It is becoming clearer and clearer what it means to have government involved in the affairs of banks and businesses. Where all the initial talk was about the “moral hazard” presented by government bailing out the private sector and how this just means that in the future banks, and other organizations, will just take on more and more risk because they know that if things go bad, the government will be there with a rescue net to save the institution.
Now, we are seeing the other side of the bailout business. In the AIG case executives and others were angry because the government interfered with bonuses and other executive decisions. And, we have the government putting lids on executive pay. And, we have government wanting to rewrite mortgages, and cap interest rates on credit card debt, and so on and so on.
This is the other side of the coin.
And, now we learn from testimony given by Ken Lewis, the CEO of Bank of America, that Hank Paulson and Ben Bernanke put a “sock” in his mouth and strongly advised him that he say nothing to the shareholders or anybody else about the implications of the merger between Bank of America and Merrill Lynch.
Furthermore, we hear from New York’s Attorney General Cuomo that Paulson threatened to fire Lewis and remove the entire Board of Directors it Bank of America did not go through with the merger with Merrill Lynch! The reward—money from the Government to help BOA through the process.
The shareholders? Well, they lost on the value of their stock. And, they also will have higher taxes or an inflation tax that they will have to pay in the future.
In addition, why should any company, financial or non-financial even think of an acquisition in the future because the government may force the management to swallow hard, take on something that is not necessarily desirable for the company, and, of course, not inform investors as to the implications of the merger transaction?
And, why should the stockholders of any company approve any acquisition that is at all questionable? The precedent has been set that they might be approving something that will cost them considerable wealth as the stock of their company tanks, and they are given no information to give them any confidence that the transaction might be a worthy one.
What if the shareholders balk? What if they fail to approve such a merger? Will the government step in and force through the merger anyway?
Talk about a mess!
Two thoughts come to mind that I must express.
First, the combination of Paulson and Bernanke was a disaster as far as I can see. I have written about how Bernanke seemed to panic last fall and the result was the TARP. (See my post “The Bailout Plan: Did Bernanke Panic”, http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.)
Paulson didn’t do much better in his handling of the crisis and the creation and oversight of the TARP. I always thought that Paulson found the whole bailout idea not to his taste and had hoped that he would be able to get out of Washington before the collapse. Unfortunately for him—and for us—he didn’t make it. As a consequence here was a man doing something that he despised, and his heart, and mind, was really not in the effort. He has left us a very unhappy legacy!
When I reflect on the events of the last fall I keep coming up with the feeling that we would be hard pressed to have found two people less capable of handling the situation than the two that were then in charge. And, then there was the “Decider”, but he was AWOL!
The second thing has to do with the fact that the bankers, and other business leaders, are getting pelted with all the blame for the financial collapse and crisis that we have experienced. Thus we have the “bad guys” in our sights. Thus, they should pay.
But, what if the conditions that existed were created by the government and these bankers and other business leaders were just responding to the incentives initiated by the government? We had a credit bubble connected with the stock market in the 1990s. The credit bubble resulted in negative real rates of interest and consumers stopped saving. The saving rate fell from 7.7% of disposable income in 1992 to about 2.0% by the end of the decade. Then there was the huge deficits that resulted from the 2001 tax cuts and the “war on terror”. This was accompanied by negative real interest rates gain which resulted in the credit bubble in the 2000s and the housing boom. The consumer savings rate remained around two or below, even becoming negative for a short period of time.
The foreign exchange market in the 2000s indicated a fear of a renewal of inflation as the value of the dollar fell by more than 40% against major currencies. What were financial managers to do in such an environment? Generally, because spreads narrow in such times and arbitrage opportunities are based on smaller differences, you tend to leverage up and mismatch maturities. This response is a normal one to gain the needed returns on equity to keep money from leaving your fund or institution.
Is this greed? Yes, but it is also just the natural response of competitive people to the incentives that are created, in this case, by the government. The Bush 43 administration may have been composed of “Free Market Capitalists” but this “gang that couldn’t shoot straight” did more to harm capitalism than most other administrations in the history of the United States.
So, government gets it both ways. It can create the crisis. And, then it can impose itself on the economy to right the system after the crisis occurs. And, best of all, the blame can all be put on “greedy” bankers and the lack of regulation.
I am sure that before this is over we will hear many more horror stories.
Showing posts with label Henry Paulson. Show all posts
Showing posts with label Henry Paulson. Show all posts
Thursday, April 23, 2009
Sunday, February 8, 2009
Bail Out or Wimp Out?
The Obama administration is going to have to make a decision soon…is it going to try and commit to a program that will actually do something for banking and other financial institutions or is it going to extend the waffling on this issue that began last fall?
People in the administration say that something has to be done…and it has to be done fast…but, there is this problem about buying assets from these troubled institutions…we don’t know what price we should pay for them.
All I can advise them in terms of setting prices is…do the very best you can…at this moment in time! Yes, there is great uncertainty as to the prices of many or most of these assets…but, that is not the issue at this stage of the game.
Beginning in December 2007, things changed in Washington, D. C. The Federal Reserve System did something that had never been done before. It innovated! It created the Term Auction Facility; it introduced a dollar swap facility with other central banks around the world; as well as the Primary Dealer credit facility. Since that time the Fed has developed several other new ways to put dollars into the banking system.
In March 2008, the Fed and the Treasury engineered the Bear Stearns takeover and in September 2008 the world changed even more as Lehman Brothers was allowed to fail and AIG was essentially nationalized. The American model of financial markets and institutions would never be the same again.
And, things continued on from there with the $700 billion bailout bill passed by Congress and the efforts of Treasury Secretary Paulson and Fed Chairman Bernanke to sooth markets and get credit flowing once again.
The Obama administration has taken over from Bush43 and argued that with the crisis at hand…something must be done to avoid a “catastrophe”…in the words of President Obama himself.
My point is…it is not time to waffle on trying to save the banking and financial system from the bad assets they have on the books.
The government IS involved…up to its neck and beyond! The Obama stimulus package is an attempt to stimulate the economy. But, in my estimation, it will not do a lot. If the current size of the package is, being generous, around $850 billion and the multiplier of this spending is between 0.4 and 0.6 (see my post of January 26, 2009, http://seekingalpha.com/article/116414-what-will-be-the-impact-of-obama-s-stimulus-plan) then the effect on the economy will be between $340 billion and $510 billion of additional output. Not a great “bang-for-the-buck”, but, we are told, it is the effort that is so important at this particular moment.
There will be more to come…promises the Obama administration. Additional programs need to follow this package. More dollars need to be thrown at the problem.
Still, there is the problem of bad assets. What is going to be done with all the toxic waste that is now held by our financial institutions?
Well, since there is way too much debt in the financial system, there could be a massive write down of assets…the banks and other financial institutions absorbing the hair cut. (See my post of February 4, 2009, http://seekingalpha.com/article/118475-two-painful-proposals-to-reduce-our-excess-debt.) At this stage of the effort there does not seem to be a lot of interest in this approach so we probably should put this idea on the back burner for another time.
Thus, if something has to be done…along with the $850 billion stimulus plan…let the Federal Government buy these toxic assets from the banks and other financial institutions. Many estimates place the difference between what these institutions value the assets on their books and the price that the Federal Government would buy them at is a minimum of $2.0 trillion. If the banks and other financial institutions took this kind of a hit to their balance sheets…many of the organizations would be bankrupt…kaput…out-of-business.
My question to this is…aren’t they bankrupt…kaput…out-of-business…already?
The issue is that many of these institutions are large…would require a lot of management talent to run them…and what about the shareholders? Well, the shareholders have no rights…because there is no equity left in these institutions. Let us recognize this and get on with it. Many of these institutions are large…which means there is a major need for management talent. But…why should the managements that got these institutions into the positions they now are in be expected to get them straightened out and healthy again?
This reminds me of many of the “dog-and-pony shows” that I observed during the S & L crisis twenty-some years ago. In these “shows” the existing management would get up in front of potential investors and say…”Yes, we have run this bank for the past 20-some years…and, yes, we basically bankrupted the band…but…WE HAVE LEARNED our lessons! Give us $100.0 million so that we can turn this bank around and make it into something you will be proud of!”
In most cases, the potential investors dug into their pockets and forked over the $100.0 million. Few, if any, of the “born again” managements were successful in turning their institutions around. Oh, well…live and learn!
Unfortunately, the same thing seems to be in play here. The managements that got us here claim that they can be the managements that get us back to health again. What did P. T. Barnum say?
A number of these banks and other financial institutions appear to be insolvent…their managements are hanging on by their finger nails…the credit system is not functioning as it might…and the government is dawdling.
