Please note that today’s Wall Street Journal carries an editorial that makes exactly the same points concerning the decline in the value of the United States dollar that I made in my post yesterday. I refer to the comments made in “A Dollar Referendum” which can be found at http://online.wsj.com/article/SB122965017184420567.html?mod=todays_us_opinion.
Let me just summarize the points made in the Wall Street Journal article.
First, after the dollar rose earlier in the fall due to the international flight to quality to invest in Treasury securities, the value of the United States dollar has fallen precipitously in December as a result of the recent Fed actions opening the gate to flood the world with dollars.
Second, why should international financial markets have any faith in the Federal Reserve to restore discipline to the markets when it “has proven that it is far better at adding liquidity than removing it”? The editorial then refers to the Fed record in maintaining exceedingly low target interest rates earlier in the 2001 to 2003 period.
Third, the editorial discusses the flow of new United States government debt that will be coming to the market…approximately $1.0 trillion…related to the proposed Obama stimulus plan. The implication is that the monetary thrust of the Fed will basically monetize this debt.
Fourth, the concern is expressed that measures of inflation, such as the consumer price index are lagging indicators, and do not capture the market’s lack of confidence in international financial markets that the Federal Reserve will be restore order once the “deflation” psychology has been defeated. The decline in the value of the United States dollar represents this expectation of market participants.
In the words of the Wall Street Journal editorial: “The dollar’s decline is a warning about the future. Mr. Bernanke’s decision to flood the world with dollars will no doubt succeed in preventing a deflation. What everyone wants to know is whether he also has the fortitude—or even the desire—to prevent a run on the world’s reserve currency.”
Friday, December 19, 2008
Thursday, December 18, 2008
The Declining Dollar
The decline in the value of the dollar has gotten increasing headlines since the Federal Reserve Board of Governors released its new monetary policy efforts on Tuesday. Many short run reasons are being given for the recent decline in the value of the dollar, especially against the Euro and the Yen.
The most intriguing explanation for the decline, however, is a longer term reason. In this explanation, analysts argue that the decline in the value of the dollar is just a continuation of the trend which began in early 2002 and continued through until early August 2008.
The story that accompanies this explanation is that a series of events in 2001 and 2002 convinced international markets that the United States government had forfeited any discipline it had established over its fiscal and monetary policies. First, there was the huge Bush (43) tax cut that moved the government’s budget from one of surplus to one of deficit. This was followed by the war on terror and the Iraq invasion which exacerbated the amount of the budget deficit.
In addition to this the Greenspan Federal Reserve cut the target Federal Funds rate to very low levels, around 1% or so, for a period of about two years. Mr. Greenspan’s concern, apparently, was fear of an extended recession following the burst of the dot.com bubble in the stock market. The result was the creation of the housing bubble as well as smaller bubbles in other areas of the economy, including commodity prices.
As a consequence of these actions, massive amounts of debt were created. Fortunately for the United States…at the time…was that over 50% of this debt…both private and public debt…was financed outside of the United States…large amounts being placed in China, India, and the middle east…although as we found out…banks all over the world acquired huge quantities of mortgage-backed debt.
The interesting thing that was learned from this period is that consumer inflation (as measured by the Consumer Price Index) could be kept in check while inflation ran rapid in asset prices (particularly in housing prices and commodity prices at this time). The monetary authorities concentrated on consumer prices and did nothing with respect to asset prices.
The thing is that “self-reinforcing expectations” can get built into asset prices leading to a massive increase of financial leverage. Consumer credit can be expanded for purchases of the items individuals purchase, but this credit expansion cannot match the possibilities for increase that exist as asset prices go up substantially, year-after-year.
Foreign exchange rates capture the relative expectations of people that operate in these markets. The specific ‘relative expectations’ that are relevant here pertain to how market participants judge how the economies of different countries are expected to perform. Performance in this instance relates to the state of the economy, performance of government’s in terms of their conduct of their economic policies, and expected inflation.
In this respect, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has stated that the price of a country’s currency is the most important price in its economy. The value of a country’s currency is, in a real sense, the “grade card” of the country’s economic and monetary policy, relative to the rest of the world.
Thus, as the value of the United States dollar fell more than 40% from early 2002 to August 2008, participants in international financial markets were indicating a belief that the government of the United States was showing little or no discipline over its budget and this was connected with an extremely “loose” monetary policy. To these market participants, the United States would have to “pay the piper”, sooner or later.
As the story continues, when the financial markets fell apart in September, the United States dollar became the “quality” asset in the world and investors flocked to the dollar as they repatriated assets from all over the globe in order to invest in U. S. Treasury securities. As a consequence of this rush to quality the value of the United States dollar rose.
This latter movement has apparently come to an end. There seems to be a number of short-run reasons for the recent decline in the value of the United States dollar…one of them being a move on the part of foreign investors to get back into their own currencies to dress up their year-end balance sheets.
But, there is another reason given for the drop in the value of the dollar and this is connected with the decisions of the Federal Reserve that were announced on Tuesday and the projected rise in the deficit of the federal government. For all intents and purposes, the target Federal Funds rate is now approximately zero. In addition, the Fed said that it would buy financial assets, long term U. S. Treasury issues and mortgage backed bonds and so forth in order to flood the financial markets with liquidity. And, they warned, they will continue to do this for as long as necessary…whatever “necessary” means. On top of this, the Obama team seems to be talking about adding roughly $1.0 trillion in expenditures to the federal budget to get the United States economy going again.
One can easily draw from this the assumption that the world will be flooded with dollars…millions and millions of dollars. How should one react to this in terms of the value of the dollar?
One could argue that this is exactly what world financial markets have been predicting would happen since early in 2002. (They did not, and could not, predict precisely the path of the collapse.) This is exactly the reason why the United States dollar has declined by about 40% since then!
The problem is that there are no “good” decisions left for the United States. This is the dilemma that must be faced when discipline in lost. When one sees the consequences of a lack of discipline, one does what one needs to do in order to get one’s life back in order. Getting discipline back into one’s life is a matter of one step at a time.
In terms of priorities…getting the economy going and avoiding a cumulative collapse is number one. Until this is accomplished, we may just have to see the value of the dollar continue to decline.
The most intriguing explanation for the decline, however, is a longer term reason. In this explanation, analysts argue that the decline in the value of the dollar is just a continuation of the trend which began in early 2002 and continued through until early August 2008.
The story that accompanies this explanation is that a series of events in 2001 and 2002 convinced international markets that the United States government had forfeited any discipline it had established over its fiscal and monetary policies. First, there was the huge Bush (43) tax cut that moved the government’s budget from one of surplus to one of deficit. This was followed by the war on terror and the Iraq invasion which exacerbated the amount of the budget deficit.
In addition to this the Greenspan Federal Reserve cut the target Federal Funds rate to very low levels, around 1% or so, for a period of about two years. Mr. Greenspan’s concern, apparently, was fear of an extended recession following the burst of the dot.com bubble in the stock market. The result was the creation of the housing bubble as well as smaller bubbles in other areas of the economy, including commodity prices.
As a consequence of these actions, massive amounts of debt were created. Fortunately for the United States…at the time…was that over 50% of this debt…both private and public debt…was financed outside of the United States…large amounts being placed in China, India, and the middle east…although as we found out…banks all over the world acquired huge quantities of mortgage-backed debt.
The interesting thing that was learned from this period is that consumer inflation (as measured by the Consumer Price Index) could be kept in check while inflation ran rapid in asset prices (particularly in housing prices and commodity prices at this time). The monetary authorities concentrated on consumer prices and did nothing with respect to asset prices.
The thing is that “self-reinforcing expectations” can get built into asset prices leading to a massive increase of financial leverage. Consumer credit can be expanded for purchases of the items individuals purchase, but this credit expansion cannot match the possibilities for increase that exist as asset prices go up substantially, year-after-year.
Foreign exchange rates capture the relative expectations of people that operate in these markets. The specific ‘relative expectations’ that are relevant here pertain to how market participants judge how the economies of different countries are expected to perform. Performance in this instance relates to the state of the economy, performance of government’s in terms of their conduct of their economic policies, and expected inflation.
In this respect, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has stated that the price of a country’s currency is the most important price in its economy. The value of a country’s currency is, in a real sense, the “grade card” of the country’s economic and monetary policy, relative to the rest of the world.
Thus, as the value of the United States dollar fell more than 40% from early 2002 to August 2008, participants in international financial markets were indicating a belief that the government of the United States was showing little or no discipline over its budget and this was connected with an extremely “loose” monetary policy. To these market participants, the United States would have to “pay the piper”, sooner or later.
As the story continues, when the financial markets fell apart in September, the United States dollar became the “quality” asset in the world and investors flocked to the dollar as they repatriated assets from all over the globe in order to invest in U. S. Treasury securities. As a consequence of this rush to quality the value of the United States dollar rose.
This latter movement has apparently come to an end. There seems to be a number of short-run reasons for the recent decline in the value of the United States dollar…one of them being a move on the part of foreign investors to get back into their own currencies to dress up their year-end balance sheets.
But, there is another reason given for the drop in the value of the dollar and this is connected with the decisions of the Federal Reserve that were announced on Tuesday and the projected rise in the deficit of the federal government. For all intents and purposes, the target Federal Funds rate is now approximately zero. In addition, the Fed said that it would buy financial assets, long term U. S. Treasury issues and mortgage backed bonds and so forth in order to flood the financial markets with liquidity. And, they warned, they will continue to do this for as long as necessary…whatever “necessary” means. On top of this, the Obama team seems to be talking about adding roughly $1.0 trillion in expenditures to the federal budget to get the United States economy going again.
One can easily draw from this the assumption that the world will be flooded with dollars…millions and millions of dollars. How should one react to this in terms of the value of the dollar?
One could argue that this is exactly what world financial markets have been predicting would happen since early in 2002. (They did not, and could not, predict precisely the path of the collapse.) This is exactly the reason why the United States dollar has declined by about 40% since then!
The problem is that there are no “good” decisions left for the United States. This is the dilemma that must be faced when discipline in lost. When one sees the consequences of a lack of discipline, one does what one needs to do in order to get one’s life back in order. Getting discipline back into one’s life is a matter of one step at a time.
In terms of priorities…getting the economy going and avoiding a cumulative collapse is number one. Until this is accomplished, we may just have to see the value of the dollar continue to decline.
Monday, December 15, 2008
Lessons on How to Beat Deflation Trap
As the United States is gearing up for additional massive efforts in both the areas of monetary and fiscal policy we need to listen to the experience of other nations who have gone through recent periods of economic distress. We need to understand, as well as possible, just how this modern recession/deflation thing works.
There is a very interesting interview with Masaaki Shirakawa, a governor of the Bank of Japan, in the Financial Times today (http://www.ft.com/cms/s/0/18086fba-ca0c-11dd-93e5-000077b07658.html). One of the important things about this interview is the emphasis it puts on understanding what is happening in different sectors of the economy instead of just focusing on aggregate information. This has importance in understanding how recessions begin as well as for understanding the depth and length of recessions.
One of the problems with modern macroeconomics, as discussed in my review of Paul Krugman’s “The Return of Depression Economics and the Crisis of 2008” appearing on Seeking Alpha on December 9, 2008, is that macroeconomists want to focus on aggregates and not what makes up the aggregates. For example, capital is defined by one of the most popular text books on macroeconomics as “the sum of all the machines, plants, and office buildings in the economy.” And, all these component parts are perfectly and costlessly interchangeable.
The difficulty with this is, according to Governor Shirakawa, is that it does not allow for an understanding of the “imbalances” and “dislocations” that evolve during an economic expansion or during asset bubbles. Thus, when the economy is expanding the monetary authority needs to “watch carefully whether the broadly defined imbalances are accumulating or not.”
Furthermore, during these times, risk-taking and financial leverage tend to expand dramatically. It is not just aggregate demand or supply that is important in understanding the evolution of the economy but also what is happening in various sectors of the economy and how the financial structure needs to unwind.
And, experience has shown that these imbalances occur even when things like the consumer price index is behaving well. “Very often in recent decades we experienced a situation in which imbalances are accumulating, despite the fact that the inflation rate is quite subdued.” He continues that “Inflation targeting is one part of a good framework to explain monetary policy. But if inflation targeting creates the social presumption that the central bank can look at consumer price inflation alone, then it might have some unintended effect of helping the creation of a bubble.” That is, asset prices in different markets, housing, stocks, and so forth, must be observed also.
Why is it important to understand this?
We need to understand this because it points to the fact that recessions or periods of deflation cannot be handled by just appeals to pumping up aggregate demand. We need to understand that the previous upswing created imbalances, bubbles, dislocations, over-investment and these previous decisions cannot just be dissolved by assuming that all capital investment is alike and that stimulating aggregate demand is not the only thing that needs to be done.
But, Governor Shirakawa argues, this does not mean that monetary or fiscal policies are not needed in combating deflation and turning the economy around. Both are a part of a sound strategy to get the economy going in the right direction.
What is also important is a focus on the imbalances and dislocations that were created in the previous run-up. The policy makers need to understand how the various sectors are working themselves out and what, if any, bumps in the road lie ahead.
For example, the prime example of the ‘asset bubble’ just experienced is the housing industry. Until the summer of 2006, the housing market was ‘riding high’ with housing prices and housing starts seeming like they would never stop. Yet they did and housing prices have dropped steadily ever since. How far will they drop? Some analysts say that housing prices must drop to at least 50% of their peak value. Also, the picture gets even darker when one observes that there are still two major clouds hanging over the future. Both are related to the ‘financial innovations’ of the 1990s…major amounts of Alt-A mortgages and the Payment-Option ARMS are going to re-price over the next two to three years. The peak in housing foreclosures and personal bankruptcies is not expected to arrive for at least a year from now.
Another example is the financial industry. Tremendous losses have already been taken by banks and others, yet more are expected. The reason for this is that the banks still don’t fully comprehend the extent of the write-downs they are going to have to take on existing assets. Then, there is the fact that the banks have not yet seen the extent of the write downs connected with credit cards, auto loans, high-yield securities, and commercial and industrial loans. And, this doesn’t even consider the possible adjustments that will need to be made in the mortgage area mentioned in the previous paragraph. Mutual funds and hedge funds now are restricting investors who want to get their money back. And, then we are starting to see some of the fraud schemes surface that were a part of the recent credit inflation.
A further example is the auto industry (which also applies to other areas of manufacturing in the United States). I think everyone can agree that there are massive areas of imbalance and dislocation in this industry. Who is at fault? The auto executives? The labor unions? The politicians? The consumer? Everybody else? I don’t believe that any one person or group can be singled out as the cause of the problems in this industry.
But, I think that we can all agree that the problems are massive. These problems have to do with technology, innovation, out-of-date facilities, inappropriate pricing of resources, and other excesses that have been built into the structure over many years. Regardless of whether or not there is a bailout of this industry, it is going to take many years for the auto industry (and, I would argue many other areas of manufacturing in the United States) to really join the 21st century. Obviously, aggregate demand policies are not going to take care of the restructuring that is needed here.
Shirakawa summarizes: “Based on our experience, the world economy or the US economy needs the elimination of excesses. Of course the exact excesses vary from country to country…In today’s US for instance, housing is excessive; household debt is also excessive—I don’t know by how much, but anyways ‘excessive’ is there.”
“Negative feedback is now at work and I cannot give you a precise answer (to how long the global crisis is to run). What is crucial is to avoid a situation in which the adjustment leads to a serious downturn in the economy.”
In conclusion, there is no quick fix. The ‘excesses’, ‘imbalances’ and ‘dislocations’ in each sector must work themselves out. Monetary and fiscal policy may be able to soothe the pain…but they will not eliminate it. I tend to agree with Governor Shirakawa
There is a very interesting interview with Masaaki Shirakawa, a governor of the Bank of Japan, in the Financial Times today (http://www.ft.com/cms/s/0/18086fba-ca0c-11dd-93e5-000077b07658.html). One of the important things about this interview is the emphasis it puts on understanding what is happening in different sectors of the economy instead of just focusing on aggregate information. This has importance in understanding how recessions begin as well as for understanding the depth and length of recessions.
One of the problems with modern macroeconomics, as discussed in my review of Paul Krugman’s “The Return of Depression Economics and the Crisis of 2008” appearing on Seeking Alpha on December 9, 2008, is that macroeconomists want to focus on aggregates and not what makes up the aggregates. For example, capital is defined by one of the most popular text books on macroeconomics as “the sum of all the machines, plants, and office buildings in the economy.” And, all these component parts are perfectly and costlessly interchangeable.
The difficulty with this is, according to Governor Shirakawa, is that it does not allow for an understanding of the “imbalances” and “dislocations” that evolve during an economic expansion or during asset bubbles. Thus, when the economy is expanding the monetary authority needs to “watch carefully whether the broadly defined imbalances are accumulating or not.”
Furthermore, during these times, risk-taking and financial leverage tend to expand dramatically. It is not just aggregate demand or supply that is important in understanding the evolution of the economy but also what is happening in various sectors of the economy and how the financial structure needs to unwind.
