

The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.  Fed Uncertainty Principle

In a recent speech at the European Central Bank, Chairman Bernanke launched into a direct attack on Chinese exchange rate policy:

Federal Reserve Chairman Ben Bernanke put aside traditional central bank niceties and launched a direct attack on the slow pace of China’s steps to strengthen its currency.

In a speech prepared for a conference at the European Central Bank on Friday morning, Bernanke said that China’s decision to undervalue the yuan has essentially thrown a monkey wrench into the global economic recovery. Bernanke Turns Up Heat on China Currency Policy

Dr. Bernanke then tied the Chinese policy to weak employment in the US:

“On its current economic trajectory, the United States runs the risk of seeing millions of workers unemployed or underemployed for many years,” Bernanke said.

The Fed could not rule out the possibility that unemployment “might rise further in the near term,” he said. This could bring an end to the tepid U.S. recovery, he said.

He pointed his finger at China’s slow adjustment of its exchange rate. Bernanke Turns Up Heat on China Currency Policy

Other Areas for Dr. Bernanke’s Deft Policymaking

If Dr. Bernanke is willing to lay the blame of high US unemployment on the Chinese perhaps he should also recommend changes to the US’s legislative regime that makes hiring difficult:

  • Why not dismantle collective bargaining rights?
  • What about those pesky environmental laws?
  • Why do we need all these inefficient workplace mandates such as equal employment opportunity, family and medical leave, veterans’ rights, etc.?
  • Why do we need a minimum wage?
  • What about the newly imposed Obamacare costs?
  • Why not change tax policy which favors overseas profits?

We have a timid, economically naive President and a divided Congress.  Into the breach steps Dr. Bernanke, filled with academic sagacity, theory and dogma.  Remember this is a man who said the subprime crisis was well contained, and who could not detect a housing bubble.

When Congress inquires into outlandish Federal Reserve policies, Chairman Bernanke brandishes as a mighty shield the need for independence. Even an audit of their books is viewed as a mortal threat.  Well Dr. Bernanke, perhaps it would be better to stick with your narrowly defined and legitimate role and jettison the imperial “fourth branch” of government nonsense.

Note to Dr. Bernanke: If you want to be overly political and wield unauthorized power, expect your independence to be severely clipped.  You cannot have it both ways.

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11
Nov 10

1984 in 2010

In George Orwell’s 1984, protagonist Winston Smith works in the Ministry of Truth.  In Airstrip One in the mythical Oceana, the Ministry serves as a perpetual propaganda machine exercising public mind control.  Winston eventually rebels against “Big Brother.”  Ultimately, he is captured, tortured and “re-educated.”

Today’s media subject us to a constant barrage of spin, messaging, falsehood and half-truth.  We have traveled from the “No Spin Zone” to the “24/7 Spin Zone.”   Dangerously, it is our own government controlling and propagating news and messages:

1.      Spin:  QE2 is designed to meet the two Federal Reserve goals of high employment and low inflation.   [Bernanke op-ed Washington Post]  Truth:  Revealed later in the op-ed piece is that QE2 supports stock prices.  Moreover, the real likely beneficiaries of QE2 are our failing large banks.

2.      Spin: QE2 will not result in the Federal Reserve monetizing our national debt.  [Bernanke June 3, 2009 testimony before Congress]:   Truth:  “For the next eight months, the nation’s central bank will be monetizing the federal debt.”  Richard Fisher, President of the Dallas Federal Reserve Bank   Speech November 8, 2010

3.       Spin:  “Structural unemployment is not increasing.”  Federal Reserve Bank of San Francisco Report Is Structural Employment on the Rise?    Truth:  In The New Reality: Permanent Job Loss , we explored the new labor force dynamics.  Noted economist David Rosenberg estimates that we have a permanent job loss of 6.2m workers.  With slow revenue growth, outsourcing, skills mismatches and tight credit conditions unemployment will remain high.

4.      Spin:  “Jobs Expand by 151,000.”   Bureau of Labor Statistics Report Truth:  This statistic is patently misleading. Labor force participation is dropping (58%): more workers are no longer participating in the labor force (36%) and therefore are not counted.  Moreover, the BLS uses the birth-death model which fictitiously creates jobs based on demographics.

