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Still Wrong After All These Years

June 21st, 2010 Posted in Uncategorized

Jun, 21 2010

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June 21, 2010

I’m quite surprised by the fact that people continue to pay serious attention to the musings of Alan Greenspan. On June 18, The Wall Street Journal saw fit to publish an opinion piece by the man referred to as “The Maestro” (although – these days – that expression is commonly used in sarcasm). The former Fed chairman expounded that recent attempts to rein in the federal budget are coming “none too soon”. Near the end of the article, Greenspan made the statement that will earn him a nomination for TheCenterLane.com’s Jackass of the Year Award:

I believe the fears of budget contraction inducing a renewed decline of economic activity are misplaced.

John Mauldin recently provided us with a thorough explanation of why Greenspan’s statement is wrong:

There are loud calls in the US and elsewhere for more fiscal constraints. I am part of that call. Fiscal deficits of 10% of GDP is a prescription for disaster. As we have discussed in previous letters, the book by Rogoff and Reinhart (This Time is Different) clearly shows that at some point, bond investors start to ask for higher rates and then the interest rate becomes a spiral. Think of Greece. So, not dealing with the deficit is simply creating a future crisis even worse than the one we just had.

But cutting the deficit too fast could also throw the country back in a recession. There has to be a balance.

* * *

That deficit reduction will also reduce GDP. That means you collect less taxes which makes the deficits worse which means you have to make more cuts than planned which means lower tax receipts which means etc. Ireland is working hard to reduce its deficits but their GDP has dropped by almost 20%! Latvia and Estonia have seen their nominal GDP drop by almost 30%! That can only be characterized as a depression for them.

Robert Reich’s refutation of Greenspan’s article was right on target:

Contrary to Greenspan, today’s debt is not being driven by new spending initiatives. It’s being driven by policies that Greenspan himself bears major responsibility for.

Greenspan supported George W. Bush’s gigantic tax cut in 2001 (that went mostly to the rich), and uttered no warnings about W’s subsequent spending frenzy on the military and a Medicare drug benefit (corporate welfare for Big Pharma) — all of which contributed massively to today’s debt. Greenspan also lowered short-term interest rates to zero in 2002 but refused to monitor what Wall Street was doing with all this free money. Years before that, he urged Congress to repeal the Glass-Steagall Act and he opposed oversight of derivative trading. All this contributed to Wall Street’s implosion in 2008 that led to massive bailout, and a huge contraction of the economy that required the stimulus package. These account for most of the rest of today’s debt.

If there’s a single American more responsible for today’s “federal debt explosion” than Alan Greenspan, I don’t know him.

But we can manage the Greenspan Debt if we get the U.S. economy growing again. The only way to do that when consumers can’t and won’t spend and when corporations won’t invest is for the federal government to pick up the slack.

This brings us back to my initial question of why anyone would still take Alan Greenspan seriously. As far back as April of 2008 – five months before the financial crisis hit the “meltdown” stage — Bernd Debusmann had this to say about The Maestro for Reuters, in a piece entitled, “Alan Greenspan, dented American idol”:

Instead of the fawning praise heaped on Greenspan when the economy was booming, there are now websites portraying him in dark colors. One site is called The Mess That Greenspan Made, another Greenspan’s Body Count. Greenspan’s memoirs, The Age of Turbulence, prompted hedge fund manager William Fleckenstein to write a book entitled Greenspan’s Bubbles, the Age of Ignorance at the Federal Reserve. It’s in its fourth printing.

The day after Greenspan’s essay appeared in The Wall Street Journal, Howard Gold provided us with this recap of Greenspan’s Fed chairmanship in an article for MarketWatch:

The Fed chairman’s hands-off stance helped the housing bubble morph into a full-blown financial crisis when hundreds of billions of dollars’ worth of collateralized debt obligations, credit default swaps, and other unregulated derivatives — backed by subprime mortgages and other dubious instruments — went up in smoke.