And, experience has shown that these imbalances occur even when things like the consumer price index is behaving well. “Very often in recent decades we experienced a situation in which imbalances are accumulating, despite the fact that the inflation rate is quite subdued.” He continues that “Inflation targeting is one part of a good framework to explain monetary policy. But if inflation targeting creates the social presumption that the central bank can look at consumer price inflation alone, then it might have some unintended effect of helping the creation of a bubble.” That is, asset prices in different markets, housing, stocks, and so forth, must be observed also.
Why is it important to understand this?
We need to understand this because it points to the fact that recessions or periods of deflation cannot be handled by just appeals to pumping up aggregate demand. We need to understand that the previous upswing created imbalances, bubbles, dislocations, over-investment and these previous decisions cannot just be dissolved by assuming that all capital investment is alike and that stimulating aggregate demand is not the only thing that needs to be done.
But, Governor Shirakawa argues, this does not mean that monetary or fiscal policies are not needed in combating deflation and turning the economy around. Both are a part of a sound strategy to get the economy going in the right direction.
What is also important is a focus on the imbalances and dislocations that were created in the previous run-up. The policy makers need to understand how the various sectors are working themselves out and what, if any, bumps in the road lie ahead.
For example, the prime example of the ‘asset bubble’ just experienced is the housing industry. Until the summer of 2006, the housing market was ‘riding high’ with housing prices and housing starts seeming like they would never stop. Yet they did and housing prices have dropped steadily ever since. How far will they drop? Some analysts say that housing prices must drop to at least 50% of their peak value. Also, the picture gets even darker when one observes that there are still two major clouds hanging over the future. Both are related to the ‘financial innovations’ of the 1990s…major amounts of Alt-A mortgages and the Payment-Option ARMS are going to re-price over the next two to three years. The peak in housing foreclosures and personal bankruptcies is not expected to arrive for at least a year from now.
Another example is the financial industry. Tremendous losses have already been taken by banks and others, yet more are expected. The reason for this is that the banks still don’t fully comprehend the extent of the write-downs they are going to have to take on existing assets. Then, there is the fact that the banks have not yet seen the extent of the write downs connected with credit cards, auto loans, high-yield securities, and commercial and industrial loans. And, this doesn’t even consider the possible adjustments that will need to be made in the mortgage area mentioned in the previous paragraph. Mutual funds and hedge funds now are restricting investors who want to get their money back. And, then we are starting to see some of the fraud schemes surface that were a part of the recent credit inflation.
A further example is the auto industry (which also applies to other areas of manufacturing in the United States). I think everyone can agree that there are massive areas of imbalance and dislocation in this industry. Who is at fault? The auto executives? The labor unions? The politicians? The consumer? Everybody else? I don’t believe that any one person or group can be singled out as the cause of the problems in this industry.
But, I think that we can all agree that the problems are massive. These problems have to do with technology, innovation, out-of-date facilities, inappropriate pricing of resources, and other excesses that have been built into the structure over many years. Regardless of whether or not there is a bailout of this industry, it is going to take many years for the auto industry (and, I would argue many other areas of manufacturing in the United States) to really join the 21st century. Obviously, aggregate demand policies are not going to take care of the restructuring that is needed here.
Shirakawa summarizes: “Based on our experience, the world economy or the US economy needs the elimination of excesses. Of course the exact excesses vary from country to country…In today’s US for instance, housing is excessive; household debt is also excessive—I don’t know by how much, but anyways ‘excessive’ is there.”
“Negative feedback is now at work and I cannot give you a precise answer (to how long the global crisis is to run). What is crucial is to avoid a situation in which the adjustment leads to a serious downturn in the economy.”
In conclusion, there is no quick fix. The ‘excesses’, ‘imbalances’ and ‘dislocations’ in each sector must work themselves out. Monetary and fiscal policy may be able to soothe the pain…but they will not eliminate it. I tend to agree with Governor Shirakawa
Thursday, December 11, 2008
Should Banks Start Lending Again?
Banks aren’t doing a lot of lending these days.
Why not?
The Federal Reserve System has bent over backwards dumping liquidity into the financial system. The United States Treasury Department has provided the banking industry with a lot of new ‘capital’. Why aren’t the banks’ lending? Why aren’t the banks even lending to themselves…
My question: Why should the banks be lending?
My answer: they shouldn’t…not right now!
A good reason for this is that United States financial institutions still do not have a firm grasp on the value of a large portion of their assets. “The biggest US financial institutions reported a sharp increase to $610 billion in so-called hard-to-value assets during the third quarter…” (“Financial groups’ problem assets hit $610 bn”, http://www.ft.com/cms/s/0/ea576c7c-c729-11dd-97a5-000077b07658.html.) These assets, primarily mortgage-backed securities and collateralized debt obligations, don’t have active markets at the present time and they are difficult to value. I should be noted that the assets so identified “are many times bigger than the market cap of the banks.”
If you were a banker right now, where would you be focusing your resources at the present time? Would you be attempting to put new loans on the books that would pay off over several years’ time…or…would you be trying to get your arms around the value of these ‘level-three’ assets and see how you can minimize the damage they might cause…in the immediate future?
As long as these assets are on-the-books bank managements are going to muddle around, attempting to minimize the information that is released, and ask for the government to protect them from the downside through asset purchase programs that shore up asset price and the like.
This only distracts efforts and prolongs things! Until the banks are forced to write down their assets to realistic (some form of market) values and take their hits…they will be unable to focus on business and get on with their lives.
But there are other things looming on the horizon. Why would you want to put on new loans when you have people talking about the rising level of foreclosures? Elizabeth Warren of Harvard who is leading the oversight of TARP stated on television last night that in the next two years 8 million houses will be in foreclosure, an amount that is about 16% of the housing stock. That is one out of every six houses in the United States will be in foreclosure within the next two years!
And, why would you want to put on new loans when you have people talking about the rising level of charge-offs related to credit cards? (See “Charge-offs Start to Shred Card Issuers”, http://online.wsj.com/article/SB122895752803296651.html?mod=todays_us_money_and_investing.) All the statistics in this area point to a surge in charge-offs that will be faced by credit card issuers in the future.
Furthermore, there is still the unknown number and size of business defaults that are coming down the road. Of course, there are the auto companies…but, the condition of the credit wings of the auto companies reinforce the concern. Ford Motor Credit Co. is teetering on the brink of bankruptcy…as is GMAC. (“GMAC Bondholders Balk at Debt Swap”, http://online.wsj.com/article/SB122891574162094585.html?mod=todays_us_money_and_investing. Also see “Doubts on GMAC bank holding plan”, http://www.ft.com/cms/s/0/3ccf9eb4-c727-11dd-97a5-000077b07658.html.)
Financial institutions cannot make loans when they are so uncertain about the loans that they have already made. Financial institutions cannot make loans when there is so much uncertainty about the length and depth of the recession, the rise in layoffs and the falloff in employment. (Just released: Jobless Claims hit a 26-year high!) Those individuals and businesses that are seeking loans want to refinance or restructure…to gain control over cash flows so that they don’t run out of cash. Borrowing related to expanding business or creating jobs is almost non-existent. (“Executives Are Grim on Economy”, http://online.wsj.com/article/SB122896532391397279.html?mod=todays_us_marketplace.)
Should banks be lending now?
The answer to this is no…they are not social institutions.
Yes, it would be helpful to the economy if all banks opened their doors and started flooding the market with loans. Everyone would benefit…right?
OK, then…who wants to be first?
Why not?
The Federal Reserve System has bent over backwards dumping liquidity into the financial system. The United States Treasury Department has provided the banking industry with a lot of new ‘capital’. Why aren’t the banks’ lending? Why aren’t the banks even lending to themselves…
My question: Why should the banks be lending?
My answer: they shouldn’t…not right now!
A good reason for this is that United States financial institutions still do not have a firm grasp on the value of a large portion of their assets. “The biggest US financial institutions reported a sharp increase to $610 billion in so-called hard-to-value assets during the third quarter…” (“Financial groups’ problem assets hit $610 bn”, http://www.ft.com/cms/s/0/ea576c7c-c729-11dd-97a5-000077b07658.html.) These assets, primarily mortgage-backed securities and collateralized debt obligations, don’t have active markets at the present time and they are difficult to value. I should be noted that the assets so identified “are many times bigger than the market cap of the banks.”
If you were a banker right now, where would you be focusing your resources at the present time? Would you be attempting to put new loans on the books that would pay off over several years’ time…or…would you be trying to get your arms around the value of these ‘level-three’ assets and see how you can minimize the damage they might cause…in the immediate future?
As long as these assets are on-the-books bank managements are going to muddle around, attempting to minimize the information that is released, and ask for the government to protect them from the downside through asset purchase programs that shore up asset price and the like.
This only distracts efforts and prolongs things! Until the banks are forced to write down their assets to realistic (some form of market) values and take their hits…they will be unable to focus on business and get on with their lives.
But there are other things looming on the horizon. Why would you want to put on new loans when you have people talking about the rising level of foreclosures? Elizabeth Warren of Harvard who is leading the oversight of TARP stated on television last night that in the next two years 8 million houses will be in foreclosure, an amount that is about 16% of the housing stock. That is one out of every six houses in the United States will be in foreclosure within the next two years!
And, why would you want to put on new loans when you have people talking about the rising level of charge-offs related to credit cards? (See “Charge-offs Start to Shred Card Issuers”, http://online.wsj.com/article/SB122895752803296651.html?mod=todays_us_money_and_investing.) All the statistics in this area point to a surge in charge-offs that will be faced by credit card issuers in the future.
Furthermore, there is still the unknown number and size of business defaults that are coming down the road. Of course, there are the auto companies…but, the condition of the credit wings of the auto companies reinforce the concern. Ford Motor Credit Co. is teetering on the brink of bankruptcy…as is GMAC. (“GMAC Bondholders Balk at Debt Swap”, http://online.wsj.com/article/SB122891574162094585.html?mod=todays_us_money_and_investing. Also see “Doubts on GMAC bank holding plan”, http://www.ft.com/cms/s/0/3ccf9eb4-c727-11dd-97a5-000077b07658.html.)
Financial institutions cannot make loans when they are so uncertain about the loans that they have already made. Financial institutions cannot make loans when there is so much uncertainty about the length and depth of the recession, the rise in layoffs and the falloff in employment. (Just released: Jobless Claims hit a 26-year high!) Those individuals and businesses that are seeking loans want to refinance or restructure…to gain control over cash flows so that they don’t run out of cash. Borrowing related to expanding business or creating jobs is almost non-existent. (“Executives Are Grim on Economy”, http://online.wsj.com/article/SB122896532391397279.html?mod=todays_us_marketplace.)
Should banks be lending now?
The answer to this is no…they are not social institutions.
Yes, it would be helpful to the economy if all banks opened their doors and started flooding the market with loans. Everyone would benefit…right?
OK, then…who wants to be first?
Wednesday, December 10, 2008
Auto Bailouts and Other Things
I have tried to stay out of the auto-bailout thing but I find that I need to add my two cents to the issue. I have done three successful turnarounds in my professional career and have consulted on quite a few more. It is from this perspective that I am making my comments. So hear goes.
First, Ford says that it can make it through the near-term without any assistance from the Federal Government. Good. Let them go for it!
Second, Chrysler…is owned by Cerberus Capital Management, LP…a private investment firm who boasts, “strong corporate governance is the cornerstone of our business.” This is a private investment firm that recently took a risk, made a big investment, has access to billions of dollars of capital…and is coming, hat-in-hand, to the Federal Government asking for money to carry Chrysler through this mess.
Come on…
Sounds like we have a new model for private equity investment!
Third, General Motors…”What’s good for General Motors is good for the United States,” as a former CEO of General Motors put it.
We bailout General Motors and then we bailout the United States? Hmmmmmmmmmmm…I don’t think that is what was meant.
General Motors is a turnaround situation!!!
In a turnaround situation you get rid of the existing management and you bring in new management!!!
Robert (Bob) Lutz says GM should stick with “Rick” Wagoner, Chairman and Chief Executive Officer, because he knows the business and knows what the current situation is and doesn’t have to be brought “up-to-speed” with the situation at GM.
I remember taking a thrift institution public during “the S & L crises” and going to numerous “dog-and-pony” shows of other companies taking their institutions public. I was especially taken aback by managements that would say…”Sure we were the management of this institution for the last 10 years in which the performance of this company got worse and worse…BUT, we have learned our lessons…we can make this bank work going forward!!!” And then they raised quite a few million dollars from people who were willing to bet on this story.
Guess what? Most of them didn’t make it!
We have also heard that the top engineers and other top management want Wagoner to stay. “He can do it!” they say.
Sure these employees want Wagoner to stay! He is the safest thing for them and their positions. A turnaround specialist would take a long, hard look at these people and what they have done and are doing and that is exactly what the top engineers and other top management don’t want!
General Motors is a turnaround situation! If anyone (the Government) is going to invest money in this organization they need to demand the appropriate leadership…and the existing CEO and his top management IS NOT the leadership that is needed.
The bailout of the auto industry is not just about thousands or millions of workers being employed. I, personally, hope that these workers do not have to experience a great deal of suffering.
The question is about whether or not any effort made by the government will have a fair probability of success. Thinking of these efforts as a bailout is not helpful when the situation calls for a turnaround. The issue, in my mind, is not being framed correctly.
OTHER THINGS
Information is starting to come out concerning the efforts to restructure mortgage debt…and the results are not encouraging.
Let me just say one thing about restructuring mortgages…or, for that matter, any debt in the present environment.
Generally, when the restructuring of debt takes place, the situation of the borrower and the situation in the economy are relatively stable. That is, any restructuring that takes place can count on income, employment, prices, sales, and so forth to remain relatively constant in the future. That way, the debt can be restructured in a way that presents the borrower with some likelihood that he or she will be able to pay off the debt.
In an environment that is not stable the situation of the borrower and the situation within the economy is constantly ‘going South.’ And, there is no certainty about ‘how far South’ these things will go. Consequently, any debt restructured in this environment has a relatively low probability of being paid off. Those restructuring the debt are just postponing the day of reckoning and continuing to put these borrowers in a position of almost assured failure.
In essence, within the current environment, those that have been foreclosed upon have gone from borrowing using a sub-prime loan to borrowing using a sub-sub-prime loan.
As I have said in many other posts…once discipline is lost…there are no good solutions to the problems created by the loss of discipline.
First, Ford says that it can make it through the near-term without any assistance from the Federal Government. Good. Let them go for it!
Second, Chrysler…is owned by Cerberus Capital Management, LP…a private investment firm who boasts, “strong corporate governance is the cornerstone of our business.” This is a private investment firm that recently took a risk, made a big investment, has access to billions of dollars of capital…and is coming, hat-in-hand, to the Federal Government asking for money to carry Chrysler through this mess.
Come on…
Sounds like we have a new model for private equity investment!
Third, General Motors…”What’s good for General Motors is good for the United States,” as a former CEO of General Motors put it.
We bailout General Motors and then we bailout the United States? Hmmmmmmmmmmm…I don’t think that is what was meant.
General Motors is a turnaround situation!!!
In a turnaround situation you get rid of the existing management and you bring in new management!!!
Robert (Bob) Lutz says GM should stick with “Rick” Wagoner, Chairman and Chief Executive Officer, because he knows the business and knows what the current situation is and doesn’t have to be brought “up-to-speed” with the situation at GM.
I remember taking a thrift institution public during “the S & L crises” and going to numerous “dog-and-pony” shows of other companies taking their institutions public. I was especially taken aback by managements that would say…”Sure we were the management of this institution for the last 10 years in which the performance of this company got worse and worse…BUT, we have learned our lessons…we can make this bank work going forward!!!” And then they raised quite a few million dollars from people who were willing to bet on this story.
Guess what? Most of them didn’t make it!
We have also heard that the top engineers and other top management want Wagoner to stay. “He can do it!” they say.
Sure these employees want Wagoner to stay! He is the safest thing for them and their positions. A turnaround specialist would take a long, hard look at these people and what they have done and are doing and that is exactly what the top engineers and other top management don’t want!
General Motors is a turnaround situation! If anyone (the Government) is going to invest money in this organization they need to demand the appropriate leadership…and the existing CEO and his top management IS NOT the leadership that is needed.
The bailout of the auto industry is not just about thousands or millions of workers being employed. I, personally, hope that these workers do not have to experience a great deal of suffering.
The question is about whether or not any effort made by the government will have a fair probability of success. Thinking of these efforts as a bailout is not helpful when the situation calls for a turnaround. The issue, in my mind, is not being framed correctly.
OTHER THINGS
Information is starting to come out concerning the efforts to restructure mortgage debt…and the results are not encouraging.
Let me just say one thing about restructuring mortgages…or, for that matter, any debt in the present environment.
Generally, when the restructuring of debt takes place, the situation of the borrower and the situation in the economy are relatively stable. That is, any restructuring that takes place can count on income, employment, prices, sales, and so forth to remain relatively constant in the future. That way, the debt can be restructured in a way that presents the borrower with some likelihood that he or she will be able to pay off the debt.