Buy the assets. Remove the shareholders…they had their turn to oversee these institutions. Take over these banks…and see that the banks get new top managements. If you are going to do it…then, do it! Cut out the half-fast programs. Postponing government action only creates more uncertainty, and, as we know too well, the market hates uncertainty.
The Obama campaign called for change in Washington, D. C. It said an Obama administration would change things…action would be taken. Well, action needs to be taken. Obama was right the other evening when he said that his administration will be remembered for stopping the economic downturn and getting things moving upwards again…or not. Not much else is going to matter. And, whether or not you agree with the policies and programs that are being presented…and to a large extent I don’t…I do agree with the general feeling that if you are going to fail…or succeed…you will have to do it in a very committed way. Half-measures are bound to fail…if for no other reason than they won’t raise the confidence of the nation.
So, Mr. Obama, come out with a strong plan for taking care of these toxic assets and come out with a strong plan for removing the chaff from the banking system. Half-way measures are not going to resolve the issue because there will still need to be further adjustments sometime down the road. Be strong! All you can do is what you think is best for the country!
People in the administration say that something has to be done…and it has to be done fast…but, there is this problem about buying assets from these troubled institutions…we don’t know what price we should pay for them.
All I can advise them in terms of setting prices is…do the very best you can…at this moment in time! Yes, there is great uncertainty as to the prices of many or most of these assets…but, that is not the issue at this stage of the game.
Beginning in December 2007, things changed in Washington, D. C. The Federal Reserve System did something that had never been done before. It innovated! It created the Term Auction Facility; it introduced a dollar swap facility with other central banks around the world; as well as the Primary Dealer credit facility. Since that time the Fed has developed several other new ways to put dollars into the banking system.
In March 2008, the Fed and the Treasury engineered the Bear Stearns takeover and in September 2008 the world changed even more as Lehman Brothers was allowed to fail and AIG was essentially nationalized. The American model of financial markets and institutions would never be the same again.
And, things continued on from there with the $700 billion bailout bill passed by Congress and the efforts of Treasury Secretary Paulson and Fed Chairman Bernanke to sooth markets and get credit flowing once again.
The Obama administration has taken over from Bush43 and argued that with the crisis at hand…something must be done to avoid a “catastrophe”…in the words of President Obama himself.
My point is…it is not time to waffle on trying to save the banking and financial system from the bad assets they have on the books.
The government IS involved…up to its neck and beyond! The Obama stimulus package is an attempt to stimulate the economy. But, in my estimation, it will not do a lot. If the current size of the package is, being generous, around $850 billion and the multiplier of this spending is between 0.4 and 0.6 (see my post of January 26, 2009, http://seekingalpha.com/article/116414-what-will-be-the-impact-of-obama-s-stimulus-plan) then the effect on the economy will be between $340 billion and $510 billion of additional output. Not a great “bang-for-the-buck”, but, we are told, it is the effort that is so important at this particular moment.
There will be more to come…promises the Obama administration. Additional programs need to follow this package. More dollars need to be thrown at the problem.
Still, there is the problem of bad assets. What is going to be done with all the toxic waste that is now held by our financial institutions?
Well, since there is way too much debt in the financial system, there could be a massive write down of assets…the banks and other financial institutions absorbing the hair cut. (See my post of February 4, 2009, http://seekingalpha.com/article/118475-two-painful-proposals-to-reduce-our-excess-debt.) At this stage of the effort there does not seem to be a lot of interest in this approach so we probably should put this idea on the back burner for another time.
Thus, if something has to be done…along with the $850 billion stimulus plan…let the Federal Government buy these toxic assets from the banks and other financial institutions. Many estimates place the difference between what these institutions value the assets on their books and the price that the Federal Government would buy them at is a minimum of $2.0 trillion. If the banks and other financial institutions took this kind of a hit to their balance sheets…many of the organizations would be bankrupt…kaput…out-of-business.
My question to this is…aren’t they bankrupt…kaput…out-of-business…already?
The issue is that many of these institutions are large…would require a lot of management talent to run them…and what about the shareholders? Well, the shareholders have no rights…because there is no equity left in these institutions. Let us recognize this and get on with it. Many of these institutions are large…which means there is a major need for management talent. But…why should the managements that got these institutions into the positions they now are in be expected to get them straightened out and healthy again?
This reminds me of many of the “dog-and-pony shows” that I observed during the S & L crisis twenty-some years ago. In these “shows” the existing management would get up in front of potential investors and say…”Yes, we have run this bank for the past 20-some years…and, yes, we basically bankrupted the band…but…WE HAVE LEARNED our lessons! Give us $100.0 million so that we can turn this bank around and make it into something you will be proud of!”
In most cases, the potential investors dug into their pockets and forked over the $100.0 million. Few, if any, of the “born again” managements were successful in turning their institutions around. Oh, well…live and learn!
Unfortunately, the same thing seems to be in play here. The managements that got us here claim that they can be the managements that get us back to health again. What did P. T. Barnum say?
A number of these banks and other financial institutions appear to be insolvent…their managements are hanging on by their finger nails…the credit system is not functioning as it might…and the government is dawdling.
Buy the assets. Remove the shareholders…they had their turn to oversee these institutions. Take over these banks…and see that the banks get new top managements. If you are going to do it…then, do it! Cut out the half-fast programs. Postponing government action only creates more uncertainty, and, as we know too well, the market hates uncertainty.
The Obama campaign called for change in Washington, D. C. It said an Obama administration would change things…action would be taken. Well, action needs to be taken. Obama was right the other evening when he said that his administration will be remembered for stopping the economic downturn and getting things moving upwards again…or not. Not much else is going to matter. And, whether or not you agree with the policies and programs that are being presented…and to a large extent I don’t…I do agree with the general feeling that if you are going to fail…or succeed…you will have to do it in a very committed way. Half-measures are bound to fail…if for no other reason than they won’t raise the confidence of the nation.
So, Mr. Obama, come out with a strong plan for taking care of these toxic assets and come out with a strong plan for removing the chaff from the banking system. Half-way measures are not going to resolve the issue because there will still need to be further adjustments sometime down the road. Be strong! All you can do is what you think is best for the country!
Sunday, February 1, 2009
Concerns about the Obama Stimulus Plan
As the Obama Stimulus Plan becomes more and more of a reality, many different people are asking many different questions about it. To me, there are four basic issues that need to be debated very seriously before any such plan is passed by Congress. The first question is…how fast do we really need to move in passing such a plan? Second…how big does the stimulus package really need to be? Third…how is all the debt created by such a plan going to be financed? And fourth, can the stimulus really be withdrawn once the crisis is over?
In terms of speed of enactment we hear over and over again that speed is of the essence. Things are really bad…and things are going to get a lot worse. We need to get into the game and do something as quickly as possible!
We heard this argument before, not too long ago. It was reported in the Wall Street Journal, that “Federal Reserve Chairman Ben Bernanke reached the end of his rope on Wednesday afternoon, September 17.” Bernanke was reacting to things falling apart in the financial industry. He called Treasury Secretary Hank Paulson and said that the administration had to move. Thursday September 18. Paulson responded that he was “on board”. Bernanke insisted that Congressional leaders had to be assembled…which Paulson set up for that Friday evening. Bernanke read them the riot act at that meeting and insisted that a bill…what became TARP…be enacted no later than Monday or everything would fall apart. (For more on this see my post on Seeking Alpha of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?”) The bill was not enacted that Monday and the last half of the TARP money was not released until just recently.
Now we are hearing the call again. We must hurry. The Obama Stimulus Plan has been put on the fast track…and the pressure is on to get the plan enacted by Congress by President’s Day, February 16. But, does this plan really need to be enacted that quickly? Is it better to have any plan by President’s Day or is it better to have a plan that works?
It seems to me that the pressure to get something done quickly has important implications for the second question asked above. Since so little is known about how effective the plan will be…the issue becomes…MORE IS BETTER! Given the uncertainty of how the plan will work, it is important to throw as much as possible against the wall in the hopes that some of it will stick.
Wow! What a way to run a government! But that is what Bernanke/Paulson did.
And, this approach gives rise to the new justification for the program…confidence. The argument goes that “If the government shows that it is serious in ending the recession and this seriousness is reflected in the size of the stimulus package…this will spur on an increase in confidence…which is just what the economy needs right now!”
Let me get this straight. It doesn’t really matter whether or not the stimulus plan works…what is important is that the stimulus plan be very large…so that people will regain confidence.