Highly leveraged banks that bet on those vehicles soon were insolvent, too, and the Fed, the U.S. Treasury and, of course, taxpayers had to foot the bill. We’re still paying.

But this was not just a case of unregulated markets run amok. Government policies clearly made things much worse — and here, too, Greenspan was the culprit.

The Fed’s manipulation of interest rates in the middle of the last decade laid the groundwork for the most fevered stage of the housing bubble. To this day, Greenspan, using heavy-duty statistical analysis, disputes the role his super-low federal funds rate played in encouraging risky behavior in housing and capital markets.

Among the harsh critiques of Greenspan’s career at the Fed, was Frederick Sheehan’s book, Panderer to Power. Ryan McMaken’s review of the book recently appeared at the LewRockwell.com website – with the title, “The Real Legacy of Alan Greenspan”. Here is some of what McMacken had to say:

. . . Panderer to Power is the story of an economist whose primary skill was self-promotion, and who in the end became increasingly divorced from economic reality. Even as early as April 2008 (before the bust was obvious to all), the L.A. Times, observing Greenspan’s post-retirement speaking tour, noted that “the unseemly, globe-trotting, money-grabbing, legacy-spinning, responsibility-denying tour of Alan Greenspan continues, as relentless as a bad toothache.”

* * *

Although Greenspan had always had a terrible record on perceiving trends in the economy, Sheehan’s story shows a Greenspan who becomes increasingly out to lunch with each passing year as he spun more and more outlandish theories about hidden profits and productivity in the economy that no one else could see. He spoke incessantly on topics like oil and technology while the bubbles grew larger and larger. And finally, in the end, he retired to the lecture circuit where he was forced to defend his tarnished record.

The ugly truth is that America has been in a bear market economy since 2000 (when “The Maestro” was still Fed chair). In stark contrast to what you’ve been hearing from the people on TV, the folks at Comstock Partners put together a list of ten compelling reasons why “the stock market is in a secular (long-term) downtrend that began in early 2000 and still has some time to go.” This essay is a “must read”. Further undermining Greenspan’s recent opinion piece was the conclusion reached in the Comstock article:

The data cited here cover the major indicators of economic activity, and they paint a picture of an economy that has moved up, but only from extremely depressed numbers to a point where they are less depressed. And keep in mind that this is the result of the most massive monetary and fiscal stimulus ever applied to a major economy. In our view the ability of the economy to undergo a sustained recovery without continued massive help is still questionable.

As always, Alan Greenspan is still wrong. Unfortunately, there are still too many people taking him seriously.

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The Poisonous Bailout

June 10th, 2010 Posted in Uncategorized

Jun, 10 2010

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June 10, 2010

The adults in the room have spoken. The Congressional Oversight Panel – headed by Harvard Law School professor Elizabeth Warren – created to oversee the TARP program, has just issued a report disclosing the ugly truth about the bailout of AIG:

The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace.

Note the present tense in that statement. Not only did the bailout have a poisonous effect on the marketplace at the time –it continues to have a poisonous effect on the marketplace. The 300-page report includes the reason why the AIG bailout continues to have this poisonous effect:

The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America‘s largest financial institutions and to assure repayment to the creditors doing business with them.

And that, dear readers, is precisely what the concept of “moral hazard” is all about. It is the reason why we should not continue to allow financial institutions to be “too big to fail”. Bad behavior by financial institutions is encouraged by the Federal Reserve and Treasury with assurance that any losses incurred as a result of that risky activity will be borne by the taxpayers rather than the reckless institutions. You might remember the pummeling Senator Jim Bunning gave Ben Bernanke during the Federal Reserve Chairman’s appearance before the Senate Banking Committee for Bernanke’s confirmation hearing on December 3, 2009:

. . . you have decided that just about every large bank, investment bank, insurance company, and even some industrial companies are too big to fail. Rather than making management, shareholders, and debt holders feel the consequences of their risk-taking, you bailed them out. In short, you are the definition of moral hazard.