In an environment that is not stable the situation of the borrower and the situation within the economy is constantly ‘going South.’ And, there is no certainty about ‘how far South’ these things will go. Consequently, any debt restructured in this environment has a relatively low probability of being paid off. Those restructuring the debt are just postponing the day of reckoning and continuing to put these borrowers in a position of almost assured failure.
In essence, within the current environment, those that have been foreclosed upon have gone from borrowing using a sub-prime loan to borrowing using a sub-sub-prime loan.
As I have said in many other posts…once discipline is lost…there are no good solutions to the problems created by the loss of discipline.
Thursday, December 4, 2008
Financial Indicators of the Deteriorating Real Economy
More and more we see concern being expressed about the deteriorating real economy and less emphasis being placed on the crises within the financial sector. The concern about the growing weakness in the real economy points to a longer and deeper recession than had been anticipated.
The current recession, as defined by the NBER, is in its 12th month and trails two other recessions which lasted 16 months as the longest post-World War II downturns on record. As economists revise their forecasts, most seem to believe that the 16 month period will be exceeded and many are saying that the current recession will reach the 20-24 month time span.
Economists only have to point to the daily release of employee layoff announcements to support their increasing pessimism. Companies are restructuring and these efforts are accompanied by reductions in workforce by 5,000 and 10,000 and more, per firm. AT&T announced today that they are going to lay off 12,000 employees and are taking a $600 million charge in the fourth quarter to cover severance payments. And, given recent experience, there will be two or three other companies announcing layoffs today. There will be more tomorrow…and Monday…and…
Then these layoffs must work their way through the rest of the economy. Lower spending…credit card defaults…additional decline in sales…more layoffs…and so on and so on. The effects are cumulative.
The policy problem is how to stop the cumulative contraction so that the downward spiral is broken.
The potential effects of this downward spiral in the real economy are being translated into the financial markets and the warnings are rather severe. For example, take the article in the Financial Times, titled “Record number of companies at risk of default”: http://www.ft.com/cms/s/0/490a8668-c154-11dd-831e-000077b07658.html. This article focuses on the Markit iTraxx Crossover index which measures the cost of protecting junk-grade companies against default. This index rose above 1,000 basis points for the first time ever indicating that “a record number of companies are on the verge of default because of deepening financial problems.”
The authors also write that “Some of the world’s leading investment-grade companies look in danger of default, according to CDS prices.” The point being that the future shows nothing but dark clouds now. As these firms continue to restructure to avoid default on their debt the situation, at least in the short run, can only worsen because the layoffs lead to lower incomes which results in lower spending which results more restructuring and so on.
This deterioration in the real economy is also being transmitted to the government sector. There are two concerns being expressed in terms of the government securities. First, at local and regional levels…state and local governments…there is a restructuring gong on as government revenues drop and attempts are made to bring government budgets into balance…or at least into manageable level of deficit.
Second, governments at the national level are attempting to protect financial markets and combat the deterioration in their real economies. As a consequence, national deficits are ballooning and concern is being raised over the possibility of default on the part of sovereign nations. Another article in the Financial Times speaks to this concern: “Sovereign CDS prices soar as debt mounts”: http://www.ft.com/cms/s/0/c441907a-c1a3-11dd-831e-000077b07658.html. “Credit default swaps, which insure against bond defaults, rose to all-time highs on the US, UK, France, Spain, Italy and Germany yesterday…The dramatic rise is due to investor concerns over the amount of bonds the government will have to issue to bail out the banks and stimulate the economy.” The concern relates not only to the current economic and financial difficulties but also to the possibility that these governments will not be able to stem the downswing and will have to issue more and more bonds in the future.
Retail sales figures for November have just been release and the story reads that November retail sales are amongst the weakest in many years.
The difficulty that any government faces in attempting to compose a monetary or fiscal policy that can turn this situation around is that it is in the best interests of most economic units in the economy, individual, family, business, or non-profit, to get back to basics, to restructure what they do, to cut back their living standard, and to reduce debt. Consequently, government efforts are like “pushing on a string”…there is nothing to push against.
The current recession, as defined by the NBER, is in its 12th month and trails two other recessions which lasted 16 months as the longest post-World War II downturns on record. As economists revise their forecasts, most seem to believe that the 16 month period will be exceeded and many are saying that the current recession will reach the 20-24 month time span.
Economists only have to point to the daily release of employee layoff announcements to support their increasing pessimism. Companies are restructuring and these efforts are accompanied by reductions in workforce by 5,000 and 10,000 and more, per firm. AT&T announced today that they are going to lay off 12,000 employees and are taking a $600 million charge in the fourth quarter to cover severance payments. And, given recent experience, there will be two or three other companies announcing layoffs today. There will be more tomorrow…and Monday…and…
Then these layoffs must work their way through the rest of the economy. Lower spending…credit card defaults…additional decline in sales…more layoffs…and so on and so on. The effects are cumulative.
The policy problem is how to stop the cumulative contraction so that the downward spiral is broken.
The potential effects of this downward spiral in the real economy are being translated into the financial markets and the warnings are rather severe. For example, take the article in the Financial Times, titled “Record number of companies at risk of default”: http://www.ft.com/cms/s/0/490a8668-c154-11dd-831e-000077b07658.html. This article focuses on the Markit iTraxx Crossover index which measures the cost of protecting junk-grade companies against default. This index rose above 1,000 basis points for the first time ever indicating that “a record number of companies are on the verge of default because of deepening financial problems.”
The authors also write that “Some of the world’s leading investment-grade companies look in danger of default, according to CDS prices.” The point being that the future shows nothing but dark clouds now. As these firms continue to restructure to avoid default on their debt the situation, at least in the short run, can only worsen because the layoffs lead to lower incomes which results in lower spending which results more restructuring and so on.
This deterioration in the real economy is also being transmitted to the government sector. There are two concerns being expressed in terms of the government securities. First, at local and regional levels…state and local governments…there is a restructuring gong on as government revenues drop and attempts are made to bring government budgets into balance…or at least into manageable level of deficit.
Second, governments at the national level are attempting to protect financial markets and combat the deterioration in their real economies. As a consequence, national deficits are ballooning and concern is being raised over the possibility of default on the part of sovereign nations. Another article in the Financial Times speaks to this concern: “Sovereign CDS prices soar as debt mounts”: http://www.ft.com/cms/s/0/c441907a-c1a3-11dd-831e-000077b07658.html. “Credit default swaps, which insure against bond defaults, rose to all-time highs on the US, UK, France, Spain, Italy and Germany yesterday…The dramatic rise is due to investor concerns over the amount of bonds the government will have to issue to bail out the banks and stimulate the economy.” The concern relates not only to the current economic and financial difficulties but also to the possibility that these governments will not be able to stem the downswing and will have to issue more and more bonds in the future.
Retail sales figures for November have just been release and the story reads that November retail sales are amongst the weakest in many years.
The difficulty that any government faces in attempting to compose a monetary or fiscal policy that can turn this situation around is that it is in the best interests of most economic units in the economy, individual, family, business, or non-profit, to get back to basics, to restructure what they do, to cut back their living standard, and to reduce debt. Consequently, government efforts are like “pushing on a string”…there is nothing to push against.
Tuesday, December 2, 2008
Trying to Understand the Recession
It is official now…the United States has been in recession since December 2007! Right now the current recession is the third longest recession since World War II and most economists believe that this recession will at least tie the other two recessions in terms of duration…a period of 16 months.
Among the major factors behind such a belief is that housing prices are still declining, housing sales are still falling, layoffs have just started to takeoff and financial institutions are still reluctant to lend…even if people and companies are willing to borrow. Some feel that the real recession is just starting to hit.
Growth-wise, real GDP rose, year-over-year, at a 0.7% rate in the third quarter of 2008, down from 2.8% in the third quarter of 2007 and 2.3% in the fourth quarter of that year. Real GDP declined in the third quarter of 2008 from the second quarter of 2008 and is expected to decline once again going from the third quarter to the fourth quarter.
The extent of this recession has even got some people talking about deflation!
Now that is something! It is something because the year-over-year rate of change in the Implicit Price Deflator of GPD, although it drops when there is a recession, has only become negative once since World War II and that was in the 1948-49 recession. (See chart from the Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s[1][id]=GNPDEF&s[1][transformation]=pc1.) Over the past seven quarters the Implicit GDP Price Deflator has averaged a 2.5% year-over-year rate of increase and increased by 2.6% in the third quarter of 2008 over the third quarter of 2007.
It is important to talk about what is happening to prices at the same time one is talking about what is happening to economic activity because that gives us a clue as to what factors are dominating economic activity. If both prices and output move in the same direction then one can say that demand factors are dominating the market. If prices and output move in opposite directions then one can say that supply factors are dominating the market. To understand what is happening in the economy, one must get some feel for which side of a market is dominating.
As the rate of growth of the economy has dropped from the rate of expansion that took place in the four quarters ending in the third quarter of 2007 (2.8%) to the four quarters ending in the third quarter of 2008 (0.7%), the rate of inflation for the same periods remained roughly constant or has declined modestly. To get such a result the drop in the demand for goods and services would have had to been roughly matched by the decline in the supply of goods and services over this time period. That is, neither side of the market strongly dominated the behavior of the economy over the past year or so.
As I have written in several posts over the past year, supply factors seem to be just as important as, or even more important than, demand factors in the current slowdown. That is, an adjustment is taking place on the supply side of the economy that must be reckoned with if we are to fully understand what is going on in the economy and respond to the situation as effectively as possible.
A possible reason for the shift in supply is that transitions are taking place in the economy or need to take place in the economy and this is impacting cost structures and organizational patterns in a way that is altering how people do business. For example, the increase in the cost of oil during the 2007-2008 period may have caused the transportation and energy industries to begin adjusting to a new world of alternative products and services that rely less on fossil-based resources. The subsequent reduction in the cost of a barrel of oil may have little impact on decisions because of the ‘price shock’ that people absorbed through the summer of 2008. The problems in the automotive industry are just one consequence of this. And, we are seeing a lot more adjustments coming in different segments of the transportation area that are not getting such a high profile. Also, new efforts to build ‘green’ industries may result from this.
Another transition is occurring in the financial industry where thousands of people are being laid off due to the downsizing that has resulted from the collapse of the financial markets. Financial institutions, I believe, are going to go through a substantial restructuring that will be based on information technology. In the past thirty years, the financial industry has shown how it can use the computer to design financial products. Now, along with the call to restructure the regulation of financial institutions, the financial industry is going to have to use the emerging information technology to control risk and enhance the openness and transparency of the industry. In moving in this direction the financial industry will become a real leader in the creation of information markets on which the rest of the economy will model itself.
Information technology continues to transform itself and in so doing will continue to create opportunities for other industries to transform themselves. The spread of information is going to accelerate with search being an integral part of this expansion along with greater and greater connectivity between users throughout the world. Computer networks will more and more become decentralized rather than centralized.
Another area where substantial transitions are taking place is in the area of State and Local governments. The model that has been used in this arena developed after World War II and is in need of a vast overhaul. In all likelihood, the current financial difficulties are going to result in these governments modernizing their function and structure while at the same time they help rebuild the infrastructure.
These are just a few of the major transitions that are taking place in the economy right now and that predominantly affect the supply side of the economy rather than the demand side. In all the efforts to “get the economy going again” we must not restrict or prevent these changes. That is, the government programs that are designed to stimulate the economy must not “lock us into” the old way of doing things. A bailout of the auto industry that keeps things “as they are” will not be helpful in the longer run.
It could be that the economy of the United States, and the world, is now going through a major restructuring, a restructuring that seems to occur every 60-80 years or so. In a sense, we are going from one age into another. One could say that the United States went through another major restructuring in the 1930s when the country was transitioning from an economy based predominantly upon agriculture to one that was based predominantly upon manufacturing. Maybe this is the time of transition from manufacturing to (you insert your term for it). Maybe the world of the ‘manufacturer’, and all that supports it, has significantly passed its peak and government props can no longer sustain it.
Two things can be drawn from this. First, government programs that just rely on stimulating demand will not prove to be very effective. The transitions must take place. They will take place relatively rapidly or they will take place at a much slower pace if the government supports the status quo. We…the government…must be careful here.
Let me state this again…the adjustments are going to take place…whether or not the government slows them down!
Second, these areas of transition are going to create major new opportunities for investment to those that are lucky enough…or wise enough…to choose the right companies. Referring to the 1930s once again, one can reference many investments that provided exceptional returns to those that sought them out and committed to them during the period in which the economy was adjusting to the brave new world that was coming. It is my belief that there will be numerous such opportunities available to us in the near future.
Among the major factors behind such a belief is that housing prices are still declining, housing sales are still falling, layoffs have just started to takeoff and financial institutions are still reluctant to lend…even if people and companies are willing to borrow. Some feel that the real recession is just starting to hit.
Growth-wise, real GDP rose, year-over-year, at a 0.7% rate in the third quarter of 2008, down from 2.8% in the third quarter of 2007 and 2.3% in the fourth quarter of that year. Real GDP declined in the third quarter of 2008 from the second quarter of 2008 and is expected to decline once again going from the third quarter to the fourth quarter.
The extent of this recession has even got some people talking about deflation!
Now that is something! It is something because the year-over-year rate of change in the Implicit Price Deflator of GPD, although it drops when there is a recession, has only become negative once since World War II and that was in the 1948-49 recession. (See chart from the Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s[1][id]=GNPDEF&s[1][transformation]=pc1.) Over the past seven quarters the Implicit GDP Price Deflator has averaged a 2.5% year-over-year rate of increase and increased by 2.6% in the third quarter of 2008 over the third quarter of 2007.
It is important to talk about what is happening to prices at the same time one is talking about what is happening to economic activity because that gives us a clue as to what factors are dominating economic activity. If both prices and output move in the same direction then one can say that demand factors are dominating the market. If prices and output move in opposite directions then one can say that supply factors are dominating the market. To understand what is happening in the economy, one must get some feel for which side of a market is dominating.
As the rate of growth of the economy has dropped from the rate of expansion that took place in the four quarters ending in the third quarter of 2007 (2.8%) to the four quarters ending in the third quarter of 2008 (0.7%), the rate of inflation for the same periods remained roughly constant or has declined modestly. To get such a result the drop in the demand for goods and services would have had to been roughly matched by the decline in the supply of goods and services over this time period. That is, neither side of the market strongly dominated the behavior of the economy over the past year or so.
As I have written in several posts over the past year, supply factors seem to be just as important as, or even more important than, demand factors in the current slowdown. That is, an adjustment is taking place on the supply side of the economy that must be reckoned with if we are to fully understand what is going on in the economy and respond to the situation as effectively as possible.
A possible reason for the shift in supply is that transitions are taking place in the economy or need to take place in the economy and this is impacting cost structures and organizational patterns in a way that is altering how people do business. For example, the increase in the cost of oil during the 2007-2008 period may have caused the transportation and energy industries to begin adjusting to a new world of alternative products and services that rely less on fossil-based resources. The subsequent reduction in the cost of a barrel of oil may have little impact on decisions because of the ‘price shock’ that people absorbed through the summer of 2008. The problems in the automotive industry are just one consequence of this. And, we are seeing a lot more adjustments coming in different segments of the transportation area that are not getting such a high profile. Also, new efforts to build ‘green’ industries may result from this.
Another transition is occurring in the financial industry where thousands of people are being laid off due to the downsizing that has resulted from the collapse of the financial markets. Financial institutions, I believe, are going to go through a substantial restructuring that will be based on information technology. In the past thirty years, the financial industry has shown how it can use the computer to design financial products. Now, along with the call to restructure the regulation of financial institutions, the financial industry is going to have to use the emerging information technology to control risk and enhance the openness and transparency of the industry. In moving in this direction the financial industry will become a real leader in the creation of information markets on which the rest of the economy will model itself.
Information technology continues to transform itself and in so doing will continue to create opportunities for other industries to transform themselves. The spread of information is going to accelerate with search being an integral part of this expansion along with greater and greater connectivity between users throughout the world. Computer networks will more and more become decentralized rather than centralized.
Another area where substantial transitions are taking place is in the area of State and Local governments. The model that has been used in this arena developed after World War II and is in need of a vast overhaul. In all likelihood, the current financial difficulties are going to result in these governments modernizing their function and structure while at the same time they help rebuild the infrastructure.
These are just a few of the major transitions that are taking place in the economy right now and that predominantly affect the supply side of the economy rather than the demand side. In all the efforts to “get the economy going again” we must not restrict or prevent these changes. That is, the government programs that are designed to stimulate the economy must not “lock us into” the old way of doing things. A bailout of the auto industry that keeps things “as they are” will not be helpful in the longer run.
It could be that the economy of the United States, and the world, is now going through a major restructuring, a restructuring that seems to occur every 60-80 years or so. In a sense, we are going from one age into another. One could say that the United States went through another major restructuring in the 1930s when the country was transitioning from an economy based predominantly upon agriculture to one that was based predominantly upon manufacturing. Maybe this is the time of transition from manufacturing to (you insert your term for it). Maybe the world of the ‘manufacturer’, and all that supports it, has significantly passed its peak and government props can no longer sustain it.
