Fulgencio Batista, the Cuban Army Sergeant who has risen to the heights of Caribbean Dictator, arrived in Washington today. This is the first time the Cuban Dictator has set foot outside his native land in 37 years. Gen. Malin Craig, the Army Chief of Staff, is shown with him as they pass the Capitol in a Cadillac
Ilargi: Of course it’s hilarious to see the Financial Times publish lines like these:
- Ben Bernanke will reach out to critics in Congress [..] The Fed chief [..] will offer to work with Congress to improve Fed transparency and oversight but in ways that do not threaten its independence.
- Chris Dodd, chairman of the Senate banking committee, promised a “thorough and comprehensive confirmation hearing”.
- Announcing the appointment, Barack Obama said it was Mr Bernanke’s “bold action and out-of-the-box thinking that has helped put the brakes on our economic freefall”.
You can't make that up. I mean, the man both gets re-nominated and then promises transparency, all within 24 hours after a judge orders him to cough up a bunch of names and numbers he’s refused to be transparent about, even if the law says he has to be. Or does it? Is the Federal Reserve a federal agency? Regardless, transparency from the Fed? Not going to happen in your lifetime.
And there's zero bold action and even less out of the box thinking involved in the life and times of Ben B. How nonsensical would you like it today? Ben Bernanke is nothing but an accountant who lacks any kind of vision and insight. Which suits the people who seated him on his throne just fine.
Bernanke is one of the most spectacular failures one can imagine when it comes to foreseeing and predicting the crisis that unfolded right under his effing nose. Stuff like this:
"We will follow developments in the subprime market closely. However, fundamental factors--including solid growth in incomes and relatively low mortgage rates--should ultimately support the demand for housing, and at this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system"
--June 5, 2007
"The Federal Reserve is not currently forecasting a recession."
-January 10, 2008
And there's a truckload more where that came from.
After completely and utterly failing to see what was going on, and you have to remember that this was the guy who got all the numbers every morning on his desk, Bernanke did the one thing he could think of doing. He threw god only knows how many trillions of dollars of taxpayer money at the problem, hoping that something would stick. Something did. Home prices temporarily have slowed their decline. Banks are churning out profits and bonuses. The stock market is up. And Bernanke is declared a hero and reappointed.
But there's nothing bold or out-of-the-box about it. It's simply the work of a one-trick pony. And when the markets go down again, which is inevitable given unemployment, foreclosures and consumer spending, Bernanke will be caught in the headlights, with no option but to pull the same stunt again. And again. It's all he knows how to do. It's a mighty expensive way to purchase temporary relief, but then, it’s not on his tab. Numbers published today by the White House and the CBO say the country faces a cumulative $9 trillion deficit from 2010-2019. You have Bernanke to thank for that. And those numbers are low-balled to the point of ridicule. The first thing I thought about right off the bat when seeing them was TARP inspector general Neil Barofsky's estimate of teh potential costs of that program alone. He put it at $23.7 trillion.
There is of course another possibility here. It could well be that Bernanke isn't nearly as air-headed as he wants us to believe he is. He may have seen the entire tragedy unfold from miles and years away. After all, as I said before, this was the guy who gets all the numbers on his desk every morning. His actions have saved one group from mayhem, namely the banking world. I don't think a lot of Wall Street voices will have complaints about the man. The developments that have led to the present crisis, and you can choose whether you’d like to go back to the eighties or just to 2000, have had one effect above all. They have enriched a select group of people to the detriment of a much broader group.
Today's situation, with all the bail-outs and Fed purchases of toxic assets, will in the future be seen as the crowning achievement of something that may well go into the books as either the takeover or the overthrow of the political system by the corporate world. Re-nominating Ben Bernanke is but one of the finishing touches. He fits the desired picture perfectly. He's the person who single-handedly guarantees that the crisis will continue.
No matter whether he's real dumb or a knowing participant, Bernanke is about the worst thing that could happen to you. He is, please please pardon my French, the archetypical ass-clown. And he's all yours.
Unemployment, Deficits To Be Far Worse Than Stated: White House
The federal government faces exploding deficits and mounting debt over the next decade, White House and congressional budget officials projected Tuesday in competing but similar economic forecasts. Both the White House Office of Management and Budget and the nonpartisan Congressional Budget Office predicted the budget deficit this year would swell to nearly $1.6 trillion, a record, and far above the then-record 2008 budget deficit of $455 billion. But while figures released by the White House foresee a cumulative $9 trillion deficit from 2010-2019, $2 trillion more than the administration estimated in May, congressional budget analysts put the 10-year figure at a lower $7.14 trillion.
One reason for the difference: The CBO projection is based on an assumption that all the tax cuts put into place in the administration of former President George W. Bush will expire on schedule by 2011 as dictated by current law. President Barack Obama's budget baseline, however, hews to his proposal to keep the tax cuts in place for families earning less than $250,000 a year. Beyond the 10-year forecast, the nation will face further challenges posed by rising health care costs and the aging of the population, the CBO said. "The budget remains on an unsustainable path" over the long-term and will require some combination of lower spending and higher tax revenues, it said.
Both forecasts see unemployment rising to 10 percent before falling and both suggest growth will return to the economy later this year but that recovery will be slow after the longest and deepest recession since the 1930s. "This recession was simply worse than the information that we and other forecasters had back in last fall and early this winter," said Obama economic adviser Christina Romer. She predicted unemployment could reach 10 percent this year and begin a slow decline next year. Still, she said, the average unemployment will be 9.3 in 2009 and 9.8 percent in 2010. The CBO had similar figures.
Both see the national debt – the accumulation of annual budget deficits – as nearly doubling over the next day. The total national debt, made up of amounts the government owes to the public, including foreign governments, as well as money it has borrowed from itself, stood Tuesday at a staggering $11.7 trillion. Obama himself may have drowned out the rising deficit news with the announcement Tuesday that he intends to nominate Ben Bernanke to a second term as chairman of the Federal Reserve. The Bernanke news, and a report that consumers are regaining some confidence, may have neutralized any disturbance in the financial markets caused by the high deficit projections. Stocks were up in late morning trading.
The deeper red ink and the gloomy unemployment forecast present Obama with an enormous challenge. The new numbers come as he prods Congress to enact a major overhaul of the health care system – one that could cost $1 trillion or more over 10 years. Obama has said he doesn't want the measure to add to the deficit, but lawmakers have been unable to agree on revenues that cover the cost. What's more, the high unemployment could last well into the congressional election campaign next year, turning the contests into a referendum on Obama's economic policies.
"The alarm bells on our nation's fiscal condition have now become a siren," Senate Minority Leader Mitch McConnell, R-Ky., said. "If anyone had any doubts that this burden on future generations is unsustainable, they're gone – spending, borrowing and debt are out of control." The revised White House estimates project that the economy will contract by 2.8 percent this year, more than twice what the White House predicted earlier this year. Romer projected that the economy would expand in 2010, but by 2 percent instead of the 3.2 percent growth the White House predicted in May. By 2011, Romer estimated, the economy would be humming at 3.6 percent growth.
Both Romer and budget director Peter Orszag said this year's contraction would have been far worse without money from the $787 billion economic stimulus package that Obama pushed through Congress as one of his first major acts as president. At the same time, the continuing stresses on the economy have, in effect, increased the size of the stimulus package because the government will have to spend more in unemployment insurance and food stamps, Orszag said. He said the cost of the stimulus package – which spends most of its money in fiscal year 2010 – will grow by tens of billions of dollars above the original $787 billion.
For now, while the country tries to come out of a recession, neither spending cuts nor broad tax increases would be prudent deficit-fighting measures. But Obama is likely to face those choices once the economy shows signs of a steady recovery, and it could test his vow to only raise taxes on the wealthy. Still, 10-year budget projections can be "wildly inaccurate," said Stan Collender, a partner at Qorvis Communications and a former congressional budget official. Collender notes that there will be five congressional elections over the next 10 years and any number of foreign and domestic challenges that will make actual deficit figures very different from the estimates.
The Obama administration did tout one number in its budget review: The 2009 deficit is now expected to be $1.58 trillion, $263 billion less than projected by the White House in May. That's largely because the White House removed a $250 billion item that it had inserted as a "place holder" in case banks needed another bailout.
The White House Caves On The Deficit
Today The White House confirmed news that leaked last Friday, about the deficit being wider than they had previously estimated. As you can see, while the deficit as a percentage of GDP has been revised down for this year -- due to less bailout spending -- it's been bumped up every year going out to 2019. Next year the hike is big -- from 8.6% to 10%.
Former CBO director doubts new deficit numbers
Former Congressional Budget Office Director Douglas Holtz-Eakin says the Obama administration's claim that the Obama's updated figures on the deficit that will be released Tuesday are "spin and nothing more." Holtz-Eakin, who was a top advisor to the presidential campaign of Sen. John McCain, R-Ariz., sent a memo Monday to House Minority Leader John Boehner, R-Ohio, accusing Obama of manipulating the numbers about future bailout costs in making the claim that the deficit will shrink by more than $260 billion from what was predicted three months ago.
"Bottom line, the budget outlook is worse, and dangerous," Holtz-Eakin writes to Boehner. The White House and the CBO are scheduled to release separate mid-session reviews on Tuesday, but the Obama administration has already leaked to the press some of the details of its report, including the rosier deficit forecast of $1.58 trillion for this year, lower than the $1.8 trillion predicted in June.
Holtz-Eakin said that said the Obama administration wrongly assumes it will receive $640 billion in revenue from the creation of a cap-and-trade system for polluters, which would rely on the passage of an energy reform bill that many Democrats oppose, plus another $200 billion from a controversial proposal to tax international businesses. The Obama administration is also counting on the idea that health care reform will not increase the deficit, which some believe is impossible. "They will continue to assume that they raise taxes on small businesses in 2011," Holtz-Eakin added. "If the economy remains weak, they will not."
As Budget Deficit Grows, So Do Doubts on Dollar
The U.S. economy may be showing signs of recovering from the financial crisis, but the jury is still out on the future of the U.S. dollar. While many analysts expect the dollar to strengthen in coming months as the crisis fades and the U.S. economy turns toward growth, a growing chorus of investors is expressing concern about the longer-term outlook for the greenback. In a new twist to an old refrain among economists, who have long worried about the effects of growing U.S. debt, they say that the huge liabilities the U.S. is taking on to dig its way out of crisis could ultimately undermine faith in the dollar.
"There has been a lot of disappointment with the way the U.S. credit crisis was handled," says Claire Dissaux, managing director of global economics and strategy for Millennium Global Investments Ltd., a London investment firm specializing in currencies. "The dollar's loss of influence is a steady and long-term trend." On Tuesday, the Obama administration added fuel to concerns about the dollar, saying the U.S. will run a cumulative budget deficit of $9 trillion over the next 10 years, $2 trillion more than it had previously projected. "That's going to be negative for the dollar," says Adam Boyton, a currency analyst at Deutsche Bank AG in New York.
President Barack Obama also reappointed Federal Reserve Chairman Ben Bernanke, whose efforts to rescue the economy have won praise, but have also entailed pumping large amounts of freshly created dollars into the financial system. Investors and economists have long harbored concerns about the dollar's decline, especially in the beginning of this decade as the federal government and consumers ran up their debtloads to finance everything from foreign wars to flat-screen TVs. Last fall's financial crash suggested that such fears may be overblown: As markets plunged in the wake of the collapse of Lehman Brothers Holdings Inc., investors scrambled to stash their cash in U.S. Treasury bills, perceiving them to be the safest investments. That boosted the value of the U.S. dollar against many of its major counterparts.
Now, though, major investors like Berkshire Hathaway Inc. Chairman Warren Buffett and bond investment firm Pimco fear the government's fiscal and monetary stimulus programs could end up fueling inflation in coming years and hammering the dollar. Higher inflation eats up the returns of bond investments that provide a fixed interest income, making them less attractive to investors. Less demand for U.S. bonds could mean a weaker dollar. Mr. Buffett, for example, worries that U.S. policy makers will fail to move decisively to curtail the nation's ballooning net debt, expected by some to rise to more than 75% of annual economic output by 2013.
Instead, policy makers might tolerate higher inflation, which makes existing debts more manageable but would hurt the U.S.'s creditors, including China and Japan. In this scenario, investors would demand much higher interest when lending to the U.S. government, raising its borrowing costs and making further budget deficits harder to finance at a time when an aging population will sharply boost the costs of social security and government-sponsored health care.
Investors are also growing more comfortable with the idea of emerging economies like China, Russia and Brazil playing a bigger role in shaping international finance. Some analysts, including Pimco portfolio manager Curtis Mewbourne, say emerging economies have a unique opportunity to use the crisis to reduce their reliance on the U.S. dollar., which tends to account for the lion's share of their foreign-exchange reserves. "Investors should consider whether it makes sense to take advantage of any periods of U.S. dollar strength to diversify their currency exposure," Mr. Mewbourne wrote in a recent note.
Earlier this year, China's central-bank governor called for moving toward a "super-sovereign" reserve currency, one not belonging to any particular country. Analysts generally see such an option as unrealistic, since the U.S. wouldn't want to give up its status as the main currency in which the world's central banks hold their reserves, and any new reserve currency would require a deep and developed market where it could be traded. There aren't yet many signs that investors are leaving the dollar. China and Japan, the biggest foreign creditors to the U.S., loaded up on longer-term Treasury debt in June, according to the latest Treasury data. China, for example, bought $26.6 billion in notes and bonds, its biggest monthly buying on record.
"The Treasury rally suggests the U.S. is facing neither an inflationary explosion nor a crisis of confidence," analysts at French bank BNP Paribas SA said in a recent note. The dollar has held its own against its major rivals in recent weeks. On Tuesday, one euro bought $1.4314, compared with $1.4293 on Monday and $1.4253 at the end of July. Any dislodging of the dollar as reserve currency will likely happen gradually if it happens at all, analysts say. Investors like China would suffer major losses if they suddenly sold a large portion of their dollar holdings. And a weak U.S. dollar would ripple far and wide, hurting the competitiveness of companies in export-dependent Germany and Japan. That could prompt policy makers there to voice concerns about the dollar's weakness to protect their own economies.