With particular emphasis on the AIG bailout, this is what Senator Bunning said to Bernanke:

Even if all that were not true, the A.I.G. bailout alone is reason enough to send you back to Princeton. First you told us A.I.G. and its creditors had to be bailed out because they posed a systemic risk, largely because of the credit default swaps portfolio. Those credit default swaps, by the way, are over the counter derivatives that the Fed did not want regulated. Well, according to the TARP Inspector General, it turns out the Fed was not concerned about the financial condition of the credit default swaps partners when you decided to pay them off at par. In fact, the Inspector General makes it clear that no serious efforts were made to get the partners to take haircuts, and one bank’s offer to take a haircut was declined. I can only think of two possible reasons you would not make then-New York Fed President Geithner try to save the taxpayers some money by seriously negotiating or at least take up U.B.S. on their offer of a haircut. Sadly, those two reasons are incompetence or a desire to secretly funnel more money to a few select firms, most notably Goldman Sachs, Merrill Lynch, and a handful of large European banks.

Hugh Son of Bloomberg BusinessWeek explained how the Congressional Oversight Panel’s latest report does not have a particularly optimistic view of AIG’s ability to repay the bailout:

The bailout includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury Department and up to $52.5 billion to buy mortgage-linked assets owned or backed by the insurer through swaps or securities lending.

AIG owes about $26.6 billion on the credit line and $49 billion to the Treasury. The company returned to profit in the first quarter, posting net income of $1.45 billion.

‘Strong, Vibrant Company’

“I’m confident you’ll get your money, plus a profit,” AIG Chief Executive Officer Robert Benmosche told the panel in Washington on May 26. “We are a strong, vibrant company.”

The panel said in the report that the government’s prospects for recovering funds depends partly on the ability of AIG to find buyers for its units and on investors’ willingness to purchase shares if the Treasury Department sells its holdings. AIG turned over a stake of almost 80 percent as part of the bailout and the Treasury holds additional preferred shares from subsequent investments.

“While the potential for the Treasury to realize a positive return on its significant assistance to AIG has improved over the past 12 months, it still appears more likely than not that some loss is inevitable,” the panel said.

Simmi Aujla of the Politico reported on Elizabeth Warren’s contention that Treasury and Federal Reserve officials should have attempted to save AIG without using taxpayer money:

“The negotiations would have been difficult and they might have failed,” she said Wednesday in a conference call with reporters. “But the benefits of crafting a private or even a joint public-private solution were so superior to the cost of a complete government bailout that they should have been pursued as vigorously as humanly possible.”

The Treasury and Federal Reserve are now in “damage control” mode, issuing statements that basically reiterate Bernanke’s “panic” excuse referenced in the above-quoted remarks by Jim Bunning.

The release of this report is well-timed, considering the fact that the toothless, so-called “financial reform” bill is now going through the reconciliation stage. Now that Blanche Lincoln is officially the Democratic candidate to retain her Senate seat representing Arkansas – will the derivatives reform provisions disappear from the bill? In light of the information contained in the Congressional Oversight Panel’s report, a responsible – honest – government would not only crack down on derivatives trading but would also ban the trading of “naked” swaps. In other words: No betting on defaults if you don’t have a potential loss you are hedging – or as Phil Angelides explained it: No buying fire insurance on your neighbor’s house. Of course, we will probably never see such regulation enacted – until after he next financial crisis.

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Doctor Doom Writes A Prescription

May 6th, 2010 Posted in Uncategorized

May, 06 2010

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May 6, 2010

As I discussed on April 26, expectations for serious financial reform are pretty low. Worse yet, Lloyd Blankfein (CEO of Goldman Sachs) felt confident enough to make this announcement, during a conference call with private wealth management clients:

“We will be among the biggest beneficiaries of reform.”

