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!
Thursday, October 30, 2008
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?
Thursday, October 23, 2008
The Federal Reserve and the Banking System--Banking Week ending October 22
At the end of the banking week closing on Wednesday September 3, 2008, Federal Reserve Bank credit amounted to $887.3 billion or roughly $0.9 trillion. At the close of the banking week ending Wednesday October 22 Federal Reserve Bank credit totaled $1,803.3 billion or about $1.8 trillion. The increase in Federal Reserve Bank credit rose 103.2% in seven weeks! These figures are from the Federal Reserve release H.4.1, Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.
Reserve balances with Federal Reserve Banks on an average daily balance rose from $10.9 billion in the earlier week to $301.3 billion in the week ending Wednesday October 22. The balances were down to $220.8 billion at the close of business on Wednesday October 22.
In terms of total bank reserves, a figure that also includes vault cash used to satisfy reserve requirements, the increase has been massive. Total bank reserves (on a non-seasonally adjusted basis), averaged $44.2 billion during the two weeks ending September 10, 2008. For the two weeks ending September 24, total bank reserves averaged $111.3 billion! And, for the two weeks ending October 22, total bank reserves averaged $327.6 billion! This is a 641.2% rise in a little more than a month.
The Monetary Base also shows substantial increases. (The Monetary Base consists of all things that are bank reserves or could become bank reserves, like the currency component of the money stock.) In the two weeks ending September 10, 2008, the Monetary Base averaged $849.9 billion. This figure rose to $915.1 billion in the two weeks ending September 24 and then climbed to $1,148.6 billion or about 1.15 trillion in the two weeks ending October 22. This is a rise of 35.2% from the earlier date. This rate is lower than the others because much of the monetary base is made up of currency in circulation which does not change as much over time.
The plan of the Federal Reserve is to liquefy world financial markets as much as possible. The Fed is pushing out the liquidity and it seems as if there is they are finally getting some response.
Money stock growth finally seems to be increasing. The M1 measure of the money stock is showing a rise of 13.0% from the 13 weeks ending July 14 to the 13 weeks ending October 13. The primary growth is coming in both the currency component and the demand deposit component of the money stock. As of yet this movement has not translated itself into the M2 measure of the money stock.
These numbers are no guarantee that the Fed’s efforts are gaining some success, but it does present a little bit of hope…and in today’s financial markets we are looking for all the hope we can find!
Reserve balances with Federal Reserve Banks on an average daily balance rose from $10.9 billion in the earlier week to $301.3 billion in the week ending Wednesday October 22. The balances were down to $220.8 billion at the close of business on Wednesday October 22.
In terms of total bank reserves, a figure that also includes vault cash used to satisfy reserve requirements, the increase has been massive. Total bank reserves (on a non-seasonally adjusted basis), averaged $44.2 billion during the two weeks ending September 10, 2008. For the two weeks ending September 24, total bank reserves averaged $111.3 billion! And, for the two weeks ending October 22, total bank reserves averaged $327.6 billion! This is a 641.2% rise in a little more than a month.
The Monetary Base also shows substantial increases. (The Monetary Base consists of all things that are bank reserves or could become bank reserves, like the currency component of the money stock.) In the two weeks ending September 10, 2008, the Monetary Base averaged $849.9 billion. This figure rose to $915.1 billion in the two weeks ending September 24 and then climbed to $1,148.6 billion or about 1.15 trillion in the two weeks ending October 22. This is a rise of 35.2% from the earlier date. This rate is lower than the others because much of the monetary base is made up of currency in circulation which does not change as much over time.
The plan of the Federal Reserve is to liquefy world financial markets as much as possible. The Fed is pushing out the liquidity and it seems as if there is they are finally getting some response.
Money stock growth finally seems to be increasing. The M1 measure of the money stock is showing a rise of 13.0% from the 13 weeks ending July 14 to the 13 weeks ending October 13. The primary growth is coming in both the currency component and the demand deposit component of the money stock. As of yet this movement has not translated itself into the M2 measure of the money stock.
These numbers are no guarantee that the Fed’s efforts are gaining some success, but it does present a little bit of hope…and in today’s financial markets we are looking for all the hope we can find!
Wednesday, October 22, 2008
Accounting Losses Represent the Past...Layoffs Represent the Future
Accounting losses report on what has been done and the consequences of those actions. The announced layoffs, in the thousands, give us an indication of what is in store for us in the future. The announced layoffs mean that retail sales will continue to be soft…goodbye Christmas volume, hello special sales even before Thanksgiving…industrial production will continue to decline…will all cars in America be produced by foreign companies…and continued declines in housing prices and increases in foreclosures…the American dream is on hold. So the wealth of Americans will continue to decline which will mean…more layoffs.
Not only is Ben Bernanke speaking gloom and doom…Hank Paulson is also now on record for a long and difficult period of economic retrenchment. The amazing thing to me is how Paulson seems to carry out what ever seems to be on Bernanke’s mind.
Remember there was a time when Paulson was letting Lehman Brothers go, implying that the rescues were over. And, then Bernanke had a meltdown…called Paulson…who arranged a meeting with congressional leaders…a meeting in which Bernanke is reported to have scared the daylights out of all present. Since then, Paulson…the free-market Paulson…has been bailing out everyone he can…while Bernanke is flooding the world with billions and billions of dollars. We should have Carl Sagan reciting these numbers to the world!
The bottom line…the Bush administration will be remembered…not exactly fondly…for a long time. The team that wanted to get out-of-town before the roof fell in didn’t make it. January 20, 2009, now, seems such a long time away.
Most of the responses we are seeing to the financial and economic crisis seem to postpone real action so that the in-coming administration will have to make the hard decisions as to what the new world of finance and economics is going to look like. And, this seems to be across the board…Iraq, Guantanamo, education, justice, health, and so on and so on. The President has all but disappeared!
According to the Wall Street Journal the only person lobbying for a position in the new (Obama) administration is Ben Bernanke. Yesterday the Journal argued that Bernanke all but submitted his resume to the Democrats by coming out in favor of the new stimulus plan being offered by the Democrats in Congress which has been supported by Obama. (See “Bernanke Endorses Obama”, http://online.wsj.com/article/SB122455027730552509.html?mod=todays_us_opinion.) Everyone else wants out.
So, we are going to have a sustained period of economic stagnation or decline. Layoffs are going to increase for a while rather than decline. How bad the economic conditions are going to get is still anyone’s guess, but the extent of the financial dislocation certainly carries with it an ominous black cloud. And little is being done about it. It is the future we have yet to see.
The financial guys have thrown about everything they have at the problem because they do not want to be accused of not providing enough “stuff” to keep the financial markets going. Now, we move to the real economy…output, employment, and dislocation! This is raising the cries for a fiscal response.
Here is where the other side of the frivolous and undisciplined behavior of the Bush administration comes home to haunt all of us. Since it has been in office, the monetary authorities kept interest rates exceedingly low while at the same time ignoring the housing bubble. When things seemed to get a little tough, the Fed drastically lowered its target interest rate. In effect, it shot off almost all of its ammunition. Not having much else it could do, the Federal Reserve flooded the world with liquidity. The monetary authority expended its resources before the battle really began and has little more it can do except direct intervention in institutions…not markets…with newly printed money.
In terms of fiscal policy the irresponsibility of this administration was also present. The problem now is how to add additional stimulus upon an already mammoth budget deficit. No one really knows whether or not a new stimulus program will do anything toward reducing the severity of the economic decline. Again, it is a case that the ammunition was basically used up before it was really needed.
This is where the lack of discipline kills you. When you really need something, you find that what you need is not there and this leaves you with little you can do going forward. The “free market” tools that could have been used to speed about a recovery have been frittered away in easy living. Now, the only recourse is greater direct government intervention into the economy in an effort to prevent the worst.
One final note: one of the implicit assumptions connected with the free market model is that there is a moral structure in the society which underlies behavior and allows the free market to be free. This moral structure leads to people acting responsibly with respect to commitments and relationships.
What we have seen in the last seven and one-half years is an administration that has underwritten fiscal prodigality and monetary laxity, behavior that has been emulated throughout the economy. In effect, the administration has undermined the moral fabric of economic prudence. Now the administration is washing its hands of its waywardness and scurrying for the door. It is someone else’s problem.
And the layoffs will grow.
I believe that a lot of the uncertainty is over. The future is not going to be pleasant. The question is…how unpleasant will it get? Not only does the economy need to be rebuilt but the moral fiber of the markets need to be reconstituted.
Not only is Ben Bernanke speaking gloom and doom…Hank Paulson is also now on record for a long and difficult period of economic retrenchment. The amazing thing to me is how Paulson seems to carry out what ever seems to be on Bernanke’s mind.