Art Cashin: We May be Eating the Seed Corn
“We’re seeing some growth in the economy, but it’s all government generated,” Art Cashin, of UBS, told CNBC. He and Dick Armey, formerly a Texas Congressman, share their insights.
Consumer sentiment, home prices show signs of life
Americans' pessimism about the economy appears to be lifting, with consumer expectations for the next six months hitting their most positive point since the recession began. The improvement stems partly from the housing market, as a national gauge of home prices on Tuesday posted its first quarterly increase in three years. The consumer and housing reports, along with President Barack Obama's reappointment of Ben Bernanke as Federal Reserve chief, sent the financial markets modestly higher. But economists warned that consumer confidence remains far below levels associated with a healthy economy and might not lead to the increased spending critical for a broad recovery.
"People's spending decisions depend more on whether they have money in their pocket than on how they feel," said Bill Cheney, chief economist at John Hancock Financial. Still, Cheney and other economists said Tuesday's report on consumer sentiment was encouraging. The New York-based Conference Board said its Consumer Confidence index rose to 54.1, from an upwardly revised 47.4 in July. That reading reversed two months of decline and easily beat analysts' expectations. Economists closely monitor confidence because consumer spending accounts for about 70 percent of U.S. economic activity. Consumer sentiment, fueled by signs the economy is stabilizing, has recovered a bit since hitting a record-low of 25.3 in February.
A reading of 90 indicates the economy is on solid footing; anything above 100 signals strong growth. Consumers' expectations for the economy over the next six months rose to 73.5 from 63.4 in July, the highest level since December 2007, when the recession began. The consumer confidence survey was sent to 5,000 households and had a cutoff date for responses of Aug. 18. More consumers said they were likely to buy a home or a car within the next six months than said so in July's survey. The outlook for jobs also improved, albeit from very low levels.
The housing sector received positive news, too. The Standard & Poor's/Case-Shiller's U.S. National Home Price Index rose 1.4 percent in the second quarter from the January-March period, the first quarterly increase in three years. Home prices, though still down nearly 15 percent from last year, are at levels last seen in early 2003. The report added to other recent positive news about housing. The National Association of Realtors said last week that sales of existing homes rose 7.2 percent in July, the fourth straight monthly gain. The Commerce Department on Wednesday is set to report new-home sales for July. Analysts also expect that figure to rise.
Higher home prices would help consumers, who are saving more and spending less as their wealth plummets during the longest recession since World War II. Falling home prices and dwindling stock portfolios made many people, even those with jobs, feel poorer. "An upturn in prices has to ease some of the pain and may even get some people to loosen up on their wallets a touch," Joel Naroff, chief economist at Naroff Economic Advisors, wrote in a note to clients. "An improving housing market coupled with better consumer spending could ensure that the recovery takes hold."
On Wall Street, stocks posted gains. The Dow Jones industrial average rose about 30 points, or 0.32 percent, and broader stock averages also gained. Many analysts expect the economy to grow 2-3 percent in the current July-September quarter, spurred by a more stable housing market and the Cash for Clunkers program, which has boosted auto sales. But economists worry that without healthier consumer spending, the recovery may weaken next year. Cash for Clunkers, which provided rebates of up to $4,500 to consumers who traded in old cars for fuel-efficient ones, ended Monday.
Obama said Tuesday that his administration's $787 billion stimulus package, and the extraordinary efforts by Bernanke to pump trillions of dollars into the financial system, have helped turn the economy around. "Our auto industry is showing signs of life," Obama said. "Business investment is showing signs of stabilizing. Our housing market and credit markets have been saved from collapse." Jobs are a weak spot, however, and could limit future consumer spending if Americans remain concerned about layoffs or declining wages.
Obama economic adviser Christina Romer predicted Tuesday that unemployment could reach 10 percent this year and average 9.8 percent next year. That's up from its current level of 9.4 percent. Frank Newport, editor-in-chief of the Gallup Poll, said consumer spending dropped last week, according to its daily surveys. "We're not seeing a sustained increase in consumer spending yet," he said. Gallup asks 3,500 people each week about their recent shopping activity. That could be a problem for retailers. Many economists expect to see another holiday season of sales declines, after last year's Christmas period was the weakest in several decades. Holiday shopping accounts for up to 40 percent of annual sales for many retailers.
Recent reports from retailers have been mixed. On Tuesday, office supply chain Staples Inc. said same-store sales fell 5 percent in the second quarter. That was an improvement from a drop of 8 percent the previous quarter.
Last week, Ann Taylor Stores Corp. said same-store sales, or sales at stores open at least one year — a key retail metric_ fell 23 percent in its second quarter as the company lost $18 million. The White House also released updated budget deficit projections Tuesday. The administration said the deficit for the current budget year, which ends Oct. 1, will total a record $1.6 trillion, while deficits for the next 10 years could total $9 trillion.
Fed chief will reach out to critics
Ben Bernanke will reach out to critics in Congress following his nomination for a second term as chairman of the Federal Reserve by the US president. The Fed chief – whose reappointment has to be confirmed by the Senate – will offer to work with Congress to improve Fed transparency and oversight but in ways that do not threaten its independence. He is also likely to say that the US central bank could be open to some modification to its emergency powers to lend to firms if an adequate special bankruptcy regime for financial groups is put in place.
Chris Dodd, chairman of the Senate banking committee, promised a “thorough and comprehensive confirmation hearing” – saying that while they had some “serious differences” Mr Bernanke was “probably the right choice”. But Stephen Roach, chairman of Morgan Stanley Asia, said the decision was “shortsighted” and Mr Bernanke had made important errors as the crisis approached.
Announcing the appointment, Barack Obama said it was Mr Bernanke’s “bold action and out-of-the-box thinking that has helped put the brakes on our economic freefall”. The Fed chief pledged to do everything in his power to “restore a more stable economic and financial environment in which opportunity can again flourish”. News of the reappointment was welcomed by most policymakers and investors. “Markets look to him for policy continuity and, when the time comes, an orderly exit from crisis management policies,” said Mohamed El-Erian, co-chief executive of Pimco.
Mark Carney, governor of the Bank of Canada, told the FT that the reapointment was “extremely well deserved and very timely.” Administration officials indicated that Mr Obama had decided to renominate Mr Bernanke now to avoid unsettling uncertainty over his prospects. Former Fed chairman Alan Greenspan joined the chorus of support, saying Mr Bernanke “has done an excellent job.”
Federal Reserve loses suit demanding transparency
A federal judge on Monday ruled against an effort by the U.S. Federal Reserve to block disclosure of companies that participated in and securities covered by a series of emergency funding programs as the global credit crisis began to intensify. In a 47-page opinion, Chief District Judge Loretta Preska of the federal court in Manhattan said the central bank failed to show that disclosure would cause borrowers in the Federal Reserve System to suffer "imminent competitive harm," by stigmatizing them for using Fed lending programs.
"The board essentially speculates on how a borrower might enter a downward spiral of financial instability if its participation in the Federal Reserve lending programs were to be disclosed," she wrote. "Conjecture, without evidence of imminent harm, simply fails to meet the board's burden." Monday's ruling comes as lawmakers and investors demand greater disclosure in how the government manages a series of programs designed to lift the economy out of its deepest recession in decades.
The case arose when two Bloomberg News reporters submitted requests under the federal Freedom of Information Act (FOIA) about actions the Fed took to shore up the financial system in 2007 and early 2008, including an expansion of lending programs and the sale of Bear Stearns Cos to JPMorgan Chase & Co. After the Fed resisted the request, Bloomberg sued to compel disclosure. Preska concluded the Fed "improperly withheld agency records in response to a FOIA request by conducting an inadequate search," she wrote. FOIA obliges federal agencies to make government documents available to the public, subject to various exemptions.
Bernanke May Leave Lasting Legacy on Fed’s Mission
Ben S. Bernanke will have a chance to become one of the most influential Federal Reserve chairmen in history as he oversees the expansion of the Fed’s authority over financial markets and tries to pull back an unprecedented surge in central bank credit, economists say. Topping Bernanke’s agenda during the next four years will be elevating the Fed’s role in reducing excessive risk in the largest financial institutions, figuring out a way to curtail asset bubbles, and scaling back $1.2 trillion of monetary stimulus at just the right speed, economists say.
“He will have the opportunity to permanently change the structure of the Federal Reserve system,” said Vincent Reinhart, former head of the Fed’s Monetary Affairs Division. Bernanke could be “on par” with Marriner Eccles, the chairman during the creation of the modern Fed in the 1930s when power was centralized in the Board of Governors, Reinhart said. President Barack Obama today nominated Bernanke, 55, for a second term, lauding the Fed chairman for helping “put the brakes on our economic free fall.”
Bernanke, a former Princeton University economist, has already set in place numerous changes since he took over from Alan Greenspan in February 2006. He’s forced more cooperation between bank supervisors and staff economists and steered the Fed toward greater transparency. He’s also made his office more accessible, explaining his actions to the public on the CBS Corp. television program “60 Minutes” and at a town-hall meeting in Kansas City, Missouri.
Bernanke has been a steward of former Fed Chairman Paul Volcker’s legacy of establishing a regime of low inflation. His own imprint will be different, however, because he is confronting a crisis that extends “beyond the banking system and beyond monetary policy,” said Richard DeKaser, chief economist at Woodley Park Research in Washington. As a result, the Obama administration is seeking to give the Fed an even larger mission. The administration wants the central bank to dictate capital, liquidity and risk-management standards at major financial companies. The proposal, which would give the Fed a bigger role in financial stability along with its responsibilities for full employment and stable prices, has met with congressional resistance.
The Senate Banking Committee “should carefully examine the impact of the Fed’s failures as a bank regulator, how such failures contributed to the financial crisis, and whether Chairman Bernanke’s performance as the chief regulator merits his reconfirmation,” Senator Richard Shelby of Alabama, the top Republican on the panel, said in a statement today. Bernanke is already preparing to play a larger part in oversight, no matter how Congress rewrites the rules of regulation. Fed bank examiners are putting more emphasis on comparing the risks inside one large bank with other large lenders.
The stakes are high, said Henry Kaufman, president of Henry Kaufman & Co. in New York. Success in overhauling supervision of the financial system would mean “improved economic conditions for an extended period of time,” Kaufman said. Failure would mean a return to “continued volatility.” The Obama plan also envisions a permanent role for Bernanke’s broadened use of the Fed as lender of last resort. The Board of Governors used emergency powers to rescue American International Group Inc., as well as markets for commercial paper, housing bonds and asset-backed securities. In the process, the Fed’s balance sheet expanded by $1.2 trillion over the past year.
Regional Fed bank presidents and scholars are divided over the direction the Fed is going. Some, such as John Taylor, an economics professor at Stanford University, are concerned that emergency loans will draw the central bank into allocating credit to politically favored industries, such as housing. Taylor, a former Treasury undersecretary, calls such actions by the monetary authority “mondustrial policy.” Others laud Bernanke for his experimentation and aggressiveness in averting a global meltdown. “His biggest legacy for sure will be having designed and implemented a policy for dealing with an intense financial crisis,” said former Fed governor Laurence Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers LLC. “Here is what is amazing: It was ad hoc, yet it looks very good.”
Some investors worry that such loans invite political pressure to continue extending credit to satisfy interest groups, threatening the Fed’s goal of keeping inflation low. “What they are doing is not monetary policy,” says Axel Merk, who has moved the $352 million Merk Hard Currency Fund away from dollar assets to avoid U.S. inflation. “His credit programs are fiscal policies. They are inviting political scrutiny and jeopardizing independence. It is a very dangerous road to be on.”
Bernanke’s first test on inflation will be reversing the $1.2 trillion in additional Fed credit his policies created over the past year. The challenge will be to maintain the Fed’s credibility for keeping prices stable, while avoiding a premature increase in interest rates that may snuff out an emerging recovery. Any move will be watched by Congress. The Fed chairman devoted a section of his semiannual testimony before Congress in July to his exit strategy, saying the Fed could neutralize money in the banking system through tools such as interest on reserves, reverse repurchase agreements, or outright sales of securities.
Traders in federal funds futures see a rising probability of an interest rate increase in March. The federal funds rate has been in a range of zero to 0.25 percent since December. A March rate rise would occur in the quarter when economists forecast the unemployment rate to peak at 10 percent, according to the median estimate of a Bloomberg News survey. That could add momentum to legislative proposals that would expose Fed policy-making to greater scrutiny.
U.S. Representative Ron Paul, a Texas Republican, has written legislation that would open the Fed’s monetary policy to audits. The measure has 282 co-sponsors in the House, according to Paul’s Web site. The timing of any tightening move is “is going to be very tricky,” said Julia Coronado, senior economist at BNP Paribas in New York and a former member of the Fed Board research staff. “Bernanke’s big long-term challenge is to maintain a prominent, independent role for the Fed.”
Much of the criticism of the Fed from Congress stems from its failure to curb asset bubbles. Subprime-mortgage originations jumped to $600 billion in 2006 from $310 billion in 2003, according to estimates by Inside Mortgage Finance. While Fed officials warned about falling standards, they were reluctant to raise interest rates to slow down credit growth. “When it comes to a credit-fueled craze, the Fed has more information that many private market participants do not have, as opposed to an equity bubble,” says Alan Blinder, a former Fed Board vice chairman. “Where you get real ruination is in speculative bubbles that are built on debt.”
As a Fed governor in 2002, Bernanke sided with Greenspan and said “monetary policy cannot be directed finely enough to guide asset prices without risking severe collateral damage to the economy.” He is likely to maintain a preference for what regulators call “supervisory tools.” Yet he’ll also probably remain open to any solution. Even the use of interest rates is back on the table for some officials. Janet Yellen, president of the San Francisco Fed, said in June, “In certain circumstances, the answer as to whether monetary policy should play a role may be a qualified yes.”
After an eventful four years, investors are now looking to the central bank for stability, said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., which manages the world’s largest bond fund, in Newport Beach, California. “Crisis management defined Bernanke’s first term,” he said. “Markets look to Bernanke for policy continuity and, when the time comes, an eventual orderly exit from a complex set of unconventional policies.”