So how effective could “financial reform” possibly be if Lloyd Bankfiend expects to benefit from it? Allan Sloan of Fortune suggested following the old Wall Street maxim of “what they promise you isn’t necessarily what you get” when examining the plans to reform Wall Street:

President Obama talks about “a common sense, reasonable, nonideological approach to target the root problems that led to the turmoil in our financial sector and ultimately in our entire economy.” But what we’ll get from the actual legislation isn’t necessarily what we hear from the Salesman-in-Chief.

Sloan offered an alternative by providing “Six Simple Steps” to help fix the financial system. He wasn’t alone in providing suggestions overlooked by our legislators.

Nouriel Roubini (often referred to as “Doctor Doom” because he was one of the few economists to anticipate the scale of the financial crisis) has written a new book with Stephen Mihm entitled, Crisis Economics: A Crash Course in the Future of Finance. (Mihm is a professor of economic history and a New York Times Magazine writer.) An excerpt from the book recently appeared in The Telegraph. The idea of fixing our “sub-prime financial system” was introduced this way:

Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel. Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.

* * *

Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis. Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again. The crisis was less a function of sub-prime mortgages than of a sub-prime financial system. Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.

Roubini and Mihm had nothing favorable to say about CDOs, which they referred to as “Chernobyl Death Obligations”. Beyond that, the authors called for more transparency in derivatives trading:

Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis. So-called over-the-counter derivatives — better described as under-the-table — must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted. Moreover, the regulation of derivatives should be consolidated under a single regulator.

Although derivatives trading reform has been advanced by Senators Maria Cantwell and Blanche Lincoln, inclusion of such a proposal in the financial reform bill faces an uphill battle. As Ezra Klein of The Washington Post reported:

The administration, the Treasury Department, the Federal Reserve, and even the FDIC are lockstep against it.

The administration, Treasury and the Fed are also fighting hard against a bipartisan effort to include an amendment in the financial reform bill that would compel a full audit of the Federal Reserve. I’m intrigued by the possibility that President Obama could veto the financial reform bill if it includes a provision to audit the Fed.

Jordan Fabian of The Hill discussed Congressman Alan Grayson’s theory about why Treasury Secretary Tim Geithner opposes a Fed audit:

But Grayson, who is known for his tough broadsides against opponents, indicated Geithner may have had a role in enacting “secret bailouts and loan guarantees” to large corporations, while New York Fed chairman during the Bush administration.

“It’s one of the biggest conflict of interests I have ever seen,” he said.

With the Senate and the administration resisting various elements of financial reform, the recent tragedy in Nashville provides us with a reminder of how history often repeats itself. The concluding remarks from the Roubini – Mihm piece in The Telegraph include this timely warning:

If we strengthen the levees that surround our financial system, we can weather crises in the coming years. Though the waters may rise, we will remain dry. But if we fail to prepare for the inevitable hurricanes — if we delude ourselves, thinking that our antiquated defences will never be breached again — we face the prospect of many future floods.

The issue of whether our government will take the necessary steps to prevent another financial crisis continues to remain in doubt.

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Too Cute By Half

April 29th, 2010 Posted in Uncategorized

Apr, 29 2010

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April 29, 2010

On April 15, I discussed the disappointing performance of the Financial Crisis Inquiry Commission (FCIC). The vapid FCIC hearings have featured softball questions with no follow-up to the self-serving answers provided by the CEOs of those too-big–to-fail financial institutions.