Two things can be drawn from this. First, government programs that just rely on stimulating demand will not prove to be very effective. The transitions must take place. They will take place relatively rapidly or they will take place at a much slower pace if the government supports the status quo. We…the government…must be careful here.
Let me state this again…the adjustments are going to take place…whether or not the government slows them down!
Second, these areas of transition are going to create major new opportunities for investment to those that are lucky enough…or wise enough…to choose the right companies. Referring to the 1930s once again, one can reference many investments that provided exceptional returns to those that sought them out and committed to them during the period in which the economy was adjusting to the brave new world that was coming. It is my belief that there will be numerous such opportunities available to us in the near future.
Tuesday, November 25, 2008
The Need for Discipline
When a person or an organization is disciplined, they usually have plenty of options…many of them good ones.
When a person or an organization is undisciplined, options are usually limited…and none of them are good!
We are seeing or have seen quite a few examples of the second of these statements in recent days and in recent months. Where does one begin?
· The auto industry…
· The financial industry…
· The housing industry…
· And the list goes on…
Discipline starts at the top…and if the discipline is not there and this lack of discipline spreads…others began to see that “lack of discipline” is the standard of the day and they too began to feast on the beast. And, the lack of discipline spreads throughout the land.
My biggest disappointment is that financial discipline broke down in a major way. My background is in finance and I was brought up with the idea that finance people were the ultimate arbiters of discipline, both in terms of individual behavior as well as organizational behavior. The first CEO I worked for told me that, as the CFO, I had to speak up strongly for the discipline of finance for if I didn’t…there was no one else in the organization that would take that position!
Well, we have seen that when the financial standards break down…there is no one left to maintain discipline.
That is the past. We now have to deal with the future. The options are not good for anyone!
Let me reiterate the statement I made above…
The culture of an organization starts at the top!
So here we are…and we still have to do something…invest our money…run our businesses…live our lives…
There are several things that I believe have to take place…
First, we have to re-establish discipline…individually…in our families…in our businesses…in our government.
Second, we have got to retrench. Here we have conflicting objectives. On the one side, we have to get back to basics, strengthen our balance sheets, and focus on what we do best. In this we have to do the best that we can…and we should not assume that someone is going to bail us out. If we do…we are bound for disappointment.
The other side of this is that retrenchment weakens the economy because the basic plan is to “pull back”, cut spending, reduce debt, and, if we can, save. This is the other side of the lack of discipline. It is fun on the upside when discipline is eased…it is tough on the down side when discipline is being re-established. This leads to the third point.
Third, we must also be community focused, locally, regionally, nationally, and internationally. While we are establishing discipline once again, we must not isolate ourselves and refuse to talk with one another. We must engage one another, talk and dialogue about what is needed, and work together to introduce solutions that build up communities in this time of trial. This will include government programs to stimulate the economy. This will include new regulations to improve the process of finance and economics. This will include new efforts at international cooperation to help us to work together and support one another. This must include the acceptance of change because the world that is coming is going to be different from the world that we have left behind.
But, this effort is going to require leadership and it is going to require leadership at the very top.
On another note, we still have much to be thankful for…so let us give thanks for what we have.
Everyone…have a Happy Thanksgiving!
Mase
When a person or an organization is undisciplined, options are usually limited…and none of them are good!
We are seeing or have seen quite a few examples of the second of these statements in recent days and in recent months. Where does one begin?
· The auto industry…
· The financial industry…
· The housing industry…
· And the list goes on…
Discipline starts at the top…and if the discipline is not there and this lack of discipline spreads…others began to see that “lack of discipline” is the standard of the day and they too began to feast on the beast. And, the lack of discipline spreads throughout the land.
My biggest disappointment is that financial discipline broke down in a major way. My background is in finance and I was brought up with the idea that finance people were the ultimate arbiters of discipline, both in terms of individual behavior as well as organizational behavior. The first CEO I worked for told me that, as the CFO, I had to speak up strongly for the discipline of finance for if I didn’t…there was no one else in the organization that would take that position!
Well, we have seen that when the financial standards break down…there is no one left to maintain discipline.
That is the past. We now have to deal with the future. The options are not good for anyone!
Let me reiterate the statement I made above…
The culture of an organization starts at the top!
So here we are…and we still have to do something…invest our money…run our businesses…live our lives…
There are several things that I believe have to take place…
First, we have to re-establish discipline…individually…in our families…in our businesses…in our government.
Second, we have got to retrench. Here we have conflicting objectives. On the one side, we have to get back to basics, strengthen our balance sheets, and focus on what we do best. In this we have to do the best that we can…and we should not assume that someone is going to bail us out. If we do…we are bound for disappointment.
The other side of this is that retrenchment weakens the economy because the basic plan is to “pull back”, cut spending, reduce debt, and, if we can, save. This is the other side of the lack of discipline. It is fun on the upside when discipline is eased…it is tough on the down side when discipline is being re-established. This leads to the third point.
Third, we must also be community focused, locally, regionally, nationally, and internationally. While we are establishing discipline once again, we must not isolate ourselves and refuse to talk with one another. We must engage one another, talk and dialogue about what is needed, and work together to introduce solutions that build up communities in this time of trial. This will include government programs to stimulate the economy. This will include new regulations to improve the process of finance and economics. This will include new efforts at international cooperation to help us to work together and support one another. This must include the acceptance of change because the world that is coming is going to be different from the world that we have left behind.
But, this effort is going to require leadership and it is going to require leadership at the very top.
On another note, we still have much to be thankful for…so let us give thanks for what we have.
Everyone…have a Happy Thanksgiving!
Mase
Sunday, November 23, 2008
The Coming Stimulus Package
Yes, we do have a President (elect)! (See “A Whiff of Leadership?” posted November 22, 2008 at http://maseportfolio.blogspot.com/ . An economic stimulus package is in the works. The underlying philosophy…the risks of not doing something big are bigger than the risks associated with inflation and an economic cleanup when the economy shifts into first gear rather than reverse.
We have seen this attitude taken by the Federal Reserve. The Fed, as we have been writing about in this blog, has not wanted to be short in supplying liquidity to the financial markets. Federal Reserve assets have more than doubled in the past ten weeks. Chairman Ben Bernanke has been given the name Helicopter Ben during this barrage of funds. But, the argument goes, the risk is too great to not put money into the financial system until the financial markets begin to function again.
Liquidity is apparently not going to get the economy humming again…spending of the private sector is going into the tank. Lending in the financial markets is not going to kick-start consumer spending or investment spending…state and local government expenditure is also in decline…so the belief is that the federal government must step into the gap and stimulate incomes and employment.
The talk seems to indicate that the Obama economic stimulus package is going to be somewhere in the neighborhood of $700 billion…of similar size to the bailout package of a couple of months ago. The idea…like that of the bailout package…is that the stimulus package must be a large number.
One thing that is crucial in all of this is that the Obama administration must give off the impression that it is operating under control…that it is disciplined. This is a hard thing to do when the philosophy of the stimulus package is the one described above. However, the administration must appear to be very intentional, on top of the situation, and ready to do what is necessary in response to new information. That is, the Obama administration must rebuild confidence in the federal government. Establishing confidence at the top is necessary because it will help to rebuild the confidence of the whole system as I discuss in “Discipline or the Lack Thereof” posted November 20, 2009, at http://maseportfolio.blogspot.com/.
President-elect Obama seems to be aware of this need to set the tone for the future. I think people, and markets, will respond very well to this because they are so hungry for leadership at this time…and are very, very anxious. So, we see two things going on right now…first, the appointment of top quality people to important positions…and, second, the intentional effort to create programs and get the discussion in Congress and the economy going so that action can be taken as soon as possible. The important emphasis right now is that the effort is intentional, not passive or just reactive.
Just a final note about the apparent appointment of Larry Summers to head the National Economic Council: this may be an inspired choice. No one questions the intelligence and ability of Summers. Being in the White House, acting as the coordinator of the economic policies of the President, monitoring the President’s economic agenda, and serving as close advisor to the President may not only fit his personality best but may be the real place his talents can fill the needs of the nation. It also superbly complements the other appointments that the President-elect has made to build his economic team.
We have seen this attitude taken by the Federal Reserve. The Fed, as we have been writing about in this blog, has not wanted to be short in supplying liquidity to the financial markets. Federal Reserve assets have more than doubled in the past ten weeks. Chairman Ben Bernanke has been given the name Helicopter Ben during this barrage of funds. But, the argument goes, the risk is too great to not put money into the financial system until the financial markets begin to function again.
Liquidity is apparently not going to get the economy humming again…spending of the private sector is going into the tank. Lending in the financial markets is not going to kick-start consumer spending or investment spending…state and local government expenditure is also in decline…so the belief is that the federal government must step into the gap and stimulate incomes and employment.
The talk seems to indicate that the Obama economic stimulus package is going to be somewhere in the neighborhood of $700 billion…of similar size to the bailout package of a couple of months ago. The idea…like that of the bailout package…is that the stimulus package must be a large number.
One thing that is crucial in all of this is that the Obama administration must give off the impression that it is operating under control…that it is disciplined. This is a hard thing to do when the philosophy of the stimulus package is the one described above. However, the administration must appear to be very intentional, on top of the situation, and ready to do what is necessary in response to new information. That is, the Obama administration must rebuild confidence in the federal government. Establishing confidence at the top is necessary because it will help to rebuild the confidence of the whole system as I discuss in “Discipline or the Lack Thereof” posted November 20, 2009, at http://maseportfolio.blogspot.com/.
President-elect Obama seems to be aware of this need to set the tone for the future. I think people, and markets, will respond very well to this because they are so hungry for leadership at this time…and are very, very anxious. So, we see two things going on right now…first, the appointment of top quality people to important positions…and, second, the intentional effort to create programs and get the discussion in Congress and the economy going so that action can be taken as soon as possible. The important emphasis right now is that the effort is intentional, not passive or just reactive.
Just a final note about the apparent appointment of Larry Summers to head the National Economic Council: this may be an inspired choice. No one questions the intelligence and ability of Summers. Being in the White House, acting as the coordinator of the economic policies of the President, monitoring the President’s economic agenda, and serving as close advisor to the President may not only fit his personality best but may be the real place his talents can fill the needs of the nation. It also superbly complements the other appointments that the President-elect has made to build his economic team.
Saturday, November 22, 2008
A Whiff of Leadership?
In the last hour of trading Friday November 21, the stock market staged a significant rally.
The cause of the rally?
The leaked news that President-elect Obama was going to choose Timothy Geithner, President of the Federal Reserve Bank of New York as the next Secretary of the Treasury.
Market participants…hungry for leadership of any kind…reacted with enthusiasm to this possibility and began to buy. As I wrote in my blog of November 20, “Discipline or the Lack Thereof”, http://maseportfolio.blogspot.com/, the market, more than anything else right now, is thirsting for leadership.
It has also been leaked that on Monday President-elect Obama will introduce his economics team. Doing this will reduce a lot of uncertainty that has been hanging over the markets and provide some insight into the direction an Obama Presidency will head. If anything, Obama is showing with his choices that he is not afraid to have strong and intelligent people around him and will not be cowered by the presence of such people. In fact, he gives off the impression that he will thrive in such an environment.
And, the people he has indicated that he will appoint are pragmatic and successful people. They find what works!
I know there are many that are disappointed in the choices that Obama is making because they don’t think that these choices represent the “change” that Obama promised in the campaign. I think that they are wrong in this charge.
As I have written in many of my blog-posts, LEADERSHIP BEGINS AT THE TOP! It is the top person that sets the culture and it is the top person that sets the agenda. Change will come because the person at the top requests that those that report to him/her provide options that incorporate change. But, this kind of change is not going to take place with a bunch of neophytes that have to learn the ropes of government first and are unproven in working at this level of issue and pressure.
There must be tested members of the team…especially at this time! But, the charge that is given the team and encouraged is to provide some new answers and solutions to the problems that are now being faced. Top quality members of the team will jump at this opportunity and, with the continued strong guidance coming from the chief executive officer, they will produce results. Good leadership raises the level of performance of all those around the leader. As we have seen in the last eight years or so…weak leadership results in the sub-par performance of all those around the leader and none escape with an unblemished record.
One can be happy with the choices that are being made and still be concerned about the future of the financial markets and the economy. There is still a lot of bad news to come in the future. As Obama, himself, has said…there cannot be two Presidents at the same time. The new administration will not take office until January 20, 2009. And, even so, economies do not reverse direction overnight and there are a lot of dislocations in the United States economy and the world that need to be worked out.
There is still great concern that financial institutions have not really discovered or revealed just how badly their assets portfolios are underwater. The layoffs and dismissals of employees are growing and we have not seen how badly this is going to affect the spending of the consumer. The housing market still seems to be declining and no one knows how the situation with respect to foreclosures and mortgages that exceed housing prices are going to be worked out. With respect to businesses, bankruptcies are still increasing and a great deal of industrial restructuring is going to have to take place even though firms don’t go into bankruptcy. State and local governments are in bad shape financially. And, what about nonprofit organizations? Educational institutions? The sports and entertainment industries? And, so on and so on…
We are just in the early stages of this reconstruction of the United States…and the world…economy. Even with the best of appointments, the United States…and the world…is going to have to go through the process of restructuring.
However, let’s concentrate on what seems to be the good news for the present time. President-elect Obama is making appointments that are giving financial market participants some hope. Even though there is still a long, difficult road ahead of us…we will gravitate toward any sign of positive leadership that is available and hang on to the hope that is present in the possibility that that leadership will take us where we need to go!
The cause of the rally?
The leaked news that President-elect Obama was going to choose Timothy Geithner, President of the Federal Reserve Bank of New York as the next Secretary of the Treasury.
Market participants…hungry for leadership of any kind…reacted with enthusiasm to this possibility and began to buy. As I wrote in my blog of November 20, “Discipline or the Lack Thereof”, http://maseportfolio.blogspot.com/, the market, more than anything else right now, is thirsting for leadership.
It has also been leaked that on Monday President-elect Obama will introduce his economics team. Doing this will reduce a lot of uncertainty that has been hanging over the markets and provide some insight into the direction an Obama Presidency will head. If anything, Obama is showing with his choices that he is not afraid to have strong and intelligent people around him and will not be cowered by the presence of such people. In fact, he gives off the impression that he will thrive in such an environment.
And, the people he has indicated that he will appoint are pragmatic and successful people. They find what works!
I know there are many that are disappointed in the choices that Obama is making because they don’t think that these choices represent the “change” that Obama promised in the campaign. I think that they are wrong in this charge.
As I have written in many of my blog-posts, LEADERSHIP BEGINS AT THE TOP! It is the top person that sets the culture and it is the top person that sets the agenda. Change will come because the person at the top requests that those that report to him/her provide options that incorporate change. But, this kind of change is not going to take place with a bunch of neophytes that have to learn the ropes of government first and are unproven in working at this level of issue and pressure.
There must be tested members of the team…especially at this time! But, the charge that is given the team and encouraged is to provide some new answers and solutions to the problems that are now being faced. Top quality members of the team will jump at this opportunity and, with the continued strong guidance coming from the chief executive officer, they will produce results. Good leadership raises the level of performance of all those around the leader. As we have seen in the last eight years or so…weak leadership results in the sub-par performance of all those around the leader and none escape with an unblemished record.
One can be happy with the choices that are being made and still be concerned about the future of the financial markets and the economy. There is still a lot of bad news to come in the future. As Obama, himself, has said…there cannot be two Presidents at the same time. The new administration will not take office until January 20, 2009. And, even so, economies do not reverse direction overnight and there are a lot of dislocations in the United States economy and the world that need to be worked out.
There is still great concern that financial institutions have not really discovered or revealed just how badly their assets portfolios are underwater. The layoffs and dismissals of employees are growing and we have not seen how badly this is going to affect the spending of the consumer. The housing market still seems to be declining and no one knows how the situation with respect to foreclosures and mortgages that exceed housing prices are going to be worked out. With respect to businesses, bankruptcies are still increasing and a great deal of industrial restructuring is going to have to take place even though firms don’t go into bankruptcy. State and local governments are in bad shape financially. And, what about nonprofit organizations? Educational institutions? The sports and entertainment industries? And, so on and so on…
We are just in the early stages of this reconstruction of the United States…and the world…economy. Even with the best of appointments, the United States…and the world…is going to have to go through the process of restructuring.
However, let’s concentrate on what seems to be the good news for the present time. President-elect Obama is making appointments that are giving financial market participants some hope. Even though there is still a long, difficult road ahead of us…we will gravitate toward any sign of positive leadership that is available and hang on to the hope that is present in the possibility that that leadership will take us where we need to go!
Thursday, November 20, 2008
Discipline or the Lack Thereof
When a person or an organization is disciplined, they usually have plenty of options…many of them good ones.
When a person or an organization is undisciplined, options are usually limited…and none of them are good!
We are seeing or have seen quite a few examples of the second of these statements in recent days and in recent months. Where does one begin?