Remember there was a time when Paulson was letting Lehman Brothers go, implying that the rescues were over. And, then Bernanke had a meltdown…called Paulson…who arranged a meeting with congressional leaders…a meeting in which Bernanke is reported to have scared the daylights out of all present. Since then, Paulson…the free-market Paulson…has been bailing out everyone he can…while Bernanke is flooding the world with billions and billions of dollars. We should have Carl Sagan reciting these numbers to the world!
The bottom line…the Bush administration will be remembered…not exactly fondly…for a long time. The team that wanted to get out-of-town before the roof fell in didn’t make it. January 20, 2009, now, seems such a long time away.
Most of the responses we are seeing to the financial and economic crisis seem to postpone real action so that the in-coming administration will have to make the hard decisions as to what the new world of finance and economics is going to look like. And, this seems to be across the board…Iraq, Guantanamo, education, justice, health, and so on and so on. The President has all but disappeared!
According to the Wall Street Journal the only person lobbying for a position in the new (Obama) administration is Ben Bernanke. Yesterday the Journal argued that Bernanke all but submitted his resume to the Democrats by coming out in favor of the new stimulus plan being offered by the Democrats in Congress which has been supported by Obama. (See “Bernanke Endorses Obama”, http://online.wsj.com/article/SB122455027730552509.html?mod=todays_us_opinion.) Everyone else wants out.
So, we are going to have a sustained period of economic stagnation or decline. Layoffs are going to increase for a while rather than decline. How bad the economic conditions are going to get is still anyone’s guess, but the extent of the financial dislocation certainly carries with it an ominous black cloud. And little is being done about it. It is the future we have yet to see.
The financial guys have thrown about everything they have at the problem because they do not want to be accused of not providing enough “stuff” to keep the financial markets going. Now, we move to the real economy…output, employment, and dislocation! This is raising the cries for a fiscal response.
Here is where the other side of the frivolous and undisciplined behavior of the Bush administration comes home to haunt all of us. Since it has been in office, the monetary authorities kept interest rates exceedingly low while at the same time ignoring the housing bubble. When things seemed to get a little tough, the Fed drastically lowered its target interest rate. In effect, it shot off almost all of its ammunition. Not having much else it could do, the Federal Reserve flooded the world with liquidity. The monetary authority expended its resources before the battle really began and has little more it can do except direct intervention in institutions…not markets…with newly printed money.
In terms of fiscal policy the irresponsibility of this administration was also present. The problem now is how to add additional stimulus upon an already mammoth budget deficit. No one really knows whether or not a new stimulus program will do anything toward reducing the severity of the economic decline. Again, it is a case that the ammunition was basically used up before it was really needed.
This is where the lack of discipline kills you. When you really need something, you find that what you need is not there and this leaves you with little you can do going forward. The “free market” tools that could have been used to speed about a recovery have been frittered away in easy living. Now, the only recourse is greater direct government intervention into the economy in an effort to prevent the worst.
One final note: one of the implicit assumptions connected with the free market model is that there is a moral structure in the society which underlies behavior and allows the free market to be free. This moral structure leads to people acting responsibly with respect to commitments and relationships.
What we have seen in the last seven and one-half years is an administration that has underwritten fiscal prodigality and monetary laxity, behavior that has been emulated throughout the economy. In effect, the administration has undermined the moral fabric of economic prudence. Now the administration is washing its hands of its waywardness and scurrying for the door. It is someone else’s problem.
And the layoffs will grow.
I believe that a lot of the uncertainty is over. The future is not going to be pleasant. The question is…how unpleasant will it get? Not only does the economy need to be rebuilt but the moral fiber of the markets need to be reconstituted.
Thursday, October 16, 2008
Banks and Asset Write Offs
Banks are using this time to take substantial write offs against their assets. The time is right for them to do this and the investment community expects them to. It would be imprudent for any institution to NOT take substantial write offs now. But, I am only arguing that the write offs should be realistic.
It should not be the case that managements try and ‘over shoot’ their losses so as to show favorable results in the future. The managements of financial institutions must work to regain the trust of their customers and investors and this can only be achieved if the managements show that they understand and can control their balance sheets. To me, it is just another sign of bad management to try and manipulate earnings now so that these institutions can re-coop these faux-values in the future. How dumb do they think we are?
Yesterday, Citigroup, Inc. reported its fourth RED quarter, writing down another $4.4 billion in assets. This brings their total writedowns to about $45 billion! Merrill Lynch & Co. wrote down $9.5 billion bringing its total writedowns to over $50 billion! The day before J. P. Morgan Chase & Co. reported write downs of $3.6 billion as well as a $640 million after-tax loss related to its acquisition of Washington Mutual. Wells Fargo set aside $2.5 billion for future loan losses and the Bank of New York Mellon Corp. increased its credit loss provisions by 20%.
This is the time in the financial cycle when organizations must come up with a firm estimate of the asset base they have to work with. They must reduce their reliance on financial leverage as much as they prudently can. They must reduce their interest rate risk by immunizing their balance sheets as much as possible. They must reduce their reliance on accounting ‘gimmicks’. They must improve their reporting and communicating processes so as to achieve as much openness and transparency with their customers and investors as they can.
To me, these are nothing more than good management practices (See my post of October 14, “Good Management Never Goes Out of Style.”). They tend to go out of use as an economy heats up and are forgotten the most right before a financial system starts to contract. Thus, management must take time and effort to get their act back in order once the contraction begins. Businesses NEVER just “tend to business” during these times because they must focus on getting back to basics and this can almost totally distract a management during this period.
Furthermore, in my estimation, financial institutions have another task at this time. To me their business model has to change somewhat to reflect the advance of Information Technology and the uses of information and data that have resulted from these advancements (See my post of October 16, “The Special Case of Financial Institution.”). It is going to be interesting to see how banks and other financial institutions adjust to these changes and create workable models of sustainable competitive advantage without just relying on financial engineering to generate earnings. Trading models and arbitrage models are unstable in the longer run and cannot help build institutions that are going to excel and last.
The financial industry is going to be a very interesting one to watch in the next few years and there are going to be some real opportunities in which to invest. It may be a little early to “pick a horse” right now…although we seem to be coming through the financial collapse we still have the economic contraction to go through and this will cause other strains and stresses on our banking and financial system. And, it seems as if most analysts are predicting that this adjustment will be relatively long and deep.
There will arise some financial organizations that will really be good buys. The question will be about how to pick them. I have expressed some ideas over this past week and I will just repeat what I think is going to be the most important factors to concentrate on. First, don’t just look at the person at the top. J. P. Morgan’s Jamie Dimon and Citi’s Vikram Pandit are getting a lot of the press right now. They, and a couple of other chief executives, are ‘showing well.’ The important thing to me, however, is the quality of the teams the chief executives are building around them. This may be difficult to discern, but a ‘good’ top executive is one who is proud of his or her team and allows them to be known and to shine. Stay away from the chief executive (and his or her company) which is the only one allowed to be in the spotlight.
Second, check out where the organization is going. The idea of focus is crucial here. Is the organization doing a good job of defining its business and the fundamentals that underlay this business? As mentioned, organizations get in trouble when they cannot define their businesses well and rely on financial engineering or ‘gimmicks’ to produce results. This is going to be somewhat tricky as financial institutions ‘re-tool’ their business model to fit modern information technology and the new regulations and regulatory institutions that will inhabit the environment. Look less to trading and arbitrage to carry the day and more to the development of products and services that build on the evolving technology and establish customer relationships.
Finally, observe how the management team brings innovation to the marketplace. Financial institutions are dealing more and more with Information Goods and consequently must learn how to adapt and innovate within a constantly changing world. In order to do this well, managements must learn from the Information Technology industry. The managements of financial institutions must realize, however, that information is inexpensive, tends to be ubiquitous, and cannot be controlled. How these managements handle this reality is ultimately going to determine who the winners are in the future.
It should not be the case that managements try and ‘over shoot’ their losses so as to show favorable results in the future. The managements of financial institutions must work to regain the trust of their customers and investors and this can only be achieved if the managements show that they understand and can control their balance sheets. To me, it is just another sign of bad management to try and manipulate earnings now so that these institutions can re-coop these faux-values in the future. How dumb do they think we are?
Yesterday, Citigroup, Inc. reported its fourth RED quarter, writing down another $4.4 billion in assets. This brings their total writedowns to about $45 billion! Merrill Lynch & Co. wrote down $9.5 billion bringing its total writedowns to over $50 billion! The day before J. P. Morgan Chase & Co. reported write downs of $3.6 billion as well as a $640 million after-tax loss related to its acquisition of Washington Mutual. Wells Fargo set aside $2.5 billion for future loan losses and the Bank of New York Mellon Corp. increased its credit loss provisions by 20%.