In stark contrast to the FCIC hearings, Tuesday brought us the bipartisan assault on Goldman Sachs by the Senate Permanent Subcommittee on Investigations. Goldman’s most memorable representatives from that event were the four men described by Steven Pearlstein of The Washington Post as “The Fab Four”, apparently because the group’s most notorious member, Fabrice “Fabulous Fab” Tourre, has become the central focus of the SEC’s fraud suit against Goldman. Tourre’s fellow panel members were Daniel Sparks (former partner in charge of the mortgage department), Joshua Birnbaum (former managing director of Structured Products Group trading) and Michael Swenson (current managing director of Structured Products Group trading). The panel members were obviously over-prepared by their attorneys. Their obvious efforts at obfuscation turned the hearing into a public relations disaster for Goldman, destined to become a Saturday Night Live sketch. Although these guys were proud of their evasiveness, most commentators considered them too cute by half. The viewing public could not have been favorably impressed. Both The Washington Post’s Steven Pearlstein as well as Tunku Varadarajan of The Daily Beast provided negative critiques of the group’s testimony. On the other hand, it was a pleasure to see the Senators on the Subcommittee doing their job so well, cross-examining the hell out of those guys and not letting them get away with their rehearsed non-answers.

A frequently-repeated theme from all the Goldman witnesses who testified on Tuesday (including CEO Lloyd Bankfiend and CFO David Viniar) was that Goldman had been acting only as a “market maker” and therefore had no duty to inform its customers that Goldman had short positions on its own products, such as the Abacus-2007AC1 CDO. This assertion is completely disingenuous. When Goldman creates a product and sells it to its own customers, its role is not limited to that of “market-maker”. The “market-maker defense” was apparently created last summer, when Goldman was defending its “high-frequency trading” (HFT) activities on stock exchanges. In those situations, Goldman would be paid a small “rebate” (approximately one-half cent per trade) by the exchanges themselves to buy and sell stocks. The purpose of paying Goldman to make such trades (often selling a stock for the same price they paid for it) was to provide liquidity for the markets. As a result, retail (Ma and Pa) investors would not have to worry about getting stuck in a “roach motel” – not being able to get out once they got in – after buying a stock. That type of market-making bears no resemblance to the situations which were the focus of Tuesday’s hearing.

Coincidentally, Goldman’s involvement in high-frequency trading resulted in allegations that the firm was “front-running” its own customers. It was claimed that when a Goldman customer would send out a limit order, Goldman’s proprietary trading desk would buy the stock first, then resell it to the client at the high limit of the order. (Of course, Goldman denied front-running its clients.) The Zero Hedge website focused on the language of the disclaimer Goldman posted on its “GS360” portal. Zero Hedge found some language in the GS360 disclaimer which could arguably have been exploited to support an argument that the customer consented to Goldman’s front-running of the customer’s orders.

At Tuesday’s hearing, the Goldman witnesses were repeatedly questioned as to what, if any, duty the firm owed its clients who bought synthetic CDOs, such as Abacus. Alistair Barr of MarketWatch contended that the contradictory answers provided by the witnesses on that issue exposed internal disagreement at Goldman as to what duty the firm owed its customers. Kurt Brouwer of MarketWatch looked at the problem this way :

This distinction is of fundamental importance to anyone who is a client of a Wall Street firm. These are often very large and diverse financial services firms that have — wittingly or unwittingly — blurred the distinction between the standard of responsibility a firm has as a broker versus the requirements of an investment advisor. These firms like to tout their brilliant and objective advisory capabilities in marketing brochures, but when pressed in a hearing, they tend to fall back on the much looser standards required of a brokerage firm, which could be expressed like this:

Well, the firm made money and the traders made money. Two out of three ain’t bad, right?

The third party referred to indirectly would be the clients who, all too frequently, are left out of the equation.

A more useful approach could involve looking at the language of the brokerage agreements in effect between Goldman and its clients. How did those contracts define Goldman’s duty to its own customers who purchased the synthetic CDOs that Goldman itself created? The answer to that question could reveal that Goldman Sachs might have more lawsuits to fear than the one brought by the SEC.