And, if this is the underlying theory behind the stimulus plan…how is this going to raise the confidence of the world wide investment community…which relates to the third question presented above…to invest in the debt of the United States government?
Oh, well…the United States dollar is the world’s reserve currency and the United States debt is the place for world investors to go when there is a “flight to quality” in world financial markets. Given this fact, people will continue to flock to United States Treasury issues. No doubt about it!
As Alice Rivlin, economist of the Brookings Institution, former member of the Board of Governors of the Federal Reserve System, First Director of the Congressional Budget Office, and Director of the Office of Management and Budget (a cabinet position and appointed by President Bill Clinton a Democrat) recently testified before Congress…”We seem to be counting on the Chinese to keep investing to pay for this (the U. S. deficits) and we’re assuming that the rest of the world isn’t going to lose confidence once we use this moment to spend on a whole range of programs. And, I’m not sure that’s the right assumption.”
Rivlin also has something to say about the fourth question…the question about what happens in the long run. She states that “Because we’re doing this outside the budget process, it means that no one has to talk about what the long-term effects of any of this might be.” That is, what is going to happen beyond the short run if much of this expenditure is still going into the economy as the economy begins to grow again. No one is anticipating how this situation might be dealt with.
As Niall Ferguson, who shares his time between Harvard University and Oxford University, stated recently at Davos…and I am paraphrasing…the new administration seems to believe that by creating an impressive amount of new leverage that it can resolve a financial crisis created by an excessive amount of leverage.
So, I go back to the first question…do we really need to rush so quickly? Yes, I agree with President Obama…he won…he gets to set the table. But, does he want to do it right…or does he just want to do it?
The Congress is supposed to be a deliberative body…it is supposed to mull things over…kick them around…debate and dialogue with one another. Isn’t it better to get something right…than to not do something well…or to do something that may not work?
Projects should not just be put into a stimulus plan…just because they are a “good idea” or because “they are something we want to do and they are available.” Projects, to be included, need to have some real justification for their inclusion in such a plan…the benefit of the project (the whole flow of benefits accruing from the project) should exceed the social cost of the project. Questions should be asked about the timing of the project and when the expected benefits are expected to be received. The Congress should be very intentional about what it is going to do…how much it is going to spend. Success of execution should be the key criteria as to whether a project gets included in the plan…not just the speed of passing the bill.
If Congress were to judge the plan…the whole plan as well as the components of the plan…in this fashion, then something more specific could be said about the size of the plan. Given that every element of the plan could stand up to some form of cost-benefit analysis then the size of the plan would be less of an issue. We would have some rationale for the size of the plan…it would not be a question of hoping some of the material thrown against the wall would stick! The parts of the plan would be chosen because they work…not because they make the plan “large”.
There still will remain questions about financing a stimulus plan. A plan constructed as suggested above would still result in the creation of a lot of new debt the United States government would have to issue. But, the investment community would have more justification to “trust” the plan because the Congress has done its homework…and, if the Congress had done its homework there would be something to say about how the debt will be financed and paid down in the future. That is, the United States government would be acting like a responsible steward of its fiscal responsibilities, something world financial markets have not seen for eight years or so.
To me, this is a crucial issue the Obama administration and the United States government has to deal with…restoring confidence in the fiscal credibility of the United States…something that Bush43 fell far short of doing. Rushing into the fray with a hastily constructed, ill-conceived stimulus plan, one that relies on the Chinese and the rest-of-the-world to finance with no thought for the future is not going to resolve the financial and economic mess we are now experiencing.
In terms of speed of enactment we hear over and over again that speed is of the essence. Things are really bad…and things are going to get a lot worse. We need to get into the game and do something as quickly as possible!
We heard this argument before, not too long ago. It was reported in the Wall Street Journal, that “Federal Reserve Chairman Ben Bernanke reached the end of his rope on Wednesday afternoon, September 17.” Bernanke was reacting to things falling apart in the financial industry. He called Treasury Secretary Hank Paulson and said that the administration had to move. Thursday September 18. Paulson responded that he was “on board”. Bernanke insisted that Congressional leaders had to be assembled…which Paulson set up for that Friday evening. Bernanke read them the riot act at that meeting and insisted that a bill…what became TARP…be enacted no later than Monday or everything would fall apart. (For more on this see my post on Seeking Alpha of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?”) The bill was not enacted that Monday and the last half of the TARP money was not released until just recently.
Now we are hearing the call again. We must hurry. The Obama Stimulus Plan has been put on the fast track…and the pressure is on to get the plan enacted by Congress by President’s Day, February 16. But, does this plan really need to be enacted that quickly? Is it better to have any plan by President’s Day or is it better to have a plan that works?
It seems to me that the pressure to get something done quickly has important implications for the second question asked above. Since so little is known about how effective the plan will be…the issue becomes…MORE IS BETTER! Given the uncertainty of how the plan will work, it is important to throw as much as possible against the wall in the hopes that some of it will stick.
Wow! What a way to run a government! But that is what Bernanke/Paulson did.
And, this approach gives rise to the new justification for the program…confidence. The argument goes that “If the government shows that it is serious in ending the recession and this seriousness is reflected in the size of the stimulus package…this will spur on an increase in confidence…which is just what the economy needs right now!”
Let me get this straight. It doesn’t really matter whether or not the stimulus plan works…what is important is that the stimulus plan be very large…so that people will regain confidence.
And, if this is the underlying theory behind the stimulus plan…how is this going to raise the confidence of the world wide investment community…which relates to the third question presented above…to invest in the debt of the United States government?
Oh, well…the United States dollar is the world’s reserve currency and the United States debt is the place for world investors to go when there is a “flight to quality” in world financial markets. Given this fact, people will continue to flock to United States Treasury issues. No doubt about it!
As Alice Rivlin, economist of the Brookings Institution, former member of the Board of Governors of the Federal Reserve System, First Director of the Congressional Budget Office, and Director of the Office of Management and Budget (a cabinet position and appointed by President Bill Clinton a Democrat) recently testified before Congress…”We seem to be counting on the Chinese to keep investing to pay for this (the U. S. deficits) and we’re assuming that the rest of the world isn’t going to lose confidence once we use this moment to spend on a whole range of programs. And, I’m not sure that’s the right assumption.”
Rivlin also has something to say about the fourth question…the question about what happens in the long run. She states that “Because we’re doing this outside the budget process, it means that no one has to talk about what the long-term effects of any of this might be.” That is, what is going to happen beyond the short run if much of this expenditure is still going into the economy as the economy begins to grow again. No one is anticipating how this situation might be dealt with.
As Niall Ferguson, who shares his time between Harvard University and Oxford University, stated recently at Davos…and I am paraphrasing…the new administration seems to believe that by creating an impressive amount of new leverage that it can resolve a financial crisis created by an excessive amount of leverage.
So, I go back to the first question…do we really need to rush so quickly? Yes, I agree with President Obama…he won…he gets to set the table. But, does he want to do it right…or does he just want to do it?
The Congress is supposed to be a deliberative body…it is supposed to mull things over…kick them around…debate and dialogue with one another. Isn’t it better to get something right…than to not do something well…or to do something that may not work?
Projects should not just be put into a stimulus plan…just because they are a “good idea” or because “they are something we want to do and they are available.” Projects, to be included, need to have some real justification for their inclusion in such a plan…the benefit of the project (the whole flow of benefits accruing from the project) should exceed the social cost of the project. Questions should be asked about the timing of the project and when the expected benefits are expected to be received. The Congress should be very intentional about what it is going to do…how much it is going to spend. Success of execution should be the key criteria as to whether a project gets included in the plan…not just the speed of passing the bill.
If Congress were to judge the plan…the whole plan as well as the components of the plan…in this fashion, then something more specific could be said about the size of the plan. Given that every element of the plan could stand up to some form of cost-benefit analysis then the size of the plan would be less of an issue. We would have some rationale for the size of the plan…it would not be a question of hoping some of the material thrown against the wall would stick! The parts of the plan would be chosen because they work…not because they make the plan “large”.
There still will remain questions about financing a stimulus plan. A plan constructed as suggested above would still result in the creation of a lot of new debt the United States government would have to issue. But, the investment community would have more justification to “trust” the plan because the Congress has done its homework…and, if the Congress had done its homework there would be something to say about how the debt will be financed and paid down in the future. That is, the United States government would be acting like a responsible steward of its fiscal responsibilities, something world financial markets have not seen for eight years or so.
To me, this is a crucial issue the Obama administration and the United States government has to deal with…restoring confidence in the fiscal credibility of the United States…something that Bush43 fell far short of doing. Rushing into the fray with a hastily constructed, ill-conceived stimulus plan, one that relies on the Chinese and the rest-of-the-world to finance with no thought for the future is not going to resolve the financial and economic mess we are now experiencing.