Politics of Bernanke Nod Could Affect Regulatory Overhaul Efforts
Federal Reserve Chairman Ben Bernanke will likely receive Senate support to remain in charge of the central bank for a second term, but his renomination could affect the Fed's efforts to secure broader regulatory authority. Top Senate Democrats signaled their support for the decision to renominate Mr. Bernanke, which was announced by President Barack Obama on Tuesday morning. Senate Majority Leader Harry Reid (D., Nev.), said in a statement he expects the Senate to confirm Mr. Bernanke, calling his expertise and leadership "crucial as our nation has endured this financial crisis." "He is the right choice for these tough times," Sen. Charles Schumer (D., N.Y.), said in a separate statement. Sen. Bob Corker (R., Tenn.), like Mr. Schumer a member of the Senate panel that will vote on Mr. Bernanke's nomination, likewise said Mr. Bernanke "has earned the right to see this through."
Still, the nomination comes at a time of low support for the Fed on Capitol Hill and at a key point of the highly charged debate over whether the central bank should have greater oversight over the largest financial firms. Mr. Bernanke, because of the Fed's role at the center of the government's response to the financial tumult last year, has been a lightning rod for criticism over the government's intervention in the financial system. The Fed has been criticized for a lack of transparency in making billions of dollars of financing available to financial firms, as well as the ad hoc decisions to rescue certain firms while letting others fail.
Mr. Bernanke's nomination hearing will give skeptical senators the opportunity to push back at the Obama administration's proposal to give the Fed broad new authority to regulate systemically important firms. Senate aides have said they are likely to scale back the powers envisioned for the Fed when they introduce legislation next month. "I expect many serious questions will be raised about the role of the Federal Reserve moving forward and what authorities it should and should not have," said Sen. Christopher Dodd (D., Conn.), chairman of the Senate Banking Committee.
Mr. Dodd offered tepid support for the decision, saying Mr. Bernanke "is probably the right choice," and said the panel will hold a thorough confirmation hearing. A Banking panel spokeswoman said staff hasn't yet met to determine when the nomination hearing will occur, but said the timing could be affected by the efforts to move regulatory overhaul legislation. Mr. Dodd's House counterpart, House Financial Services Chairman Barney Frank (D., Mass.), said he strongly supported Mr. Bernanke receiving a second term. "He has acted to provide needed liquidity to the economy and has demonstrated that he is fully ready to reverse course when economic conditions dictate," Mr. Frank said in a statement.
History suggests Mr. Bernanke's nomination shouldn't face too much opposition in the Senate, which has traditionally deferred to the White House on central bank choices. Mr. Bernanke's predecessor, former Chairman Alan Greenspan, repeatedly received wide support from both parties when he was renominated during this decade and last. The nomination could bolster ongoing efforts by Fed critics to allow greater oversight of the central bank's operations. There has been growing bipartisan support in the House of Representatives for legislation authored by Rep. Ron Paul (R., Texas), that would allow government examiners to audit the Fed.
Though unlikely to become law, the mounting support for the measure -- roughly two-thirds of House lawmakers are cosponsors -- means an attempt could be made to attach it to the broader regulatory overhaul legislation. Sen. Schumer, trying to tamp down those efforts, warned critics about using Mr. Bernanke's nomination for political gains. "Chairman Bernanke's confirmation hearing shouldn't be used as a stage by those with wrongheaded political agendas like trimming the Fed's independence," Mr. Schumer said.
Bernanke Team May Have New Look as Second Term Begins
Federal Reserve Chairman Ben S. Bernanke, nominated today for a second four-year term at the helm of the central bank, will be working with a reshaped team. President Barack Obama, who nominated Bernanke for a second term beginning in February, still must fill two other vacancies on the Fed’s Board of Governors, which has operated without its full seven-member complement since April 2006. On top of that, Vice Chairman Donald Kohn’s term expires in June, and Gary Stern, the longest-serving policy maker, will retire when a replacement is named. The turnover means Obama will be able to appoint a majority of governors in his first year. Bernanke will have to convince the Fed’s new members to concentrate on maintaining the economic recovery and put aside concerns about a revival of inflation, said former Fed Governor Lyle Gramley.
“For the next two years the focus is going to be on growth,” said Gramley, now senior economic adviser to New York- based Soleil Securities Corp. “It’s going to be very important for the president to appoint to the board people who can jump in and be effective from day one.” Speaking alongside Obama today in Martha’s Vineyard, Massachusetts, Bernanke, 55, said his Fed colleagues have “demonstrated remarkable resourcefulness, dedication and stamina under trying conditions,” without mentioning the personnel vacancies. Obama said that “we will continue to maintain a strong and independent Federal Reserve.”
Obama has made one other Fed appointment, naming Daniel Tarullo, 56, a former Clinton administration economics aide, to replace Randall Kroszner, a University of Chicago economist and Bush appointee who left in January. That kept the Fed board at five members. Tarullo has taken the lead in efforts to strengthen the Fed’s bank supervision and regulation. With governors filling the two vacant seats, the board would gain additional expertise and capacity for handling its responsibilities across the range of central bank operations, from banking supervision to consumer protection. Seven active governors would also make it easier to form the required quorums for its twice-monthly meetings and when it considers authorizing discount-window lending during “unusual and exigent circumstances.”
“The Fed has been on thin ice, operating with five members on the board,” said David Jones, a former Fed economist who is working on his fifth book about the central bank. “It will be important to bring the board to full capacity in this type of crisis situation.” In addition to economists familiar with monetary policy, Obama will probably seek governor candidates with expertise in banking regulation as his administration seeks to strengthen oversight of the financial institutions at the heart of the economic crisis, said former Fed governor Robert Heller.
The departures of Stern and potentially Kohn would leave Bernanke without the presence of two veterans who have more than 65 years of central bank experience combined. Upon Stern’s departure, Kansas City Fed President Thomas Hoenig, 62, who’s been with the central bank since 1973 and became the district bank’s chief in 1991, will be the longest- serving member of the Federal Open Market Committee. The other 11 presidents were appointed in 2003 or later, with the most recent being William Dudley, who replaced now- Treasury Secretary Timothy Geithner at the New York Fed in January. The 12 regional Fed-bank chiefs are picked by the district banks’ boards of directors and approved by the Fed board in Washington.
The Democratic-controlled Senate declined to act on two candidates from President George W. Bush, a Republican, in 2007. Bush nominated Kroszner for reappointment and two other people, Elizabeth Duke and Larry Klane, to fill the vacancies. The Senate in 2008 approved one, Duke, a former community banker, to keep the Fed’s board from falling below five members. In less than three years, Obama will have the option of replacing Duke, 57. Her term ends in January 2012. The fifth governor, Kevin Warsh, 39, an investment banker and Bush policy adviser appointed in 2006, has a term running through 2018.
Stern, who became Minneapolis Fed president in 1985, turns 65 in November, making him subject to a mandatory retirement rule for district-bank chiefs. Presidents initially appointed after age 55 can, at the option of the board of directors, be permitted to serve until attaining 10 years of service in the office or age 70, whichever comes first. Hoenig is allowed to serve until he turns 65 in two years. After that, there are no other presidents who will be required to retire for several years.
Goldman’s Hatzius Says Fed Balance Sheet Could Hit $4 Trillion
Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc., said the Federal Reserve could double the size of the central bank’s balance sheet again if needed to support economic growth. A rise in the balance sheet to $4 trillion is a “possibility,” Hatzius said in an interview on Bloomberg Radio in New York. “It is going to depend on not just what inflation does, but also on whether the economy does move back to a slower growth pace.”
Fed Chairman Ben S. Bernanke has cut the main U.S. interest rate to almost zero and more than doubled total assets on the central bank’s balance sheet to unclog credit markets and help meet banks’ demand for cash. Fed officials have started to phase out such programs, deciding this month to let a $300 billion program to purchase long-term Treasuries expire in October. The size of the Federal Reserve’s balance sheet has increased to $2.02 trillion as the central bank purchased assets aimed at lowering interest rates, as of the week ended Aug. 12.
The Fed must now guide the world’s largest economy back to growth and reduce unemployment approaching 10 percent while shrinking the balance sheet to prevent a surge in inflation, Hatzius said. “Rates need to stay low,” he said. The Fed “could become more aggressive in purchasing assets. They have not gotten a lot of bang for the buck on that policy so far.” U.S. unemployment will surge to 10 percent this year and the budget deficit will widen to $1.5 trillion next year, reflecting a “deeper recession” than previously expected, the White House said today.
Dismantle Bernanke's 'Happy Conspiracy' ... now!
by Paul Farrell
At last week's annual Jackson Hole meeting of Fed execs, Boss Ben Bernanke's braggadocio about saving the world from another Great Depression had the feel of an egomaniacal dictator trying to cement his legacy in history. Any good behaviorist would tell you Bernanke's got some dangerous biases isolating him from reality (remember two years ago when he was denying the meltdown). His brash claims and radical, secretive policies present a grave danger to American capitalism and democracy.
In fact, Bernanke now appears to be America's (and the world's) most dangerous man, far more dangerous than Hank Paulson and the "Goldman Conspiracy" ever was. He's now acting like the supreme dictator of that larger conspiracy Jack Bogle called the "Happy Conspiracy" in "The Battle for the Soul of Capitalism: How the Financial System Undermined Social Ideals, Damaged Trust in the Markets, Robbed Investors of Trillions -- And What to Do About It."
This indictment of Bernanke as a dictator leading Wall Street's "Happy Conspiracy" became clear after reading "Dismantling the Temple," William Greider's brilliant essay in The Nation magazine. Greider is the author of "Secrets of the Temple: How the Federal Reserve Runs the Country." Greider's essay is an absolute must-read for anyone interested in the future of capitalism, the decline of democracy, the next mega-meltdown, and the real "Great Depression 2" ... from which Bernanke cannot save us.
Why worry? Because the danger really is imminent. The same clueless Congress that did nothing when Paulson and the Goldman Conspiracy nearly bankrupted America is now about to give Bernanke's out-of-control "Happy Conspiracy" even more power, and another bigger chance to destroy our capitalism. Here is a summary of Greider's history about how the Fed is sabotaging America:
- The Fed was created by Congress in 1913, "independent" from "the rest of government, aloof from regular politics and with one powerful exception: the bankers." However, the destructive ideologies of Greenspan and Reaganomics prove how the Fed is manipulated by and dangerously dependent on politicians.
- The Fed is "the black hole of our democracy -- the crucial contradiction." And the recent credit crisis blew "the Fed's cover." Voters and taxpayers have no "voice in these most important public policies" because the Fed "operated in secrecy."
- "The past year, the Fed has flooded the streets with money, distributing trillions of dollars to banks, financial markets and commercial interests. ... People and politicians are shocked ... confused ... angered."
- Where did the Fed get those trillions? They "printed it, out of thin air. That is what central banks do. Who told the Fed governors they could do this? Nobody, really -- not Congress or the president." The Fed "does not submit its budgets to Congress for authorization and appropriation. It raises its own money, sets its own priorities," keeps Congress and the American people in the dark.
- Wall Street bankers own the Fed, it's their private club. They "collaborate closely on Fed policy. Banks are the 'shareholders' who ostensibly own the 12 regional Federal Reserve banks. Bankers sit on the boards of directors, proposing interest-rate changes for Fed governors," serve on a "special advisory council that meets privately with governors to critique monetary policy and management of the economy." The Fed's a legal conspiracy making bankers very, very "happy."
- Congress is now "demanding greater transparency." Bernanke says "no," an audit would amount to "a takeover of monetary policy by the Congress." What a dictator. Greider quotes the Constitution: "The Congress shall have the power to coin money [and] regulate the value thereof." He adds that the Constitution "does not grant the president or the Treasury secretary this power. Nor does it envision a secretive central bank" acting as a megaphone for a president's political ideology.
- Bernanke's powers go far beyond anything Paulson demanded last year. And he's now fighting a turf war because the "Happy Conspiracy" needs secrecy: no audits, no supervision, no transparency, no oversight, and zero accountability to taxpayers. Why? That way they can steal from the American people at will.
- Greider's big warning: Recently Obama made a monumental mistake when he "proposed to make the central bank the supercop to guard against 'systemic risk' and set its own regulations. Obama's proposal gives the central bank even greater power" but does "not propose any changes in the Fed's privileged status."
Giving the Fed more power to self-regulate in secrecy is a guaranteed set-up for a bigger mega-meltdown around 2013, the Fed's centennial anniversary. Now is "a good time to dismantle the temple" warns Greider. "Democratize the Fed. Or tear it down. Create something new in its place that's accountable to the public." Here are his "six reasons why granting the Fed even more power is a really bad idea:"
1. More power rewards failure, creating 'moral hazard'
Get it? Under Greenspan and now Bernanke the Fed has been a dismal failure: "Like the largest banks that have been bailed out, the Fed was a co-author of the destruction," says Greider. "During the past 25 years, it failed to protect the country against reckless banking and finance adventures," blinded by the politics of Greenspan and Reaganomics. "The Fed did not see this disaster coming ... did nothing to warn people." Or they did see it and let it happen, blinded by Wall Street's greed.
2. Fed policies will continue destabilizing U.S. and global economies
Under Greenspan and Bernanke the Fed has dangerously destabilized the American economy and global credit, stock and currency markets. Greider warns: "Its extreme swings in monetary policy, combined with utter disregard for timely regulatory enforcement, steadily shifted economic rewards away from the real economy of production, work and wages and toward the financial realm, where profits and incomes were wildly inflated by false valuations" as "the Fed tilted in favor of capital over labor."
3. The Fed's not objective, cannot investigate its own systemic flaws
Wall Street owns the Fed and has a monstrous conflict of interest. Greider's example: "The Fed served as midwife to Citigroup, the failed conglomerate now on government life support. ... Now the Fed keeps Citigroup alive with a $300 billion loan guarantee," protecting "the banking behemoths that it promoted, if only to cover its own mistakes."
4. The Fed cannot be trusted to protect taxpayers against Wall Street
Rich Wall Street executives manage the Federal Reserve System. Only a fool (or a clueless Congress) will ever trust the Fed to protect taxpayers. The Fed needs independent oversight. Congress needs to take back its constitutional responsibility.