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Failed Financial Reform And Failed Justice

April 26th, 2010 Posted in Uncategorized

Apr, 26 2010

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April 26, 2010

As the long-awaited financial reform legislation finally seems to be headed toward enactment, the groans of disappointment are loud and clear. My favorite reporter at The New York Times, Gretchen Morgenson, did a fine job of exposing the shortcomings destined for inclusion in this lame bill:

Unfortunately, the leading proposals would do little to cure the epidemic unleashed on American taxpayers by the lords of finance and their bailout partners. The central problem is that neither the Senate nor House bills would chop down big banks to a more manageable and less threatening size. The bills also don’t eliminate the prospect of future bailouts of interconnected and powerful companies.

Too big to fail is alive and well, alas. Indeed, several aspects of the legislative proposals sanction and codify the special status conferred on institutions that are seen as systemically important. Instead of reducing the number of behemoth firms assigned this special status, the bills would encourage smaller companies to grow large and dangerous so that they, too, could have a seat at the bailout buffet.

* * *

It is disappointing that none of the current proposals call for breaking up institutions that are now too big or on their way there. Such is the view of Richard W. Fisher, president of the Federal Reserve Bank of Dallas.

“The social costs associated with these big financial institutions are much greater than any benefits they may provide,” Mr. Fisher said in an interview last week. “We need to find some international convention to limit their size.”

* * *

Edward Kane, a finance professor at Boston College and an authority on financial institutions and regulators, said that it was not surprising that substantive changes for both groups are not on the table. After all, powerful banks want to maintain their ability to privatize gains and socialize losses.

“To understand why defects in in solvency detection and resolution persist, analysts must acknowledge that large financial institutions invest in building and exercising political clout,” Mr.Kane writes in an article, titled “Defining and Controlling Systemic Risk,” that he is scheduled to present next month at a Federal Reserve conference.

But regulators, eager to avoid being blamed for missteps in oversight, also have an interest in the status quo, Mr. Kane argues. “As in a long-running poker game in which one player (here, the taxpayer) is a perennial and relatively clueless loser,” he writes, “other players see little reason to disturb the equilibrium.”

At Forbes, Robert Lenzner focused on the human failings responsible for the bad behavior of the big banks with his emphasis on the notion that “a fish stinks from the head”:

No well-intentioned reform bill that will pass Congress can prevent the mind-blowing stupidity, hubris and denial utilized by the big fish of Wall Street from stinking from the head.

* * *

Transparency won’t help if the Obama plan does not absolutely require all derivatives to be registered at the Securities and Exchange Commission. It’s an invitation for abuse as five major market making banks like JPMorgan Chase account for 95% of all derivatives transactions and a very large share of their profits. We haven’t seen evidence that they police themselves satisfactorily.

Derivatives expert Janet Tavakoli recently expressed her disgust over the disingenuousness of the current version of this legislation:

Our proposed “financial reform” bill is a sham, and the health of our society and our economy is at stake.

Ms. Tavakoli referred to the recent Huffington Post article by Dan Froomkin, which highlighted the criticism of the financial reform legislation provided by Professor William Black (the former prosecutor from the Savings and Loan crisis, whose execution was called for by Charles Keating). Froomkin embraced the logic of economist James Galbraith, who emphasized that rather than relying on the expertise of economists to shape financial reform, we should be looking to the assistance of criminologists. William Black reinforced this idea:

Criminologists, Black said, are trained to identify the environments that produce epidemics of fraud — and in the case of the financial crisis, the culprit is obvious.

“We’re looking at incentive structures,” he told HuffPost. “Not people suddenly becoming evil. Not people suddenly becoming crazy. But people reacting to perverse incentive structures.”

CEOs can’t send out a memo telling their front-line professionals to commit fraud, “but you can send the same message with your compensations system, and you can do it without going to jail,” Black said.

Criminologists ask “fundamentally different types of question” than the ones being asked.

Back at The New York Times, Frank Rich provided us with a rare example of mainstream media outrage over the lack of interest in prosecuting the fraudsters responsible for the financial disaster that put eight million people out of work:

That no one at Lehman Brothers has yet been held liable for its Enronesque bookkeeping deceit is appalling. That we still haven’t seen the e-mail and documents that would illuminate A.I.G.’s machinations with Goldman and the rest of its counterparties amounts to a cover-up. That investigative journalists have consistently been way ahead of the authorities, the S.E.C. included, in uncovering Wall Street’s foul play is a scandal. If this culture remains in place, the whole crisis will have gone to waste.