5.      Spin:  Inflation is low (below 2%),  therefore Social Security cost of living adjustment does not apply.  Truth:  The Federal Reserve uses a 2.2% inflation deflator when calculating Gross Domestic Product.  Since the beginning of the summer the following commodities jumped in price: corn (71%); oil (24%); oats (106%); wheat (67%); soy (44%); copper (47%); gold (21%) and silver (48%).  Commodity price increases have passed through to higher retail prices in every sector. Source:  Karl Denninger

6.      Spin: After performing stress tests on 19 banks, secretary Geithner declared the banking system fundamentally sound.  Truth:  Even after TARP, TALF, government guarantees and other programs have exceeded last year’s number of bank failures.  And this with two months of the year to go.  See Tracking Bank Failures: 2010 Exceed 2009 Bank Failures. More takeunders like that of Wilmington Trust are certainly possible, and that bank discounted its stock by 40%.  See A Canary in the Mine

7.      Spin:  The Administration has assured us that the brewing mortgage foreclosure crisis is merely a paperwork problem.   Truth:  Foreclosuregate raises a number of significant problems related to mortgage securitization.  Problems range from poor underwriting standards to outright fraud in court filings.   See This Magic Moment, Postscript to Foreclosuregate

8.      Spin:  The Treasury Secretary assures our trading partners and us that the US wants a strong dollar.   Truth:  QE2 has weakened the dollar and enraged our trading partners.  Since summer 2010,  the dollar has declined 16%.

9.      Spin:  the economy is recovering.   Truth:  Interest rates been held at zero percent for an extended period of time.  If the economy is recovering, why do we even need QE2?

10.  Spin:  Initial unemployment claims for the week of November 6, 2010, dropped by 24k .  Truth:  Unfortunately, that series has been revised downward from the previous week 36 times out of 42 weeks in 2010.  Similarly, continuing claims for unemployment insurance have been revised downward 42 out of 44 weeks.  Finally, without BLS adjustments the initial claim report would have shown a loss of 38k jobs.  Jobless Claims at 435K on Expectation of 450k, To Be Revised Worse Next Week

Becoming Winston Smith

The US Ministry of Truth has been on a concerted campaign to ignore or distort economic statistics to convince the American public that the recession has ended and a recovery is well under way.

The newest object of government attention is the stock market, with the goal of boosting prices to induce a recovery.  Charles Hugh Smith estimates that the Fed’s QE2 efforts since June have resulted in a net loss to the US economy of $4.6T.  That loss includes the 19% gain in the stock market.  See Fed’s QE2 Misadventure Costs U.S. Households $4.6 Trillion

We have been so conditioned to hear lies and spin that we can no longer discern the truth.  We have all become like 1984’s Winston Smith, the wayward and tragic civil servant. So far, no politician has the guts to stand up and say we have real structural problems in the economy. It will take more than hope and spin to solve our problems.  There needs to be some period of economic contraction, debt write off, fiscal and monetary austerity and probably another stock market crash before a real recovery can happen.  Who will have the courage to tell us an unpopular, unspun truth?

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19
Aug 10

Artificial Sweeteners

Artificial sweeteners have been the subject of health concerns.  Aspartame, for example, has been found to be a migraine headache trigger.  Products containing it carry a health warning for PKU, a rare hereditary disease.  Today we learn that diet sodas markedly increase the risk of pre-term deliveries.  See Add Diet Soda to the List of Things to Avoid While Pregnant.

Similarly, the Federal Reserve and the Administration have not trusted that the economy can heal through natural market forces.  Instead we have been served up the economic equivalent of artificial sweeteners.  Concerned by slow growth, not even negative growth, the government again is firing up the machinery for money printing and stimulus.

In each instance, the government is intervening, distorting, and artificially “sweetening”  the bond market, the housing market and, indirectly, the stock market.  What are the consequences?

There is No Free Lunch

Martin Hutchinson in The Peril of False Bottoms targets faulty government policy as the reason for our anemic economic recovery.  Excessive economic stimulus and a misguided zero interest rate policy has created false bottoms in the housing and stock markets.    A false bottom is defined as a stabilized “price far above the likely long-run price equilibrium of the assets concerned.”