5. More Fed power means more companies want 'too big to fail' status
If Congress continues neglecting its constitutional responsibilities and gives Bernanke supreme dictatorial powers over the "Happy Conspiracy," Greider says "a new superclass of 40 or 50 financial giants will emerge as the born-again 'money trust' that citizens railed against 100 years ago. But this time, it will be armed with a permanent line of credit from Washington. The Fed, having restored and consolidated the battered Wall Street club will doubtless also shield" companies like GE "against failure."
6. The Fed will be a rich-man's club dominating everything from the top
The Fed will "dominate everything from the top down" if Bernanke is anointed absolute dictator over the "Happy Conspiracy." Obama's misguided proposal will "foster even greater concentration of financial power."
Every "large company left out of the protected class will want to join by growing larger and acquiring the banking elements needed to qualify." And "most enterprises in banking and commerce will compete with the big boys at greater disadvantage, vulnerable to predatory power plays the Fed has implicitly blessed."
If Congress is stupid enough to abdicate its constitutional powers to the Fed, God help America's democracy. And for capitalism, this will go down as the biggest blunder of Obama's presidency, worse that Clinton's dismantling of the Glass-Steagall Act. And yet, Greider hints that the worst-case-scenario may be inevitable: "The obstacles to democratizing the Fed are obviously formidable. Tampering with the temple is politically taboo. But this crisis has demonstrated that the present arrangement no longer works for the public interest. The society of 1913 no longer exists."
Still, America "has a rare opportunity to reconstitute the Federal Reserve as a normal government agency, shorn of the bankers' preferential trappings and the fallacious claim to 'independent' status as well as the claustrophobic demand for secrecy." But unfortunately, "many in Congress will be afraid to take on the temple and reluctant to violate the taboo surrounding the Fed. It will probably require popular rebellion." Why? Because Congress (like the Fed) dances to the bidding of Wall Street and its lobbyists who donate megabucks to their campaigns. So don't expect reform until the next crisis, a mega-meltdown around 2013, the centennial anniversary of the Fed.
Till then, you're on notice that the man most likely to destroy American capitalism is Ben Bernanke and his "Happy Conspiracy" of Wall Street bankers that own our Federal Reserve Banks.
The troubling side of Ben Bernanke
Ben Bernanke has proved himself a heroic fire-fighter, saving world from a calamitous spiral into debt deflation by showering markets with liquidity. A good thing too. He helped cause the raging fire of 2007-2009 in the first place. As a Princeton professor and then a junior Federal Reserve governor, Mr Bernanke was the intellectual architect of his predecessor Alan Greenspan's policies that so distorted global finance and pushed debt to historic extremes.
Indeed, he was picked to join the Fed because he provided academic cover for Greenspan's view that asset bubbles do not matter. He blamed credit excesses on Asia's "saving glut", arguing that reserve accumulation by export nations suppressed global bond yields. That let the Fed off the hook for its own role in driving the US savings rate to zero – and consumption through the roof – by holding interest rates below "Wicksell's Natural Rate". It is this twin-sided nature of Bernanke that raises nagging questions about his reappointment as chairman of the Fed. He has admitted errors: it was wrong to think the sub-prime crisis could be contained. But he has yet to acknowledge that his economic ideology is deeply flawed.
Bill White, former chief economist at the Bank for International Settlements, said the error of the central banking fraternity over past 20 years has been to cut real interest rates ever lower to keep the game going. This has lured the world into a debt trap. The effect is to keep drawing prosperity from the future – until the future arrives. "It does the job for a while but moves in interest rates have to be ever more violent to achieve the same effect. My worry is that we may have reached the point where the policy ceases to work altogether.
"These imbalances come back to haunt you, and that is where the world now is. People have been induced to bring forward purchases by taking on debt and there has been a massive expansion in corporate investment," he said.
Economists call this critique "intertemporal misallocation". It is a favourite of the Austrian School. It plays almost no role in the "New Keynesian" thinking of Bernanke. His reflex is to see any fall in demand as an outside shock to be corrected by extra stimulus. What he does not accept is that the adrenal glands of the economic system have been depleted by perpetual credit stimulus, giving the world a form of Addison's Disease.
Bernanke made his name studying the "credit channel" causes of depressions, chiefly drawing on the 1930s. He was quick to see the danger when the financial system had its heart attack on August 20, 2007, the day yields on three-month Treasuries collapsed on flight to safety. He dusted off his manual for fighting slumps – his 2002 speech, Deflation: Making Sure It Doesn't Happen Here – and coolly embarked on monetary revolution. Rates were slashed to zero. The Fed stepped into to prop up the banks, commercial paper, mortgage securities, and finally Treasuries. Nothing like this had been tried before. He did so against fierce resistance from Fed hawks. Only a man so convinced of his mission could have pulled it off.
Given his calmness under fire, and his grasp of credit mechanics, it makes sense for President Barack Obama to give him a second term. We are not out of danger. The markets might have taken fright at a political appointee.
Yet Bernanke's certainty is troubling. The thrust of his academic writings is that the Depression was a "financial event" that could have been avoided if the Fed had flooded the economy with money (by bond purchases) to prevent a banking crash. This theory – half-Friedmanite – has merits. The Fed made horrible mistakes. But it neglects other causes of the slump: industrial over-capacity created by the 1920s bubble, so like today.
It also led to the Greenspan doctrine that central banks can let stock market and housing booms run their course, stepping in to "clean up afterwards". Bernanke spelled out the policy bluntly in his 2002 speech. "The US Government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost," he said. The "no cost" flippancy grates now. Washington says the damage will lift the US federal debt by $9 trillion (£5.5 trillion) over the next decade, pushing the total towards 100pc of GDP. In any case, the Fed cannot use this machinery so easily after all. Foreigners own 40pc of US Treasury debt and have a partial veto on the policy. Overt attempts to "monetise" US debt will cause the policy to short-circuit. Investors will dump US bonds.
Bernanke's theoretical model is clearly wrong – since he was blind-sided two years ago – and must lead him into fresh error. The risk is that he will mismanage the Fed's "exit strategy" by tightening policy too soon on the false assumption that recovery is secure. He knows this was the Fed blunder of 1936-1937, but also seems to think he has basically licked our Great Recession of 2008-2009. Has he really? As Mark Twain put it: "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."
The case against Bernanke
by Stephen Roach
Barack Obama has rendered one of his most important post-crisis verdicts: Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve. This is a very shortsighted decision. While America’s head central banker deserves credit for being creative and courageous in orchestrating an unusually aggressive monetary easing programme, it is important to remember that his pre-crisis actions played an equally critical role in setting the stage for the most wrenching recession since the 1930s. It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure. Maybe the patient needs a new doctor.
Mr Bernanke made three critical mistakes in his pre-Lehman incarnation: First, and foremost, he was deeply wedded to the philosophical conviction that central banks should be agnostic when it comes to asset bubbles. On this count, he stood with his predecessor – serial bubble-blowing Alan Greenspan – who argued that monetary authorities are best positioned to clean up the mess after the bursting of asset bubbles rather than to pre-empt the damage. As a corollary to this approach, both Mr Bernanke and Mr Greenspan drew the wrong conclusions from post-bubble strategies earlier in this decade put in place after the bursting of the equity bubble in 2000. In retrospect, the Fed’s injection of excess liquidity in 2001-2003, which Mr Bernanke endorsed with fervour, played a key role in setting the stage for the lethal mix of property and credit bubbles.
Second, Mr Bernanke was the intellectual champion of the “global saving glut” defence that exonerated the US from its bubble-prone tendencies and pinned the blame on surplus savers in Asia. While there is no denying the demand for dollar assets by foreign creditors, it is absurd to blame overseas lenders for reckless behaviour by Americans that a US central bank should have contained. Asia’s surplus savers had nothing to do with America’s irresponsible penchant for leveraging a housing bubble and using the proceeds to fund consumption. Mr Bernanke’s saving glut argument was at the core of a deep-seated US denial that failed to look in the mirror and pinned blame on others.
Third, Mr Bernanke is cut from the same market libertarian cloth that got the Fed into this mess. Steeped in the Greenspan credo that markets know better than regulators, Mr Bernanke was aligned with the prevailing Fed mindset that abrogated its regulatory authority in the era of excess. The derivatives’ explosion, extreme leverage of regulated and shadow banks and excesses of mortgage lending were all flagrant abuses that both Mr Bernanke and Mr Greenspan could have said no to. But they did not. As a result, a complex and unstable system veered dangerously out of control.
Notwithstanding these mistakes, Mr Obama may be premature in giving Mr Bernanke credit for the great cure. No one knows for certain as to whether the Fed’s strategy will ultimately be successful. The worst of the US recession appears to have been arrested for now – a fairly typical, but temporary, outgrowth of the time-honoured inventory cycle. But the sustainability of any post-bubble recovery is always dubious. Just ask Japan 20 years after the bursting of its bubbles.
While financial markets are giddy with hopes of economic revival – in part inspired by Mr Bernanke’s cheerleading at the Fed’s annual Jackson Hole gathering – there is still good reason to believe that the US recovery will be anaemic and fragile. US consumers are in the early stages of a multi-year retrenchment as they cut debt and rebuild retirement saving. The unusual breadth and synchronicity of the global recession will restrain US export demand from becoming a new growth engine.
It would be the height of folly to reward Mr Bernanke for the recovery that never stuck. Yet Mr Bernanke’s apparent reward is, unfortunately, typical of the snap judgments that guide Washington decision-making. In this same vein, it is hard to forget Mr Greenspan’s mission-accomplished speech in 2004 that claimed “our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful”. Eager to declare the crisis over, the Obama verdict may be equally premature.
The Bernanke reappointment is a welcome chance for a broader debate over the conduct and role of US monetary policy. Mr Obama has made sweeping proposals that give the Fed broad new powers in managing systemic risks. I argued in the Financial Times 10 months ago that the Fed should not be granted these powers without greater accountability as required by a “financial stability mandate” – in effect, forcing the Fed to shape monetary policy with an aim towards avoiding asset bubbles and imbalances. Without a revamped policy mandate, it is conceivable that we could face another destabilising crisis.
Ultimately, these decisions boil down to the person – in this case, Mr Bernanke – who is being charged with the awesome responsibility as America’s chief economic policymaker. As a student of the Great Depression, he should have known better. Yes, he reacted strongly after the fact in taking actions to avoid the pitfalls highlighted by his own research. But he lacked the foresight and courage to resist the most reckless tendencies of the era of excess. The world needs central bankers who avoid problems, not those who specialise in post-crisis damage control. For that reason, alone, he should not be reappointed. Let the debate begin.
The writer is chairman of Morgan Stanley Asia
Forget About The Chinese Stock Market, The Whole Chinese Economy Is A Bubble Waiting To Burst
Financial commentators are obsessively debating whether the recent rise in the Chinese stock market means there's a bubble -- and if so, when it's going to burst. My take? Who cares! What happens to the broader Chinese economy is what we should really be watching. It will have a far-reaching impact on the rest of the world -- much more far-reaching than a decline in stocks. Despite everything, the Chinese economy has shown incredible resilience recently. Although its biggest customers -- the United States and Europe -- are struggling (to say the least) and its exports are down more than 20 percent, China is still spitting out economic growth numbers as if there weren't a worry in the world. The most recent estimate put annual growth at nearly 8 percent.
Is the Chinese economy operating in a different economic reality? Will it continue to grow, no matter what the global economy is doing? The answer to both questions is no. China's fortunes over the past decade are reminiscent of Lucent Technologies in the 1990s. Lucent sold computer equipment to dot-coms. At first, its growth was natural, the result of selling goods to traditional, cash-generating companies. After opportunities with cash-generating customers dried out, it moved to start-ups -- and its growth became slightly artificial. These dot-coms were able to buy Lucent's equipment only by raising money through private equity and equity markets, since their business models didn't factor in the necessity of cash-flow generation.
Funds to buy Lucent's equipment quickly dried up, and its growth should have decelerated or declined. Instead, Lucent offered its own financing to dot-coms by borrowing and lending money on the cheap to finance the purchase of its own equipment. This worked well enough, until it came time to pay back the loans. The United States, of course, isn't a dot-com. But a great portion of its growth came from borrowing Chinese money to buy Chinese goods, which means that Chinese growth was dependent on that very same borrowing.
Now the United States and the rest of the world is retrenching, corporations are slashing their spending, and consumers are closing their pocket books. This means that the consumption of Chinese goods is on the decline. And this is where the dot-com analogy breaks down. Unlike Lucent, China has nuclear weapons. It can print money at will and can simply order its banks to lend. It is a communist command economy, after all. Lucent is now a $2 stock. China won't go down that easily.
The Chinese central bank has a significant advantage over the U.S. Federal Reserve. Chairman Ben Bernanke and his cohort may print a lot of money (and they did), but there's almost nothing they can do to speed the velocity of money. They simply cannot force banks to lend without nationalizing them (and only the government-sponsored enterprises have been nationalized). They also cannot force corporations and consumers to spend. Since China isn't a democracy, it doesn't suffer these problems. China's communist government owns a large part of the money-creation and money-spending apparatus. Money supply therefore shot up 28.5 percent in June. Since it controls the banks, it can force them to lend, which it has also done.
Finally, China can force government-owned corporate entities to borrow and spend, and spend quickly itself. This isn't some slow-moving, touchy-feely democracy. If the Chinese government decides to build a highway, it simply draws a straight line on the map. Any obstacle -- like a hospital, a school, or a Politburo member's house -- can become a casualty of the greater good. (Okay -- maybe not the Politburo member's house).
Although China can't control consumer spending, the consumer is a comparatively small part of its economy. Plus, currency control diminishes the consumer's buying power. All of this makes the United States' TARP plans look like child's play. If China wants to stimulate the economy, it does so -- and fast. That's why the country is producing such robust economic numbers.
Why is China doing this? It doesn't have the kind of social safety net one sees in the developed world, so it needs to keep its economy going at any cost. Millions of people have migrated to its cities, and now they're hungry and unemployed. People without food or work tend to riot. To keep that from happening, the government is more than willing to artificially stimulate the economy, in the hopes of buying time until the global system stabilizes. It's literally forcing banks to lend -- which will create a huge pile of horrible loans on top of the ones they've originated over the last decade.