Unfortunately, the likelihood that any significant financial reform will be enacted as a result of the financial crisis is about the same as the likelihood that we will see anyone doing a “perp walk” for the fraudulent behavior that caused the meltdown. Don’t expect serious reform and don’t expect justice.

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Unrealistic Expectations

April 22nd, 2010 Posted in Uncategorized

Apr, 22 2010

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April 22, 2010

Newsweek’s Daniel Gross is back at it again. His cover story for Newsweek’s April 9 issue is another attempt to make a preemptive strike at writing history. You may remember his cover story for the magazine’s July 25 issue, entitled: “The Recession Is Over”. During the eight months since the publication of that article, the sober-minded National Bureau of Economic Research, or NBER — which is charged with making the determination that a recession has ended – has yet to make such a proclamation.

The most recent cover story by Daniel Gross, “The Comeback Country” has drawn plenty of criticism. (The magazine cover used the headline “America’s Back” to introduce the piece.) At The Huffington Post, Dan Dorfman discussed the article with Olivier Garret, the CEO of Casey Research, an economic and investment consulting firm. Garret described the Newsweek cover story as “fantasy journalism” and he shared a number of observations with Dan Dorfman:

“You know when a magazine like Newsweek touts a bullish economic recovery on its cover, just the opposite is likely to be the case,” he says. “It sees superficial signs of improvement, but it’s ignoring the big picture.”

* * *

Meanwhile, Garret sees additional signs of economic anguish. Among them: More foreclosures and delinquencies of real estate properties will plague construction spending; banks haven’t yet cleaned up their balance sheets; private debt is no longer going down as it did in 2009; both short and long term rates should be headed higher, and many companies, he says, tell him they’re reluctant to invest and hire.

He also sees some major corporate bankruptcies, worries about the country’s ability to repay its debt, looks for rising cost of capital, which should further slow the economy, and expects a spreading sovereign debt crisis.

* * *

Many economists are projecting GDP growth in the range of 3% to 4% in the first quarter and similar growth for the entire year. Much too optimistic, Garret tells me. His outlook (which would clobber the stock market if he’s right): up 0.4%-0.5% in the first quarter after revisions and between 0% and 1% for all of 2010.

“Fantasy economies only work in the mind, not in real life,” he says.

Given his bleak economic outlook, Garret expects a major market adjustment, say about a 10% to 20% decline in stock prices over the next six months. He figures it could be triggered by one event, such as as an extension of the sovereign debt crisis.

David Cottle of The Wall Street Journal had this reaction to the Newsweek article:

Therefore, when you see a cover such as Newsweek’s recent effort, yelling “America’s Back” in no uncertain terms, it’s quite tempting to stock up on bonds, cash, tinned goods and ammunition.

Now, in fairness to the author, Daniel Goss, he makes the good point that the U.S. economy is growing at a clip that has consistently surprised gloomy forecasters. It is. The turnaround we’ve seen since Lehman Brothers imploded has been remarkable, if not entirely satisfying, he says, and he is quite right. At the very least, U.S. growth is all-too-predictably leaving the European version in the dust. Goss is also pretty upfront about the corners of the U.S. economy that have so far failed to keep up: job creation and the housing market being the most obvious.

However, the problem with all these ‘back to normal’ pieces, and Goss’s is only one of many creeping out as the sky resolutely fails to fall in, is that the ‘normal’ they want to go back to was, in reality, anything but.

The financial sector remains unreformed, the global economy remains dangerously unbalanced. The perilous highways that brought us to 2007 have not been sealed off in favor of straighter, if slower, roads. Of course it would be great for us all if America were ‘back’ and so we must hope Newsweek’s cover doesn’t join the ranks of those which cruel history renders unintentionally hilarious .