Bernanke has precedent for providing excessive liquidity and holding interest rates too low for too long.  Greenspan reacted to the internet stock market crash by flooding the market with liquidity.  Doing this drove the market to over 14,000 on the Dow Jones Index and created a housing boom.   In the 2008-2009 real estate and stock market crash we learned  how flawed this policy was.

More on False Bottoms

Hutchinson points out federally inspired housing market distortions:

House prices are currently 47% above their level in January 2000, according to the S&P Case-Shiller 20-city index, compared to a 49% rise in prices since that time – in other words, they are in real terms at the same level as at the top of an immense speculative boom.During the recent contortions, the U.S. monetary and fiscal authorities have established false bottoms in two markets. The first is housing, where subsidies to first-time buyers, ultra-low mortgage rates, government guarantees on $700,000 home mortgages and foreclosure-avoidance schemes have prevented the housing market from falling even to its average level where the average house price is about 3.4 times average earnings. The Peril of False Bottoms

These misguided policies have consequences:

…with additional buyers having been sucked into the market, it is now likely that house prices will fall further than this. Indeed, if the appalling suggestion put forward last week that the government through Fannie Mae and Freddie Mac forgive $1 trillion of defaulted home mortgages is put into effect, they will undoubtedly do so. Nothing could be more designed to destroy confidence in the housing market than a massive subsidy to the most foolish and improvident home buyers, at the expense of the thrifty and careful renters who are the major source of potential new demand for housing.

If the buyer pool is attacked in this way, or forced into unnecessary losses by being made to buy too soon, house prices may not bottom out at the market-clearing level … but may continue falling.  The Peril of False Bottoms

Wither the Stock Market?

The stock market is the second false bottom:

Currently at 10,650 as I write, the market is 35% above its appropriate “middling” target. The “trailing” P/E ratio of 20.4 on the Standard and Poors 500 is also above its historic average, even though corporate and bank earnings are currently inflated by ultra-low financing costs and a steep yield curve. Thus at some point we can expect reality to intrude, and the market to drop to its likely cycle low in the region of 5,000 on the Dow Jones index.

Again market prices are too high for any intelligent buyer.  And worse, buyers will then be unavailable to buy stocks at the bottom. The Perils of a False Bottom

Politics v. Economics

Politicians are worried about the next election.  Thus, we see the desperation of the Administration to throw economic caution to the wind.   Zero interest rates, forgiveness of imprudent debt, subsidies to overpaid public sector workers (with no corollary “give backs”) are all hallmarks of erratic and misguided government policy.  They also sacrifice long-term prudence for the feel good of short term stimulus.

Who will pay this price?  Unfortunately, it will be stock market investors, pension plans, life insurance companies and homeowners.  Directly or indirectly, that is virtually all of us.  We need to beware politicians handing out artificially sweetened candy. Just like aspartame and our physical health, artificial economic sweeteners can be harmful to our financial health.

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4
Apr 10

Nothing from Nothing

Nothin’ from nothin’ leaves nothin’
You gotta have somethin’
If you wanna be with me…
I’m not tryin’ to be your hero
‘Cause that zero is too cold for me

Nothing from Nothing – Billy Preston

Zero interest rates have a clear and pernicious effect upon the elderly. See Is The Administration Determined to Make the Elderly Poor? Worse, this policy has broader implications for all savers and our national competitiveness. A robust household saving rate is integral to investment and long term American prosperity.  America’s two major competitors have healthy household savings rates, Germany (10.9 % in 2008) and China (30% in 2009) vs. 1.8% in the US in 2008.  Not surprisingly, the export led economies of China and Germany have fared better than the US during the financial crisis.  And while the mainstream media has not focused on the zero interest rate strangle hold, more voices on the subject are appearing.

Genesis of the Problem

Our low savings rate has been US economic policy for the past decade.  An “emergency” interest rate cut to near zero has followed every financial crisis from the dot.com bubble burst to the housing market crash.  Unfortunately, these “emergency rates” have robbed savers, pension funds and insurance companies.  In a recent Wall Street Journal op-ed Charles Schwab laid out the problem of seniors in particular:

Today’s historically low interest rates may be feeding banks’ profitability, but they are financially starving our seniors.