But don't confuse fast growth with sustainable growth. Much of China's growth over the past decade has come from lending to the United States. The country suffers from real overcapacity. And now growth comes from borrowing -- and hundreds of billion-dollar decisions made on the fly don't inspire a lot of confidence. For example, a nearly completed, 13-story building in Shanghai collapsed in June due to the poor quality of its construction.
This growth will result in a huge pile of bad debt -- as forced lending is bad lending. The list of negative consequences is very long, but the bottom line is simple: There is no miracle in the Chinese miracle growth, and China will pay a price. The only question is when and how much.
Another casualty of what's taking place in China is the U.S. interest rate. China sold goods to the United States and received dollars in exchange. If China were to follow the natural order of things, it would have converted those dollars to renminbi (that is, sell dollars and buy renminbi). The dollar would have declined and renminbi would have risen. But this would have made Chinese goods more expensive in dollars -- making Chinese products less price-competitive. China would have exported less, and its economy would have grown at a much slower rate.
But China chose a different route. Instead of exchanging dollars back into renminbi and thus driving the dollar down and the renminbi up -- the natural order of things -- China parked its money in the dollar by buying Treasuries. It artificially propped up the dollar. And now, China is sitting on 2.2 trillion of them.
Now, China needs to stimulate its economy. It's facing a very delicate situation indeed: It needs the money internally to finance its continued growth. However, if it were to sell dollar-denominated treasuries, several bad things would happen. Its currency would skyrocket -- meaning the loss of its competitive low-cost-producer edge. Or, U.S. interest rates would go up dramatically -- not good for its biggest customer, and therefore not good for China. This is why China is desperately trying to figure out how to withdraw its funds from the dollar without driving it down -- not an easy feat.
And the U.S. government isn't helping: It's printing money and issuing Treasuries at a fast clip, and needs somebody to keep buying them. If China reduces or halts its buying, the United States may be looking at high interest rates, with or without inflation. (The latter scenario is most worrying.)
All in all, this spells trouble -- a big, big Chinese bubble. Identifying such bubbles is a lot easier than timing their collapse. But as we've recently learned, you can defy the laws of financial gravity for only so long. Put simply, mean reversion is a bitch. And the longer excesses persist, the harder the financial gravity will bring China's economy back to Earth.
So Where's The Growth? Chinese State Enterprise Profits Down 23%
Latest data shows that profits for Chinese State Owned Enterprises (SOE's) has fallen 22.8% YoY in the first seven months of 2009. In contrast, the stock market has rocketed higher YTD on economic growth expectations. The decline in profit moderated in July, but still seems very much at odds with optimism in regards to China's near-term growth. Profit also fell 2% in July from June, though the results of a single month might not be too dependable. Margins appear to be clearly under pressure given profits fell by a higher percentage than revenue.Alibaba: The SOEs' operating revenue was RMB 11.64 trillion in the first seven months of this year, down 4.7% year on year. The operating revenue of the centrally-controlled enterprises decreased 3.6% year on year to RMB 7.38 trillion, while that of locally-administered state enterprises was down 6.6% from a year earlier and reached RMB 4.26 trillion.
This could be further evidence that China is stimulating GDP growth at the expense of profits, by pushing unprofitable economic decisions to be made. It's worrisome since while uneconomic projects might make GDP data look good in the near term, such growth is illusory in the long term and actually destroys value. Measured in terms of profit, China's SOE economy is declining. Hopefully for Chinese stock market investors, the private sector will deliver on expectations and pick up the slack.
China’s stimulus shows the problem of success
China has rebounded from the global slump with vigour. In the second quarter, its official figures showed year-on-year gross domestic product growth of 7.9 per cent. Those who doubt the quality of China’s macroeconomic statistics can check its physical statistics: in June, electricity production increased 5.2 per cent, reversing the falls of the previous eight months. It is almost certain that China’s GDP will grow more than 8 per cent this year. But there are problems looming. More investment thanks to China’s rescue package threatens to worsen the already severe overcapacity, while the cash injection is already creating asset bubbles.
The reason for China’s stimulus is simple. While it did not suffer a western-style financial crisis, it was hit hard by the second-order effects, as exports suddenly collapsed. In 2007, the growth rate of exports was 25.7 per cent, and exports made up 36 per cent of GDP. In November last year the exports shrank 2.2 per cent on the year, and have fallen continuously since then. In May 2009, exports plunged 26.4 per cent against a year earlier. The fall of exports may have cut GDP growth 3 percentage points. If its indirect impact is included, it may have shaved more than 5 points off China’s 2008 growth.
The Chinese government reacted very quickly. In November 2008, the government introduced a Rmb4,000bn ($580bn, €404bn, £354bn) stimulus package for 2009 and 2010. The prescribed dosage of the stimulus is very large, at 14 per cent of GDP in 2008. China can afford such an expansionary fiscal policy. Over the past decade, China’s budget deficit was very low, and in 2007 it ran a budget surplus. As a result, China’s debt should only be about 20 per cent of GDP even after the stimulus. The government has plentiful room to manoeuvre.
Here, though, comes the first problem. The most important component in the stimulus package is investment in infrastructure. Fixed asset investment has long been the most important driving force for China’s economic growth, and has been growing faster than GDP since the turn of the century. Due to the dual role of fixed asset investment in creating demand in the short run and supply in the long run, an increasing investment rate will create immediate excess demand for a while, then the economy will shift from a phase of overheating to overcapacity. Correspondingly, inflation pressure will be replaced by deflation pressure.
Since late 2003, China’s macroeconomic policy was aimed at controlling overheating. Because the overheating was mainly caused by the rapid increase in fixed asset investment, overcapacity was building up at the same time. Strong external demand postponed the arrival of overcapacity. Unfortunately, the government’s efforts failed to contain the investment fever. For example, in 2004, when the government tried to clamp down on investment fever in steel production, China’s steel capacity was 400m tonnes. In 2007, it passed 600m tonnes. Only when exports collapsed was the extent of overcapacity exposed – and in a dramatic fashion.
To maintain decent growth and avoid massive unemployment, the Chinese government was left with no option but to replace flagging external demand by domestic demand. But in the short run it is difficult to stimulate domestic consumption; investment demand became the only alternative. As a result of the stimulus package, the growth rate of fixed asset investment hit 36 per cent year-on-year in the first half of 2009, and China’s investment rate may have surpassed 50 per cent of GDP.
The government knows very well that the economy has been suffering from overcapacity. This is why government-financed investment in the stimulus package is concentrated in infrastructure, rather than new factories. However, there are still problems with an investment-centred expansionary fiscal policy. Due to the hasty and under-supervised implementation, waste in infrastructure construction is ubiquitous, and the prospective returns of this big push into infrastructure are less than promising.
More resources should be used in building a decent social safety network, so household consumption can play a more important role in driving economic growth. Government spending should be conducive to private investment and help the development of small and medium-sized enterprises, but many local governments are squeezing these businesses hard to compensate for falling tax revenues. Faced with the clear overcapacity after the sudden withdrawal of external demand, the Chinese government now is trying hard to stabilise export growth. Tax rebates are becoming an important export promotion policy.
Unfortunately, it is more likely that due to the adjustment in the US’s imbalances – particularly a fall in consumption – contraction of China’s export markets is inevitable. China’s rebalancing is more the result of the global economic crisis than of policy initiative. China could do more to eliminate both internal and external price distortions to reduce its dependency on external markets. While China’s crisis management has succeeded in reviving growth, its achievements in structural adjustment are mixed.
Now to the second problem. In the first half of 2009, bank credits increased Rmb7,300bn, above the official target for the full year. Credit growth was surprisingly high, and the same was true of the broad money supply, M2, which grew at a record rate relative to GDP. As a result, the inter-bank money market has been inundated with liquidity. It is right that China should adopt an accommodating monetary policy in response to the global financial crisis and domestic slowdown. However, China did not suffer a liquidity shortage and credit crunch. Its monetary multiplier has been more or less stable. China does not need a helicopter to drop money from the sky.
The excess liquidity has led to the resurgence of asset bubbles. At present, overcapacity is preventing inflation becoming a threat. However, with broad money above 160 per cent of GDP, the situation could change, and change quickly, due to internal or external shocks. Global policymakers are focused on the US Federal Reserve’s next steps. China’s monetary authority may also need to worry about its exit strategy.
To achieve a sustainable rebound, China needs to strike a fine balance between crisis management and structural reforms. If China fails to tackle its structural problems, including its export dependency, high investment rate and wide income gaps, growth is unlikely to be sustainable. The current crisis has provided China with a good opportunity not only for structural adjustment but also for institutional reforms. It is in China’s and the world’s interests to see the necessary measures are adopted with conviction.
China Premier Rejects 'Blindly Optimistic' View of Economy
China's Premier Wen Jiabao expressed caution about the country's economic recovery, saying the effects of some short-term policies may fade while longer-term policies will take time to have an impact. Ending a three-day visit to the eastern province of Zhejiang, Mr. Wen warned against being "blindly optimistic," according to a statement by the State Council. His comments suggest that Beijing feels it is too early to consider exiting the four trillion yuan ($585.6 billion) fiscal stimulus and other steps that have buoyed the world's third-biggest economy. (Global issuers of corporate debt are being forced to renegotiate terms in China because of capital problems.)
Mr. Wen's remarks also highlight growing tension in China's policy debate as the government calls for staying the course while some lawmakers have started to argue for sharply curbing loan growth in the second half. The premier reiterated that China must maintain stable macroeconomic policies, namely its "moderately loose" monetary policy and "active" fiscal policy. He didn't raise concerns about inflation, but said China should "ensure market liquidity is reasonably ample." He called for "strengthening the balance and sustainability of credit in supporting economic and social development."
While reinforcing Beijing's official stance, Mr. Wen's comments didn't rule out policy tweaks. The People's Bank of China said this month it will fine-tune its policies based on the economic situation and changes in prices. Expectations that Beijing might rein in loan growth caused sharp falls in Chinese stock prices for much of this month, reverberating through markets around the world. Last week, lawmakers, including former central bank Vice Governor Wu Xiaoling, voiced concern about the potential risks of the enormous stimulus efforts. Lawmaker Yin Zhongqing said that new yuan loans, which surged to nearly eight trillion yuan in the first seven months, should be limited to 10 trillion yuan for the full year.
Mr. Wen appeared to try to damp public debate, saying policy makers must "unify our thoughts toward the judgment of the central government in the economic situation, and unify our actions toward carrying out the decisions of the central government" regarding the raft of measures to combat the global financial crisis. Beijing's stimulus program helped to lift China's economic growth to 7.9% year-to-year in the second quarter, from 6.1% in the first quarter.
Rule of the iron rooster
Under the leadership of the Communist Party, the people in China brace up to cope with the financial crisis and have scored marked successes to the worldwide attention. High-level figures from the western political and economic spheres ... envy China’s superb performance ... as well as “China’s spirit”– the kind of solid, unbreakable “Great Wall” at heart to ward off the financial crisis.
– English-language editorial in the People’s Daily, official mouthpiece of the Communist party of China, July 30
China’s rulers can be excused a modicum of less-than-grammatical gloating after the economic rebound the country has achieved in recent months. With its quick and overwhelming response to the crisis, Beijing appears to have engineered a powerful V-shaped recovery and by most estimates is on track to exceed the 8 per cent growth target it set at the start of the year.
Official readings of industrial production, fixed investment, power consumption and gross domestic product all show a strong revival, while equity and property prices have soared in recent months. There have even been signs of a recovery in exports, although these are still about one-quarter below the levels of a year ago.
But a growing number of economists and officials say the positive growth data hide worrying structural imbalances and the government’s response to the crisis may only have postponed an inevitable reckoning. With the world looking to China as a beacon to lead the way out of economic gloom, a second downturn would have a big impact on global confidence, not to mention commodity prices.
“There is such a thing as good 5 per cent growth and bad 8 per cent growth,” according to one senior adviser to the government. “We worry that what we’re seeing falls more into the latter category.”
On an annual basis, China’s economy grew 7.9 per cent in the second quarter, well up from 6.1 per cent in the first quarter. If measured sequentially the rebound was even more obvious, economists estimate, with seasonally adjusted quarter-on-quarter growth at zero in the fourth quarter of 2008 but picking up to 3 per cent in the first three months of this year and as much as 16-17 per cent in the second quarter.
This was thanks largely to the government’s Rmb4,000bn ($585bn, €409bn, £355bn) fiscal stimulus and the Rmb7,370bn of new bank loans extended in the first half of the year, triple the amount lent in the same period a year earlier. Economists at BNP Paribas estimate that the loan expansion was equivalent to 45 per cent of half-year GDP and say they know of no other economy that has created credit on such a scale since the second world war.
This lending boom, carried out by the country’s state-controlled banks on the orders of the central government, has raised concerns that much of the money has gone to borrowers who will not be able to pay it back. “I worry what’s happening now is similar to what happened in the US in 2001 – the government is flooding the economy with cash that just ends up papering over the problems,” says a Chinese corporate executive who used to live in the US.
Royal Bank of Scotland analysts say around 20 per cent of new loans in the first half may have found their way into the equity market and another 30 per cent into property and other financial assets, helping to inflate unsustainable asset bubbles.
“The property market is so hot right now and prices are going up so much that it really is a seller’s market,” says Wang Qing, a driver earning Rmb2,500 a month who has started speculating on real estate by buying and selling small apartments in his spare time. “The sales agent told me the other day I had to fly to Hong Kong to meet the seller of one apartment just to show I was sincere, because there were too many other bids out there.”
China’s stock market is up 64 per cent this year but has dropped 14 per cent in the past three weeks as investors panicked over signs the government was starting to rein in excessive loan growth. Analysts say the steep drop shows how much of this year’s rise has been fuelled by bank loans channelled into speculative activity.
“Everyone privately thinks this is an asset bubble driven purely by liquidity,” says a senior executive at a Chinese investment bank. “Those in the private sector who have been able to get loans from the state banks are mostly keeping it for a rainy day or speculating on the stock and property markets; very little is going into the real economy.”