This is the time in the financial cycle when organizations must come up with a firm estimate of the asset base they have to work with. They must reduce their reliance on financial leverage as much as they prudently can. They must reduce their interest rate risk by immunizing their balance sheets as much as possible. They must reduce their reliance on accounting ‘gimmicks’. They must improve their reporting and communicating processes so as to achieve as much openness and transparency with their customers and investors as they can.
To me, these are nothing more than good management practices (See my post of October 14, “Good Management Never Goes Out of Style.”). They tend to go out of use as an economy heats up and are forgotten the most right before a financial system starts to contract. Thus, management must take time and effort to get their act back in order once the contraction begins. Businesses NEVER just “tend to business” during these times because they must focus on getting back to basics and this can almost totally distract a management during this period.
Furthermore, in my estimation, financial institutions have another task at this time. To me their business model has to change somewhat to reflect the advance of Information Technology and the uses of information and data that have resulted from these advancements (See my post of October 16, “The Special Case of Financial Institution.”). It is going to be interesting to see how banks and other financial institutions adjust to these changes and create workable models of sustainable competitive advantage without just relying on financial engineering to generate earnings. Trading models and arbitrage models are unstable in the longer run and cannot help build institutions that are going to excel and last.
The financial industry is going to be a very interesting one to watch in the next few years and there are going to be some real opportunities in which to invest. It may be a little early to “pick a horse” right now…although we seem to be coming through the financial collapse we still have the economic contraction to go through and this will cause other strains and stresses on our banking and financial system. And, it seems as if most analysts are predicting that this adjustment will be relatively long and deep.
There will arise some financial organizations that will really be good buys. The question will be about how to pick them. I have expressed some ideas over this past week and I will just repeat what I think is going to be the most important factors to concentrate on. First, don’t just look at the person at the top. J. P. Morgan’s Jamie Dimon and Citi’s Vikram Pandit are getting a lot of the press right now. They, and a couple of other chief executives, are ‘showing well.’ The important thing to me, however, is the quality of the teams the chief executives are building around them. This may be difficult to discern, but a ‘good’ top executive is one who is proud of his or her team and allows them to be known and to shine. Stay away from the chief executive (and his or her company) which is the only one allowed to be in the spotlight.
Second, check out where the organization is going. The idea of focus is crucial here. Is the organization doing a good job of defining its business and the fundamentals that underlay this business? As mentioned, organizations get in trouble when they cannot define their businesses well and rely on financial engineering or ‘gimmicks’ to produce results. This is going to be somewhat tricky as financial institutions ‘re-tool’ their business model to fit modern information technology and the new regulations and regulatory institutions that will inhabit the environment. Look less to trading and arbitrage to carry the day and more to the development of products and services that build on the evolving technology and establish customer relationships.
Finally, observe how the management team brings innovation to the marketplace. Financial institutions are dealing more and more with Information Goods and consequently must learn how to adapt and innovate within a constantly changing world. In order to do this well, managements must learn from the Information Technology industry. The managements of financial institutions must realize, however, that information is inexpensive, tends to be ubiquitous, and cannot be controlled. How these managements handle this reality is ultimately going to determine who the winners are in the future.
Wednesday, October 15, 2008
The Special Case of Financial Institutions
In my last post, “Good Management Never Goes Out of Style”, I discussed what I believe to lie at the foundation of good management. The primary emphasis of this argument is that good management focuses upon what helped to create any competitive advantage it might have and maintains that focus over the longer run. In order to do this, good management must obtain good talent and then give the good talent the room and authority to put that talent to work. Good management facilitates good talent by creating a culture of high performance while keeping the focus of the business on what can sustain the competitive advantage of the firm.
Competitive advantage produces exceptional returns but these returns are difficult to sustain because potential competitors, seeing the exceptional returns, attempt to duplicate the results and aggressive market response reduces the firms’ advantage and drives down returns. In some instances, the firm with the competitive advantage may be able to sustain competitive advantage. However, the company may not be able to sustain the competitive advantage…in many cases, it is just not possible. In such cases the only really effective action management can take is to become very efficient and reduce expense ratios.
One recognizes when these foundational principles are being neglected when firms resort to gimmicks to achieve performance. In the last post I mentioned two such gimmicks: increased leverage and the mismatching of maturities. There are many other gimmicks that can be used such as assuming additional risk, accounting tricks (hello Enron), attempts at diversification, and secrecy. As I argued, these efforts generally represent an attempt to force results and come about either from greed or hubris or both. Because they are forced and are not related to basic underlying market realities they eventually fail, often at great cost. Arguing that the world has changed and that this world-change requires new standards only lasts for so long. Losing or changing focus may produce results in the short run but it never succeeds in the longer run.
Financial institutions represent a special case that needs to be discussed separately. The reason for this is that financial institutions are generally intermediaries and therefore depend upon the two ends of the market that they intermediate. The commercial bank is the prime example of an intermediary for historically a commercial bank took small deposits from relatively small economic units that didn’t have any alternatives to depositing it’s funds in the bank, and made large loans to larger economic units that needed the funds to run their businesses. As a consequence of the nature of the business, a commercial bank was grounded in its local or regional economy. Only a few borrowers had a national presence.
This dependency started to break up in the 1960s. Bank borrowers got larger and larger and demanded larger and larger loans. Financial markets developed so that these larger borrowers found that they had more sources of funds than before. In order to support these borrowers, commercial banks had to create new instruments to raise the funds they needed to meet the changing conditions. Commercial banks began to innovate and the result was the large negotiable Certificate of Deposit and the Eurodollar markets. These markets were large and deep, sufficiently so that commercial banks could buy or sell all the funds they wanted to at the going market interest rate. (In the terms of the economist, the supply curve of funds became perfectly elastic.) “Liability Management” was created! Now banks were only limited in their size by their capital base. And, commercial banks could become truly international!
The large customers of the banks found that their sources of funds became more elastically supplied and hence their demand for funds from their commercial banks became more elastic. Bank spreads declined!
Competition worked! Now the race was on! The rest is history!
The problem with innovation in financial markets is that finance is just about information…and the marginal cost of creating more and more information is very, very low. (For an example of this idea see “Information Markets: What Businesses Can Learn from Financial Innovation” by Wilhelm and Downing, Harvard Business School Press, 2001.) Consequently, information can be cut up in many, many different ways. The primary example of this is the Mortgage Backed Security that allows mortgages to be cut up into tranches, including toxic waste, into interest only securities, principal only securities, or any other way that might be thought of and sold.
Thus, financial innovation in making financial more efficient narrows spreads as the supplies of funds becomes more and more elastic…people can buy and sell as much as they want without affecting the price of the funds they are buying or selling. But, in such markets, leverage can become infinite! And, how do people then make money? Well, they must find mismatches…mismatches in risk, mismatches in maturities, mismatches in information, mismatches in timing. There becomes no limit to gimmicks.
We have seen two types of responses to this. First, there was an increase in secrecy. With spreads narrowing it becomes imperative that others not know what you are doing. Long Term Capital Management was noted for its attempts to keep secret what it was doing. The reason…if others know what you are doing the spreads narrow even more. (Three cheers for competition!) Another way to increase secrecy was to put things “off-balance sheet”. In this way institutions could get away with smaller capital bases and riskier business than if they kept these assets “on” the balance sheet.
The second type of response is to review your business model. This is an appropriate thing to do, but in changing ones business model one must be careful about whether or not the change really builds a different business model or not. Financial institutions responded to declining interest rate spreads by cultivating the “fee-based” business model. It can be argued that this effort really did not change the nature of the business but just shifted business. If I create the mortgage, I can then sell the mortgage for a fee. Another institution can package mortgages and get a fee for that. And, another organization can service the mortgages and get a fee for that. And, another institution can…. And, so on and so on.
In this example, the financial business has not changed…just different pieces of the package have been shifted around…and risk is located somewhere else out in the world, someplace no one knows where.
A business model can be changed in a way that can create value. This is what I think the financial services industry is going to have to do. The financial institutions industry is not the only industry that is facing massive changes in this Information Age. When it becomes nearly costless to create information, the old business loses relevance and must find a new way to create value. The question for management becomes, “What is it about what I do that I can, at least initially, create a competitive advantage?”
The follow up question becomes, “After I create the initial competitive advantage, what do I do next?” We see in the case of Information Goods that time pacing becomes extremely important. I tell the young IT entrepreneurs that I work with, “It is all fine and good that you have captured a niche in the market but you must already be planning the next generation of the product or the new, new product that you will bring to market.” Modern technology produces such an environment.