Thursday, December 18, 2008
The Declining Dollar
The decline in the value of the dollar has gotten increasing headlines since the Federal Reserve Board of Governors released its new monetary policy efforts on Tuesday. Many short run reasons are being given for the recent decline in the value of the dollar, especially against the Euro and the Yen.
The most intriguing explanation for the decline, however, is a longer term reason. In this explanation, analysts argue that the decline in the value of the dollar is just a continuation of the trend which began in early 2002 and continued through until early August 2008.
The story that accompanies this explanation is that a series of events in 2001 and 2002 convinced international markets that the United States government had forfeited any discipline it had established over its fiscal and monetary policies. First, there was the huge Bush (43) tax cut that moved the government’s budget from one of surplus to one of deficit. This was followed by the war on terror and the Iraq invasion which exacerbated the amount of the budget deficit.
In addition to this the Greenspan Federal Reserve cut the target Federal Funds rate to very low levels, around 1% or so, for a period of about two years. Mr. Greenspan’s concern, apparently, was fear of an extended recession following the burst of the dot.com bubble in the stock market. The result was the creation of the housing bubble as well as smaller bubbles in other areas of the economy, including commodity prices.
As a consequence of these actions, massive amounts of debt were created. Fortunately for the United States…at the time…was that over 50% of this debt…both private and public debt…was financed outside of the United States…large amounts being placed in China, India, and the middle east…although as we found out…banks all over the world acquired huge quantities of mortgage-backed debt.
The interesting thing that was learned from this period is that consumer inflation (as measured by the Consumer Price Index) could be kept in check while inflation ran rapid in asset prices (particularly in housing prices and commodity prices at this time). The monetary authorities concentrated on consumer prices and did nothing with respect to asset prices.
The thing is that “self-reinforcing expectations” can get built into asset prices leading to a massive increase of financial leverage. Consumer credit can be expanded for purchases of the items individuals purchase, but this credit expansion cannot match the possibilities for increase that exist as asset prices go up substantially, year-after-year.
Foreign exchange rates capture the relative expectations of people that operate in these markets. The specific ‘relative expectations’ that are relevant here pertain to how market participants judge how the economies of different countries are expected to perform. Performance in this instance relates to the state of the economy, performance of government’s in terms of their conduct of their economic policies, and expected inflation.
In this respect, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has stated that the price of a country’s currency is the most important price in its economy. The value of a country’s currency is, in a real sense, the “grade card” of the country’s economic and monetary policy, relative to the rest of the world.
Thus, as the value of the United States dollar fell more than 40% from early 2002 to August 2008, participants in international financial markets were indicating a belief that the government of the United States was showing little or no discipline over its budget and this was connected with an extremely “loose” monetary policy. To these market participants, the United States would have to “pay the piper”, sooner or later.
As the story continues, when the financial markets fell apart in September, the United States dollar became the “quality” asset in the world and investors flocked to the dollar as they repatriated assets from all over the globe in order to invest in U. S. Treasury securities. As a consequence of this rush to quality the value of the United States dollar rose.
This latter movement has apparently come to an end. There seems to be a number of short-run reasons for the recent decline in the value of the United States dollar…one of them being a move on the part of foreign investors to get back into their own currencies to dress up their year-end balance sheets.
But, there is another reason given for the drop in the value of the dollar and this is connected with the decisions of the Federal Reserve that were announced on Tuesday and the projected rise in the deficit of the federal government. For all intents and purposes, the target Federal Funds rate is now approximately zero. In addition, the Fed said that it would buy financial assets, long term U. S. Treasury issues and mortgage backed bonds and so forth in order to flood the financial markets with liquidity. And, they warned, they will continue to do this for as long as necessary…whatever “necessary” means. On top of this, the Obama team seems to be talking about adding roughly $1.0 trillion in expenditures to the federal budget to get the United States economy going again.
One can easily draw from this the assumption that the world will be flooded with dollars…millions and millions of dollars. How should one react to this in terms of the value of the dollar?
One could argue that this is exactly what world financial markets have been predicting would happen since early in 2002. (They did not, and could not, predict precisely the path of the collapse.) This is exactly the reason why the United States dollar has declined by about 40% since then!
The problem is that there are no “good” decisions left for the United States. This is the dilemma that must be faced when discipline in lost. When one sees the consequences of a lack of discipline, one does what one needs to do in order to get one’s life back in order. Getting discipline back into one’s life is a matter of one step at a time.
In terms of priorities…getting the economy going and avoiding a cumulative collapse is number one. Until this is accomplished, we may just have to see the value of the dollar continue to decline.
The most intriguing explanation for the decline, however, is a longer term reason. In this explanation, analysts argue that the decline in the value of the dollar is just a continuation of the trend which began in early 2002 and continued through until early August 2008.
The story that accompanies this explanation is that a series of events in 2001 and 2002 convinced international markets that the United States government had forfeited any discipline it had established over its fiscal and monetary policies. First, there was the huge Bush (43) tax cut that moved the government’s budget from one of surplus to one of deficit. This was followed by the war on terror and the Iraq invasion which exacerbated the amount of the budget deficit.
In addition to this the Greenspan Federal Reserve cut the target Federal Funds rate to very low levels, around 1% or so, for a period of about two years. Mr. Greenspan’s concern, apparently, was fear of an extended recession following the burst of the dot.com bubble in the stock market. The result was the creation of the housing bubble as well as smaller bubbles in other areas of the economy, including commodity prices.
As a consequence of these actions, massive amounts of debt were created. Fortunately for the United States…at the time…was that over 50% of this debt…both private and public debt…was financed outside of the United States…large amounts being placed in China, India, and the middle east…although as we found out…banks all over the world acquired huge quantities of mortgage-backed debt.
The interesting thing that was learned from this period is that consumer inflation (as measured by the Consumer Price Index) could be kept in check while inflation ran rapid in asset prices (particularly in housing prices and commodity prices at this time). The monetary authorities concentrated on consumer prices and did nothing with respect to asset prices.
The thing is that “self-reinforcing expectations” can get built into asset prices leading to a massive increase of financial leverage. Consumer credit can be expanded for purchases of the items individuals purchase, but this credit expansion cannot match the possibilities for increase that exist as asset prices go up substantially, year-after-year.
Foreign exchange rates capture the relative expectations of people that operate in these markets. The specific ‘relative expectations’ that are relevant here pertain to how market participants judge how the economies of different countries are expected to perform. Performance in this instance relates to the state of the economy, performance of government’s in terms of their conduct of their economic policies, and expected inflation.
In this respect, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has stated that the price of a country’s currency is the most important price in its economy. The value of a country’s currency is, in a real sense, the “grade card” of the country’s economic and monetary policy, relative to the rest of the world.
Thus, as the value of the United States dollar fell more than 40% from early 2002 to August 2008, participants in international financial markets were indicating a belief that the government of the United States was showing little or no discipline over its budget and this was connected with an extremely “loose” monetary policy. To these market participants, the United States would have to “pay the piper”, sooner or later.
As the story continues, when the financial markets fell apart in September, the United States dollar became the “quality” asset in the world and investors flocked to the dollar as they repatriated assets from all over the globe in order to invest in U. S. Treasury securities. As a consequence of this rush to quality the value of the United States dollar rose.
This latter movement has apparently come to an end. There seems to be a number of short-run reasons for the recent decline in the value of the United States dollar…one of them being a move on the part of foreign investors to get back into their own currencies to dress up their year-end balance sheets.
But, there is another reason given for the drop in the value of the dollar and this is connected with the decisions of the Federal Reserve that were announced on Tuesday and the projected rise in the deficit of the federal government. For all intents and purposes, the target Federal Funds rate is now approximately zero. In addition, the Fed said that it would buy financial assets, long term U. S. Treasury issues and mortgage backed bonds and so forth in order to flood the financial markets with liquidity. And, they warned, they will continue to do this for as long as necessary…whatever “necessary” means. On top of this, the Obama team seems to be talking about adding roughly $1.0 trillion in expenditures to the federal budget to get the United States economy going again.
One can easily draw from this the assumption that the world will be flooded with dollars…millions and millions of dollars. How should one react to this in terms of the value of the dollar?
One could argue that this is exactly what world financial markets have been predicting would happen since early in 2002. (They did not, and could not, predict precisely the path of the collapse.) This is exactly the reason why the United States dollar has declined by about 40% since then!