Of the rest that has gone that way, the bulk has been to state companies and government-backed infrastructure projects, particularly the tiegong?ji or “iron rooster” – a homonym for the Chinese words for rail, roads and airports. The huge projects have revived demand for steel, concrete and other raw materials but this kind of capital-intensive state investment creates relatively few jobs. Yet over the next three years, the railways ministry plans to add 20,000km of track to the existing 80,000km, with a total investment of more than Rmb2,000bn. At this rate, China’s rail network will this year overtake that of India to become the second-longest in the world, behind the US.
As for roads, construction began in the first half on 111 expressways totalling 12,000km with an investment of Rmb700bn, according to the ministry of transport. By the end of last year China had just over 60,000km of high-speed roads, compared with 75,000km in the US. But if plans by local governments are included, China’s high-speed road network would expand to 180,000km in the next few years, an astounding figure considering China has only 38m passenger vehicles against 230m in the US.
Some officials say the most worrying element of the infrastructure-heavy stimulus package is the fixation with building airports. For instance, the town of Jiaxing in eastern Zhejiang province is roughly an hour’s drive on brand new expressways from three of the country’s busiest international airports – two in Shanghai and one in the city of Hangzhou. In spite of this proximity, and a planned high-speed rail line connecting Shanghai and Hangzhou, the Jiaxing government has decided to build a commercial airport on the site of a military landing strip, with an estimated investment of Rmb300m.
Jiaxing officials say they expect to recoup their money by 2025 but sceptics say this kind of investment will never repay itself and will instead end up as a bad loan on the books of the state banks. “The main concern we have now is that a tremendous volume of loans was extended very rapidly to the corporate sector at a time when corporate profitability was declining,” says Charlene Chu at Fitch Ratings. “That would suggest there will be some significant asset quality problems down the road.”
While state-owned enterprises have been inundated with loans from the state banks, economists worry too that China’s vibrant private sector has been largely left to fend for itself.
“The fiscal and monetary policy response to the crisis has mostly benefited the largest enterprises and biggest projects,” says Wang Yijiang, professor of economics and human resources management at the Cheung Kong Graduate School of Business in Beijing. “The small and medium-sized enterprise sector provides 75 per cent of the jobs to China’s urban workforce but now it is shrinking for the first time in 30 years of economic reforms.”
Aged 42, Chen Guangming has spent half his life as a migrant worker in China’s big northern cities but at the end of last year became one of an estimated 23m who lost their jobs and returned home to the villages. “This year it is much harder to find work and I spent most of the year waiting in my village until some relatives told me about this job,” he says, indicating the construction site where he is paid Rmb70 for a 10-hour day.
The latest 6.1m graduates from Chinese universities have also been struggling to find work. The education ministry says 68 per cent have been employed so far but independent estimates put the number at only around 50 per cent. More than 1.5m of last year’s graduates are also still searching for work.
At a talent fair next to Beijing’s ancient Lama Temple, 24-year-old Peng Chuan, who graduated with a degree in English in July 2008, has lowered his sights and is looking for work as a waiter. “Salaries in the private sector have fallen so much but some of my classmates managed to get jobs in the government by leveraging their family connections,” he says.
Competition is fierce these days and landing a secure post requires many to pull strings or offer inducements to those who vet the applicants. “I had a chance to work in a bureau at the railway ministry but I would have had to pay Rmb100,000 to get the job and my family couldn’t afford that,” adds Mr Peng.
While official figures show steady income growth and rising consumption, many economists say these numbers are unreliable because they are heavily weighted towards state-sector salaries and government procurement. Incomes and private consumption are likely to be growing weakly if at all, they say, making it harder for domestic consumption to compensate for the large drop in exports.
They worry that when the effect of the stimulus recedes and Beijing reins bank lending back in, economic imbalances will re-emerge and the government could face another crisis. “It is too early to say that China’s recovery is a V-shaped one,” says Cheung Kong business school’s Prof Wang. “There are many people who truly believe the economy will face another big slide and the recovery will look more like a W.”
Judge Orders SEC to Explain Handling of BofA Case
A federal judge on Tuesday ordered the Securities and Exchange Commission to explain why it didn't pursue allegations that Bank of America Corp. executives lied in a proxy statement about bonuses for Merrill Lynch employees. The SEC said it couldn't investigate the bank executives' culpability because they said they had relied on their lawyers' advice, and without the bank giving up its private discussions with its lawyers, the SEC couldn't build a case.
U.S. District Judge Jed S. Rakoff called this reasoning "at war with common sense." If that were the regulator's policy, "it would seem that all a corporate officer who has produced a false proxy statement need offer by way of defense is that he or she relied on counsel, and, if the company does not waive the privilege, the assertion will never be tested, and the culpability of both the corporate officer and the company counsel will remain beyond scrutiny."
The SEC and Bank of America have asked the judge in federal district court in New York to approve a $33 million consent decree settling the issue.
Instead, Judge Rakoff, citing an obligation to ensure the deal is fair and in the public interest, ordered the SEC and the bank to explain themselves at an Aug. 10 hearing and written submissions that were filed Monday. In an order Tuesday, Judge Rakoff said that the initial submissions raised additional issues, and ordered the SEC and the bank to address them in their final submissions, due Sept. 9. When shareholders have been victimized by a corporation, SEC policy calls for seeking penalties "from culpable individual offenders acting for the corporation," Judge Rakoff observed.
In this case, the SEC alleged that "Bank of America, through its management effectively lied to its own shareholders," Judge Rakoff wrote, but sought a penalty only from the bank, meaning that the shareholders themselves – "and arguably indirectly … U.S. taxpayers" -- would pay for the violation. The U.S. government helped finance Bank of America's takeover of Merrill Lynch. The SEC found fault with proxy documents sent to investors in November 2008, claiming the documents showed Merrill wouldn't pay year-end bonuses without Bank of America's consent, while a separate document never distributed to shareholders had Bank of America approving as much as $5.8 billion in bonuses.
In its court filings, Bank of America said it agreed to settle the charges so it "would not face the unnecessary distraction of a protracted dispute with one of its principal regulators at a time when the financial industry continues to face difficult challenges stemming from uncertain and turbulent conditions." Judge Rakoff was unconvinced. "Whatever this chain of vague expressions may mean, if it is intended to suggest that Bank of America settled this case to curry favor with the SEC or to avoid retaliation by the SEC, the court needs to know the specifics," he wrote.
Proof banks are sitting on severely delinquent home loans
The housing market is not going to bounce back because there’s a huge pipeline of severely delinquent and underwater mortgages out there that still haven’t been absorbed by the market.
Courtesy of the NY Fed, here’s concrete proof banks are sitting on huge numbers of bad loans rather than foreclosing and letting them hit the market. (Ignore the data for 2006: there were few foreclosures back then. Focus on the early 2007 to early 2009 trend.)
This first set of graphs shows the probability that once a borrower goes 60 days late, he then fails to make his next payment and goes 90 days late:
Note the percentage of supposedly “near-prime” Alt-A loans where a 60-day-late borrower cures has plunged from 25% to 5%. The percentage of delinquent loans that get repaid in full because of a refinancing (in yellow) has also dropped from low to virtually zero.
So we see once borrowers miss a couple payments they have no ability or no intention to get current.
You’d expect, with this trend, for banks to then be more aggressive about foreclosing on seriously delinquent mortgagers. Yet we see the opposite: The next set shows what banks do for loans than are 90+ days delinquent.
So banks have gone from foreclosing on about 45% of their severely delinquent Alt-A loans each month to 20%.
So if you own a house that’s underwater, in practice you can probably keep living there (or collecting rent payments) for a year or so without making payments to the bank. You have 3 months before the loan is bad enough for the bank to foreclose, around 3 more months before the bank starts the foreclosure process and who knows how much longer before the bank actually moves to take possession of your home.
On that last point, the next graph shows the declining percentage of Alt-A loans in the foreclosure process that resolve out of foreclosure (i.e., short sale or refinance) and the likewise declining percentage of these loans banks are taking possession of:
Finally we see soaring losses on first mortgages:
This would be much worse if you included second mortgages, and worse still if banks weren’t propping up the market by sitting on bad loans. Worse still, banks are sitting on bad loans in the weakest markets the longest.
Bottom line, U.S. banks are still not owning up to their bad mortgage debt. Our government is turning a blind eye hoping the problem will go away. It won’t. This policy was tried and failed in Japan, where the economy never really recovered.
In fact, the Japanese stock market is lower now than it was 24 years ago in 1985:
Freddie Mac July portfolio down,delinquencies jump
Freddie Mac, the second-largest U.S. home funding company, on Tuesday said its mortgage investment portfolio shrank by an annualized 44.5 percent rate in July, while delinquencies on loans it guarantees accelerated. The portfolio decreased to $799.1 billion, for an annualized 1.2 percent decrease year-to-date, the McLean, Virginia-based company said in its monthly volume summary. The portfolio size, however, was nearly unchanged on a year-over-year basis. In July 2008, the portfolio was $798.2 billion.
Freddie Mac earlier this month reported a surprising profit in the second quarter and indicated that it may not need additional federal aid, at least for now. Delinquencies, which increase stress on the company's capital, jumped to 2.95 percent of its book of business in July from 2.78 percent in June and 1.01 percent in July 2008. The multifamily delinquency rate, however, was unchanged at 0.11 percent in July. A year earlier it was 0.03 percent.
Freddie Mac said refinance-loan purchase volume was $34.1 billion in July, down sharply from June's $50.9 billion. Activity peaked earlier this year, with March's $52 billion its largest refinance month since 2003. The net amount of mortgage-related investments portfolio mortgage purchase and sale agreements entered into during the month of July totaled $11.0 billion, up from the $9.9 billion entered into during the month of June.
The company's total mortgage portfolio decreased at a 3.3 percent annualized rate in July to $2.234 trillion, for an annualized 2.1 percent increase year to date. In early September 2008, the U.S. government seized control of Freddie Mac and its larger sibling, Fannie Mae, amid heightened worries about shrinking capital at the congressionally chartered companies. The current agreement with the U.S. Treasury has the retained portfolio at Fannie Mae and Freddie Mac capped at $900 billion until Dec. 31, 2009 when they are to start declining by 10 percent per year until they reach $250 billion.
The government is now relying heavily on Fannie Mae and Freddie Mac in its efforts to stimulate the U.S. housing market by buying more mortgage loans, easing refinancing and helping homeowners avoid foreclosure. The housing market has suffered the worst downturn since the Great Depression. The hard-hit U.S housing market, however, has been showing signs of stabilization, with sales rising and home price declines moderating in many regions of the country. In fact, according to some indexes, home prices in some regions have risen.
The Pareto Principle and the Next Wave Down in Real Estate
by Charles Hugh Smith
In February 2007 I suggested a 4% mortgage delinquency rate could trigger a decline in the entire housing market. Since that proved prescient, we should revisit the analytic tool behind that call: the Pareto Principle.
There is a whiff of euphoria in the housing market, a heavily touted confidence that "the bottom is in." It's all roaring back--rising sales, multiple bids by anxious buyers,3.5% down payments, low mortgage rates and the bonus of an $8,000 first-time home buyer credit (a gift from U.S. taxpayers). Housing Lifts Recovery Hopes (Wall Street Journal)
Foreclosure-related sales account for over 30% of all sales nationally, and over 70% in hard-hit markets such as Las Vegas, but like piranhas feasting on a school of weakened fish, nobody in the real estate business mentions the huge losses of capital and equity which created all these "bargains."
All we need for a complete bubble reflation is people avidly gaming the system... oh wait, we have that, too. A recent Time magazine cover story on Las Vegas contained this informative tidbit (courtesy of Michael Goodfellow):
(Realtor) Boemio specializes in short selling, in a particularly Vegas way. Basically, she finds clients who owe more on their house than the house is worth (and that's about 60% of homeowners in Las Vegas) and sells them a new house similar to the one they've been living in at half the price they paid for their old house. Then she tells them to stop paying the mortgage on their old place until the bank becomes so fed up that it's willing to let the owner sell the house at a huge loss rather than dragging everyone through foreclosure. Since that takes about nine months, many of the owners even rent out their old house in the interim, pocketing a profit.
Hmm, isn't this the same recipe of froth, low down payments, cheap, easy mortgage money and scamming which got us in trouble the last time? Only the lenders lose, but then now that Ginnie Mae and FHA have stepped up to replace the disgraced, bankrupt shells of Fannie Mae and Freddie Mac, then it really isn't the lenders taking the risks, it's the U.S. taxpayer (again).
It's the same oldmispriced risk and misallocated capital which created and popped the housing bubble in the first place, with the lagniappe insanity of giving people $8,000 of taxpayer funds to prop up home sales to benefit builders, realtors and lenders. (Hats off to their lobbyists--Congress stood on its hind legs and barked on command. "How many years to the next election, Tuffy? Bark! Good dog--only one!")
It's not just new buyers and gamers buying--it's investors plunking down all cash for "bargains," in many cases outbidding each other just like the good old days.
'Cash is king' in market for foreclosed homes (SFGate.com)
All-cash sales are most common where prices are low and bank-owned properties account for the lion's share of listings. In foreclosure-ridden Pittsburg, for instance, 42.7 percent of home sales in the first three weeks of July had no record of a purchase loan, according to county data analyzed by MDA DataQuick. The median price for those transactions was $105,000.
For the same period in San Pablo, 45.1 percent of sales appeared to be cash transactions; their median price was $110,000. In the Bay Area overall, 22.2 percent of sales in the July period looked like cash transactions; their median was $200,000, DataQuick said.
"Houses are less expensive than they've been in over a decade, and there is a Gold Rush mentality out there," said Andrew LePage, an analyst with San Diego's DataQuick. "If you want to be the one who gets the house, in some cases you just have to have cash."
Despite the cheerleading, the gaming and the "Gold Rush mentality" there are a few flies in the ointment. Topping the list: almost one in seven mortgages are distressed--in foreclosure or delinquent:
4.3% of mortgages in foreclosure (marketwatch.com)
The non-seasonally adjusted delinquency rate increased from 8.22 percent in the first quarter of 2009 to 8.86 percent this quarter.
The delinquency rate includes loans that are at least one payment past due but does not include loans somewhere in the process of foreclosure. The percentage of loans in the foreclosure process at the end of the second quarter was 4.30 percent. The combined percentage of loans in foreclosure and at least one payment past due was 13.16 percent on a non-seasonally adjusted basis, the highest ever recorded in the MBA delinquency survey.