· The auto industry…
· The financial industry…
· The housing industry…
· And the list goes on…
Oh, how about the American government?
Doesn’t seem like our government has many options these days…and none of them seem to be good ones.
I have made clear over the past eleven months that I believe that culture starts at the top…and in this case, it starts with the leadership of the United States government. Right from the beginning the current administration exhibited an exceptional lack of discipline…except for the requirement of loyalty to its own people and programs. Large tax cuts followed by an expensive war underwritten by the monetary authority could in no way be considered to be a “conservative” economic program. And, this was just the start!
But, the culture spreads…and once others began to see that “lack of discipline” was the standard of the day, they too began to feast on the beast. And, the lack of discipline spread throughout the land.
My biggest disappointment is that financial discipline broke down in a major way. My background is in finance and I was brought up with the idea that finance people were the ultimate arbiters of discipline, both in terms of individual behavior as well as organizational behavior. The first CEO I worked for told me that I had to speak up strongly from the discipline of finance for if I didn’t…there was no one else in the organization that would take that position!
Well, we have seen that when the financial standards break down…there is no one left to maintain discipline.
That is the past. We now have to deal with the future. The options are not good for anyone!
Let me reiterate the statement I made above…
I believe that culture starts at the top!
Right now there is no leadership at the top and we will not have any until January 20, 2009. This is nothing new…we have not had any leadership at the top for quite some time now…and that is one reason for our current dilemma. Those at the top, early on, wanted to sneak out of the door before things broke loose in the financial or product markets…but they didn’t make it. Even though their hearts were not in it and they had no idea what to do, they were forced to act in some way in an attempt to alleviate the financial mess. But, now, more than ever, they are looking for the door.
So here we are…and we still have to do something…invest our money…run our businesses…live our lives…
There are several things, I believe, that have to take place…
First, we have to re-establish discipline…individually…in our families…in our businesses…in our government.
Second, we have got to retrench. Here we have conflicting objectives. On the one side, we have to get back to basics, strengthen our balance sheets, and focus on what we do best. In this we have to do the best that we can…and we should not assume that someone is going to bail us out. If we do…we are bound for disappointment.
The other side of this is that retrenchment weakens the economy because the basic plan is to “pull back”, cut spending, reduce debt, and, if we can, save. This is the other side of the lack of discipline. It is fun on the upside when discipline is eased…it is tough on the down side when discipline is being re-established. This leads to the third point.
Third, we must also be community focused, locally, regionally, nationally, and internationally. While we are establishing discipline once again, we must not isolate ourselves and refuse to talk with one another. We must engage one another, talk and dialogue about what is needed, and work together to introduce solutions that build up communities in this time of trial. This will include government programs to stimulate the economy. This will include new regulations to improve the process of finance and economics. This will include new efforts at international cooperation to help us to work together and support one another. This must include the acceptance of change because the world that is coming is going to be different from the world that we have left behind.
But, this effort is going to require leadership and it is going to require leadership at the very top. Hopefully, we are going to get that leadership.
Hopefully.
People are looking for the bottom…the bottom of the stock market plunge…the bottom of the housing collapse…the bottom of the financial crisis…and so on.
My view is unchanged. Until the United States gets some leadership in place with a strong vision of what it is going to do and moves forward in a very disciplined way…the search for a bottom in these areas is premature.
When a person or an organization is undisciplined, options are usually limited…and none of them are good!
We are seeing or have seen quite a few examples of the second of these statements in recent days and in recent months. Where does one begin?
· The auto industry…
· The financial industry…
· The housing industry…
· And the list goes on…
Oh, how about the American government?
Doesn’t seem like our government has many options these days…and none of them seem to be good ones.
I have made clear over the past eleven months that I believe that culture starts at the top…and in this case, it starts with the leadership of the United States government. Right from the beginning the current administration exhibited an exceptional lack of discipline…except for the requirement of loyalty to its own people and programs. Large tax cuts followed by an expensive war underwritten by the monetary authority could in no way be considered to be a “conservative” economic program. And, this was just the start!
But, the culture spreads…and once others began to see that “lack of discipline” was the standard of the day, they too began to feast on the beast. And, the lack of discipline spread throughout the land.
My biggest disappointment is that financial discipline broke down in a major way. My background is in finance and I was brought up with the idea that finance people were the ultimate arbiters of discipline, both in terms of individual behavior as well as organizational behavior. The first CEO I worked for told me that I had to speak up strongly from the discipline of finance for if I didn’t…there was no one else in the organization that would take that position!
Well, we have seen that when the financial standards break down…there is no one left to maintain discipline.
That is the past. We now have to deal with the future. The options are not good for anyone!
Let me reiterate the statement I made above…
I believe that culture starts at the top!
Right now there is no leadership at the top and we will not have any until January 20, 2009. This is nothing new…we have not had any leadership at the top for quite some time now…and that is one reason for our current dilemma. Those at the top, early on, wanted to sneak out of the door before things broke loose in the financial or product markets…but they didn’t make it. Even though their hearts were not in it and they had no idea what to do, they were forced to act in some way in an attempt to alleviate the financial mess. But, now, more than ever, they are looking for the door.
So here we are…and we still have to do something…invest our money…run our businesses…live our lives…
There are several things, I believe, that have to take place…
First, we have to re-establish discipline…individually…in our families…in our businesses…in our government.
Second, we have got to retrench. Here we have conflicting objectives. On the one side, we have to get back to basics, strengthen our balance sheets, and focus on what we do best. In this we have to do the best that we can…and we should not assume that someone is going to bail us out. If we do…we are bound for disappointment.
The other side of this is that retrenchment weakens the economy because the basic plan is to “pull back”, cut spending, reduce debt, and, if we can, save. This is the other side of the lack of discipline. It is fun on the upside when discipline is eased…it is tough on the down side when discipline is being re-established. This leads to the third point.
Third, we must also be community focused, locally, regionally, nationally, and internationally. While we are establishing discipline once again, we must not isolate ourselves and refuse to talk with one another. We must engage one another, talk and dialogue about what is needed, and work together to introduce solutions that build up communities in this time of trial. This will include government programs to stimulate the economy. This will include new regulations to improve the process of finance and economics. This will include new efforts at international cooperation to help us to work together and support one another. This must include the acceptance of change because the world that is coming is going to be different from the world that we have left behind.
But, this effort is going to require leadership and it is going to require leadership at the very top. Hopefully, we are going to get that leadership.
Hopefully.
People are looking for the bottom…the bottom of the stock market plunge…the bottom of the housing collapse…the bottom of the financial crisis…and so on.
My view is unchanged. Until the United States gets some leadership in place with a strong vision of what it is going to do and moves forward in a very disciplined way…the search for a bottom in these areas is premature.
Friday, November 14, 2008
Did Bernanke Panic?
I have been going over and over the events of the week beginning September 15, 2008 and I continue to come up with one basic conclusion: the reaction of Fed Chairman Ben Bernanke to the existing financial market strains was somewhat precipitous. A good start to understanding the time-line for that week is the article that appeared in the November 10 Wall Street Journal: “Paulson, Bernanke strained for consensus in Bailout” http://online.wsj.com/article/SB122628169939012475.html?mod=todays_us_page_one. The article begins “Federal Reserve Chairman Ben Bernanke reached the end of his rope on Wednesday afternoon, September 17.”
The week before, the week beginning September 8, the government nationalized Fannie Mae and Freddie Mac. Lehman Brothers was next. Secretary of the Treasury Hank Paulson put his foot down on this one…no bailout for Lehman…that’s final! Monday, September 15 Lehman Brothers filed for bankruptcy. The next troubled firm was AIG and frantic efforts were made to find additional cash for AIG. The basic signal being given to the market was…the bailouts are over. Lehman had to find its own way out or declare bankruptcy. AIG also had to find its own solution. The ‘free-market’ leanings of Paulson and others made for a reluctant leadership.
And then Tuesday evening came and the world changed. That evening the AIG $85 billion bailout was announced. When I heard this news around 9:00 PM that night, things just seemed to feel different: this was a different world than it was before. One didn’t know how…but it was different.
The Wall Street Journal article reports that by Wednesday afternoon “Bernanke reached the end of his rope”. He called Paulson and “with an occasional quaver in his voice” he spoke “unusually bluntly” to the Treasury Secretary. Paulson did not move immediately. He had to sleep on it. Thursday morning he committed.
Paulson called the leadership in Congress and asked for them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and “scared the daylights out of everyone.” Bernanke knew his history of the Great Depression and he knew currents events. He was very logical and very articulate. The leaders were told that they had to act and they had to act fast. The plan was to have a bill before Congress on Monday seeking Congressional approval (of both houses) by the following Friday. The Treasury Department had a bill ready (3 pages long) by midnight Saturday evening. The price tag…$700 billion. Why $700 billion? Because it was a big number!
As we know, the bill was rewritten and finally passed on Friday, October 3. What was the bill to do? No one really knew. The important thing, according to Bernanke, was that something was being done and that something was big!
And, the Fed did not stand idle. Helicopter Ben began to flood the financial markets with liquidity. The important thing was to get a lot of liquidity “out there” and worry about cleaning it up later, once the crisis was over. As I have reported elsewhere Reserve Bank Credit has risen from $890 billion in the banking week ending September 10, 2008 to about $2.2 trillion in the banking week ending November 12, 2008. (I have also noted that it took 94 years to get Reserve Bank Credit up to $890 billion and only nine weeks to have it more than double.) The rationale for this increase…the financial markets are in a liquidity trap and we don’t know how much is needed…we just cannot fail to supply enough!
Here we are in the middle of November. The basic conclusion relating to the financial crisis so far is that although we cannot tell whether or not the effort is working, we believe that things are better off than they would have been if the actions of Paulson and Bernanke had not been taken.
However, discontent is now being expressed. Paulson has changed the direction of the $700 billion bailout package and Congress is not particularly happy with this move and expressing its discontent. No one really seems to know what to do. Since events have slowed down and the ‘immediate’ need for the rapid passage of the package seems to have passed away…as might be expected…everyone and his brother and sister have got their hands out to get a piece of the bailout pie. Apparently, lobbyists are over-running the Treasury Department trying to get their share. And, Henry Paulson’s reputation has seemed to tank along with the stock market. (See the article by Rebecca Christie and Matthew Benjamin on Bloomberg.com titled “Paulson Credibility Takes Hit with Rescue-Plan Shift." It seems like no one can be a part of this administration without having their image tarnished.)
And, one question still remains. While Paulson and Bernanke seem to be running this whole show…where is the “decider”? The “decider” has apparently decided to hide out in the White House bunker. This has left Paulson and Bernanke hanging…trying to do something…with no steady hand overseeing their efforts and no vision for a plan.
It seems obvious that the driving force behind all the activity over the last nine weeks has been Ben Bernanke…he is, in a real sense, the initiator, if not the architect, of the hasty and ill-thought out bailout effort. On Wednesday afternoon, September 17 Bernanke reached the end of his rope. The rest, as they say, is history.
It is my personal hope that President-elect Obama will be able to name his own Chairman of the Board of Governors of the Federal Reserve System when he becomes President.
The week before, the week beginning September 8, the government nationalized Fannie Mae and Freddie Mac. Lehman Brothers was next. Secretary of the Treasury Hank Paulson put his foot down on this one…no bailout for Lehman…that’s final! Monday, September 15 Lehman Brothers filed for bankruptcy. The next troubled firm was AIG and frantic efforts were made to find additional cash for AIG. The basic signal being given to the market was…the bailouts are over. Lehman had to find its own way out or declare bankruptcy. AIG also had to find its own solution. The ‘free-market’ leanings of Paulson and others made for a reluctant leadership.
And then Tuesday evening came and the world changed. That evening the AIG $85 billion bailout was announced. When I heard this news around 9:00 PM that night, things just seemed to feel different: this was a different world than it was before. One didn’t know how…but it was different.
The Wall Street Journal article reports that by Wednesday afternoon “Bernanke reached the end of his rope”. He called Paulson and “with an occasional quaver in his voice” he spoke “unusually bluntly” to the Treasury Secretary. Paulson did not move immediately. He had to sleep on it. Thursday morning he committed.
Paulson called the leadership in Congress and asked for them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and “scared the daylights out of everyone.” Bernanke knew his history of the Great Depression and he knew currents events. He was very logical and very articulate. The leaders were told that they had to act and they had to act fast. The plan was to have a bill before Congress on Monday seeking Congressional approval (of both houses) by the following Friday. The Treasury Department had a bill ready (3 pages long) by midnight Saturday evening. The price tag…$700 billion. Why $700 billion? Because it was a big number!
As we know, the bill was rewritten and finally passed on Friday, October 3. What was the bill to do? No one really knew. The important thing, according to Bernanke, was that something was being done and that something was big!
And, the Fed did not stand idle. Helicopter Ben began to flood the financial markets with liquidity. The important thing was to get a lot of liquidity “out there” and worry about cleaning it up later, once the crisis was over. As I have reported elsewhere Reserve Bank Credit has risen from $890 billion in the banking week ending September 10, 2008 to about $2.2 trillion in the banking week ending November 12, 2008. (I have also noted that it took 94 years to get Reserve Bank Credit up to $890 billion and only nine weeks to have it more than double.) The rationale for this increase…the financial markets are in a liquidity trap and we don’t know how much is needed…we just cannot fail to supply enough!
Here we are in the middle of November. The basic conclusion relating to the financial crisis so far is that although we cannot tell whether or not the effort is working, we believe that things are better off than they would have been if the actions of Paulson and Bernanke had not been taken.
However, discontent is now being expressed. Paulson has changed the direction of the $700 billion bailout package and Congress is not particularly happy with this move and expressing its discontent. No one really seems to know what to do. Since events have slowed down and the ‘immediate’ need for the rapid passage of the package seems to have passed away…as might be expected…everyone and his brother and sister have got their hands out to get a piece of the bailout pie. Apparently, lobbyists are over-running the Treasury Department trying to get their share. And, Henry Paulson’s reputation has seemed to tank along with the stock market. (See the article by Rebecca Christie and Matthew Benjamin on Bloomberg.com titled “Paulson Credibility Takes Hit with Rescue-Plan Shift." It seems like no one can be a part of this administration without having their image tarnished.)
And, one question still remains. While Paulson and Bernanke seem to be running this whole show…where is the “decider”? The “decider” has apparently decided to hide out in the White House bunker. This has left Paulson and Bernanke hanging…trying to do something…with no steady hand overseeing their efforts and no vision for a plan.
It seems obvious that the driving force behind all the activity over the last nine weeks has been Ben Bernanke…he is, in a real sense, the initiator, if not the architect, of the hasty and ill-thought out bailout effort. On Wednesday afternoon, September 17 Bernanke reached the end of his rope. The rest, as they say, is history.
It is my personal hope that President-elect Obama will be able to name his own Chairman of the Board of Governors of the Federal Reserve System when he becomes President.
Thursday, November 13, 2008
The State of the Bailout
Treasury Secretary Paulson gave a press conference yesterday and indicated that things had changed…that the focus of the bailout effort would not be on the purchase of ‘toxic assets’ but would be aimed to assist the capital needs of financial institutions and consumer finance. This ‘shift’ in focus has been duly noted by the press.
Is the ‘bailout’ program having any success?
To answer this question, I am roughly in the same spot of someone I heard being interviewed on Marketplace on NPR radio: the ‘expert’ was asked the following question “Has the efforts to add liquidity to financial markets and financial institutions shown any results to date?” His reply: “I think things are better than they would have been if the efforts had not been made.”
Does that give you a lot of confidence?
I just don’t think that at this time anyone can say more. We are in the middle of a situation that no one present has ever been through. Fed Chairman Ben Bernanke, an expert on the Great Depression, has seen to it that financial markets and financial institutions have been flooded with liquidity. From the banking week ending September 10, 2008, Reserve Bank Credit has risen from about $890 billion to $2.1 trillion in the banking week ending November 5, 2008. This is roughly a 210% increase in a matter of 8 weeks. (Dare I remind you that it took 94 years for the total of Reserve Bank Credit to reach just $890 billion and only eight weeks to add $1,167 billion more!)
The $700 billion bailout bill…is now turning into a provision of capital for financial institutions…a provision that the Treasury hopes will buy time for institutions to work out their bad asset problems. The unknown question here is whether or not $700 billion is enough or will Congress have to float more funds.
The underlying rationale for the provision of all this liquidity is that either (1) officials are going to be blamed for allowing another MAJOR economic bust to take place or (2) these officials are going to have a problem cleaning up for all the liquidity that they have supplied to the financial markets on such short notice. Success, in the eyes of the officials means that they will have to clean up all the liquidity once the financial markets begin working again. Failure…”is not an option.”
No one knows at this time what is going to happen…
The idea is to keep tossing more and more liquidity into the pot until financial institutions feel that enough is enough! No one has been here before! This is all new!
Your guess is as good as mine…
And then there is the need for fiscal stimulus. The Congress is going to consider a stimulus package which seems to be similar to the first stimulus package they passed earlier this year. It will be aimed at consumers and, although it may not be any more effective than the first package, it can be done quickly, and it will show that the Congress IS doing something AND any little stimulus to the economy will be appreciated.