The problem is that there are no “good” decisions left for the United States. This is the dilemma that must be faced when discipline in lost. When one sees the consequences of a lack of discipline, one does what one needs to do in order to get one’s life back in order. Getting discipline back into one’s life is a matter of one step at a time.
In terms of priorities…getting the economy going and avoiding a cumulative collapse is number one. Until this is accomplished, we may just have to see the value of the dollar continue to decline.
Friday, November 14, 2008
Did Bernanke Panic?
I have been going over and over the events of the week beginning September 15, 2008 and I continue to come up with one basic conclusion: the reaction of Fed Chairman Ben Bernanke to the existing financial market strains was somewhat precipitous. A good start to understanding the time-line for that week is the article that appeared in the November 10 Wall Street Journal: “Paulson, Bernanke strained for consensus in Bailout” http://online.wsj.com/article/SB122628169939012475.html?mod=todays_us_page_one. The article begins “Federal Reserve Chairman Ben Bernanke reached the end of his rope on Wednesday afternoon, September 17.”
The week before, the week beginning September 8, the government nationalized Fannie Mae and Freddie Mac. Lehman Brothers was next. Secretary of the Treasury Hank Paulson put his foot down on this one…no bailout for Lehman…that’s final! Monday, September 15 Lehman Brothers filed for bankruptcy. The next troubled firm was AIG and frantic efforts were made to find additional cash for AIG. The basic signal being given to the market was…the bailouts are over. Lehman had to find its own way out or declare bankruptcy. AIG also had to find its own solution. The ‘free-market’ leanings of Paulson and others made for a reluctant leadership.
And then Tuesday evening came and the world changed. That evening the AIG $85 billion bailout was announced. When I heard this news around 9:00 PM that night, things just seemed to feel different: this was a different world than it was before. One didn’t know how…but it was different.
The Wall Street Journal article reports that by Wednesday afternoon “Bernanke reached the end of his rope”. He called Paulson and “with an occasional quaver in his voice” he spoke “unusually bluntly” to the Treasury Secretary. Paulson did not move immediately. He had to sleep on it. Thursday morning he committed.
Paulson called the leadership in Congress and asked for them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and “scared the daylights out of everyone.” Bernanke knew his history of the Great Depression and he knew currents events. He was very logical and very articulate. The leaders were told that they had to act and they had to act fast. The plan was to have a bill before Congress on Monday seeking Congressional approval (of both houses) by the following Friday. The Treasury Department had a bill ready (3 pages long) by midnight Saturday evening. The price tag…$700 billion. Why $700 billion? Because it was a big number!
As we know, the bill was rewritten and finally passed on Friday, October 3. What was the bill to do? No one really knew. The important thing, according to Bernanke, was that something was being done and that something was big!
And, the Fed did not stand idle. Helicopter Ben began to flood the financial markets with liquidity. The important thing was to get a lot of liquidity “out there” and worry about cleaning it up later, once the crisis was over. As I have reported elsewhere Reserve Bank Credit has risen from $890 billion in the banking week ending September 10, 2008 to about $2.2 trillion in the banking week ending November 12, 2008. (I have also noted that it took 94 years to get Reserve Bank Credit up to $890 billion and only nine weeks to have it more than double.) The rationale for this increase…the financial markets are in a liquidity trap and we don’t know how much is needed…we just cannot fail to supply enough!
Here we are in the middle of November. The basic conclusion relating to the financial crisis so far is that although we cannot tell whether or not the effort is working, we believe that things are better off than they would have been if the actions of Paulson and Bernanke had not been taken.
However, discontent is now being expressed. Paulson has changed the direction of the $700 billion bailout package and Congress is not particularly happy with this move and expressing its discontent. No one really seems to know what to do. Since events have slowed down and the ‘immediate’ need for the rapid passage of the package seems to have passed away…as might be expected…everyone and his brother and sister have got their hands out to get a piece of the bailout pie. Apparently, lobbyists are over-running the Treasury Department trying to get their share. And, Henry Paulson’s reputation has seemed to tank along with the stock market. (See the article by Rebecca Christie and Matthew Benjamin on Bloomberg.com titled “Paulson Credibility Takes Hit with Rescue-Plan Shift." It seems like no one can be a part of this administration without having their image tarnished.)
And, one question still remains. While Paulson and Bernanke seem to be running this whole show…where is the “decider”? The “decider” has apparently decided to hide out in the White House bunker. This has left Paulson and Bernanke hanging…trying to do something…with no steady hand overseeing their efforts and no vision for a plan.
It seems obvious that the driving force behind all the activity over the last nine weeks has been Ben Bernanke…he is, in a real sense, the initiator, if not the architect, of the hasty and ill-thought out bailout effort. On Wednesday afternoon, September 17 Bernanke reached the end of his rope. The rest, as they say, is history.
It is my personal hope that President-elect Obama will be able to name his own Chairman of the Board of Governors of the Federal Reserve System when he becomes President.
The week before, the week beginning September 8, the government nationalized Fannie Mae and Freddie Mac. Lehman Brothers was next. Secretary of the Treasury Hank Paulson put his foot down on this one…no bailout for Lehman…that’s final! Monday, September 15 Lehman Brothers filed for bankruptcy. The next troubled firm was AIG and frantic efforts were made to find additional cash for AIG. The basic signal being given to the market was…the bailouts are over. Lehman had to find its own way out or declare bankruptcy. AIG also had to find its own solution. The ‘free-market’ leanings of Paulson and others made for a reluctant leadership.
And then Tuesday evening came and the world changed. That evening the AIG $85 billion bailout was announced. When I heard this news around 9:00 PM that night, things just seemed to feel different: this was a different world than it was before. One didn’t know how…but it was different.
The Wall Street Journal article reports that by Wednesday afternoon “Bernanke reached the end of his rope”. He called Paulson and “with an occasional quaver in his voice” he spoke “unusually bluntly” to the Treasury Secretary. Paulson did not move immediately. He had to sleep on it. Thursday morning he committed.
Paulson called the leadership in Congress and asked for them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and “scared the daylights out of everyone.” Bernanke knew his history of the Great Depression and he knew currents events. He was very logical and very articulate. The leaders were told that they had to act and they had to act fast. The plan was to have a bill before Congress on Monday seeking Congressional approval (of both houses) by the following Friday. The Treasury Department had a bill ready (3 pages long) by midnight Saturday evening. The price tag…$700 billion. Why $700 billion? Because it was a big number!
As we know, the bill was rewritten and finally passed on Friday, October 3. What was the bill to do? No one really knew. The important thing, according to Bernanke, was that something was being done and that something was big!
And, the Fed did not stand idle. Helicopter Ben began to flood the financial markets with liquidity. The important thing was to get a lot of liquidity “out there” and worry about cleaning it up later, once the crisis was over. As I have reported elsewhere Reserve Bank Credit has risen from $890 billion in the banking week ending September 10, 2008 to about $2.2 trillion in the banking week ending November 12, 2008. (I have also noted that it took 94 years to get Reserve Bank Credit up to $890 billion and only nine weeks to have it more than double.) The rationale for this increase…the financial markets are in a liquidity trap and we don’t know how much is needed…we just cannot fail to supply enough!
Here we are in the middle of November. The basic conclusion relating to the financial crisis so far is that although we cannot tell whether or not the effort is working, we believe that things are better off than they would have been if the actions of Paulson and Bernanke had not been taken.
However, discontent is now being expressed. Paulson has changed the direction of the $700 billion bailout package and Congress is not particularly happy with this move and expressing its discontent. No one really seems to know what to do. Since events have slowed down and the ‘immediate’ need for the rapid passage of the package seems to have passed away…as might be expected…everyone and his brother and sister have got their hands out to get a piece of the bailout pie. Apparently, lobbyists are over-running the Treasury Department trying to get their share. And, Henry Paulson’s reputation has seemed to tank along with the stock market. (See the article by Rebecca Christie and Matthew Benjamin on Bloomberg.com titled “Paulson Credibility Takes Hit with Rescue-Plan Shift." It seems like no one can be a part of this administration without having their image tarnished.)
And, one question still remains. While Paulson and Bernanke seem to be running this whole show…where is the “decider”? The “decider” has apparently decided to hide out in the White House bunker. This has left Paulson and Bernanke hanging…trying to do something…with no steady hand overseeing their efforts and no vision for a plan.
It seems obvious that the driving force behind all the activity over the last nine weeks has been Ben Bernanke…he is, in a real sense, the initiator, if not the architect, of the hasty and ill-thought out bailout effort. On Wednesday afternoon, September 17 Bernanke reached the end of his rope. The rest, as they say, is history.