What does this mean for the management of financial institutions? That is for the future to determine. I have my own ideas. But, another question is…and this is just as important…what does this mean for the regulation of financial institutions? In building new financial regulation in this Information Age we cannot just fight the past wars…especially the wars we are now engaged in. That, of course, is the hardest thing for the Government…both the President and Congress…to do! It is going to be an interesting ride.
Competitive advantage produces exceptional returns but these returns are difficult to sustain because potential competitors, seeing the exceptional returns, attempt to duplicate the results and aggressive market response reduces the firms’ advantage and drives down returns. In some instances, the firm with the competitive advantage may be able to sustain competitive advantage. However, the company may not be able to sustain the competitive advantage…in many cases, it is just not possible. In such cases the only really effective action management can take is to become very efficient and reduce expense ratios.
One recognizes when these foundational principles are being neglected when firms resort to gimmicks to achieve performance. In the last post I mentioned two such gimmicks: increased leverage and the mismatching of maturities. There are many other gimmicks that can be used such as assuming additional risk, accounting tricks (hello Enron), attempts at diversification, and secrecy. As I argued, these efforts generally represent an attempt to force results and come about either from greed or hubris or both. Because they are forced and are not related to basic underlying market realities they eventually fail, often at great cost. Arguing that the world has changed and that this world-change requires new standards only lasts for so long. Losing or changing focus may produce results in the short run but it never succeeds in the longer run.
Financial institutions represent a special case that needs to be discussed separately. The reason for this is that financial institutions are generally intermediaries and therefore depend upon the two ends of the market that they intermediate. The commercial bank is the prime example of an intermediary for historically a commercial bank took small deposits from relatively small economic units that didn’t have any alternatives to depositing it’s funds in the bank, and made large loans to larger economic units that needed the funds to run their businesses. As a consequence of the nature of the business, a commercial bank was grounded in its local or regional economy. Only a few borrowers had a national presence.
This dependency started to break up in the 1960s. Bank borrowers got larger and larger and demanded larger and larger loans. Financial markets developed so that these larger borrowers found that they had more sources of funds than before. In order to support these borrowers, commercial banks had to create new instruments to raise the funds they needed to meet the changing conditions. Commercial banks began to innovate and the result was the large negotiable Certificate of Deposit and the Eurodollar markets. These markets were large and deep, sufficiently so that commercial banks could buy or sell all the funds they wanted to at the going market interest rate. (In the terms of the economist, the supply curve of funds became perfectly elastic.) “Liability Management” was created! Now banks were only limited in their size by their capital base. And, commercial banks could become truly international!
The large customers of the banks found that their sources of funds became more elastically supplied and hence their demand for funds from their commercial banks became more elastic. Bank spreads declined!
Competition worked! Now the race was on! The rest is history!
The problem with innovation in financial markets is that finance is just about information…and the marginal cost of creating more and more information is very, very low. (For an example of this idea see “Information Markets: What Businesses Can Learn from Financial Innovation” by Wilhelm and Downing, Harvard Business School Press, 2001.) Consequently, information can be cut up in many, many different ways. The primary example of this is the Mortgage Backed Security that allows mortgages to be cut up into tranches, including toxic waste, into interest only securities, principal only securities, or any other way that might be thought of and sold.
Thus, financial innovation in making financial more efficient narrows spreads as the supplies of funds becomes more and more elastic…people can buy and sell as much as they want without affecting the price of the funds they are buying or selling. But, in such markets, leverage can become infinite! And, how do people then make money? Well, they must find mismatches…mismatches in risk, mismatches in maturities, mismatches in information, mismatches in timing. There becomes no limit to gimmicks.
We have seen two types of responses to this. First, there was an increase in secrecy. With spreads narrowing it becomes imperative that others not know what you are doing. Long Term Capital Management was noted for its attempts to keep secret what it was doing. The reason…if others know what you are doing the spreads narrow even more. (Three cheers for competition!) Another way to increase secrecy was to put things “off-balance sheet”. In this way institutions could get away with smaller capital bases and riskier business than if they kept these assets “on” the balance sheet.
The second type of response is to review your business model. This is an appropriate thing to do, but in changing ones business model one must be careful about whether or not the change really builds a different business model or not. Financial institutions responded to declining interest rate spreads by cultivating the “fee-based” business model. It can be argued that this effort really did not change the nature of the business but just shifted business. If I create the mortgage, I can then sell the mortgage for a fee. Another institution can package mortgages and get a fee for that. And, another organization can service the mortgages and get a fee for that. And, another institution can…. And, so on and so on.
In this example, the financial business has not changed…just different pieces of the package have been shifted around…and risk is located somewhere else out in the world, someplace no one knows where.
A business model can be changed in a way that can create value. This is what I think the financial services industry is going to have to do. The financial institutions industry is not the only industry that is facing massive changes in this Information Age. When it becomes nearly costless to create information, the old business loses relevance and must find a new way to create value. The question for management becomes, “What is it about what I do that I can, at least initially, create a competitive advantage?”
The follow up question becomes, “After I create the initial competitive advantage, what do I do next?” We see in the case of Information Goods that time pacing becomes extremely important. I tell the young IT entrepreneurs that I work with, “It is all fine and good that you have captured a niche in the market but you must already be planning the next generation of the product or the new, new product that you will bring to market.” Modern technology produces such an environment.
What does this mean for the management of financial institutions? That is for the future to determine. I have my own ideas. But, another question is…and this is just as important…what does this mean for the regulation of financial institutions? In building new financial regulation in this Information Age we cannot just fight the past wars…especially the wars we are now engaged in. That, of course, is the hardest thing for the Government…both the President and Congress…to do! It is going to be an interesting ride.
Tuesday, October 14, 2008
Good Management Never Goes Out Of Style!
I recently asked a group I was speaking to what was the difference between responding to incentives and “greed”. “Greed” is, of course, one of those loaded words that can immediately draw a visceral reaction when mentioned. The basic answer of the group was that greed was like pornography…greed is what an individual sees it to be. Responding to incentives is how the world goes about its daily living and for the response to incentives to become greed is just a matter of degree…it is an “excessive” response to incentives.
A concept like greed, to me, is like the concept of ego. All successful people have an ego…and that ego can be quite large for people who are very, very successful. But, it is not the fact that successful people can have extremely large egos that gets to me…it is how those people with extremely large egos use their egos. Let me give you three people with extremely large egos whose egos do not both me: Tiger Woods, Michael Jordon, and Bill Russell. (Yes, these are all sports figures, but they serve my purpose in this post.) Yes, these individuals have very large egos but…these people tend to make other people around them at least as good, if not better, than they would be otherwise. That is, they raise other people to levels they would not be able to achieve individually and this produces teams that win and win and win!
The point I am trying to make is that responding to incentives, in and of itself, is not “bad” but how this response is applied that makes all the difference in the world. “Greed” in building a management team and creating an exceptional company is definitely good and a benefit to the society and culture in which it resides while “greed” aims at self glory tends to be destructive and short-lived.
The difference to me is focus, with an emphasis on the longer term, on sustainability. To me, this is what ultimately defines “good management” and it is something that one should look for because good management, even in the face of fads and frenzies, never goes out of style. “Good management” builds winners…sustainable winners. “Good management” is what one should look for to invest in at all times.
Good management must first create an organization that has some kind of competitive advantage, something that differentiates it from other organizations, within the marketplace. This competitive advantage is generally built upon something the firm has, some core competencies that others don’t possess. And, these core competencies are enhanced by the team that management builds to enhance and sustain these core competencies.
In judging a company, I have gotten away from just looking at the head of the organization, the top dog. What has become crucial in my appraisal of any organization is the people the head person brings in to support and enhance the firm. If a leader surrounds him- or her-self with very talented people, people that will challenge and question the leader, people that will push others, including the leader, to do their very best, then I believe that such a company will have a fair chance to build up a competitive advantage over other companies and sustain that competitive advantage over time. A “leader” that cannot stand to have other “stars” around his heavenly presence may be able to create a competitive advantage for his company to start with, but generally he will not be able to sustain that competitive advantage over time.
A company in which the leader facilitates the very capable people around them is better able to “keep focus” on what is important much better than the leader that must generate all the ideas himself. It is important in the modern environment to constantly be bringing new or better products to market on a regular basis, but someone must keep the focus of the company. “Good management” encourages, supports, and promotes the team to keep up this “time pacing” of new products and services while, at the same time, maintaining focus on what created the competitive advantage of the company and what factors will sustain this competitive advantage.