Moody's Economy.com estimates that lenders will foreclose on 1.89 million homes in 2009, up from 1.43 million last year.
Then there's these factors:
Souring Prime Loans Compound Mortgage Woes (Wall Street Journal)
Improving Home Sales Belie Market Reality (Wall Street Journal)
Can Vanished Real Estate Wealth Come Back? (Wall Street Journal)
I have applied the Pareto Principle to the housing market over the years, and now that foreclosures have hit the critical 4% mark, it's time to revisit the 4/64 rule and the 80/20 rule.I was introduced to the Pareto Principle by longtime correspondents Harun I. and U.K.C. The Pareto distribution quite effectively predicted that the 4% "vital few" subprime defaults would have an outsized effect on the 64% "trivial many" households with mortgages.
Readers of this blog learned in May 2006 of the likelihood that 5 millions homes would soon be in foreclosure:
How Many Foreclosures Will Hit the Market?(May 1, 2006)
Can 4% of Homeowners Sink the Entire Market?(February 21, 2007)
How 4% of Mortgages Have Brought Down the Entire Market (August 21, 2007)
Will Delinquencies Trigger a New American Revolution?(April 7, 2008)
Feedback Loop of Recession: Housing Bust, Debt and Layoffs(March 10, 2008)
Could 50% of All Homes End Up in Foreclosure?(June 3, 2008)
Why Housing Is Far from Bottoming: Depression, Demographics, Defaults and Dumps(October 8, 2008)
Bingo, foreclosures are on track to exceed 5 million shortly. (1.3 M in 2007, 2.3 M in 2008 and 1.8 M (est.) in 2009.)
Critics might well ask why the The Pareto distribution should apply to the mortgage/housing market. It is a fair question, because the Pareto Principle is not causal--it merely captures the distribution probabilities within groups.
That said, there are a number of fundamental causal drivers which suggest the 4% of homes in foreclosure will have a dramatic, long-term negative influence on the value of 64% of the housing market (the 4/64 rule).
Once the number of distressed mortgages rises from 13% to 20%, then we can anticipate the 80/20 rule will apply: those 20% will wield an outsized influence on the remaining 80% of mortgages. Recall there are about 50 million mortgaged homes in the U.S. and about 25 million owned free and clear. The value of all homes will be pressured as foreclosed and distressed housing is placed on a saturated market.
A key driver of future delinquency is negative equity. Owing more than the value of the home saps homeowners' willingness to "stay the course" and keep sacrificing to pay the mortgage. Regardless of your opinions on the morality of this trend, it is undeniable:
More than 15.2 million U.S. mortgages, or 32.2% of all mortgaged properties, were in a negative-equity position on June 30, edging down from 32.5% at the end of March, according to the real-estate information company, which tracks data on about 90% of mortgage loans nationwide.
The aggregate property value for loans in a negative-equity position was $3.4 trillion, according to the report.
Negative equity can occur because of a decline in property value, an increase in mortgage debt or a combination of both. Negative equity is a strong driver of foreclosures,
Foreclosures Drag on U.S. Recovery (Dismal Scientist)
Foreclosures depress house prices through three channels: increased supply, discounting, and the neighborhood effect. In the first case, additional inventory comes on the market when homes are foreclosed, adding to supply just as the recession is curbing new household formation, keeping demand for housing weak. Second, banks typically discount the price of foreclosed properties to encourage quick sales. Foreclosed homes also are often damaged, reducing their value. None of the conventional price indices capture this effect.
Finally, foreclosed properties drive down prices for nearby homes, regardless of whether they, too, are distressed. Simply being located next to a foreclosed property renders a home less desirable. This is reflected in overall house prices: According to a recent Federal Housing Finance Agency survey,California house prices excluding foreclosed properties had fallen 36% from the market peak through the first quarter of 2009, not much different than the 41% decline in the FHFA price index that includes foreclosed properties.
Once the homes with negative equity surpassed 20% of the total market, a new dynamic set in. One recent report estimated 50% of U.S. homes would be "under water" by 2011. Given the Pareto distribution, this seems entirely reasonable and even conservative.
What about all those homes being snapped up with investor cash? The idea, of course, is that the "smart buyers" will rent the properties out to cover all the carrying costs and then profit as housing "recovers."
Please excuse my cynical snort. Being a landlord/landlady is not an easy business. Human being have all sorts of perverse reactions to higher rents, such as moving out and leaving you with big fat vacancies.
Humans under financial stress also display all sorts of quirky behaviors such as not paying the rent, or paying sporadically. And when you try to evict them, other quirks can kick in, like suing you for discrimination, claiming you failed to keep the property habitable, and so on. Some might take out their anger at your unreasonable greed by trashing the house. To make them go away usually requires a few thousand dollars' cash "incentive."
So much for those "easy profits."
Most annoyingly, houses actually require constant upkeep and financial investment to be rentable. Houses are not bonds. They do not pay "dividends" with no work and no further expenses. Costly things are always going wrong. You can ignore them and be a slumlord, but then an amusing reaction called "karma" sets in and you end up getting the kind of tenants you deserve.
Fantasies of easy wealth via landlording die quick and hard. A funny thing happened on the way to a long, drawn-out New Depression--lots of people no longer have the financial ability to pay rent in any amount above zero. All those folks the new "investors" are counting on to rent their trashed, abandonedhouses will be moving back home with parents, sleeping on sofas, renovating garages and outbuildings into semi-habitable spaces, moving into welfare SROs, moving back to their nation of origin, etc.
Just anecdotally, I know of one investor who bought a multi-unit building and promptly jacked the rents 20% to reap a tidier profit. Most of the tenants are leaving. Good luck with that "I'm gonna get rich as an absentee landlord" game. I anticipate a wave of desperate sellers in 2010 trying to dump their "can't lose rental investments" for any price as long as it's cash.
Yes, it is possible to earn a modest positive return on rental properties, if you maintain the property scrupulously, screen your tenants as if they were future in-laws, study your neighborhood rental markets carefully and respond to your tenants as valued customers rather than annoyances. Few landlords are willing or able to do the above and hence losses and vacancies are guaranteed.
And the mortgage re-sets just keep coming. We've all seen this chart so often that we've become numb to the dire consequences it implies:
Let's also consider the waveform of every financial bubble. With minor variations just to keep life interesting, all financial bubbles follow this basic progression:
There is always a false bottom/false dawn marked by euphoric buying by those who expect a resumption of a trend which is irrevocably broken. Now that foreclosed houses are drawing 30 cash bids above asking, I think we can safely announce that the post-false bottom peak is at hand.
There is generally a rough symmetry to bubbles. Thus since the housing bubble took about 11 years to reach its apex (roughly 1996-2006) then we can expect about an 11-year downcycle (2007-2017) give or take a few years. To expect a decade-long bubble to bottom in a mere 18 months is folly.
Few beyond historians know that half of all urban homes were in default/delinquency during the Great Depression of the 1930s. Various Federal schemes were put in place to suppress this national default: bans on foreclosures, renegotiating existing under-water loans, etc. None of them changed the fundamental reality or "fixed" the housing market. We would be wise to recall this history before placing too much faith in re-runs of the same policies.
California Budget Revisited
Many look to California for guidance on where the future is heading. In this current economy, it would seem that some are looking for other economic leaders. A $26 billion budget deficit, a housing market that is still wobbling around, and employment that seems to continue to get worse. The current California economy, unlike many states in the nation, still seems solidly in a recession. Yet on a nationwide level, there does seem to be faint hopes that things are getting worse at a slightly slower clip. Unemployment isn’t flying off a cliff but jobs are still being lost. The housing market on a nationwide basis seems to have hit a sales bottom (although prices still seem to be heading lower). Yet California has unique struggles that will make it a late bloomer in coming out of the recession.
If you haven’t already noticed, part of the budget balancing act contained earlier withholdings. California Realtors are gearing up to fight this because many are independent contractors and get a 1099 tax form instead of the more typical W-2. Most who get paid via the W-2 pay taxes on a rolling monthly basis. Yet many that operate under the 1099 pay quarterly estimates of their taxes. In many cases, this creates massive fluctuations with revenues. But you have to love the argument coming out from Realtors:
“(OC Register) The Vote May be TODAY! Please call your Assembly member NOW!” an association “Red Alert” to members said after the measure emerged from conference committee in June. “C.A.R. OPPOSES (this) proposal to force independent contractors to make interest-free loans to the state!”
Unlike wage earners, who get taxes deducted from their paychecks, independent contractors aren’t subject to any withholdings. But contractors, who get a 1099 tax form instead of a W-2, are required to make estimated tax payments every three months.
Some state officials proposed that those paying independent contractors be required to withhold 3% of their income and send it to the state. The plan would accelerate tax payments and generate more cash for California’s coffers, they maintain.”
You have got to love this one. Where were Realtors when brokers were giving out no money down loans and Alt-A junk to the public? Where were Realtors when the $700 billion taxpayer bailout rescued banks? I didn’t hear much opposition about that tax credit for home buyers which amounts to a free taxpayer subsidy to those who buy homes. Now they are opposed to paying taxes earlier? This isn’t even a tax hike. This is a typical case of cognitive dissonance in action.
Some seem to think that we are already out of the woods with the July budget:
For what it is worth, the state is still issuing IOUs. They are however ahead of schedule and are planning to phase out the program come September 4. Even with all the massive cuts in programs and no new revenue streams the state is going to need to borrow some $10.5 billion for the fiscal year. The chart above depicts that situation. Without the borrowing, we would be in the red in a couple of days. And much of the expectation is things will stay at this level:
Keep in mind that the above cuts of approximately $15 billion and the $10.5 billion in borrowing balance the budget for part of the last fiscal year and the 2009-10 year. But the underlying basis is the worst has already occurred. Given the current cuts, it is assured that the economy will face additional pain at least into the next fiscal year. Many have only recently started furloughs which means less disposable income for the economy.
The current unemployment rate of 11.9 percent underscores the actual underemployment rate of 22 percent:
And people are doing what they can. The economy has actually pushed many unemployed to seek a new avenue of income. Game shows:
“(USA Today) Before the economy soured, Pomerantz says, few prospective contestants skewed older, college-educated and unemployed. Now its 10%, she says.
Catch 21 players can win a maximum of $50,000 - apparently enough of a draw these days to lure auditioners atypical of the “average Joes” who usually want on. Casting for a third season run of about 200 shows, “it’s absolutely clear we are seeing a lot of professionals who have lost their jobs or are looking for a way to supplement income,” says producer Scott Sternberg.”
People are simply trying to make ends meet. And with 812,000 Californians receiving unemployment insurance, there are many simply trying to figure out how to handle the current downturn in the economy. The unemployment insurance fund has been in the red since the start of the year:
And the loss of jobs has occurred in practically every industry:
The only two sectors that are slightly positive on a 12 month basis are education, health services and agriculture. But even healthcare, the last place to cut is having to scale back:
“(LA Times) One of the state’s largest employers, healthcare giant Kaiser Permanente, said it would eliminate more than 1,800 positions as it struggles with drooping membership, uncertain healthcare reform and shriveling Medicare reimbursement rates.
Job reductions will occur within the next few months, the Oakland-based nonprofit said Tuesday. Many of the purged positions — just under 2% of Kaiser employees — are temporary, on-call or short-hour. Most Kaiser medical centers in California will be affected.”
The real question many should ask is what industry is going to bring us out of this recession? Also, we are assured additional financial losses with the Alt-A and option ARM products. There is now speculation that banks will be doing lease-back options to current owners. That is, renting the home back to the distressed borrower at market level rents with a future purchase option. But how many people will jump on to this program? Are banks capable of being landlords? I hold my own reservations here. Remember Hope Now? This was going to supposedly help tens of thousands and helped out a handful of people. With about 1,000 properties going back to banks each day, they will have to decide quickly what they plan on doing.
California relied much too heavily on real estate and is now paying the price. To assume real estate will lead us out again ignores the amount of distress property still coming down the pipeline. 2010 should offer us a better glimpse of where we are heading. And now, we are only starting to see the impacts of the major budget cuts. Many are just starting school. Bigger class sizes and a public college system unable to meet the demand of the recently unemployed. And those that can go to college, are now facing higher fees (10 percent at CSU and 9.4 percent at the UC). Even community colleges hiked up their fees from $20 to $26. Less money for consumption. Cash for clunkers ends today. At a certain point, the gimmicks start running out.
Greed & The Other Seven Deadly Sins!
by Satyajit Das
Greed is back already, perhaps it never went away. On the back of revived earnings, compensation for star bankers is looking up. Even signing and guaranteed bonuses are stirring. Excessive executive remuneration is widely viewed as a symptom of ‘greed’, one of the seven deadly sins. For some, excessive pay contravenes ideas of ‘equality’. Bankers should be paid the same as a nurse who should be paid the same as a doctor. This misunderstands the concept of equality. Anatole France observed: “The law, in its majestic equality, forbids the rich as well as the poor to sleep under bridges, to beg in the streets, and to steal bread.”
It challenges concepts of motivating achievement through reward. Objective assessment of different contributions is also likely to prove difficult. Concern about excessive pay also focuses on ‘allocation’; ‘who’ gets ‘what’. Mark Twain once admitted: “I am opposed to millionaires, but it would be dangerous to offer me the position.” For others, the issue is ‘proportionality’; a chief executive’s reward is disproportionate to his or her contribution. Tight, in-bred circles of directors and consultants determine senior executive salaries. ‘Benchmarking’ exercises merely reinforce the ‘norm’ with packages being justified as ‘needing to buy the best talent’ or ‘meeting the demands of a competitive market’. Results are also easily manipulated to meet specified performance hurdles for bonuses. Recent severance payments highlight that failure is better rewarded than success.
John Kenneth Galbraith identified this pattern long ago: “The salary of the chief executive of the large corporation is not a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.” But who is responsible? Many people are now shareholders, directly or through superannuation schemes. Critics ironically acquiesce in the award of generous senior executive packages. They either actively vote in favour of these contracts or fail to challenge the arrangements, as is their right.