It is my personal hope that President-elect Obama will be able to name his own Chairman of the Board of Governors of the Federal Reserve System when he becomes President.
Thursday, November 13, 2008
The State of the Bailout
Treasury Secretary Paulson gave a press conference yesterday and indicated that things had changed…that the focus of the bailout effort would not be on the purchase of ‘toxic assets’ but would be aimed to assist the capital needs of financial institutions and consumer finance. This ‘shift’ in focus has been duly noted by the press.
Is the ‘bailout’ program having any success?
To answer this question, I am roughly in the same spot of someone I heard being interviewed on Marketplace on NPR radio: the ‘expert’ was asked the following question “Has the efforts to add liquidity to financial markets and financial institutions shown any results to date?” His reply: “I think things are better than they would have been if the efforts had not been made.”
Does that give you a lot of confidence?
I just don’t think that at this time anyone can say more. We are in the middle of a situation that no one present has ever been through. Fed Chairman Ben Bernanke, an expert on the Great Depression, has seen to it that financial markets and financial institutions have been flooded with liquidity. From the banking week ending September 10, 2008, Reserve Bank Credit has risen from about $890 billion to $2.1 trillion in the banking week ending November 5, 2008. This is roughly a 210% increase in a matter of 8 weeks. (Dare I remind you that it took 94 years for the total of Reserve Bank Credit to reach just $890 billion and only eight weeks to add $1,167 billion more!)
The $700 billion bailout bill…is now turning into a provision of capital for financial institutions…a provision that the Treasury hopes will buy time for institutions to work out their bad asset problems. The unknown question here is whether or not $700 billion is enough or will Congress have to float more funds.
The underlying rationale for the provision of all this liquidity is that either (1) officials are going to be blamed for allowing another MAJOR economic bust to take place or (2) these officials are going to have a problem cleaning up for all the liquidity that they have supplied to the financial markets on such short notice. Success, in the eyes of the officials means that they will have to clean up all the liquidity once the financial markets begin working again. Failure…”is not an option.”
No one knows at this time what is going to happen…
The idea is to keep tossing more and more liquidity into the pot until financial institutions feel that enough is enough! No one has been here before! This is all new!
Your guess is as good as mine…
And then there is the need for fiscal stimulus. The Congress is going to consider a stimulus package which seems to be similar to the first stimulus package they passed earlier this year. It will be aimed at consumers and, although it may not be any more effective than the first package, it can be done quickly, and it will show that the Congress IS doing something AND any little stimulus to the economy will be appreciated.
But, a second stimulus bill is being talked up. This one would be more capital intensive and aim at real projects like projects to rebuild the United States infrastructure. The idea here is that consumers are not going to start spending much until their job security is enhanced and they are sure that they will hold onto their homes. Businesses are going to have to restructure their balance sheets and have some confidence that consumers are going to start spending again before they loosen their purse strings and begin to invest in capital projects again. We seem to be a long way from either of these so the argument goes that the Government needs to engage in some real “Keynesian” pump-priming. The problem with a Government expenditure program like this is that it takes time to prepare and then, once the bill is passed, it takes time for the projects to be implemented. So, help does not come quickly.
And, what about the stock markets? When are they going to come back? Well, we hear all the time that the price an investor is willing to pay for a stock is dependent upon future cash flows. Right now, market expectations concerning future cash flows are pretty depressed and uncertain. Investors must be able to sense a turnaround in future cash flows for them to develop any confidence to begin purchasing stocks. And, investors don’t really know the value of the assets on the books of a large number of companies. To me, a good argument can still be made for more asset charge offs, more bankruptcies, and more depressed forecasts of future cash flows. In my mind, we are not near the bottom here, particularly given the situation described above.
What about uncertainty?
There is lots of it. Much of the uncertainty pertains to the programs that will be coming out of the new administration and the leadership that is put into place by that administration. It is still a long way until January 20, 2009. The current administration has been reluctant to do anything in the past until it became absolutely necessary to do something about the financial markets and the economy. They still want to pass on as much of the decision making as possible to the newly elected administration. So, we are still in a limbo as far as the national leadership is concerned.
What about the international situation and international leadership?
Also an unknown. People are talking about a new Bretton Woods…the international financial structure set up after the second world war. First off, that conference had two years of preparation and negotiation before the meeting was held. There has basically been little or no preparation for the meetings to take place this weekend. Second, the first Bretton Woods conference had seasoned world leadership behind it. That is not the case at the current time. Third, there is almost no intellectual consensus concerning the cause of the current situation and what should be done about it. Fourth, the world is still going through a economic downturn with more countries declaring every week that they are now in a recession.
International coordination and cooperation are going to have to be vital components of the world economic and financial markets in the future but for right now, I don’t think that we can expect much concrete to be forthcoming from the world community.
So, in my view, we will continue to see a downward drift to stock markets with a substantial amount of volatility. What else is new?
For bond markets, United States government securities are going to continue to be the pick for risk-averse investors and spreads will continue to rise between the least risky debt and that considered to be more risky. I saw that the spread between Baa corporate bonds and Aaa corporate bonds exceeded 300 basis points last week. For even lesser credits the spread has been increasing at an almost exponential rate. If there is any indication that the credit crisis is NOT over, it can be picked up from the market place.
The only thing that seems to be positive news at this time is that the Bush plan to get the price of oil below $60 a barrel has been tremendously successful so far!
Is the ‘bailout’ program having any success?
To answer this question, I am roughly in the same spot of someone I heard being interviewed on Marketplace on NPR radio: the ‘expert’ was asked the following question “Has the efforts to add liquidity to financial markets and financial institutions shown any results to date?” His reply: “I think things are better than they would have been if the efforts had not been made.”
Does that give you a lot of confidence?
I just don’t think that at this time anyone can say more. We are in the middle of a situation that no one present has ever been through. Fed Chairman Ben Bernanke, an expert on the Great Depression, has seen to it that financial markets and financial institutions have been flooded with liquidity. From the banking week ending September 10, 2008, Reserve Bank Credit has risen from about $890 billion to $2.1 trillion in the banking week ending November 5, 2008. This is roughly a 210% increase in a matter of 8 weeks. (Dare I remind you that it took 94 years for the total of Reserve Bank Credit to reach just $890 billion and only eight weeks to add $1,167 billion more!)
The $700 billion bailout bill…is now turning into a provision of capital for financial institutions…a provision that the Treasury hopes will buy time for institutions to work out their bad asset problems. The unknown question here is whether or not $700 billion is enough or will Congress have to float more funds.
The underlying rationale for the provision of all this liquidity is that either (1) officials are going to be blamed for allowing another MAJOR economic bust to take place or (2) these officials are going to have a problem cleaning up for all the liquidity that they have supplied to the financial markets on such short notice. Success, in the eyes of the officials means that they will have to clean up all the liquidity once the financial markets begin working again. Failure…”is not an option.”
No one knows at this time what is going to happen…
The idea is to keep tossing more and more liquidity into the pot until financial institutions feel that enough is enough! No one has been here before! This is all new!
Your guess is as good as mine…
And then there is the need for fiscal stimulus. The Congress is going to consider a stimulus package which seems to be similar to the first stimulus package they passed earlier this year. It will be aimed at consumers and, although it may not be any more effective than the first package, it can be done quickly, and it will show that the Congress IS doing something AND any little stimulus to the economy will be appreciated.
But, a second stimulus bill is being talked up. This one would be more capital intensive and aim at real projects like projects to rebuild the United States infrastructure. The idea here is that consumers are not going to start spending much until their job security is enhanced and they are sure that they will hold onto their homes. Businesses are going to have to restructure their balance sheets and have some confidence that consumers are going to start spending again before they loosen their purse strings and begin to invest in capital projects again. We seem to be a long way from either of these so the argument goes that the Government needs to engage in some real “Keynesian” pump-priming. The problem with a Government expenditure program like this is that it takes time to prepare and then, once the bill is passed, it takes time for the projects to be implemented. So, help does not come quickly.
And, what about the stock markets? When are they going to come back? Well, we hear all the time that the price an investor is willing to pay for a stock is dependent upon future cash flows. Right now, market expectations concerning future cash flows are pretty depressed and uncertain. Investors must be able to sense a turnaround in future cash flows for them to develop any confidence to begin purchasing stocks. And, investors don’t really know the value of the assets on the books of a large number of companies. To me, a good argument can still be made for more asset charge offs, more bankruptcies, and more depressed forecasts of future cash flows. In my mind, we are not near the bottom here, particularly given the situation described above.
What about uncertainty?