Alternatively, a leader that does not build a strong team to surround him finds that the competitive advantage that the company initially boasted slips away over time. This is because creating a competitive advantage produces exceptional returns. (In the book “Competition Demystified” by Bruce Greenwald and Judd Kahn, exceptional returns are defined as a 15% to 25 % return on capital after taxes.) However, here is where the longer run is important. Others see this exceptional return and capital is drawn into this space to attempt to get some of the action. This additional competition works to break down the competitive advantage and reduce the returns that are earned by those in this specific industry.
One should note that the competitive advantage may come about only because the firm happens to be in the right spot at the right time; it has nothing to do with talent. Being in the right place at the start of a “bubble”, for example, can make someone look like a genius when there is nothing to back up the performance. (See Taleb’s first book “Fooled by Randomness” for a discussion of this phenomenon.)
In either case, as returns are being threatened by greater competition, the “leader” that has little talented support staff and limited new ideas begins to lose focus on what got them the initial competitive advantage and starts to focus on other factors that can enhance returns and have nothing to do with core competencies. Financial engineering is one such diversion that can bring continued returns. Increased leverage and mismatching maturities, as we have seen, are two such types of financial engineering that bring positive results…at least in the short run.
Less than stellar management, therefore, tends to lose focus on what initially brought them attention and eventually puts greater and greater reliance on other factors, like financial engineering, to keep attention. As is often the case, however, one cannot always tell the wheat from the chaff as the economy experiences “good times.” Only with the bust do we really find out who the good managers/leaders are.
Or are their clues we can observe earlier on that can give us some insight into which companies have “good management”? I, of course, believe that you can identify good managements early on. I have emphasized the word “sustainable”…which of course has to do with long term performance. Greenwald and Kahn argue that good managements are able to sustain the 15% to 25% returns for an extended period of time while still focusing on core competencies. Sustainable competitive advantage is also connected with relatively stable market shares within the core industry of the company.
Sustainable competitive advantage is connected with “how” the firm is able to achieve the high returns and the stable market share. Where do the earnings come from? Have they come from the core competencies of the company? Does the company attract and build up the talent that continually enhances these core competencies? Or, does the company have to go outside these core competencies to keep up performance? Or, do these companies rely upon financial leverage or strategies connected with mismatching durations to maintain performance?
Good management does not go out of style! I don’t believe that one has to argue for “conservative” management practices across the board. I do believe, however, that one should insist that the management of a company keep its focus on what it is strong in and build from that foundation and not depend upon extraordinary means to “puff up” its performance. In this, I believe that good management will build a good team and act “conservatively” because it doesn’t need to rely solely on its “super star leader” or “gimmicks” to create a winner…a team that continues to win over time. Therefore, I would argue that the concept of “Greed” is connected with FORCED performance…not with true achievement!
A concept like greed, to me, is like the concept of ego. All successful people have an ego…and that ego can be quite large for people who are very, very successful. But, it is not the fact that successful people can have extremely large egos that gets to me…it is how those people with extremely large egos use their egos. Let me give you three people with extremely large egos whose egos do not both me: Tiger Woods, Michael Jordon, and Bill Russell. (Yes, these are all sports figures, but they serve my purpose in this post.) Yes, these individuals have very large egos but…these people tend to make other people around them at least as good, if not better, than they would be otherwise. That is, they raise other people to levels they would not be able to achieve individually and this produces teams that win and win and win!
The point I am trying to make is that responding to incentives, in and of itself, is not “bad” but how this response is applied that makes all the difference in the world. “Greed” in building a management team and creating an exceptional company is definitely good and a benefit to the society and culture in which it resides while “greed” aims at self glory tends to be destructive and short-lived.
The difference to me is focus, with an emphasis on the longer term, on sustainability. To me, this is what ultimately defines “good management” and it is something that one should look for because good management, even in the face of fads and frenzies, never goes out of style. “Good management” builds winners…sustainable winners. “Good management” is what one should look for to invest in at all times.
Good management must first create an organization that has some kind of competitive advantage, something that differentiates it from other organizations, within the marketplace. This competitive advantage is generally built upon something the firm has, some core competencies that others don’t possess. And, these core competencies are enhanced by the team that management builds to enhance and sustain these core competencies.
In judging a company, I have gotten away from just looking at the head of the organization, the top dog. What has become crucial in my appraisal of any organization is the people the head person brings in to support and enhance the firm. If a leader surrounds him- or her-self with very talented people, people that will challenge and question the leader, people that will push others, including the leader, to do their very best, then I believe that such a company will have a fair chance to build up a competitive advantage over other companies and sustain that competitive advantage over time. A “leader” that cannot stand to have other “stars” around his heavenly presence may be able to create a competitive advantage for his company to start with, but generally he will not be able to sustain that competitive advantage over time.
A company in which the leader facilitates the very capable people around them is better able to “keep focus” on what is important much better than the leader that must generate all the ideas himself. It is important in the modern environment to constantly be bringing new or better products to market on a regular basis, but someone must keep the focus of the company. “Good management” encourages, supports, and promotes the team to keep up this “time pacing” of new products and services while, at the same time, maintaining focus on what created the competitive advantage of the company and what factors will sustain this competitive advantage.
Alternatively, a leader that does not build a strong team to surround him finds that the competitive advantage that the company initially boasted slips away over time. This is because creating a competitive advantage produces exceptional returns. (In the book “Competition Demystified” by Bruce Greenwald and Judd Kahn, exceptional returns are defined as a 15% to 25 % return on capital after taxes.) However, here is where the longer run is important. Others see this exceptional return and capital is drawn into this space to attempt to get some of the action. This additional competition works to break down the competitive advantage and reduce the returns that are earned by those in this specific industry.
One should note that the competitive advantage may come about only because the firm happens to be in the right spot at the right time; it has nothing to do with talent. Being in the right place at the start of a “bubble”, for example, can make someone look like a genius when there is nothing to back up the performance. (See Taleb’s first book “Fooled by Randomness” for a discussion of this phenomenon.)
In either case, as returns are being threatened by greater competition, the “leader” that has little talented support staff and limited new ideas begins to lose focus on what got them the initial competitive advantage and starts to focus on other factors that can enhance returns and have nothing to do with core competencies. Financial engineering is one such diversion that can bring continued returns. Increased leverage and mismatching maturities, as we have seen, are two such types of financial engineering that bring positive results…at least in the short run.
Less than stellar management, therefore, tends to lose focus on what initially brought them attention and eventually puts greater and greater reliance on other factors, like financial engineering, to keep attention. As is often the case, however, one cannot always tell the wheat from the chaff as the economy experiences “good times.” Only with the bust do we really find out who the good managers/leaders are.
Or are their clues we can observe earlier on that can give us some insight into which companies have “good management”? I, of course, believe that you can identify good managements early on. I have emphasized the word “sustainable”…which of course has to do with long term performance. Greenwald and Kahn argue that good managements are able to sustain the 15% to 25% returns for an extended period of time while still focusing on core competencies. Sustainable competitive advantage is also connected with relatively stable market shares within the core industry of the company.
Sustainable competitive advantage is connected with “how” the firm is able to achieve the high returns and the stable market share. Where do the earnings come from? Have they come from the core competencies of the company? Does the company attract and build up the talent that continually enhances these core competencies? Or, does the company have to go outside these core competencies to keep up performance? Or, do these companies rely upon financial leverage or strategies connected with mismatching durations to maintain performance?
Good management does not go out of style! I don’t believe that one has to argue for “conservative” management practices across the board. I do believe, however, that one should insist that the management of a company keep its focus on what it is strong in and build from that foundation and not depend upon extraordinary means to “puff up” its performance. In this, I believe that good management will build a good team and act “conservatively” because it doesn’t need to rely solely on its “super star leader” or “gimmicks” to create a winner…a team that continues to win over time. Therefore, I would argue that the concept of “Greed” is connected with FORCED performance…not with true achievement!
Friday, October 10, 2008
The Federal Reserve and the Banking System
At the end of the banking week closing on Wednesday September 3, 2008, Federal Reserve Bank credit amounted to $887.3 billion or roughly $0.9 trillion. At the close of the banking week ending Wednesday October 8, Federal Reserve Bank credit totaled $1,575.6 billion or about $1.6 trillion. The increase in Federal Reserve Bank credit rose 77.6% in five weeks! These figures are from the Federal Reserve release H.4.1, Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.
Reserve balances with Federal Reserve Banks rose from $3.8 billion in the earlier Wednesday to $175.6 billion on Wednesday October 8. (On a daily average basis the figure for the week ending October 9, 2008 was $119.7 billion, up from $10.9 billion for the week ending September 3, 2008, and up from $7.1 billion in the banking week ending October 10, 2007.) Again, these figures are from the Federal Reserve release H.4.1.