In February 2006, when Ben Bernanke was first sworn in as chairman of the Federal Reserve, the federal-funds target rate stood at 4.5%. That same year, the average yield on a one-year certificate of deposit was 5.4%. A retiree who diligently saved for a lifetime and had amassed a nest egg of $100,000 could count on an added $5,400 in retirement income per year. That may not sound like much to the average Wall Street Journal subscriber, but for a senior on fixed incomes that extra money improved the quality of his life.

Today’s average rate for an identical one-year CD is roughly 1.3%. On the same nest egg, that retiree will now get annual payout of just $1,300—a 76% decline in four years. See Low Rates are Squeezing Seniors

The Administration is Tone Deaf

Mr. Schwab is way too well mannered in his criticism: banks are now profitable at the expense of the entire economy, and the government endorses this policy.  Tim Geithner on the Today Show almost offhandedly asserted that:

It’s “deeply unfair” that some financial institutions that got taxpayer-paid bailouts are emerging in better shape from the recession than millions of ordinary Americans.

Geithner also argued that President Barack Obama had no choice when confronted with a financial crisis. See Pickpocketing Trillions from the People to Give to the Oligarchy was Deeply Unfair

What Secretary Geithner did not mention is that the banks can now virtually mint money by way of this zero interest rate policy.  The Secretary portrays himself as a powerless actor when in reality he is an architect of this policy and could encourage the end of this detrimental policy.

For Every Action There is an Equal and Opposite Reaction

From 1959-1994 the historic savings rate averaged 8.45%.  Given the damage done to net worth in the recession we need to return to that savings level or higher.  However, the government focused on restoring consumption with the “cash for clunkers” program and new home buyer tax credits.  Provisions of the new health care legislation (which imposes a 2.9% Medicare tax on “unearned income;” that is, interest, dividends, etc.) further discourage savings.

Finally, a graphic rendering from Michael Panzner of how low interest rates undercut savings attempts:

Panzner Savings Chart

The savings problem falls heavily to baby boomers heading into retirement.  In the recently released Employee Benefit Research Institute 2010 Retirement Confidence Survey 27% of participants had less than $1000 in savings and 54% had less than $25,000 of savings. (Primary residence value is excluded in this analysis, but we know how variable and ephemeral that asset can be.)  With a zero interest rate policy we are encouraging those who should not be speculating to invest in an overvalued stock market or take inflation risk with longer dated fixed income products. Worse, people are dipping into savings for living expenses.

Charles Schwab concludes with a plea for the government to keep the plight of the seniors in mind.  We need an outcry from pension funds, insurance companies, AARP, Congress and others who rely on safe fixed income investments to stop the insanity. We need to stop artificially depressing interest rates.  Messrs. Geithner and Bernanke: ’cause that zero is too cold for me (and for the country).

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American Society / Business / Economics / Financial / Municipal Finance / Political / Uncategorized — 0 Comments
16
Mar 10

The Failure of Extrapolation

The human mind loves linear extrapolation over time.  We build 5-year plans.  Graphically, five-year plans look like hockey sticks: first, slow and minuscule income, revenue growth in the first year, and then spectacular growth by the fifth year.  I have sat through a dizzying number of presentations for start up businesses which rarely, if ever, achieve their predicted spectacular growth.  For every Apple or Google there is a Pets.com and bankruptcy. ­­­ However, hope springs eternal.

Rosy Scenario and Her Evil Twin

Investment analysts, CEOs and government officials constantly project questionable positivity.  Prosperity is always around the corner, green shoots of recovery are everywhere, and a chicken will appear in every pot.  We pillory realistic if negative analysts as pessimistic naysayers, prophets of doom or worse.  But we ignore reality at our peril. More often than not Rosy Scenario often clashes with her evil twin Dashed Expectation.  The results are often calamitous.