There is lots of it. Much of the uncertainty pertains to the programs that will be coming out of the new administration and the leadership that is put into place by that administration. It is still a long way until January 20, 2009. The current administration has been reluctant to do anything in the past until it became absolutely necessary to do something about the financial markets and the economy. They still want to pass on as much of the decision making as possible to the newly elected administration. So, we are still in a limbo as far as the national leadership is concerned.
What about the international situation and international leadership?
Also an unknown. People are talking about a new Bretton Woods…the international financial structure set up after the second world war. First off, that conference had two years of preparation and negotiation before the meeting was held. There has basically been little or no preparation for the meetings to take place this weekend. Second, the first Bretton Woods conference had seasoned world leadership behind it. That is not the case at the current time. Third, there is almost no intellectual consensus concerning the cause of the current situation and what should be done about it. Fourth, the world is still going through a economic downturn with more countries declaring every week that they are now in a recession.
International coordination and cooperation are going to have to be vital components of the world economic and financial markets in the future but for right now, I don’t think that we can expect much concrete to be forthcoming from the world community.
So, in my view, we will continue to see a downward drift to stock markets with a substantial amount of volatility. What else is new?
For bond markets, United States government securities are going to continue to be the pick for risk-averse investors and spreads will continue to rise between the least risky debt and that considered to be more risky. I saw that the spread between Baa corporate bonds and Aaa corporate bonds exceeded 300 basis points last week. For even lesser credits the spread has been increasing at an almost exponential rate. If there is any indication that the credit crisis is NOT over, it can be picked up from the market place.
The only thing that seems to be positive news at this time is that the Bush plan to get the price of oil below $60 a barrel has been tremendously successful so far!
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.
Sunday, September 21, 2008
Thoughts on "The Plan"
Well, “The Plan” is becoming a reality. What exactly it is and whether or not it will be successful is still a mystery. That is not the issue at this point in time.
To me the important thing is the philosophy behind “The Plan”. Up to now the policy makers have been shooting at a moving target…and the target that they have been going for is usually behind where the market and the institutions are. Thus, the policy makers have always been behind the curve…and things keep getting worse.
Now a new effort is being made. I think that we can clearly see the hand of Fed Chairman Ben Bernanke behind this move. I think that Bernanke finally won the day with the AIG effort. Bernanke, the student of the Great Depression, finally convinced everyone that the only way to really stop the down draft that was going on was to get out in front of it…not keep shooting behind it.
That is, the action had to be big enough to overwhelm the debt deflation going on.
This is the lesson from the Great Depression. One cannot let the debt deflation continue to cumulate. One must get out ahead of it.
This doesn’t mean that such actions may not cause problems in the future…inflation, moral hazard, or whatever. None of these are the problem now. If such problems are present in the future then the future will just have to deal with them. First…we have to reach the future without a major collapse.
The concern now is that debt deflation will get out-of-hand and the problem will only grow with time. That is why the policy makers believe that it is necessary to create a big enough plan to get ahead of the cumulating debt deflation and do more than is necessary to stop the downward cycle.
Will it be big enough? Will it succeed? Who knows? This is decision making under uncertainty and we are way beyond graduate school!
The policymakers believe that this package will be enough. But, they don’t know that either. My sense is that they just believe that the package needs to be big enough to really have a chance to work.
If “The Plan” works will this be the end of the effort?
No, the effort will still be in its early stages. The financial system and its regulatory framework will have to be revamped. What this administration is doing is attempting to buy time by stopping the downward spiral of financial markets and financial institutions. It is not proposing a solution about how the system will move forward. That will be up to the next administration.
Nothing the Paulson/Bernanke team has done suggests how the financial system and its regulation should be re-structured. The Fannie Mae/Freddie Mac bailout did not do it. Nothing that has taken place since that action has done it. This will be the job of the next administration.
And, Congress should remember this and not try and make all sorts of additions to “The Plan”.
In terms of the next administration, I believe that the two presidential candidates need to put their new programs and plans, like universal health care, on the back burner. I don’t believe that they will have much of a chance to put any of their promises or polices into place for three or four years. They are going to have to create the brave new world and get things back into order before anything else can be put into place. Thus, the candidates need to put their campaign promises into their back pocket for another time. I don’t think that it really helps the situation to talk much about them.
The presidential candidates need to see what the current administration puts into place and then needs to try and build on this to construct a plan to get financial institutions and markets back on their feet, to revamp the regulatory system, and to devise an economic policy that is both realistic and builds confidence, nationally and internationally. This is what the candidates are going to have to sell…first to the people of the United States and then to the Congress of the United States and then to the rest of the world.
The Paulson/Bernanke plan has to have a chance to work. It is not going to help right now to have the candidates confuse the issue with second guessing and petty attacks. This is going to be a fine line to walk, but the nation needs to pull together right now to stop the downward spiral.
Just one other point on the activities of this last week: it was necessary to get the President out in front of the cameras and speak about the financial chaos to the world. For too long in the current financial meltdown the President’s absence has been noticeable. Now, the whole world has seen the President speak out. Unfortunately for him, the puppet strings were quite obvious and one could see Hank Paulson’s lips move as the President attempted to mouth the words that were being spoken. One only has to wonder how much of his administration was conducted in this way only with someone named Dick Chaney controlling the strings and mouthing the words.
To me the important thing is the philosophy behind “The Plan”. Up to now the policy makers have been shooting at a moving target…and the target that they have been going for is usually behind where the market and the institutions are. Thus, the policy makers have always been behind the curve…and things keep getting worse.
Now a new effort is being made. I think that we can clearly see the hand of Fed Chairman Ben Bernanke behind this move. I think that Bernanke finally won the day with the AIG effort. Bernanke, the student of the Great Depression, finally convinced everyone that the only way to really stop the down draft that was going on was to get out in front of it…not keep shooting behind it.
That is, the action had to be big enough to overwhelm the debt deflation going on.
This is the lesson from the Great Depression. One cannot let the debt deflation continue to cumulate. One must get out ahead of it.
This doesn’t mean that such actions may not cause problems in the future…inflation, moral hazard, or whatever. None of these are the problem now. If such problems are present in the future then the future will just have to deal with them. First…we have to reach the future without a major collapse.
The concern now is that debt deflation will get out-of-hand and the problem will only grow with time. That is why the policy makers believe that it is necessary to create a big enough plan to get ahead of the cumulating debt deflation and do more than is necessary to stop the downward cycle.
Will it be big enough? Will it succeed? Who knows? This is decision making under uncertainty and we are way beyond graduate school!
The policymakers believe that this package will be enough. But, they don’t know that either. My sense is that they just believe that the package needs to be big enough to really have a chance to work.
If “The Plan” works will this be the end of the effort?
No, the effort will still be in its early stages. The financial system and its regulatory framework will have to be revamped. What this administration is doing is attempting to buy time by stopping the downward spiral of financial markets and financial institutions. It is not proposing a solution about how the system will move forward. That will be up to the next administration.
Nothing the Paulson/Bernanke team has done suggests how the financial system and its regulation should be re-structured. The Fannie Mae/Freddie Mac bailout did not do it. Nothing that has taken place since that action has done it. This will be the job of the next administration.
And, Congress should remember this and not try and make all sorts of additions to “The Plan”.
In terms of the next administration, I believe that the two presidential candidates need to put their new programs and plans, like universal health care, on the back burner. I don’t believe that they will have much of a chance to put any of their promises or polices into place for three or four years. They are going to have to create the brave new world and get things back into order before anything else can be put into place. Thus, the candidates need to put their campaign promises into their back pocket for another time. I don’t think that it really helps the situation to talk much about them.
The presidential candidates need to see what the current administration puts into place and then needs to try and build on this to construct a plan to get financial institutions and markets back on their feet, to revamp the regulatory system, and to devise an economic policy that is both realistic and builds confidence, nationally and internationally. This is what the candidates are going to have to sell…first to the people of the United States and then to the Congress of the United States and then to the rest of the world.
The Paulson/Bernanke plan has to have a chance to work. It is not going to help right now to have the candidates confuse the issue with second guessing and petty attacks. This is going to be a fine line to walk, but the nation needs to pull together right now to stop the downward spiral.
Just one other point on the activities of this last week: it was necessary to get the President out in front of the cameras and speak about the financial chaos to the world. For too long in the current financial meltdown the President’s absence has been noticeable. Now, the whole world has seen the President speak out. Unfortunately for him, the puppet strings were quite obvious and one could see Hank Paulson’s lips move as the President attempted to mouth the words that were being spoken. One only has to wonder how much of his administration was conducted in this way only with someone named Dick Chaney controlling the strings and mouthing the words.