But, a second stimulus bill is being talked up. This one would be more capital intensive and aim at real projects like projects to rebuild the United States infrastructure. The idea here is that consumers are not going to start spending much until their job security is enhanced and they are sure that they will hold onto their homes. Businesses are going to have to restructure their balance sheets and have some confidence that consumers are going to start spending again before they loosen their purse strings and begin to invest in capital projects again. We seem to be a long way from either of these so the argument goes that the Government needs to engage in some real “Keynesian” pump-priming. The problem with a Government expenditure program like this is that it takes time to prepare and then, once the bill is passed, it takes time for the projects to be implemented. So, help does not come quickly.
And, what about the stock markets? When are they going to come back? Well, we hear all the time that the price an investor is willing to pay for a stock is dependent upon future cash flows. Right now, market expectations concerning future cash flows are pretty depressed and uncertain. Investors must be able to sense a turnaround in future cash flows for them to develop any confidence to begin purchasing stocks. And, investors don’t really know the value of the assets on the books of a large number of companies. To me, a good argument can still be made for more asset charge offs, more bankruptcies, and more depressed forecasts of future cash flows. In my mind, we are not near the bottom here, particularly given the situation described above.
What about uncertainty?
There is lots of it. Much of the uncertainty pertains to the programs that will be coming out of the new administration and the leadership that is put into place by that administration. It is still a long way until January 20, 2009. The current administration has been reluctant to do anything in the past until it became absolutely necessary to do something about the financial markets and the economy. They still want to pass on as much of the decision making as possible to the newly elected administration. So, we are still in a limbo as far as the national leadership is concerned.
What about the international situation and international leadership?
Also an unknown. People are talking about a new Bretton Woods…the international financial structure set up after the second world war. First off, that conference had two years of preparation and negotiation before the meeting was held. There has basically been little or no preparation for the meetings to take place this weekend. Second, the first Bretton Woods conference had seasoned world leadership behind it. That is not the case at the current time. Third, there is almost no intellectual consensus concerning the cause of the current situation and what should be done about it. Fourth, the world is still going through a economic downturn with more countries declaring every week that they are now in a recession.
International coordination and cooperation are going to have to be vital components of the world economic and financial markets in the future but for right now, I don’t think that we can expect much concrete to be forthcoming from the world community.
So, in my view, we will continue to see a downward drift to stock markets with a substantial amount of volatility. What else is new?
For bond markets, United States government securities are going to continue to be the pick for risk-averse investors and spreads will continue to rise between the least risky debt and that considered to be more risky. I saw that the spread between Baa corporate bonds and Aaa corporate bonds exceeded 300 basis points last week. For even lesser credits the spread has been increasing at an almost exponential rate. If there is any indication that the credit crisis is NOT over, it can be picked up from the market place.
The only thing that seems to be positive news at this time is that the Bush plan to get the price of oil below $60 a barrel has been tremendously successful so far!
Is the ‘bailout’ program having any success?
To answer this question, I am roughly in the same spot of someone I heard being interviewed on Marketplace on NPR radio: the ‘expert’ was asked the following question “Has the efforts to add liquidity to financial markets and financial institutions shown any results to date?” His reply: “I think things are better than they would have been if the efforts had not been made.”
Does that give you a lot of confidence?
I just don’t think that at this time anyone can say more. We are in the middle of a situation that no one present has ever been through. Fed Chairman Ben Bernanke, an expert on the Great Depression, has seen to it that financial markets and financial institutions have been flooded with liquidity. From the banking week ending September 10, 2008, Reserve Bank Credit has risen from about $890 billion to $2.1 trillion in the banking week ending November 5, 2008. This is roughly a 210% increase in a matter of 8 weeks. (Dare I remind you that it took 94 years for the total of Reserve Bank Credit to reach just $890 billion and only eight weeks to add $1,167 billion more!)
The $700 billion bailout bill…is now turning into a provision of capital for financial institutions…a provision that the Treasury hopes will buy time for institutions to work out their bad asset problems. The unknown question here is whether or not $700 billion is enough or will Congress have to float more funds.
The underlying rationale for the provision of all this liquidity is that either (1) officials are going to be blamed for allowing another MAJOR economic bust to take place or (2) these officials are going to have a problem cleaning up for all the liquidity that they have supplied to the financial markets on such short notice. Success, in the eyes of the officials means that they will have to clean up all the liquidity once the financial markets begin working again. Failure…”is not an option.”
No one knows at this time what is going to happen…
The idea is to keep tossing more and more liquidity into the pot until financial institutions feel that enough is enough! No one has been here before! This is all new!
Your guess is as good as mine…
And then there is the need for fiscal stimulus. The Congress is going to consider a stimulus package which seems to be similar to the first stimulus package they passed earlier this year. It will be aimed at consumers and, although it may not be any more effective than the first package, it can be done quickly, and it will show that the Congress IS doing something AND any little stimulus to the economy will be appreciated.
But, a second stimulus bill is being talked up. This one would be more capital intensive and aim at real projects like projects to rebuild the United States infrastructure. The idea here is that consumers are not going to start spending much until their job security is enhanced and they are sure that they will hold onto their homes. Businesses are going to have to restructure their balance sheets and have some confidence that consumers are going to start spending again before they loosen their purse strings and begin to invest in capital projects again. We seem to be a long way from either of these so the argument goes that the Government needs to engage in some real “Keynesian” pump-priming. The problem with a Government expenditure program like this is that it takes time to prepare and then, once the bill is passed, it takes time for the projects to be implemented. So, help does not come quickly.
And, what about the stock markets? When are they going to come back? Well, we hear all the time that the price an investor is willing to pay for a stock is dependent upon future cash flows. Right now, market expectations concerning future cash flows are pretty depressed and uncertain. Investors must be able to sense a turnaround in future cash flows for them to develop any confidence to begin purchasing stocks. And, investors don’t really know the value of the assets on the books of a large number of companies. To me, a good argument can still be made for more asset charge offs, more bankruptcies, and more depressed forecasts of future cash flows. In my mind, we are not near the bottom here, particularly given the situation described above.
What about uncertainty?
There is lots of it. Much of the uncertainty pertains to the programs that will be coming out of the new administration and the leadership that is put into place by that administration. It is still a long way until January 20, 2009. The current administration has been reluctant to do anything in the past until it became absolutely necessary to do something about the financial markets and the economy. They still want to pass on as much of the decision making as possible to the newly elected administration. So, we are still in a limbo as far as the national leadership is concerned.
What about the international situation and international leadership?
Also an unknown. People are talking about a new Bretton Woods…the international financial structure set up after the second world war. First off, that conference had two years of preparation and negotiation before the meeting was held. There has basically been little or no preparation for the meetings to take place this weekend. Second, the first Bretton Woods conference had seasoned world leadership behind it. That is not the case at the current time. Third, there is almost no intellectual consensus concerning the cause of the current situation and what should be done about it. Fourth, the world is still going through a economic downturn with more countries declaring every week that they are now in a recession.
International coordination and cooperation are going to have to be vital components of the world economic and financial markets in the future but for right now, I don’t think that we can expect much concrete to be forthcoming from the world community.
So, in my view, we will continue to see a downward drift to stock markets with a substantial amount of volatility. What else is new?
For bond markets, United States government securities are going to continue to be the pick for risk-averse investors and spreads will continue to rise between the least risky debt and that considered to be more risky. I saw that the spread between Baa corporate bonds and Aaa corporate bonds exceeded 300 basis points last week. For even lesser credits the spread has been increasing at an almost exponential rate. If there is any indication that the credit crisis is NOT over, it can be picked up from the market place.
The only thing that seems to be positive news at this time is that the Bush plan to get the price of oil below $60 a barrel has been tremendously successful so far!
Wednesday, November 5, 2008
What to do with the Fed!
There are two articles out this morning that discuss the Federal Reserve and the role of the Federal Reserve in the economy. One is in the New York Times and focuses upon Paul Volcker, “To Treat the Fed as Volcker Did,” http://www.nytimes.com/2008/11/05/business/05views.html?ref=business, and the other is in the Financial Times, “Deflation risk boosts case for inflation target,” http://www.ft.com/cms/s/0/19b92aea-aade-11dd-897c-000077b07658.html?nclick_check=1. Each of the articles recommends that the mandate of the Federal Reserve be changed from focusing upon inflation and full employment to just focusing upon inflation.
The basic argument of the articles is that focusing upon keeping inflation low and unemployment low is “structurally contradictory”…to quote the New York Times article. Whereas I agree with the fact that forcing the Fed to attempt to achieve these two objectives is “structurally contradictory” and that this dual mandate should be eliminated, I believe that we need to go even further in terms of the Fed’s mandated objective.
The Federal Reserve should be concerned with stable prices but there are problems with the use of inflation as the target of monetary policy. One of the problems is measurement. To use the Consumer Price Index (CPI) is troublesome. First of all, it is an index and is a constructed measure. Since it is an attempt to measure what happens during a period of time it is constructed in terms of “flow” variables and not “stock” variables.
The major example of this is the price of housing which needs to be the price of a “flow”…the flow of housing services consumed by consumers over a period of time…and not the price of the “stock”…the price at which a house sells for. Since there are many owner occupied houses in America, the price of the housing services…rent…must be estimated. How good this estimation is, particularly during a bubble like we have experienced in the past eight years, is questionable. And, the rental component is a relatively large one in the CPI because the consumption of housing services is a large portion of the consumer’s budget.
Second, there is the question about whether or not we should be concerned with the total CPI or only with the “core” CPI. By eliminating two of the more volatile components of the CPI we certainly get a more stable view of the movement in the prices of basic consumer goods, but does this really reflect the true rate of inflation that the consumer has to live with?
A third point, alluded to above, is the problem of “asset bubbles.” Asset bubbles occur in asset prices, not the price of the services…like the price of a house, not the rent one pays for the services one consumes over a period of time. Policymakers have a problem focusing on, say, rental prices, and the price of assets at the same time. There is no measure to balance the behavior of the two prices in terms of policy decisions. Hence, the dilemma that the Federal Reserve’s Open Market Committee has in making decisions as to the stance of monetary policy. Thus, I have problems with the idea that the central bank should focus on an inflation target as the sole objective of monetary policy.
What, then, do I recommend as a policy target for the Federal Reserve in its conduct of monetary policy? I believe that the policy target of the Federal Reserve should be the value of the United States dollar in foreign exchange markets. My support for this is…none other than…Paul Volcker. Volcker has written that “a nation’s exchange rate is the single most important price in its economy...So it is hard for any government to ignore large swings in its exchange rate….” This quote is from the book by Paul Volcker and Toyoo Gyohten, “Changing Fortunes: The World’s Money and the Threat to American Leadership,” (New York: Times Books, 1992), page 160.
There are two basic reasons for the Fed to focus on the nation’s exchange rate. First, a nation’s exchange rate is based upon the expectations of market participants. Market participants have expectations about relative rates of inflation in different countries around the world and are willing to put their money out into the market on the basis of these expectations. The inflation rates they are interested in are related not only to “flow” prices but also to “stock” prices. Thus, international investment managers move money around based upon inflation in asset prices as well as consumer prices.
The value of the United States dollar began to decline in early 2002. It declined almost steadily…with some periods of stability…into the summer of 2008. Something was going on in the United States economy relative to other countries during this period of time. As Volcker argues “it is hard for any government to ignore large swings in its exchange rate…” and yet the United States government did!
My point is…that participants in international financial markets were trying to tell us something. Market participants reacted to the huge deficits created by tax cuts and the ‘war on terror’ and the extremely low interest rates supported by the Federal Reserve by selling dollars. In terms of inflation they were telling us that the inflation taking place in the United States was going to be substantial relative to the inflation that was going to occur in other countries. Although this inflation did not seem to get out-of-hand in terms of the Consumer Price Index, other things going on in the United States…like the housing bubble!
Markets tell us something and we need to pay attention to them! Markets swings are based upon future expectations rather than on historical data as is used in the construction of price indices. We need to observe market prices and attempt to understand what the market is trying to tell us. My argument is that this is more relevant to the conduct of monetary policy than is focusing upon an inflation rate based on the historical record. I agree with Volcker, “a nation’s exchange rate is the single most important price in its economy.”
Therefore, I believe that the Federal Reserve should target the value of the United States dollar for the conduct of monetary policy. This does not mean that the target should be a fixed one. Conditions change…the economic policies of other countries may vary…and there may be other reasons such as the pricing of oil by the oil cartel or war breaking out somewhere in the world.
And, this leads to my second point…the United States must act as a partner in the world. Focusing upon the exchange rate forces the policy makers, when they are determining the direction of monetary policy, to consider what other nations are doing. America has ignored other nations over the past eight years until the current crisis began to unfold. We cannot afford to go forward into the future independent of what the rest of the world is doing. See my post of November 1, 2008, “The Need for an American Economic Strategy,” http://maseportfolio.blogspot.com/.
One final point about the Federal Reserve at this time: I believe that Chairman Ben Bernanke should step down as Chairman of the Board of Governors of the Federal Reserve System so that the new President can appoint a Chairman of his own choosing. Confidence and trust is going to be important for the success of the new President and I do not believe that Bernanke provides these commodities. My own choice for the new Chairman of Board of Governors is Timothy Geithner, the current President of the Federal Reserve Bank of New York. Geithner is not an academic and has been through many storms, not only in his current position, but in the Rubin Treasury Department. I think he would be an excellent choice and would come into the position with the confidence and trust of participants in international financial markets as well as in governmental circles around the world.
The basic argument of the articles is that focusing upon keeping inflation low and unemployment low is “structurally contradictory”…to quote the New York Times article. Whereas I agree with the fact that forcing the Fed to attempt to achieve these two objectives is “structurally contradictory” and that this dual mandate should be eliminated, I believe that we need to go even further in terms of the Fed’s mandated objective.
The Federal Reserve should be concerned with stable prices but there are problems with the use of inflation as the target of monetary policy. One of the problems is measurement. To use the Consumer Price Index (CPI) is troublesome. First of all, it is an index and is a constructed measure. Since it is an attempt to measure what happens during a period of time it is constructed in terms of “flow” variables and not “stock” variables.
The major example of this is the price of housing which needs to be the price of a “flow”…the flow of housing services consumed by consumers over a period of time…and not the price of the “stock”…the price at which a house sells for. Since there are many owner occupied houses in America, the price of the housing services…rent…must be estimated. How good this estimation is, particularly during a bubble like we have experienced in the past eight years, is questionable. And, the rental component is a relatively large one in the CPI because the consumption of housing services is a large portion of the consumer’s budget.
Second, there is the question about whether or not we should be concerned with the total CPI or only with the “core” CPI. By eliminating two of the more volatile components of the CPI we certainly get a more stable view of the movement in the prices of basic consumer goods, but does this really reflect the true rate of inflation that the consumer has to live with?
A third point, alluded to above, is the problem of “asset bubbles.” Asset bubbles occur in asset prices, not the price of the services…like the price of a house, not the rent one pays for the services one consumes over a period of time. Policymakers have a problem focusing on, say, rental prices, and the price of assets at the same time. There is no measure to balance the behavior of the two prices in terms of policy decisions. Hence, the dilemma that the Federal Reserve’s Open Market Committee has in making decisions as to the stance of monetary policy. Thus, I have problems with the idea that the central bank should focus on an inflation target as the sole objective of monetary policy.
What, then, do I recommend as a policy target for the Federal Reserve in its conduct of monetary policy? I believe that the policy target of the Federal Reserve should be the value of the United States dollar in foreign exchange markets. My support for this is…none other than…Paul Volcker. Volcker has written that “a nation’s exchange rate is the single most important price in its economy...So it is hard for any government to ignore large swings in its exchange rate….” This quote is from the book by Paul Volcker and Toyoo Gyohten, “Changing Fortunes: The World’s Money and the Threat to American Leadership,” (New York: Times Books, 1992), page 160.
There are two basic reasons for the Fed to focus on the nation’s exchange rate. First, a nation’s exchange rate is based upon the expectations of market participants. Market participants have expectations about relative rates of inflation in different countries around the world and are willing to put their money out into the market on the basis of these expectations. The inflation rates they are interested in are related not only to “flow” prices but also to “stock” prices. Thus, international investment managers move money around based upon inflation in asset prices as well as consumer prices.
The value of the United States dollar began to decline in early 2002. It declined almost steadily…with some periods of stability…into the summer of 2008. Something was going on in the United States economy relative to other countries during this period of time. As Volcker argues “it is hard for any government to ignore large swings in its exchange rate…” and yet the United States government did!
My point is…that participants in international financial markets were trying to tell us something. Market participants reacted to the huge deficits created by tax cuts and the ‘war on terror’ and the extremely low interest rates supported by the Federal Reserve by selling dollars. In terms of inflation they were telling us that the inflation taking place in the United States was going to be substantial relative to the inflation that was going to occur in other countries. Although this inflation did not seem to get out-of-hand in terms of the Consumer Price Index, other things going on in the United States…like the housing bubble!