Ignoring Reality

The last decade has brought ignoring reality to a high art form.  Linear extrapolation has brought the following prophesies:

  • Dow 36,000
  • Internet businesses with no customers and unrealistic business plans worth several times the value of established companies (IBM, DuPont)
  • Ever-rising housing prices
  • The FIRE economy (Financial, Insurance, Real Estate) supporting the entire American economy
  • Sustained non-problematic leverage ratios of 30 and 40:1
  • Debt growth several standard deviations greater than GDP
  • Counterparties to derivative contracts always making good
  • Never defaulting on sovereign debt
  • Pension fund assets always earning between 7-9%
  • Federal debt growing faster than tax receipts
  • Public sector wages growing faster than GDP and tax receipts
  • Aggressive accounting (Enron, Lehman) considered good financial engineering
  • Zero interest rates restoring economic prosperity.

Past is Not Always Prologue

We are prisoners of our past experiences.  We expect the Federal Reserve to cut interest rates and the economy to magically recover.  We are surprised when the nominal unemployment rate is at 9.7% and the actual is 17%.   We are surprised when Wall Street bonuses soar and Main Street suffers.  We are surprised when Moody’s threatens to downgrade US debt from AAA rating. See Moody’s Says U.S. Debt Could Test Triple-A Rating

Rarely do we say that this time is different.   As a society, we have incurred debt far exceeding our capacity to repay.  Balance sheet recessions/depressions are far worse than previous inventory recessions.  Just as the Vietnamese fooled our World War II trained generals, the Federal Reserve and Administration are intent on fighting an outdated economic war.

It is time for some nonlinear thinking.  Instead of posturing, Congress should be asking Ben Bernanke for a Plan B.  Averting financial Armageddon is not enough.  JP Morgan CEO, Jamie Dimon, projected a banking crisis every five to seven years.  See Elizabeth Warren Exposes Jamie Dimon. As a society we can ill afford another year like 2008.  Reality is gaining on us.

How well did the five-year plans work out for the brittle Soviet system?   Is it time to ditch Rosy Scenario and deal with reality?

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2
Mar 10

Goldman and the Winner Take All Society

Finally, Goldman Sachs has gone too far.  In A Reputation as Good as Goldman?  Part I, we discussed Goldman’s selling of mortgage backed securities, and its role in the current Greek budget crisis.  These activities clearly contributed to its self-inflicted reputational damage.

Perhaps the hubris went further.   Does Goldman believe that its status as a favored Federal Reserve “too big to fail” firm will insulate it from government investigation? Last week Ben Bernanke put a dent in Goldman’s Teflon shield:

Ben S. Bernanke, the Federal Reserve chairman, told Congress Thursday that the Fed was ‘looking into a number of questions relating to Goldman Sachs and other companies and their derivatives arrangements with Greece.’

Mr. Bernanke said the Securities and Exchange Commission was also concerned about how derivatives — financial instruments that are largely unregulated and do not trade on public exchanges — have contributed to Greece’s problems. ‘Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive,’ he said. See In Greece’s Crisis, Fed Studies Wall St.’s Activities.

In Is Goldman Finally About to Be Leashed and Collared? Yves Smith observes and analyzes Goldman’s corporate culture.  As a former employee, she reports on colleagues’ piggish and overly aggressive behavior. But in an otherwise excellent post, I believe she overlooks the role of current compensation systems.

Pay Practices and Reputation

In previously discussing the banking crisis, we pointed out a fundamental principal: you get what you incent.

Banks were interested in generating upfront fees. Incentives were predicated on “making the deal.”  The best way to make a deal was to ignore the creditworthiness of the borrower.  The banker who made the bad loan suffered no personal financial penalty.  There was no “skin in the game.” Why not write as many loans to poor credits as possible? See Hard Truths from the Banking Crisis.

The Goldman culture incents a “winner take all” mentality.  Since it is a public corporation rather than a partnership everyone is an employee.    A highly mobile employee rather than an owner is far less concerned about the firm’s long term reputation.  That employee wants to maximize current compensation; worrying about future consequences is for suckers.  Drawing on this paradigm, we are not shocked by headlines excoriating the firm for trading against its clients’ interests, shorting the municipal bonds it helped underwrite, skirting EU rules, or tanking the housing market.