In terms of total bank reserves, a figure that also includes vault cash used to satisfy reserve requirements, the increase has been massive. Total bank reserves (on a non-seasonally adjusted basis), averaged $44.2 billion during the two weeks ending September 10, 2008. For the two weeks ending September 24, total bank reserves averaged $111.3 billion! And, for the two weeks ending October 8, total bank reserves averaged $179.5 billion! Using monthly figures, total bank reserves for September 2008 are 243% larger than September 2007!
Wow! I’m breathless!
The Monetary Base also shows substantial increases. (The Monetary Base consists of all things that are bank reserves or could become bank reserves, like the currency component of the money stock.) In the two weeks ending September 10, 2008, the Monetary Base averaged $849.9 billion. This figure rose to $915.1 billion in the two weeks ending September 24 and then climbed to $989.8 in the two weeks ending October 8. The year-over-year increase from September 2007 to September 2008 is 9.9%! (This year-over-year increase is as low as it is because the currency component of the money stock is such a large part of the measure and this figure doesn’t change very much over time. Still, an increase of about 10% is a huge increase!)
The plan of the Federal Reserve is to liquefy world financial markets as much as possible. It is doing its job. The problem seems to be that there is a liquidity trap. (See my post of October 8, 2008, “Caught in a Liquidity Trap”.) The Fed is pushing out the liquidity…but institutions are absorbing the liquidity without pushing it on.
Reserve balances with Federal Reserve Banks rose from $3.8 billion in the earlier Wednesday to $175.6 billion on Wednesday October 8. (On a daily average basis the figure for the week ending October 9, 2008 was $119.7 billion, up from $10.9 billion for the week ending September 3, 2008, and up from $7.1 billion in the banking week ending October 10, 2007.) Again, these figures are from the Federal Reserve release H.4.1.
In terms of total bank reserves, a figure that also includes vault cash used to satisfy reserve requirements, the increase has been massive. Total bank reserves (on a non-seasonally adjusted basis), averaged $44.2 billion during the two weeks ending September 10, 2008. For the two weeks ending September 24, total bank reserves averaged $111.3 billion! And, for the two weeks ending October 8, total bank reserves averaged $179.5 billion! Using monthly figures, total bank reserves for September 2008 are 243% larger than September 2007!
Wow! I’m breathless!
The Monetary Base also shows substantial increases. (The Monetary Base consists of all things that are bank reserves or could become bank reserves, like the currency component of the money stock.) In the two weeks ending September 10, 2008, the Monetary Base averaged $849.9 billion. This figure rose to $915.1 billion in the two weeks ending September 24 and then climbed to $989.8 in the two weeks ending October 8. The year-over-year increase from September 2007 to September 2008 is 9.9%! (This year-over-year increase is as low as it is because the currency component of the money stock is such a large part of the measure and this figure doesn’t change very much over time. Still, an increase of about 10% is a huge increase!)
The plan of the Federal Reserve is to liquefy world financial markets as much as possible. It is doing its job. The problem seems to be that there is a liquidity trap. (See my post of October 8, 2008, “Caught in a Liquidity Trap”.) The Fed is pushing out the liquidity…but institutions are absorbing the liquidity without pushing it on.
Thursday, October 9, 2008
A Government Bank Takeover Plan?
“The Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system.”
So reads the New York Times in the middle of the afternoon on Thursday. This was in advance of the rapid sell off that again came at the end of the trading day. Dow Jones…down…680 points!
Treasury Secretary Paulson made remarks to this effect on Wednesday and the possibility of this happening was supported by the White House before 2:00 PM Thursday afternoon.
This, of course, is a real confidence builder. But, the administration has become very adept at letting out clues that the system is falling apart. Two weeks ago, Fed Chairman Bernanke made allusions to the fact that the economy might not be around the next Monday. The whole Paulson Plan was based on the assumption that many financial institutions could not exist unless they had a “buyer of last resort” to put a floor under securities prices. And the good news just continues to come out.
No wonder the financial system is frozen. No one knows what institutions are going to fail…or be bailed out. Yet, the Treasury Secretary and the Fed Chairman continue to talk about how bad things are. Why should anyone lend to anyone else when there is no idea about who might not be able to pay back their loans. Still, we hear from these high officials that things are terribly bad!
And, these officials are the ones that supposedly have inside information on the condition of individual institutions!
What do these officials know that we don’t know?
These officials are not getting any sleep…but they really need to think through what they say. They may think that they are giving out information that will build confidence…but, the limited amount of information that is being given out only creates more distrust. The reason being is that market participants interpret what the officials are saying as an indication that there is more negative information known by the officials than they are telling. This leaves bankers and others adrift for they do not know who the negative information applies to.
So reads the New York Times in the middle of the afternoon on Thursday. This was in advance of the rapid sell off that again came at the end of the trading day. Dow Jones…down…680 points!
Treasury Secretary Paulson made remarks to this effect on Wednesday and the possibility of this happening was supported by the White House before 2:00 PM Thursday afternoon.
This, of course, is a real confidence builder. But, the administration has become very adept at letting out clues that the system is falling apart. Two weeks ago, Fed Chairman Bernanke made allusions to the fact that the economy might not be around the next Monday. The whole Paulson Plan was based on the assumption that many financial institutions could not exist unless they had a “buyer of last resort” to put a floor under securities prices. And the good news just continues to come out.
No wonder the financial system is frozen. No one knows what institutions are going to fail…or be bailed out. Yet, the Treasury Secretary and the Fed Chairman continue to talk about how bad things are. Why should anyone lend to anyone else when there is no idea about who might not be able to pay back their loans. Still, we hear from these high officials that things are terribly bad!
And, these officials are the ones that supposedly have inside information on the condition of individual institutions!
What do these officials know that we don’t know?
These officials are not getting any sleep…but they really need to think through what they say. They may think that they are giving out information that will build confidence…but, the limited amount of information that is being given out only creates more distrust. The reason being is that market participants interpret what the officials are saying as an indication that there is more negative information known by the officials than they are telling. This leaves bankers and others adrift for they do not know who the negative information applies to.
Wednesday, October 8, 2008
Why haven't the financial markets responded?
The stock market has experienced a serious decline since the passage of the Paulson Plan. The money and bond markets still seem to be frozen in spite of a coordinated cut in world central bank target rates. The only way that this behavior can be explained in my mind is that without strong leadership…from the very top…the financial markets will continue to be weak. Even though others…Paulson and Bernanke…have tried to provide some form of leadership, the leadership that must be exhibited from the very top continues to be missing. (See my post of September 25, 2008, “The Absence of Leadership.)
Missing this leadership, members of the Bush 43 administration were hoping and praying that events would be relatively quiet until they were able to sneak out of Washington in January 2009 and let someone else handle the situation.
They didn’t make it!
And, like any other organization that does not have a leader, good people with good intentions when faced with calamities try to come up with some plan or some action that will plug the hole in the dike. The problem with this is that they have to work around the leader. And, there is no unifying force present is such situations, no calm hand on the tiller listening to alternatives, asking questions, and guiding responses. And there is no one around to punish dissidents.
Up until a couple of weeks ago, Treasury Secretary Paulson and Fed Chairman Bernanke tried to band aid the system, proposing temporary responses to the growing crises that would tide things over until the new government came into office to deal with the problems. It seemed as if Paulson and Bernanke had reached a game plan…a bailout took place for Fannie and Freddie…and, Lehman was to fail with no help and nothing would be done for AIG.
Then, it appears by all reports…Bernanke reached a turning point!
Bernanke called Paulson and indicated that the financial markets were falling apart and that if nothing were done the economy might not be there the next Monday. The Congressional leadership had to be informed of this development and brought on board for a major flood of liquidity. In no instance could the financial system and the economy come up short of liquidity!
Paulson set up the meeting with the Congressional leadership and at that meeting Bernanke poured out his story of woe. And, according to some of the members of Congress that were there…Bernanke scared the life out of them!
One question needs to be asked at this point…where was the “decider”?
The Treasury plan was assembled as quickly as possible for passage by Congress as quickly as possible…no hearings…really, no questioning…things were so bad that there was no time for these niceties that could take place when things were not so dire.
And, then the financial markets froze!
Why not?
Here was the Chairman of the Board of Governors of the Federal Reserve System saying that the economy might not be there on Monday. What did he know that market participants didn’t? What was going on in Europe and elsewhere? Here was a major case of asymmetric information. And the people that were without information were the suppliers of funds.
Bear Stearns had failed. Merrill Lynch had failed. Fannie and Freddie had failed. Lehman had failed. Washington Mutual had failed. AIG had failed. Wachovia had failed. Who was going to be next? What did the Fed and the Treasury know that market participants didn’t know?