Markets tell us something and we need to pay attention to them! Markets swings are based upon future expectations rather than on historical data as is used in the construction of price indices. We need to observe market prices and attempt to understand what the market is trying to tell us. My argument is that this is more relevant to the conduct of monetary policy than is focusing upon an inflation rate based on the historical record. I agree with Volcker, “a nation’s exchange rate is the single most important price in its economy.”
Therefore, I believe that the Federal Reserve should target the value of the United States dollar for the conduct of monetary policy. This does not mean that the target should be a fixed one. Conditions change…the economic policies of other countries may vary…and there may be other reasons such as the pricing of oil by the oil cartel or war breaking out somewhere in the world.
And, this leads to my second point…the United States must act as a partner in the world. Focusing upon the exchange rate forces the policy makers, when they are determining the direction of monetary policy, to consider what other nations are doing. America has ignored other nations over the past eight years until the current crisis began to unfold. We cannot afford to go forward into the future independent of what the rest of the world is doing. See my post of November 1, 2008, “The Need for an American Economic Strategy,” http://maseportfolio.blogspot.com/.
One final point about the Federal Reserve at this time: I believe that Chairman Ben Bernanke should step down as Chairman of the Board of Governors of the Federal Reserve System so that the new President can appoint a Chairman of his own choosing. Confidence and trust is going to be important for the success of the new President and I do not believe that Bernanke provides these commodities. My own choice for the new Chairman of Board of Governors is Timothy Geithner, the current President of the Federal Reserve Bank of New York. Geithner is not an academic and has been through many storms, not only in his current position, but in the Rubin Treasury Department. I think he would be an excellent choice and would come into the position with the confidence and trust of participants in international financial markets as well as in governmental circles around the world.
Saturday, November 1, 2008
The Need for an American Economic Strategy
The lead article in this week’s Business Week (November 10, 2008) is by Michael Porter, the Bishop William Lawrence University Professor at the Harvard Business School. Porter is calling for the next President to formulate an economic strategy for the United States.
Formulating and promoting such a strategy will help the country in two ways. First, it will start to provide some leadership to the country in economic affairs…leadership that has been sorely missing in recent years. Second, it will provide a framework that “embodies clear priorities” and will lay out an understanding of the strengths that the United States needs to preserve and the weaknesses that threaten the prosperity of the United States the most. Porter strongly argues that the “United States lacks a coherent strategy for addressing its own challenges.”
I could not agree more that the new President needs to provide strong leadership in establishing the goals and objectives to be strived for in the area of economic strategy and needs to direct everything that he does to reflect the effort to attain these goals and objectives. In my experience running companies or leading organizations I felt it was my responsibility as the leader of the organization to make clear what we were striving for and then back up this vision with my performance: that is by being consistent with this vision in all my actions and in all my statements.
Let me now highlight what I think are the most important things in Porter’s list of what should be included in the economic strategy. I can’t argue with the general thrust of what Porter says, but, of course, I have my own priorities. I will discuss three specific areas: education, innovation and entrepreneurship, and global integration.
This country was founded upon the spread of information and the role that education plays in this spread. To me, the modern world really started when moveable type was invented because this allowed for the printing of books and pamphlets and newspapers and all sorts of other things. With this invention, information spread and people got to read things they had never seen before and compare ideas in a way they never had a chance to do before. With this new knowledge they could debate different theories, see and compare different data sets, and argue and debate and dialogue. The result was the Reformation, the Counter-Reformation, the Enlightenment, Modernity, and even Post-Modernity along with many other less well known movements.
The founding of America was also a result of this spread of information and early on it was argued that a democracy such as this should have an educated people so that they could be aware of the issues being faced by the country and could intelligently elect their leaders. Being able to read was also considered to be very important in establishing the type of moral climate that would support a democratically elected government. Being able to read meant that citizens could read the Bible for themselves and interpret it for themselves…something that was not always allowed in the Old World. Schools…and colleges were important…education was stressed. And so major institutions of higher learning were established…Harvard, Yale, Columbia, Princeton, the University of Pennsylvania, and William and Mary, to name a few.
Americans found out later that having schools and colleges contributed to the expansion of knowledge and the expansion of knowledge was good for innovation and the expansion of trade. Technical schools and colleges evolved. And, this allowed for information to continue to spread and for new ideas to circulate and for new things to be tried…and the country grew and prospered.
The American success story hinges to a great deal on the creation, evolution, and enhancement of higher education in the United States. But, Porter writes, “America now ranks 12th in tertiary (college or higher) educational attainment for 25- to 34-year-olds. We have made no progress in this vital area over the past 30 years, unlike almost every other country.”
He goes on, “All Americans know that the public education system is a serious weakness….In the global economy, just being an American is no longer enough to guarantee a good job at a good wage. Without world-class education and skills, Americans must compete with workers in other countries for jobs that could be moved anywhere.” Early in this decade I spent four years taking classes in Princeton. I was amazed to see who populated the Firestone Library. I could not argue that Americans were even a significant minority in attendance there. I have also noticed a similar situation at Penn State’s main campus. Education is not a major priority of Americans these days, yet Americans will be the first to decry the movement of jobs elsewhere in the world.
Innovation and entrepreneurship have been the workhorses of the American economy. Porter writes, “The United States has an unparalleled environment for entrepreneurship and starting new companies.” He adds, “United States entrepreneurship has been fed by a science, technology, and innovation machine that remains by far the best in the world.” We have this engine as the primary driver of American growth and prosperity. Yet, “America’s belief in competition is waning.” Also, there is resentment and fear directed at new ways of doing things and new directions of research. People on the edge of their professions or fields of study are referred to as “elites”, as “celebrities”, as “anti-religious.” Change threatens people. New ideas threaten people. People that others don’t understand threaten people.
America is facing a split, as are other areas of the world. See my post, “The Split in America,” October 29, 2008, http://masepoliticalcommentary.blogspot.com/. We cannot allow the environment of innovation and entrepreneurship that has existed in the United States to fall away. The next President of the United States must work hard to ensure the continued presence of an environment that is receptive and encouraging to those that want to step out and take chances.
Finally, the next President must work to encourage a feeling of trust and partnership within the world community when it comes to economics and finance. For too much of the past eight years or so, America has tended to act unilaterally when it comes to policies and programs related to international trade and finance. The United States can no longer continue to do this. The current world crisis, if it shows anything, shows that the world is too integrated and nations are too dependent upon one another to act in any other way than in partnership with one another.
People believed at one time that other major economies could “disconnect” from the United States if the United States wanted to continue acting independently of them. This has proven to be a fallacy. Somehow, someway nations and the leaders of nations are going to have to work together to begin to build, even the most elemental and rudimentary parts of, a world system. We can all retreat into our own little shells like the nations did after World War I. But, like they found out then, this can only lead to further conflict and possibly an even worse war. American, even though it remains the largest economy and the most powerful nation in the world, must act as a partner and help to build up other nations, not ignore them or put them down.
The next President has a lot of business already on his plate. But, if America is going to move forward, the next President is going to have to show some leadership. Porter writes that “America’s political system, especially as it has evolved in recent times, almost guarantees an absence of strategic thinking at the federal level. Government leaders react to current events piecemeal, rather than developing a strategy that unfolds over years.”
The next President can deal in this little area or that little program or with this little disturbance if he wants to. What America really needs, however, is for the next President to give us a vision…something we can get behind…so that we, at least, know what direction he is trying to move us in.
“Now is the moment when the United States needs to break this cycle,” Porter cries. Now is the moment for some leadership.
Mr. President-elect…go for it!
Formulating and promoting such a strategy will help the country in two ways. First, it will start to provide some leadership to the country in economic affairs…leadership that has been sorely missing in recent years. Second, it will provide a framework that “embodies clear priorities” and will lay out an understanding of the strengths that the United States needs to preserve and the weaknesses that threaten the prosperity of the United States the most. Porter strongly argues that the “United States lacks a coherent strategy for addressing its own challenges.”
I could not agree more that the new President needs to provide strong leadership in establishing the goals and objectives to be strived for in the area of economic strategy and needs to direct everything that he does to reflect the effort to attain these goals and objectives. In my experience running companies or leading organizations I felt it was my responsibility as the leader of the organization to make clear what we were striving for and then back up this vision with my performance: that is by being consistent with this vision in all my actions and in all my statements.
Let me now highlight what I think are the most important things in Porter’s list of what should be included in the economic strategy. I can’t argue with the general thrust of what Porter says, but, of course, I have my own priorities. I will discuss three specific areas: education, innovation and entrepreneurship, and global integration.
This country was founded upon the spread of information and the role that education plays in this spread. To me, the modern world really started when moveable type was invented because this allowed for the printing of books and pamphlets and newspapers and all sorts of other things. With this invention, information spread and people got to read things they had never seen before and compare ideas in a way they never had a chance to do before. With this new knowledge they could debate different theories, see and compare different data sets, and argue and debate and dialogue. The result was the Reformation, the Counter-Reformation, the Enlightenment, Modernity, and even Post-Modernity along with many other less well known movements.
The founding of America was also a result of this spread of information and early on it was argued that a democracy such as this should have an educated people so that they could be aware of the issues being faced by the country and could intelligently elect their leaders. Being able to read was also considered to be very important in establishing the type of moral climate that would support a democratically elected government. Being able to read meant that citizens could read the Bible for themselves and interpret it for themselves…something that was not always allowed in the Old World. Schools…and colleges were important…education was stressed. And so major institutions of higher learning were established…Harvard, Yale, Columbia, Princeton, the University of Pennsylvania, and William and Mary, to name a few.
Americans found out later that having schools and colleges contributed to the expansion of knowledge and the expansion of knowledge was good for innovation and the expansion of trade. Technical schools and colleges evolved. And, this allowed for information to continue to spread and for new ideas to circulate and for new things to be tried…and the country grew and prospered.
The American success story hinges to a great deal on the creation, evolution, and enhancement of higher education in the United States. But, Porter writes, “America now ranks 12th in tertiary (college or higher) educational attainment for 25- to 34-year-olds. We have made no progress in this vital area over the past 30 years, unlike almost every other country.”
He goes on, “All Americans know that the public education system is a serious weakness….In the global economy, just being an American is no longer enough to guarantee a good job at a good wage. Without world-class education and skills, Americans must compete with workers in other countries for jobs that could be moved anywhere.” Early in this decade I spent four years taking classes in Princeton. I was amazed to see who populated the Firestone Library. I could not argue that Americans were even a significant minority in attendance there. I have also noticed a similar situation at Penn State’s main campus. Education is not a major priority of Americans these days, yet Americans will be the first to decry the movement of jobs elsewhere in the world.
Innovation and entrepreneurship have been the workhorses of the American economy. Porter writes, “The United States has an unparalleled environment for entrepreneurship and starting new companies.” He adds, “United States entrepreneurship has been fed by a science, technology, and innovation machine that remains by far the best in the world.” We have this engine as the primary driver of American growth and prosperity. Yet, “America’s belief in competition is waning.” Also, there is resentment and fear directed at new ways of doing things and new directions of research. People on the edge of their professions or fields of study are referred to as “elites”, as “celebrities”, as “anti-religious.” Change threatens people. New ideas threaten people. People that others don’t understand threaten people.
America is facing a split, as are other areas of the world. See my post, “The Split in America,” October 29, 2008, http://masepoliticalcommentary.blogspot.com/. We cannot allow the environment of innovation and entrepreneurship that has existed in the United States to fall away. The next President of the United States must work hard to ensure the continued presence of an environment that is receptive and encouraging to those that want to step out and take chances.
Finally, the next President must work to encourage a feeling of trust and partnership within the world community when it comes to economics and finance. For too much of the past eight years or so, America has tended to act unilaterally when it comes to policies and programs related to international trade and finance. The United States can no longer continue to do this. The current world crisis, if it shows anything, shows that the world is too integrated and nations are too dependent upon one another to act in any other way than in partnership with one another.
People believed at one time that other major economies could “disconnect” from the United States if the United States wanted to continue acting independently of them. This has proven to be a fallacy. Somehow, someway nations and the leaders of nations are going to have to work together to begin to build, even the most elemental and rudimentary parts of, a world system. We can all retreat into our own little shells like the nations did after World War I. But, like they found out then, this can only lead to further conflict and possibly an even worse war. American, even though it remains the largest economy and the most powerful nation in the world, must act as a partner and help to build up other nations, not ignore them or put them down.
The next President has a lot of business already on his plate. But, if America is going to move forward, the next President is going to have to show some leadership. Porter writes that “America’s political system, especially as it has evolved in recent times, almost guarantees an absence of strategic thinking at the federal level. Government leaders react to current events piecemeal, rather than developing a strategy that unfolds over years.”
The next President can deal in this little area or that little program or with this little disturbance if he wants to. What America really needs, however, is for the next President to give us a vision…something we can get behind…so that we, at least, know what direction he is trying to move us in.
“Now is the moment when the United States needs to break this cycle,” Porter cries. Now is the moment for some leadership.
Mr. President-elect…go for it!
Thursday, October 30, 2008
On Daming "Free" Markets!
Currently, there is a rush to jump on the bandwagon to damn the concept of free markets…or, at least “freer” markets. I say “freer” markets because the American economy has never had totally “free” markets. But, the current meltdown has coincided with the claim that “freer” markets don’t work!
We even see the sorry spectacle of Alan Greenspan appearing before Congress and admitting that he was “shocked” that the system didn’t work as he had imagined it would. The problem with this, in my mind, is that Alan Greenspan, in his responses, had to take one of two positions. The first one was to admit that his conceptual thinking about how financial markets and the economy worked was wrong. The second one was that he…and the Fed…and the Bush administration…screwed up royally.
Perhaps there was really only one response that Greenspan considered.
It is important to consider the second possible response, however, because it is important for our consideration of how we interpret the financial meltdown and the causes of this meltdown. How we interpret these events will influence our efforts to regulate or re-regulate the financial system.
Returning to the concept of “freer” markets one must argue that we can never achieve completely free markets, that there will always be laws, regulations, and regulators that impact financial and economic markets. The issue is where the balance is struck between more oversight and control and less oversight and control.
The danger is that if we totally focus on the idea that markets don’t work very well without a lot of regulation and oversight we will set the balance further to the side of constraining and controlling the economic and financial system. In my opinion, this would not be helpful, in the longer run, to the financial system and the health of the economy and economic growth.
Certainly, industry leaders cannot be absolved of all responsibility. It can be strongly argued that the past eight years or so did not produce a stellar performance by the leaders of finance and commerce in the United States. Risk management and executive oversight fell fall short of what should have been desired. But, this is not the entire story.
For economic and financial markets to function in an effective way they must be associated with “appropriate” monetary and fiscal policies. I have argued for a long time that the monetary and fiscal policies of the Bush administration have been abysmal and these policies created an environment that encouraged the behavior that was exhibited by our leaders of finance and commerce. (See my post of October 28, 2008, “The Threat of Too Much Regulation,” http://maseportfolio.blogspot.com/.)
My big fear is that, in a rush to judgment, all the blame will be placed upon the greed of the bankers and the fact that financial markets don’t work well if they don’t have a lot of regulation. If we re-regulate American finance and industry assuming this to be the only story, I fear that we will only be dampening our future and our children’s future.
Also, if we make this assumption about our bankers and the financial markets we will let Mr. Bush and Mr. Greenspan “off the hook”. Our governmental leaders are at least as guilty of the current financial morass as are our industry leaders…IF NOT MORE! If we are to re-regulate financial institutions and financial markets in a sensible and realistic way we cannot ignore the role that our government leaders played in the current crisis. WE MUST BE VERY CAREFUL NOT TO OVER-REGULATE!
We even see the sorry spectacle of Alan Greenspan appearing before Congress and admitting that he was “shocked” that the system didn’t work as he had imagined it would. The problem with this, in my mind, is that Alan Greenspan, in his responses, had to take one of two positions. The first one was to admit that his conceptual thinking about how financial markets and the economy worked was wrong. The second one was that he…and the Fed…and the Bush administration…screwed up royally.
Perhaps there was really only one response that Greenspan considered.
It is important to consider the second possible response, however, because it is important for our consideration of how we interpret the financial meltdown and the causes of this meltdown. How we interpret these events will influence our efforts to regulate or re-regulate the financial system.
Returning to the concept of “freer” markets one must argue that we can never achieve completely free markets, that there will always be laws, regulations, and regulators that impact financial and economic markets. The issue is where the balance is struck between more oversight and control and less oversight and control.
The danger is that if we totally focus on the idea that markets don’t work very well without a lot of regulation and oversight we will set the balance further to the side of constraining and controlling the economic and financial system. In my opinion, this would not be helpful, in the longer run, to the financial system and the health of the economy and economic growth.
Certainly, industry leaders cannot be absolved of all responsibility. It can be strongly argued that the past eight years or so did not produce a stellar performance by the leaders of finance and commerce in the United States. Risk management and executive oversight fell fall short of what should have been desired. But, this is not the entire story.