Goldman operates in a larger Wall Street and indeed general culture that encourages greed at the expense of overall civic good:

  • Successful hedge funds report individual earnings in the hundreds of million dollars per employee.
  • Loyalty is dead.  Employees change firms. Highly paid athletes change teams without a second thought.
  • The media treats great wealth as reason for great celebrity.
  • Compensation validates individual worth.
  • Government backstops losses and allows gains to remain private.
  • The zeitgeist promotes: “I better grab as much as I can now before the economy implodes.”

Does It Have To Be This Way?

Any alert Board of Directors should be asking some difficult questions.  Why aren’t we concerned about the long-term firm reputation?  What do we want the corporate culture to be? Just because we can legally do a transaction should we be doing it?  How do we blend partnership-based personal accountability with a public corporation structure?   How do we get employees to care about the long-term view?  How do we meet the competitive threat of hedge funds and private equity without damaging corporate reputation? How does our compensation system comport with these concerns?

Yves Smith noted that it was as dangerous for anyone to get in the way of a Goldman employee and a profit making opportunity as it was to get between a predatory animal and its kill.  Goldman has managed to get itself between a very worried Obama Administration and a very angry public.  How ironic if the Goldman predatory lion becomes the Administration sacrificial lamb.

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27
Jan 10

We Can Handle the Truth

“You can’t handle the truth!” Col. Nathan R.Jessep in A Few Good Men

After his election President Obama had the opportunity to educate the public on the causes of the financial crisis and the necessary steps to help us emerge from it.  Over this past year, he has squandered this chance, and in so doing has created the political backlash that is occurring today.

Policy Making and the Truth

With great fanfare, we inaugurated President Obama against the backdrop of the greatest financial crisis since the Great Depression.  In any new Administration, policy making is never easy and advisors at times seem to operate in virtual echo chambers, hearing only themselves.  They presented Obama with a range of options: nationalize the banks; let them fail and let the bankruptcy courts sort it all out; continue the Bush/Paulson bailout policies.  From the beginning, Obama advisors took the middle of the road policy to continue the bailouts.  As voters and participants in a democracy, we can now see the missing piece in this scenario. President Obama owed the public an explanation of this policy choice.  My guess is that his advisers warned against candor.  I would further conjecture these advisers felt that candor would have made the crisis worse.  Elites always worry about scaring the masses. This was confirmed at today’s Congressional hearings on AIG.  AIG was viewed by both Timothy Geithner and Henry Paulson, as the “end of the financial world as we knew it.”  The Administration and we are now suffering the consequences of this subterfuge.

Back to the Future

President Obama could have made a few simple points that would have educated the public, built a consensus for his policy choice and left open future policy options if the bailout approach failed.

President Obama could have made these simple and direct points:

  • We are facing the greatest financial crisis since the Great Depression
  • We got into this problem by borrowing too much, and producing and saving too little
  • At the center of this crisis are the large money center banks and Wall Street investment firms
  • Using inappropriate levels of borrowing and creating non-transparent products, derivatives, which could not be accurately valued or traded, these banks and firms gambled with our money.
  • Banks, however, are the transmission mechanism for getting money into the economy through check clearing, making loans and other services.
  • We are going to provide enough support for the banks to continue their necessary and transparent functions.
  • There will be a consequence to any bank for needing this ad hoc and unusual government support.
  • Shareholders and creditors of the banks must share in some of the losses.
  • Bank employee bonuses will be severely limited or eliminated until the banks recover.
  • The government will take part ownership in the banks until they return to financial health.
  • I have asked my Attorney General to investigate whether these institutions committed any crimes.  I will ask him to hold indictments in abeyance until we are on our way to recovery.
  • Let me assure you that the government will punish wrongdoing.

We Build Prisons of our Own Making

We know this fictional address to the public did not take place.  The Obama Administration now owns the policies of failed bailouts.  The recovery is precarious and now the government asserts that the health of the stock market hinges on re-appointing Ben Bernanke as Federal Reserve Chairman.  The Massachusetts senatorial election was a wakeup call that the middle class is “mad as hell and isn’t going to take it anymore.” See The President Wakes Up and Smells the Election Results.