The initial effort to get “the bill” through Congress failed! There was no one in a leadership position that could call the troops to order. (Even presidential candidate John McCain road out at the head of his Calvary to lead the charge to get the bill passed…only no one followed him! No leadership here.) Paulson could not do it…he was not the leader…there was no leader!
The “decider” was marched out…but he was dazed and only mouthed the words that were given. Why should anyone have any confidence in what was being done?
Is the bill passed last Friday any good? After what went on in the two previous weeks the bill seems somewhat irrelevant…a very costly irrelevant. There is still no vision going forward. There is no strategy. There is no structure. There is little or nothing. At best we are told that maybe in four weeks the “Paulson Plan” will be up and running.
That will be after the election and we will have a president-elect. But, the president-elect will have to wait for over two months before he can do anything about the financial crisis.
Meanwhile the Fed floods world financial markets with liquidity?
Bernanke’s study of the Great Depression taught him that during such a crisis the world cannot have too much liquidity. And, so “Helicopter Ben” is acting on that premise. Total reserves in the United States banking system, for the two weeks ending September 10, averaged about $44 billion on a non-seasonally adjusted basis. For the two weeks ending September 24, the total reserve figure was about $111 billion. Never has the United States banking system received so many reserves so rapidly. And look at the sources and uses statement of the Federal Reserve System…the H.4.1 release. In the last three weeks the sources of reserves in the banking system increased by more than 50%!!!!!
Never have we seen anything like this! Never!
This is what happens when there is no leadership. One cannot blame this situation on previous administrations or other conditions within the world. The current leader of the free world is MIA.
Unfortunately for the financial markets, for the economy, for workers, for families, for everyone else…there will not be a new president for several months yet. And, we still have to uncertainty with respect to what the newly elected president will do. Will he, when in office, be able to provide the leadership that is so badly needed?
So, there is still an enormous amount of uncertainty with respect to the future and this enormous amount of uncertainty will reign in the markets until such leadership surfaces. And, the financial markets will still remain tentative as they attempt to discern who will fail next…and then next after that…and then next after that…
Missing this leadership, members of the Bush 43 administration were hoping and praying that events would be relatively quiet until they were able to sneak out of Washington in January 2009 and let someone else handle the situation.
They didn’t make it!
And, like any other organization that does not have a leader, good people with good intentions when faced with calamities try to come up with some plan or some action that will plug the hole in the dike. The problem with this is that they have to work around the leader. And, there is no unifying force present is such situations, no calm hand on the tiller listening to alternatives, asking questions, and guiding responses. And there is no one around to punish dissidents.
Up until a couple of weeks ago, Treasury Secretary Paulson and Fed Chairman Bernanke tried to band aid the system, proposing temporary responses to the growing crises that would tide things over until the new government came into office to deal with the problems. It seemed as if Paulson and Bernanke had reached a game plan…a bailout took place for Fannie and Freddie…and, Lehman was to fail with no help and nothing would be done for AIG.
Then, it appears by all reports…Bernanke reached a turning point!
Bernanke called Paulson and indicated that the financial markets were falling apart and that if nothing were done the economy might not be there the next Monday. The Congressional leadership had to be informed of this development and brought on board for a major flood of liquidity. In no instance could the financial system and the economy come up short of liquidity!
Paulson set up the meeting with the Congressional leadership and at that meeting Bernanke poured out his story of woe. And, according to some of the members of Congress that were there…Bernanke scared the life out of them!
One question needs to be asked at this point…where was the “decider”?
The Treasury plan was assembled as quickly as possible for passage by Congress as quickly as possible…no hearings…really, no questioning…things were so bad that there was no time for these niceties that could take place when things were not so dire.
And, then the financial markets froze!
Why not?
Here was the Chairman of the Board of Governors of the Federal Reserve System saying that the economy might not be there on Monday. What did he know that market participants didn’t? What was going on in Europe and elsewhere? Here was a major case of asymmetric information. And the people that were without information were the suppliers of funds.
Bear Stearns had failed. Merrill Lynch had failed. Fannie and Freddie had failed. Lehman had failed. Washington Mutual had failed. AIG had failed. Wachovia had failed. Who was going to be next? What did the Fed and the Treasury know that market participants didn’t know?
The initial effort to get “the bill” through Congress failed! There was no one in a leadership position that could call the troops to order. (Even presidential candidate John McCain road out at the head of his Calvary to lead the charge to get the bill passed…only no one followed him! No leadership here.) Paulson could not do it…he was not the leader…there was no leader!
The “decider” was marched out…but he was dazed and only mouthed the words that were given. Why should anyone have any confidence in what was being done?
Is the bill passed last Friday any good? After what went on in the two previous weeks the bill seems somewhat irrelevant…a very costly irrelevant. There is still no vision going forward. There is no strategy. There is no structure. There is little or nothing. At best we are told that maybe in four weeks the “Paulson Plan” will be up and running.
That will be after the election and we will have a president-elect. But, the president-elect will have to wait for over two months before he can do anything about the financial crisis.
Meanwhile the Fed floods world financial markets with liquidity?
Bernanke’s study of the Great Depression taught him that during such a crisis the world cannot have too much liquidity. And, so “Helicopter Ben” is acting on that premise. Total reserves in the United States banking system, for the two weeks ending September 10, averaged about $44 billion on a non-seasonally adjusted basis. For the two weeks ending September 24, the total reserve figure was about $111 billion. Never has the United States banking system received so many reserves so rapidly. And look at the sources and uses statement of the Federal Reserve System…the H.4.1 release. In the last three weeks the sources of reserves in the banking system increased by more than 50%!!!!!
Never have we seen anything like this! Never!
This is what happens when there is no leadership. One cannot blame this situation on previous administrations or other conditions within the world. The current leader of the free world is MIA.
Unfortunately for the financial markets, for the economy, for workers, for families, for everyone else…there will not be a new president for several months yet. And, we still have to uncertainty with respect to what the newly elected president will do. Will he, when in office, be able to provide the leadership that is so badly needed?
So, there is still an enormous amount of uncertainty with respect to the future and this enormous amount of uncertainty will reign in the markets until such leadership surfaces. And, the financial markets will still remain tentative as they attempt to discern who will fail next…and then next after that…and then next after that…
A Liquidity Trap?
Is this what a liquidity trap looks like?
A liquidity trap gives one the feeling that the monetary authorities are pushing on a string. The amount of liquidity the Federal Reserve and other central banks around the world have provided for the financial markets has been huge. The Paulson Plan was supposed to create confidence that illiquid assets would now have some liquidity. The Fed Plan to purchase commercial paper was supposed to create confidence that illiquid assets would now have some liquidity.
Yet, the financial markets remain silent.
Seemingly, no one wants to commit because no one is sure about the solvency of other participants in the financial markets.
Bernanke spooked the financial markets again yesterday as he talked about a possible cut in interest targets…which he did follow through on. The speech was to the National Association for Business Economists at their 50th anniversary get-together in Washington, D. C.
The message the market heard, however, was how dire things were.
And, the market asked…what does Bernanke know that we don’t?
The absence of leadership seems to reach new heights daily. (See Mase: Economics and Finance for October 7, 2008.)
But, now we are apparently in a liquidity trap. Consumers are pulling back their spending…the latest figures out on consumer credit even show a decline. Businesses are consolidating and cutting spending and hiring plans. State and Local governments are going to the Federal Government to get cash to help them meet payrolls. And, then the Federal Government…
Get out your old copy of Keynes’ General Theory.
A liquidity trap gives one the feeling that the monetary authorities are pushing on a string. The amount of liquidity the Federal Reserve and other central banks around the world have provided for the financial markets has been huge. The Paulson Plan was supposed to create confidence that illiquid assets would now have some liquidity. The Fed Plan to purchase commercial paper was supposed to create confidence that illiquid assets would now have some liquidity.
Yet, the financial markets remain silent.
Seemingly, no one wants to commit because no one is sure about the solvency of other participants in the financial markets.
Bernanke spooked the financial markets again yesterday as he talked about a possible cut in interest targets…which he did follow through on. The speech was to the National Association for Business Economists at their 50th anniversary get-together in Washington, D. C.
The message the market heard, however, was how dire things were.
And, the market asked…what does Bernanke know that we don’t?
The absence of leadership seems to reach new heights daily. (See Mase: Economics and Finance for October 7, 2008.)
But, now we are apparently in a liquidity trap. Consumers are pulling back their spending…the latest figures out on consumer credit even show a decline. Businesses are consolidating and cutting spending and hiring plans. State and Local governments are going to the Federal Government to get cash to help them meet payrolls. And, then the Federal Government…
Get out your old copy of Keynes’ General Theory.