Wednesday, July 16, 2008
Leader-less
It all starts at the top!
How desperate are things? Well, the “Decider” stepped out yesterday to calm the American people’s fears about the financial system and the economy. Here is a person who has no credibility…a person that has been put in front of the American people time-after-time to build up their confidence and encourage them to stay-the-course…a person who is worn out and has no energy…and we hear from him that things are “OK”. Thank goodness he didn’t call us a bunch of whiners!
It is apparent, however, that his leadership permeates his whole executive team. The result was dramatically seen elsewhere in Washington, D. C. yesterday. U. S. Treasury Secretary Henry Paulson carries little or no weight in the current exercises. (See, for example, http://www.bloomberg.com/apps/news?pid=20601068&sid=aWssvqlta37Q&refer=home#.) The testimony of Federal Reserve Chairman Ben Bernanke was weak and muddled. Who can we turn to?
In my experience the Chief Executive sets the tone for the organization…the culture, if you will. Everything the Chief Executive does, or says, or seems, is reflected in his or her team and the performance of the institution he or she leads. The “Buck Stops” with the Chief Executive, whether or not the Chief Executive accepts this fact or not.
How are things going in the world? Mister leader…you are the captain of the ship…responsibility falls to you!
Secretary Paulson and Chairman Bernanke are honorable men. They are also capable men. But, so is Colin Powell. The performance of the team is always, for better or worse, overshadowed by the boss. If the Chief Executive is a capable leader…if the Chief Executive has good people around and facilitates the use of their talents…if the Chief Executive doesn’t fall victim to the flattery and ego-inflation of some of his team…that Chief Executive can produce extraordinary results. However, if the Chief Executive does not possess these talents…even good, capable people perform way below what is possible.
In my estimation we are beyond specifics when attempting to judge where the economy is and the soundness of the financial system. We have a leadership void and as a consequence we face a situation in which things can only deteriorate further until some form of real leadership is re-established within the United States government. The scary thing is that we seem to be facing a minimum of six months before the possibility of a change can become a reality. Not only do we have the “Gang that couldn’t shoot straight” in office, but the “Gang” is also a “lame duck”!
What needs to be done, in my estimation, is greater than just specific responses to market conditions. We need leadership in the following areas.
· International cooperation and coordination in economic advancement. The United States is still the one super power in the world but it needs to be a part of the development taking place in other nations and areas. The United States may be disliked and resented by others but the United States is still needed by these nations and areas and can still be a facilitator in the development and advancement of the rest of the world. (You might also look at the T. Friedman editorial this morning http://www.nytimes.com/2008/07/16/opinion/16friedman.html?hp.) And, the United States cannot close itself off from other parts of the world as “Reverse Globalization” takes place. Conversation and communication needs to be expanded from just the G-8 to the G-20.
· The United States must get it monetary and fiscal policy “in sync” with the rest of the world. The government must cease to believe that it can continue to operate its economic policy independently of the world. The budget of the United States government must be brought under control and managed with a firm discipline. Monetary policy must be directed to focus on the value of the dollar and possibilities of future inflation. The Federal Reserve must not be burdened with more and more responsibilities that can present it with conflicting goals and objectives. We have seen what difficulties can arise by just having two objectives—inflation and economic growth.
· The United States must develop a “real” energy policy! Enough of band aids. Enough of political posturing. Enough of catering to the financial interests of a small segment of the economy. If T. Boone Pickens can move on this issue…surely others can also move! (http://www.pickensplan.com/)
These, of course, are longer run concerns, but they pertain to the strategic direction of the United States. If we don’t have a vision of what is needed and if we don’t have leaders that can express a vision we can buy into and trust, then the responses and reactions that happen within the short run result in nothing but a ‘random walk’ and we end up with a hodge-podge of consequences that do not serve us well over the longer run.
Yes, I know…in the long run we are all dead. (Keynes) But, we only become desperate for fixes in the short run when there is an absence of leadership and no one seems to know where we are going.
My short run concern is that since participants in domestic and international markets have little or no confidence in the leadership that exists within the United States…in the business and financial community as well as in the political sphere…the drift in the financial markets and the economy will continue to be on the downward side. Economists and other pundits can continue to come up with suggestions and schemes to contain the trouble or dreamscapes to resolve the whole problem…but, that is all they will be until leadership is established once again. Unfortunately, the current players seem to lack this skill.
How desperate are things? Well, the “Decider” stepped out yesterday to calm the American people’s fears about the financial system and the economy. Here is a person who has no credibility…a person that has been put in front of the American people time-after-time to build up their confidence and encourage them to stay-the-course…a person who is worn out and has no energy…and we hear from him that things are “OK”. Thank goodness he didn’t call us a bunch of whiners!
It is apparent, however, that his leadership permeates his whole executive team. The result was dramatically seen elsewhere in Washington, D. C. yesterday. U. S. Treasury Secretary Henry Paulson carries little or no weight in the current exercises. (See, for example, http://www.bloomberg.com/apps/news?pid=20601068&sid=aWssvqlta37Q&refer=home#.) The testimony of Federal Reserve Chairman Ben Bernanke was weak and muddled. Who can we turn to?
In my experience the Chief Executive sets the tone for the organization…the culture, if you will. Everything the Chief Executive does, or says, or seems, is reflected in his or her team and the performance of the institution he or she leads. The “Buck Stops” with the Chief Executive, whether or not the Chief Executive accepts this fact or not.
How are things going in the world? Mister leader…you are the captain of the ship…responsibility falls to you!
Secretary Paulson and Chairman Bernanke are honorable men. They are also capable men. But, so is Colin Powell. The performance of the team is always, for better or worse, overshadowed by the boss. If the Chief Executive is a capable leader…if the Chief Executive has good people around and facilitates the use of their talents…if the Chief Executive doesn’t fall victim to the flattery and ego-inflation of some of his team…that Chief Executive can produce extraordinary results. However, if the Chief Executive does not possess these talents…even good, capable people perform way below what is possible.
In my estimation we are beyond specifics when attempting to judge where the economy is and the soundness of the financial system. We have a leadership void and as a consequence we face a situation in which things can only deteriorate further until some form of real leadership is re-established within the United States government. The scary thing is that we seem to be facing a minimum of six months before the possibility of a change can become a reality. Not only do we have the “Gang that couldn’t shoot straight” in office, but the “Gang” is also a “lame duck”!
What needs to be done, in my estimation, is greater than just specific responses to market conditions. We need leadership in the following areas.
· International cooperation and coordination in economic advancement. The United States is still the one super power in the world but it needs to be a part of the development taking place in other nations and areas. The United States may be disliked and resented by others but the United States is still needed by these nations and areas and can still be a facilitator in the development and advancement of the rest of the world. (You might also look at the T. Friedman editorial this morning http://www.nytimes.com/2008/07/16/opinion/16friedman.html?hp.) And, the United States cannot close itself off from other parts of the world as “Reverse Globalization” takes place. Conversation and communication needs to be expanded from just the G-8 to the G-20.
· The United States must get it monetary and fiscal policy “in sync” with the rest of the world. The government must cease to believe that it can continue to operate its economic policy independently of the world. The budget of the United States government must be brought under control and managed with a firm discipline. Monetary policy must be directed to focus on the value of the dollar and possibilities of future inflation. The Federal Reserve must not be burdened with more and more responsibilities that can present it with conflicting goals and objectives. We have seen what difficulties can arise by just having two objectives—inflation and economic growth.
· The United States must develop a “real” energy policy! Enough of band aids. Enough of political posturing. Enough of catering to the financial interests of a small segment of the economy. If T. Boone Pickens can move on this issue…surely others can also move! (http://www.pickensplan.com/)
These, of course, are longer run concerns, but they pertain to the strategic direction of the United States. If we don’t have a vision of what is needed and if we don’t have leaders that can express a vision we can buy into and trust, then the responses and reactions that happen within the short run result in nothing but a ‘random walk’ and we end up with a hodge-podge of consequences that do not serve us well over the longer run.
Yes, I know…in the long run we are all dead. (Keynes) But, we only become desperate for fixes in the short run when there is an absence of leadership and no one seems to know where we are going.
My short run concern is that since participants in domestic and international markets have little or no confidence in the leadership that exists within the United States…in the business and financial community as well as in the political sphere…the drift in the financial markets and the economy will continue to be on the downward side. Economists and other pundits can continue to come up with suggestions and schemes to contain the trouble or dreamscapes to resolve the whole problem…but, that is all they will be until leadership is established once again. Unfortunately, the current players seem to lack this skill.
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