In tonight’s State of the Union Address, President Obama scratched the surface of candor. He stated that he hated helping the banks, but that failure to do so would have led to greater unemployment, business closure and lost homes.  President Obama, it is not too late for complete candor. It is not too late to commence investigations and prosecutions.

Col. Jessep was wrong: the American public can handle the truth!

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26
Nov 09

Can We Continue the Status Quo?

Every so often one comes across a brilliant essay that cuts to the heart of the problem.  Writing for the Prudent Bear in “Wanted: Iconoclasts,” Martin Hutchinson identifies the rising political anger at the “partnering” of the Obama Administration and Wall Street:

In such an atmosphere, with unemployment above 10% and rising, and U.S. living standards descending inexorably towards those of the Third World, it is not surprising that the public beyond the Washington Beltway is in an iconoclastic mood. Its iconoclasm is rational, economically speaking. The tight oligopoly of Wall Street is profiting excessively from its 2008 bailout by taxpayers, with the payments to Goldman Sachs and others on the AIG credit default swaps coming to seem increasingly misguided and possibly corrupt, given Goldman Sachs’s close connection with the Treasury Secretary Hank Paulson who disbursed taxpayers’ money in such an unproductive manner. AIG and Citigroup remain in business, with even AIG Financial Products, the cause of much of 2008′s pain, still in operation. Fannie Mae and Freddie Mac remain dispensing their guarantees to the housing market, noticed by the media only at the end of each quarter as they tote up their losses and demand further billions of the taxpayers’ money. The economically damaging subsidies to home purchase, diverting as they do scarce U.S. capital towards yet more unproductive housing, have just been extended both in time, for a further six months and in scope, to existing homeowners. The economic recovery, such as it is, appears to [be] sic producing almost no jobs but only an ever-widening spiral in commodity prices, affecting the costs of everything the public consumes and eroding the value of its meager savings.

Mr. Hutchison levels his criticism of the management of the financial crisis at the behavior of Obama, Bernanke and Geithner, whose knee jerk response was to maintain rather than reform system.  They chose to bolster bankrupt financial institutions at taxpayer expense. Further, they chose zero interest rate policies which punish savers and trillion dollar deficits ad infinitum which punish all taxpayers and future generations.  They created a giant irrational structure. (See Why Do All Irrational Structures Fail?).

Offering Solutions

Mr. Hutchinson does not deliver a jeremiad.  Instead, he departs from dire rants and prognostications and points to a rational way out of the ongoing crisis.  Recognizing that the current economic-political trajectory we are currently on is unsustainable, he provides policy prescriptions to end the crisis:

It will thus have become obvious that the housing market needs to be restored to a fully private market state, in which government subsidies are confined to the truly indigent. Zombie banks must be closed down, while the beneficiaries of “too big to fail” must be forced to slim down and divest operations until they are of a size where failure is conceivable. Commercial banks will simply become regional entities, whose failure would damage a regional economy but not the entire financial system. The trading behemoths will be broken into several competitors, whose market share will be too small for them to profit from “insider information” about market flows – a modest transactions tax will also reduce trading’s dominance. Home mortgages will once again be granted locally, with derivatives and securitization technology used only to prevent cost squeezes in high-growth areas. The obvious cost reductions in health-care, eliminating the current system’s cross-subsidizations, will be legislated to reduce the sector’s oppressive cost growth. Public expenditure generally will be put on a strict diet, with expansionist foreign policy ended, both in its belligerent and its globalist forms.  Finally, monetary policy will set interest rates at a level that rewards savers properly and prevents bubbles.

Conclusion

Staying on our current course of action is irrational.  Mr. Hutchinson clearly links together politics and economics.  Often economists take a narrower view, ignoring political realities.  Since this is not a normal recession and has all the hallmarks of a depression, “business as usual” policy measures taken to date have been ineffective and have deepened the crisis. There is a growing political reaction among the masses of Americans who face unemployment, inflated gasoline prices and foreclosure.  Democratic losses in recent elections were an early harbinger of that discontent.  There is still time for Obama, Bernanke and Geithner to become iconoclasts, break with orthodoxy and restore economic growth which will benefit all Americans.  Continuing the status quo will be harmful to the current ruling political class, the Wall Street elite and the economy.

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