Tuesday, October 7, 2008
The Absence of Leadership is Killing Us!
The absence of leadership in the United States government is costing us…and the rest of the world…dearly! (See my post of September 25, 2008, “The Absence of Leadership.) Many have declared that Bush 43 is MIA. Whatever, there is a void at the top of the current administration…and, we are paying the price for this void!
Without any leadership, members of the Bush 43 administration were hoping and praying that events would be relatively quiet until they were able to sneak out of Washington in January 2009 and let someone else handle the situation.
They didn’t make it!
And, like any other organization that does not have a leader…short of staging a revolution and disposing the top man…good people with good intentions when faced with calamities try to come up with some plan or some action that will plug the hole in the dike.
The problem with this is that they have to work around the leader. And, there is no unifying force present is such situations, no calm hand on the tiller listening to alternatives, asking questions, and guiding responses. And there is no one around to punish dissidents.
Up until a couple of weeks ago, Treasury Secretary Paulson and Fed Chairman Bernanke tried to band aid the system, proposing temporary responses to the growing crises that would tide things over until the new government came into office to deal with the problems. It seemed as if Paulson and Bernanke had reached a game plan…a bailout took place for Fannie and Freddie…and, Lehman was to fail with no help and nothing would be done for AIG.
Then, it appears by all reports…Bernanke panicked!
Bernanke called Paulson and indicated that the financial markets were falling apart and that if nothing were done the economy might not be there the next Monday. The Congressional leadership had to be informed of this development and brought on board for a major flood of liquidity. In no instance could the financial system and the economy come up short of liquidity!
Paulson set up the meeting with the Congressional leadership and at that meeting Bernanke poured out his story of woe. And, according to some of the members of Congress that were there…Bernanke scared the life out of them!
One question needs to be asked at this point…where was the “decider”?
The Treasury plan was assembled as quickly as possible for passage by Congress as quickly as possible…no hearings…really, no questioning…things were so bad that there was no time for these niceties that could take place when things were not so dire.
And, then the financial markets froze!
Why not?
Here was the Chairman of the Board of Governors of the Federal Reserve System saying that the economy might not be there on Monday. What did he know that market participants didn’t? What was going on in Europe and elsewhere? Here was a major case of asymmetric information. And the people that were without information were the suppliers of funds.
Bear Stearns had failed. Merrill Lynch had failed. Fannie and Freddie had failed. Lehman had failed. Washington Mutual had failed. AIG had failed. Wachovia had failed. Who was going to be next? What did the Fed and the Treasury know that market participants didn’t know?
The initial effort to get “the bill” through Congress failed! There was no one in a leadership position that could call the troops to order. (Even presidential candidate John McCain road out at the head of his Calvary to lead the charge to get the bill passed…only no one followed him! No leadership here.) Paulson could not do it…he was not the leader…there was no leader!
The straw-leader was marched out…but he was dazed and only mouthed the words that were given. Why should anyone have any confidence in what was being done?
Is the bill passed Friday any good? After what went on in the two previous weeks the bill seems somewhat irrelevant…a very costly irrelevant. There is still no leadership going forward. There is no vision. There is no structure. There is nothing. At best we are told that maybe in four weeks the “plan” will be up and running.
That will be after the election and we will have a president-elect. But, the president-elect will have to wait for over two months before he can do anything about the financial crisis.
And, what about the Fed?
The Federal Reserve System is flooding the world in liquidity. Bernanke’s study of the Great Depression taught him that during such a crisis the world cannot have too much liquidity. And, so “Helicopter Ben” is acting on that premise. Total reserves in the United States banking system, for the two weeks ending September 10, averaged about $44 billion on a non-seasonally adjusted basis. For the two weeks ending September 24, the total reserve figure was about $111 billion. Never has the United States banking system received so many reserves so rapidly. And look at the sources and uses statement of the Federal Reserve System…the H.4.1 release. In the last three weeks the sources of reserves in the banking system increased by more than 50%!!!!!
Never have we seen anything like this!
This is what happens when there is no leadership. One cannot blame this situation on previous administrations or other conditions within the world. The current leader of the free world is absent.
Unfortunately for the financial markets, for the economy, for workers, for families, for everyone else…there will not be a new president for several months yet. And, we still have to worry that one of the two candidates, when in office, will be able to provide the leadership we need.
We still face uncertainty about our leadership for the future. Therefore, uncertainty will reign in the markets until such leadership surfaces. And, the financial markets will still remain tentative as they attempt to discern who will fail next…and then next after that…and then next after that…
Without any leadership, members of the Bush 43 administration were hoping and praying that events would be relatively quiet until they were able to sneak out of Washington in January 2009 and let someone else handle the situation.
They didn’t make it!
And, like any other organization that does not have a leader…short of staging a revolution and disposing the top man…good people with good intentions when faced with calamities try to come up with some plan or some action that will plug the hole in the dike.
The problem with this is that they have to work around the leader. And, there is no unifying force present is such situations, no calm hand on the tiller listening to alternatives, asking questions, and guiding responses. And there is no one around to punish dissidents.
Up until a couple of weeks ago, Treasury Secretary Paulson and Fed Chairman Bernanke tried to band aid the system, proposing temporary responses to the growing crises that would tide things over until the new government came into office to deal with the problems. It seemed as if Paulson and Bernanke had reached a game plan…a bailout took place for Fannie and Freddie…and, Lehman was to fail with no help and nothing would be done for AIG.
Then, it appears by all reports…Bernanke panicked!
Bernanke called Paulson and indicated that the financial markets were falling apart and that if nothing were done the economy might not be there the next Monday. The Congressional leadership had to be informed of this development and brought on board for a major flood of liquidity. In no instance could the financial system and the economy come up short of liquidity!
Paulson set up the meeting with the Congressional leadership and at that meeting Bernanke poured out his story of woe. And, according to some of the members of Congress that were there…Bernanke scared the life out of them!
One question needs to be asked at this point…where was the “decider”?
The Treasury plan was assembled as quickly as possible for passage by Congress as quickly as possible…no hearings…really, no questioning…things were so bad that there was no time for these niceties that could take place when things were not so dire.
And, then the financial markets froze!
Why not?
Here was the Chairman of the Board of Governors of the Federal Reserve System saying that the economy might not be there on Monday. What did he know that market participants didn’t? What was going on in Europe and elsewhere? Here was a major case of asymmetric information. And the people that were without information were the suppliers of funds.
Bear Stearns had failed. Merrill Lynch had failed. Fannie and Freddie had failed. Lehman had failed. Washington Mutual had failed. AIG had failed. Wachovia had failed. Who was going to be next? What did the Fed and the Treasury know that market participants didn’t know?
The initial effort to get “the bill” through Congress failed! There was no one in a leadership position that could call the troops to order. (Even presidential candidate John McCain road out at the head of his Calvary to lead the charge to get the bill passed…only no one followed him! No leadership here.) Paulson could not do it…he was not the leader…there was no leader!
The straw-leader was marched out…but he was dazed and only mouthed the words that were given. Why should anyone have any confidence in what was being done?
Is the bill passed Friday any good? After what went on in the two previous weeks the bill seems somewhat irrelevant…a very costly irrelevant. There is still no leadership going forward. There is no vision. There is no structure. There is nothing. At best we are told that maybe in four weeks the “plan” will be up and running.
That will be after the election and we will have a president-elect. But, the president-elect will have to wait for over two months before he can do anything about the financial crisis.
And, what about the Fed?
The Federal Reserve System is flooding the world in liquidity. Bernanke’s study of the Great Depression taught him that during such a crisis the world cannot have too much liquidity. And, so “Helicopter Ben” is acting on that premise. Total reserves in the United States banking system, for the two weeks ending September 10, averaged about $44 billion on a non-seasonally adjusted basis. For the two weeks ending September 24, the total reserve figure was about $111 billion. Never has the United States banking system received so many reserves so rapidly. And look at the sources and uses statement of the Federal Reserve System…the H.4.1 release. In the last three weeks the sources of reserves in the banking system increased by more than 50%!!!!!
Never have we seen anything like this!
This is what happens when there is no leadership. One cannot blame this situation on previous administrations or other conditions within the world. The current leader of the free world is absent.
Unfortunately for the financial markets, for the economy, for workers, for families, for everyone else…there will not be a new president for several months yet. And, we still have to worry that one of the two candidates, when in office, will be able to provide the leadership we need.
We still face uncertainty about our leadership for the future. Therefore, uncertainty will reign in the markets until such leadership surfaces. And, the financial markets will still remain tentative as they attempt to discern who will fail next…and then next after that…and then next after that…
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