There may be a double standard. Critics were willing to hand executive generous pay packets so those talented managers would make them richer. Many turned a blind eye to excesses when they became richer through higher share prices and dividends. George Orwell reminds us: “People sleep peaceably in their beds at night only because rough men stand ready to do violence on their behalf.” Criticism of excessive remuneration packages ironically necessitates committing the other six deadly sins. Critics secretly perhaps ‘lust’ after the same riches that they are now censure. Their desire for increased wealth to fuel excess consumption – the sin of ‘gluttony’ – drives greed.
Critics are guilty of ‘sloth’ in their laziness in not exercising their power as shareholders to rein in compensation excesses. Critics may be guilty also of the sin of ‘wrath’ as they now indulge their righteous anger. They commit the sin of ‘envy’ as their stand may be merely resentment at those in the world who have done better. Finally, critics are almost certainly guilty of ‘pride’, being conscious of their superiority in making their principled stand against greed.
In truth, critics are looking for scapegoats and simple answers to the losses suffered as a result of the Global Financial Crisis. This is evident in the return of large paydays as share prices have rebounded. John Stuart Mill cautioned: “Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”. Excessive executive remuneration is not a simple matter of ‘greed’ but symptomatic of deeply flawed economic and social systems. In their classic 1933 book – The Modern Corporation and Private Property – Adolf Berle and Gardiner Means argued that companies were akin to feudal kingdoms run by “princes of industry” consistent with their own interests.
Half a century later, directors and managers (with modest shareholdings) in conjunction with, for the most part, benign investment managers still run enterprises in a manner not always consistent with the interest of ‘absentee’ shareholders. John Maynard Keynes was aware of this: “Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone.” All systems are flawed. The real issue is their effectiveness.
Unfortunately, as Keynes wrote: “The decadent international but individualistic capitalism in the hands of which we found ourselves …. is not a success. It is not intelligent. It is not beautiful. It is not just. It is not virtuous. And it doesn't deliver the goods.” Genuine reform of executive remuneration requires understanding of the true problems and reforming the economic system rather than merely treating one of the symptoms.
First Amendment Award for Outstanding Journalism: Best News Anchor Dylan Ratigan
In the movie Network, life-long news anchor Howard Beale declares one of the most famous lines in cinematic history, “I’m mad as hell, and I’m not going to take this anymore!” This line resonates through time because we all can relate to the feeling on some level. Recently, news anchor Dylan Ratigan expressed our feelings during the economic crisis as he pierced the corporate veil with his razor-sharp questions and insights. After an extended stay at CNBC and co-founding the popular show Fast Money, Ratigan graduated to the world stage of money and politics as host of the MSNBC show Morning Meeting. Consequently, we are all better off now that Ratigan can extend beyond Wall Street to government chambers and power alleys around the globe.
Unlike most news anchors who either robotically read the teleprompter or pretend to be looking out for you, Ratigan does his Fourth Estate duties by asking uncomfortable questions and forcing us to look in the mirror. He has been a true patriot shining a spotlight on the thieves who turned our economy into a gambling pit while they subsequently ripped off taxpayers. If news anchors did more of Ratigan’s reporting and less promotions for their books or speaking tours, we might have more of a democracy and less of a corpocracy. I sat down with Ratigan to discuss his career, journalism, the state of affairs, and what the hell we must do to regain control.
Damien: Do you think we are undergoing a shift where people are sick of entertainment masquerading as news? If so, what do you see happening?
Dylan: I think the environment in this country dictates what people want from their news. When people feel there are things they do not know yet are dangerous to them and their family — in the physical sense, the financial sense, whatever — they go to the place which makes them feel the information is best. Prior to the events of last year we had a lot of news outlets in this country that were successful because in a boom time they were able to accumulate an audience who enjoyed an entertainment version of the news. When the events of last year transpired and more than $16 trillion of America’s future capital had to be committed to support the banks, a more intense line of questioning became more valuable. Last fall I said, “We’re living in an American Idol world, and the financial crisis changed the news business into Jeopardy.” Suddenly everyone was saying, “Hey, hold on a second here. American Idol is a lot of fun, but what’s going on around here?” Since I was 15 years in the process of asking better questions, I was well equipped for the shift. I feel fortunate to have the background and training to continue asking questions.
Damien: If you’re making a grand a day watching Jim Cramer, you’re in a good mood and everything’s ‘Boo-Yah.’ When that game stops and you lose your job, you’ll want to know what Dylan Ratigan has to say.
Dylan: That’s very flattering of you to say. For reporters similar to me it’s like being able to speak Arabic at a time when you really need an Arabic speaker. There are a group of journalists who have a very good understanding of the subject. In my case, it was an opportunity to add value in general news and policy. The entire opportunity was driven by circumstance.
Damien: Since you started at Bloomberg and their mission is to focus on news which sells terminals, how did you transcend that focus to become a great journalist in general?
Dylan: I was raised as a reporter at Bloomberg News where they drilled into us that our job was to get the best information possible for the person buying the [Bloomberg] terminal for $1000 a month. I positively interpret my teaching at Bloomberg as the lesson, “Your first priority is your customer.” So, as applied to MSNBC now, I work for my boss Phil Griffin but truly work for whoever chooses to watch my show. If I do a good job of providing information for whoever chooses to watch my show and more people choose to watch my show, then I’m still using the skills Bloomberg taught me.
Bloomberg trained me as a reporter. For four years I wrote for the newswire 12 hours a day. I covered IPOs, stock markets, other capital markets, M&A, etc. I got to understand the entire financial landscape and know the community. That was the foundation for me. Then I went to Bloomberg TV because it looked more fun and paid better. Then, as Malcom Gladwell discusses in his book Outliers, I got my 10,000 hours of practice at CNBC over the course of five-plus years. A lot of that time I was doing three shows a day, everyday. That was incredibly valuable broadcast training. I learned how to effectively and desirably communicate in public — and that takes practice. And, CNBC allowed me to cultivate an audience for the type of journalism I’m interested in pursuing.
Damien: Now that you’re at MSNBC which is more general in scope, has your reporting style changed?
Dylan: No. The same principles apply to asking smart questions and representing the interests of the taxpayers relative to politicians, banks, and anyone else who would seek to steal the taxpayers’ money because the taxpayer is seen as an easy mark. While some of these stories may begin on Wall Street, there’s a culture in this country of picking off the taxpayer for the benefit of some group of people — the corn lobby, the oil lobby, the health insurance companies, banks, unions etc. They all want a little piece of the action. So, while I’m no longer involved in the day-to-day coverage of the financial markets, I’ve never been more involved in asking the powerful people why generational theft is their policy.
Damien: Dylan, what advice do you have for a new generation of media leaders who are inspired to follow in your footsteps?
Dylan: I view my current position at this particular point in time as a tremendous privilege, responsibility, and good fortune. I’m not doing my job to make Dylan Ratigan a TV star. I’m doing this to ask good questions of the power structure in a way which everyone can understand the questions and answers. So, my most basic advice is focus on the purpose of what you’re doing and be great. The more collectively those of us who choose the path of journalism are willing to talk about whatever truth needs to be talked about, the better off we will be as a society. The key is to direct the attention outward in a way that’s easily accessible and digestible. It’s not about being the smartest. It’s about being the most effective.
For example, our ambition at MSNBC is to be like the smart yet entertaining cartoon The Simpsons. People think “funny” has to be stupid and “smart” can’t be fun. However, we must consistently deliver a fun show with insightful information to get everyone involved in important conversations. Also, I advise understanding the intentions of capitalism so you can ask the correct questions. Let me explain a little because it’s very important to understand … Money equals imprisonment or freedom. Either a person is imprisoned because they have no money and can’t do anything, or they have the money to freely do what they desire. So, you either have money or you need it.
In a truly capitalist system, power should be accumulated through achievement. As a society, we would want those who do things well and add value to have more power. So, for capitalism to function properly there must be a connection between achievement and power. People must wake up every morning with the drive to achieve as opposed to running scams to get pieces of paper called “money.” In addition, we need to have a clear and even playing field. When our real-world system diverges from these basic principles, we get into trouble. As journalists, we must aim the questions at the divergences.
Damien: So, your advising that journalists understand the underlying presuppositions of our society?
Dylan: Exactly. Understand why people got on a boat in the 1600’s. What were their ideas? They thought, “What if we get to a country where there is freedom of religion and equal opportunity?” When they first got here there wasn’t equal opportunity, but we’ve made great strides since then. Getting back to the thought about true capitalism, if companies such as General Motors and Citibank can’t earn money from succeeding in the marketplace, they should fail. Then, a new adapted version of those businesses would emerge.
That’s what happens in a true capitalist system. However, in our system — whatever you want to call it — these businesses behaved more like drug cartels who make tons of money and then influence the government to protect them from the fair laws of failure. This is exactly the same as the banks, health insurers, unions, etc. who are saying, “Our business model is obsolete, we made a huge amount of money, so let’s send that money to the government to insure a legal structure that creates barriers to entry for our businesses.” In other words, they are causing anti-capitalist behavior by creating anti-competitive legal structures — for example, health insurers.
The rules of capitalism are very simple: the capital markets exist as a warehouse of capital accumulated through innovation because you pay people for innovation. As a result, you have an incredibly innovative society. It’s like a leaf blower spreading capital all over the country because capitalists are competing with each other to pick the next winning company. However, that means the government’s role is to oversee the capital markets and make sure capital is being directed back into the economy to award further innovation and value. In our screwed up world, the capitalists decided to chase money rather than achievement. So, they said, “What if we turn the entire housing market into a speculative instrument? From what can we skim 1/100th of a basis point and still pay ourselves billions of dollars each?”
Damien: The biggest asset each person possesses.
Dylan: Bingo. And we arrive at that place by simply asking good questions.
Damien: On a related note, do you ever feel like your good questions are drowned out by the overwhelming amount of PR in the media?
Dylan: No. I feel more hopeful than ever. The beautiful thing about technology, America, and capitalism is our freedom of information. I believe in a few years everyone in this country will know how this place is being run — even if tomorrow I got run over by a bus. I am hopeful because I know we can vote to change the system. We can say, “All lobbying money must be disclosed.” This will prevent the major lobbying interests from continuing to run this country to their benefit and everyone else’s detriment. Each of these powerful groups may not be operating with bad intentions, but they operate in an undemocratic veil of secrecy.
Lobbying may be good or bad. That’s not my job to know. But it is un-American to allow any particular institution to assert financial control or influence over legislators who are supposed to be making decisions in the interests of the nation. Our representatives are not hired to benefit any one group at the expense of the nation. Just look at what happened when the corn group overdid ethanol at the expense of the nation, health insurers overdid their profits at the expense of the nation, and banks overdid their risk at the expense of the nation.
Circling back to hope … I am also hopeful because Americans can spend their own dollars. As people have better information and a clearer understanding of how things are connected, every American will be able to better use their two most powerful assets: the right to vote and the right to freely spend the untaxed portion of their money. When these two powers are combined with good information, great things are possible. Remember, this country once had slaves, women couldn’t vote, etc. This is not a static nation. We’ve wrestled much bigger problems than undemocratic influence. We’ve got some very smart people, an entire generation of citizens with a different view of information and information gathering, and the capacity to deliver information globally in a blink. It’s all about the truth. And if the truth is readily available, the system is actually quite good.
So, the big issue right now is to eliminate the aspects of our system which allow the obscuration of the truth — meaning, all the different things which are not done in public. For instance, the distribution of a few trillion dollars to the banks on behalf of the American people.
Damien: While we’re focused on truth and technology, why do you think so many journalists avoided properly investigating the financial crisis for their audience who relied on them for critical information?
Dylan: Conversations about why things went wrong can be very unnerving and scary. Any conversation which conflicts with the status quo can make people feel uncomfortable. Also, this story has many layers of complexity, so it’s challenging for people to figure out the best way to cover it. I can’t answer beyond that. You’ll have to ask them.
Nicolas Sarkozy announces bonus curbs and urges G20 nations to follow suit
Nicolas Sarkozy threw down the gauntlet to other G20 nations tonight when he announced a new set of rules limiting traders' bonuses and vowed to make the country the global "example" for the cleaning up of the banking system. Speaking after a meeting with his country's banking chiefs, the French president said that tougher controls would be imposed which would link bonuses to performance and would strip traders of their financial reward if they subsequently fail to deliver.
Other countries would do well to take heed, he added. "The issue of transparency and responsibility in bonuses will be central at the Pittsburgh [G20] summit," said Sarkozy, who is flying to Berlin on Monday for talks with Angela Merkel, the German chancellor. "I'll be flexible on practical details, but not on the substance." The French banking union said it would adopt the new rules with immediate effect. BNP Paribas, the bank which enraged the French public recently by setting aside a bonus package of €1bn (£870m) for its highest paid executives, said it would be cutting that package by half, to €500m, in accordance with the new guidelines.
"From now on the trader must wait three years to cash in all of their bonus and if in the following two years their activity loses money, he will not have his bonus," said Sarkozy, adding compliance with the guidelines would be closely monitored and that banks which did not play by the rules would not have access to mandates to state activities such as lucrative privatisations. "We will not work with banks that do not apply these rules," he said.
Speaking of the "bonus malus" scheme which he helped to put forward, Baudouin Prot, the chief executive of BNP Paribas, said the regulations were necessary – but that they would only work if adopted globally. "The difficulty is that this regulation cannot only be put in place in one single country," he said, evoking a widespread feeling among France's financial community that their country's business reputation could be sacrificed to its president's trail-blazing political ambitions.
Before the meeting, the banks were said to be willing to submit themselves to stringent limitations and controls – as long as talk of a national upper limit on bonuses was taken off the table. "It is naturally indispensable that such good practices be applied in all countries," added Prot. "It's a way of reducing the risks of new excesses and a new crisis." During the meeting, attended by top executives from banks including the struggling Société Générale, Sarkozy warned against the return of risky trading practices now that the worst of the financial crisis seemed to be over.
France technically emerged from recession this month, showing a growth rate of 0.3% in the second quarter. But the president and his right-wing government remains concerned about the aftershocks on his popularity. According to a poll for TNS Sofres commissioned this month, more than 50% of French people believe bankers' bonuses to be "excessive".