For economic and financial markets to function in an effective way they must be associated with “appropriate” monetary and fiscal policies. I have argued for a long time that the monetary and fiscal policies of the Bush administration have been abysmal and these policies created an environment that encouraged the behavior that was exhibited by our leaders of finance and commerce. (See my post of October 28, 2008, “The Threat of Too Much Regulation,” http://maseportfolio.blogspot.com/.)
My big fear is that, in a rush to judgment, all the blame will be placed upon the greed of the bankers and the fact that financial markets don’t work well if they don’t have a lot of regulation. If we re-regulate American finance and industry assuming this to be the only story, I fear that we will only be dampening our future and our children’s future.
Also, if we make this assumption about our bankers and the financial markets we will let Mr. Bush and Mr. Greenspan “off the hook”. Our governmental leaders are at least as guilty of the current financial morass as are our industry leaders…IF NOT MORE! If we are to re-regulate financial institutions and financial markets in a sensible and realistic way we cannot ignore the role that our government leaders played in the current crisis. WE MUST BE VERY CAREFUL NOT TO OVER-REGULATE!
Monday, October 27, 2008
The Threat Of Too Much Regulation
Once again, Tom Friedman of the New York Times has some very worthwhile things to say. Whereas one may not totally agree with all of his arguments, I believe that one can always gain something by reading him.
This past Sunday, Friedman commented upon the government bailout and the coming effort to re-regulate the financial markets: http://www.nytimes.com/2008/10/26/opinion/26friedman.html. He quotes the consultant David Smick: “Government bailouts and guarantees, while at times needed, always come with unintended consequences.” Then he goes on to say that he, Friedman, “is not criticizing the decision to shore up the banks…We need better regulation. But, most of all, we need better management.”
Friedman concludes, however, that “We must not overshoot in regulating the markets because they (the bankers) overshot in their risk-taking.”
This is all the further the argument is carried these days: they (the bankers) “overshot in their risk-taking.” There is very little discussion about how the environment was created in which this excessive risk-taking arose. Since almost all of the blame is falling on the bankers, it is to be expected that almost all the re-regulation will also fall on the bankers.
But, Friedman argues, “We must not overshoot in regulating the markets…” and rightfully so. We must not overshoot in regulating the markets because maybe…just maybe…the environment for excessive risk-taking was created by the government and not by the bankers. This is not a new argument, but it is one that tends to be forgotten while people focus primarily on the current turmoil that is swirling around them. It also tends to be forgotten because economic consequences tend to occur with a substantial lag behind the causative events that started everything off.
In looking for such a cause, I once again return to the failure of the current administration to combat the decline in the value of the United States dollar. The performance of a currency relative to other currencies depends upon market perceptions about future rates of inflation. If the inflation rate in the home country is expected to be more rapid than the inflation rates in other countries, the value of the home country’s currency will tend to decline. The value of the home country’s currency will tend to appreciate when the opposite is the case.
The value of the United States dollar began to decline in 2002 and continued to decline through August 2008. This decline followed about seven years in which the value of the United States dollar rose. So, it can be assumed that participants in foreign exchange markets came to believe that future inflation in the United States would exceed that in other countries, a reversal of the belief that had existed over the previous decade.
What seemed to be the cause of this change in expectations? The change seems to be very closely related to the Bush tax cuts, the consequent anticipation of substantial deficits in the Federal budget, and the acceleration in the costs associated with the war on terror and in Iraq. The deficits themselves are not considered to be inflationary, but in the western world, every major increase in government budget deficits were connected with a monetization of the debt at some time in the future. Given the size of the projected deficits it was expected that the United States government could not avoid monetizing a large portion of these anticipated deficits.
In the case of the United States, however, an unexpected path was taken. The large deficits of the United States government were underwritten by China, Middle-Eastern oil producing nations, and others. In effect, foreign governments monetized the Bush deficits taking the pressure off the Federal Reserve, even allowing the Fed to keep short term interest rates at extremely low levels for three-to-four years. This was something unheard of in terms of global economics.
And, where did a great deal of the funds connected with the monetized debt go? It went into the United States housing market. The history of financial innovation in the late twentieth century is a fascinating one. Of especial interest is the growth of the market for securitized mortgages. The first package of securitized mortgages came to market in the first half of the 1970s. By the middle of the 1980s, mortgage-related securities became the largest component of the capital markets. Playing in this end of the market became ‘sexier’ than any other. And, the attraction grew and grew and drew in more and more new players from around the world. The market for securitized mortgages became the playground for the world and attracted a large portion of the United States dollars now circulating around the globe.
Thus, through the market for securitized mortgages, the United States housing market became one of the bubbles that resulted from the ‘monetizing’ of the large deficits that were created by the United States government. The expected United States inflation came about through unusual channels, but the participants in the foreign exchange markets were correct in calling for the decline in the value of the United States dollar.
In my view, the speculative atmosphere that evolved in financial markets and financial institutions which resulted in excessive risk-taking was the result of the failure of policy makers to defend the value of the United States dollar. Most other countries in the world that created government deficits that were monetized had to back off from such policies as the value of their currencies declined on foreign exchange markets. This response was due to the resulting inflation in those countries. (France in the 1980s is a prime example.) These countries did not have others within the world like China and the countries of the Middle East, to absorb their debt the way that China and the Middle East purchased the United States debt.
The massive United States government deficits went global and in going global helped flood world financial markets with funds that narrowed interest rate spreads and created an environment where more and more risk had to be taken to keep institutional returns up. Financial leverage and other techniques of financial engineering became commonplace. The structure of the marketplace became more and more fragile.
The rest is history. But, now we have to deal with the aftermath. In my mind, the fault for the financial collapse does not lie solely with the bankers…a large share of blame should fall to the Government officials that created the environment in which the bankers had to operate. Yes, one can argue that the bankers took on excessive risk. But, one cannot let the Government officials off the hook. We cannot afford to over-regulate the financial markets because the government was irresponsible.
Yes, the financial markets need to be regulated but…who is going to regulate the regulators and the policymakers? Congress does not seem capable of it.
It seems to me that the regulators and the policy makers need some oversight but the only ones
that can ultimately provide that oversight are you and me…the voters. How can we, therefore, react in a timely manner against “bad policy” and bring about a change in direction? That, as always, remains the main question.
This past Sunday, Friedman commented upon the government bailout and the coming effort to re-regulate the financial markets: http://www.nytimes.com/2008/10/26/opinion/26friedman.html. He quotes the consultant David Smick: “Government bailouts and guarantees, while at times needed, always come with unintended consequences.” Then he goes on to say that he, Friedman, “is not criticizing the decision to shore up the banks…We need better regulation. But, most of all, we need better management.”
Friedman concludes, however, that “We must not overshoot in regulating the markets because they (the bankers) overshot in their risk-taking.”
This is all the further the argument is carried these days: they (the bankers) “overshot in their risk-taking.” There is very little discussion about how the environment was created in which this excessive risk-taking arose. Since almost all of the blame is falling on the bankers, it is to be expected that almost all the re-regulation will also fall on the bankers.
But, Friedman argues, “We must not overshoot in regulating the markets…” and rightfully so. We must not overshoot in regulating the markets because maybe…just maybe…the environment for excessive risk-taking was created by the government and not by the bankers. This is not a new argument, but it is one that tends to be forgotten while people focus primarily on the current turmoil that is swirling around them. It also tends to be forgotten because economic consequences tend to occur with a substantial lag behind the causative events that started everything off.
In looking for such a cause, I once again return to the failure of the current administration to combat the decline in the value of the United States dollar. The performance of a currency relative to other currencies depends upon market perceptions about future rates of inflation. If the inflation rate in the home country is expected to be more rapid than the inflation rates in other countries, the value of the home country’s currency will tend to decline. The value of the home country’s currency will tend to appreciate when the opposite is the case.
The value of the United States dollar began to decline in 2002 and continued to decline through August 2008. This decline followed about seven years in which the value of the United States dollar rose. So, it can be assumed that participants in foreign exchange markets came to believe that future inflation in the United States would exceed that in other countries, a reversal of the belief that had existed over the previous decade.
What seemed to be the cause of this change in expectations? The change seems to be very closely related to the Bush tax cuts, the consequent anticipation of substantial deficits in the Federal budget, and the acceleration in the costs associated with the war on terror and in Iraq. The deficits themselves are not considered to be inflationary, but in the western world, every major increase in government budget deficits were connected with a monetization of the debt at some time in the future. Given the size of the projected deficits it was expected that the United States government could not avoid monetizing a large portion of these anticipated deficits.
In the case of the United States, however, an unexpected path was taken. The large deficits of the United States government were underwritten by China, Middle-Eastern oil producing nations, and others. In effect, foreign governments monetized the Bush deficits taking the pressure off the Federal Reserve, even allowing the Fed to keep short term interest rates at extremely low levels for three-to-four years. This was something unheard of in terms of global economics.
And, where did a great deal of the funds connected with the monetized debt go? It went into the United States housing market. The history of financial innovation in the late twentieth century is a fascinating one. Of especial interest is the growth of the market for securitized mortgages. The first package of securitized mortgages came to market in the first half of the 1970s. By the middle of the 1980s, mortgage-related securities became the largest component of the capital markets. Playing in this end of the market became ‘sexier’ than any other. And, the attraction grew and grew and drew in more and more new players from around the world. The market for securitized mortgages became the playground for the world and attracted a large portion of the United States dollars now circulating around the globe.
Thus, through the market for securitized mortgages, the United States housing market became one of the bubbles that resulted from the ‘monetizing’ of the large deficits that were created by the United States government. The expected United States inflation came about through unusual channels, but the participants in the foreign exchange markets were correct in calling for the decline in the value of the United States dollar.
In my view, the speculative atmosphere that evolved in financial markets and financial institutions which resulted in excessive risk-taking was the result of the failure of policy makers to defend the value of the United States dollar. Most other countries in the world that created government deficits that were monetized had to back off from such policies as the value of their currencies declined on foreign exchange markets. This response was due to the resulting inflation in those countries. (France in the 1980s is a prime example.) These countries did not have others within the world like China and the countries of the Middle East, to absorb their debt the way that China and the Middle East purchased the United States debt.
The massive United States government deficits went global and in going global helped flood world financial markets with funds that narrowed interest rate spreads and created an environment where more and more risk had to be taken to keep institutional returns up. Financial leverage and other techniques of financial engineering became commonplace. The structure of the marketplace became more and more fragile.
The rest is history. But, now we have to deal with the aftermath. In my mind, the fault for the financial collapse does not lie solely with the bankers…a large share of blame should fall to the Government officials that created the environment in which the bankers had to operate. Yes, one can argue that the bankers took on excessive risk. But, one cannot let the Government officials off the hook. We cannot afford to over-regulate the financial markets because the government was irresponsible.
Yes, the financial markets need to be regulated but…who is going to regulate the regulators and the policymakers? Congress does not seem capable of it.
It seems to me that the regulators and the policy makers need some oversight but the only ones
that can ultimately provide that oversight are you and me…the voters. How can we, therefore, react in a timely manner against “bad policy” and bring about a change in direction? That, as always, remains the main question.
Saturday, October 25, 2008
Forthcoming Regulatory Changes?
Reading the Wall Street Journal Saturday morning, I saw the headlines, “Bush Administration Rushes Regulatory Changes Before Time Is Up.” See http://online.wsj.com/article/SB122489005913868559.html?mod=todays_us_page_one.
My heartbeat accelerated. I started reading the first paragraph…”The Bush administration is hurrying to push through regulatory changes in politically sensitive areas such as endangered-species protection…WHAT!...health-care policy…Huh?...and other areas.”
The article stated that this is the rush to “cement new regulations” by pushing through “last-minute changes” intended to cement the legacy of the out-going President. These regulations are consistent with the philosophy of the current administration and are aimed toward stamping the imprint of the administration on Washington, D. C. before its turns out the lights on January 19, 2009.
Whoa! I thought we had a financial crisis…one brought on by insufficient regulation…a crisis that is now spreading deeper and deeper into the bowels of Main Street…and the world. What about the progress of the bailout of all the financial institutions of the country, the rescue of homeowners that are facing foreclosure, the plans being announced daily to lay off thousands of more workers, and the deepening recession? What about the financial world that is going to exist after the collapse of 2008 and the institutions and regulation that are going to define the “game” and its players in the future?
The problem is that when it comes to dealing with the financial crisis, this administration…the gang that couldn’t shoot straight…doesn’t have a consistent vision or philosophy to deal with the economic and financial situation. We saw this in the “breakdown” of former Fed Chairman Alan Greenspan in his appearance before Congress this past week. Greenspan commented that he was in “a state of shocked dis-belief”. Helicopter Ben…the current Fed Chairman…is tossing billions and billions of dollars out into the world! And, Treasury Secretary Paulson is running around trying this plan…and then changing the plan…and then changing the plan again…and then changing the plan again…
The problem is…no one is in charge…and no one has any idea what to do.
Need I say it again…the ‘decider’ has decided to take it on the lamb…the leader of the free world is no where to be seen.
Perhaps we should take some sage advice from Anna Schwartz who was the co-author with Nobel prize-winner Milton Freidman of “A Monetary History of the United States”. An interview with Ms. Schwartz appeared in the most recent issue of Barron’s, “Tearing Into the Fed and Treasury Plans” (October 27, 2008). I don’t agree with all Ms. Schwartz has to say, but here is some wisdom I think is very important for all of us to consider.
“The way you clear up problems in the credit market is through coming up with a clear, understandable plan and then executing it precisely.
My hope is that they will solve the problem by doing a bang-up job. But there’s already been talk about having to come back for more money. The risk of being unclear and doing things ad hoc is that you gradually destroy faith in the financial system…
…if we keep making things more uncertain, and feeding the fear without minimizing the problems, we could eventually make it so that Americans lose faith in their financial system.”
I just don’t see where the “clear, reasonable plan” is going to come from. Also, at the present time, I don’t see where the people are that are going to “execute the plan precisely.” And, with the economy falling deeper and deeper into a recession, a leader has not yet arisen that is providing us with the “philosophy and vision” we need to guide us through the recovery.
The scary thing coming out of the interview with Ms. Schwartz is the concern about a “loss of faith” and the “feeding of fear”. Where is the leader we need?
My heartbeat accelerated. I started reading the first paragraph…”The Bush administration is hurrying to push through regulatory changes in politically sensitive areas such as endangered-species protection…WHAT!...health-care policy…Huh?...and other areas.”
The article stated that this is the rush to “cement new regulations” by pushing through “last-minute changes” intended to cement the legacy of the out-going President. These regulations are consistent with the philosophy of the current administration and are aimed toward stamping the imprint of the administration on Washington, D. C. before its turns out the lights on January 19, 2009.
Whoa! I thought we had a financial crisis…one brought on by insufficient regulation…a crisis that is now spreading deeper and deeper into the bowels of Main Street…and the world. What about the progress of the bailout of all the financial institutions of the country, the rescue of homeowners that are facing foreclosure, the plans being announced daily to lay off thousands of more workers, and the deepening recession? What about the financial world that is going to exist after the collapse of 2008 and the institutions and regulation that are going to define the “game” and its players in the future?
The problem is that when it comes to dealing with the financial crisis, this administration…the gang that couldn’t shoot straight…doesn’t have a consistent vision or philosophy to deal with the economic and financial situation. We saw this in the “breakdown” of former Fed Chairman Alan Greenspan in his appearance before Congress this past week. Greenspan commented that he was in “a state of shocked dis-belief”. Helicopter Ben…the current Fed Chairman…is tossing billions and billions of dollars out into the world! And, Treasury Secretary Paulson is running around trying this plan…and then changing the plan…and then changing the plan again…and then changing the plan again…
The problem is…no one is in charge…and no one has any idea what to do.
Need I say it again…the ‘decider’ has decided to take it on the lamb…the leader of the free world is no where to be seen.
Perhaps we should take some sage advice from Anna Schwartz who was the co-author with Nobel prize-winner Milton Freidman of “A Monetary History of the United States”. An interview with Ms. Schwartz appeared in the most recent issue of Barron’s, “Tearing Into the Fed and Treasury Plans” (October 27, 2008). I don’t agree with all Ms. Schwartz has to say, but here is some wisdom I think is very important for all of us to consider.
“The way you clear up problems in the credit market is through coming up with a clear, understandable plan and then executing it precisely.
My hope is that they will solve the problem by doing a bang-up job. But there’s already been talk about having to come back for more money. The risk of being unclear and doing things ad hoc is that you gradually destroy faith in the financial system…
…if we keep making things more uncertain, and feeding the fear without minimizing the problems, we could eventually make it so that Americans lose faith in their financial system.”
I just don’t see where the “clear, reasonable plan” is going to come from. Also, at the present time, I don’t see where the people are that are going to “execute the plan precisely.” And, with the economy falling deeper and deeper into a recession, a leader has not yet arisen that is providing us with the “philosophy and vision” we need to guide us through the recovery.
The scary thing coming out of the interview with Ms. Schwartz is the concern about a “loss of faith” and the “feeding of fear”. Where is the leader we need?
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