But back where? That’s the real question.

Meanwhile, the Pew Research Center has turned to Americans themselves to find out just how “back” America really is. This report from April 20 didn’t seem to resonate so well with the rosy picture painted by Daniel Gross:

Americans are united in the belief that the economy is in bad shape (92% give it a negative rating), and for many the repercussions are hitting close to home. Fully 70% of Americans say they have faced one or more job or financial-related problems in the past year, up from 59% in February 2009. Jobs have become difficult to find in local communities for 85% of Americans. A majority now says that someone in their household has been without a job or looking for work (54%); just 39% said this in February 2009. Only a quarter reports receiving a pay raise or a better job in the past year (24%), while almost an equal number say they have been laid off or lost a job (21%).

As economic conditions continue to deteriorate for middle-class Americans, the first few months of 2009 are already looking like “the good old days”. The “comeback” isn’t looking too good.

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The Goldman Fallout

April 19th, 2010 Posted in Uncategorized

Apr, 19 2010

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April 19, 2010

In the aftermath of the disclosure concerning the Securities and Exchange Commission’s fraud suit against Goldman Sachs, we have heard more than a little reverberation of Matt Taibbi’s “vampire squid” metaphor, along with plenty of concern about which other firms might find themselves in the SEC’s crosshairs.

As Jonathan Weil explained for Bloomberg News :

As Wall Street bombshells go, the lawsuit that the Securities and Exchange Commission filed against Goldman Sachs Group Inc. is about as big as it gets.

At The Economist, there was a detectable scent of schadenfreude in the discussion, which reminded readers that despite Lloyd Blankfein’s boast of having repaid Goldman’s share of the TARP bailout, not everyone has overlooked Maiden Lane III:

IS THE most powerful and controversial firm on Wall Street about to get the comeuppance that so many think it deserves?

* * *

The charges could hardly come at a worse time for Goldman. The firm has been under fire on a number of fronts, including over the handsome payout it secured from the New York Fed as a derivatives counterparty of American International Group, an insurer that almost failed in 2008. In a string of negative articles over the past year, Goldman has been accused of everything from double-dealing for its own advantage to planting its own people in the Treasury and other agencies to ensure that its interests were looked after.

At this point, those who criticized Matt Taibbi for his tour de force against Goldman (such as Megan McArdle) must be experiencing a bit of remorse. Meanwhile, those of us who wrote items appearing at GoldmanSachs666.com are exercising our bragging rights.

The complaint filed against Goldman by the SEC finally put to rest the tired old lie that nobody saw the financial crisis coming. The e-mails from Goldman VP, Fabrice Tourre, made it perfectly clear that in addition to being aware of the imminent collapse, some Wall Street insiders were actually counting on it. Jonathan Weil’s Bloomberg article provided us with the translated missives from Mr. Tourre:

“More and more leverage in the system. The whole building is about to collapse anytime now,” Fabrice Tourre, the Goldman Sachs vice president who was sued for his role in putting together the deal, wrote on Jan. 23, 2007.

“Only potential survivor, the fabulous Fab … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”

A few weeks later, Tourre, now 31, e-mailed a top Goldman trader: “the cdo biz is dead we don’t have a lot of time left.” Goldman closed the Abacus offering in April 2007.

Michael Shedlock (a/k/a Mish) has quoted a number of sources reporting that Goldman may soon find itself defending similar suits in Germany and the UK.

Not surprisingly, there is mounting concern over the possibility that other investment firms could find themselves defending similar actions by the SEC. As Anusha Shrivastava reported for The Wall Street Journal, the action in the credit markets on Friday revealed widespread apprehension that other firms could face similar exposure:

Credit markets were shaken Friday by the news as investors tried to figure out whether other firms or other structured finance products will be affected.

Investors are concerned that the SEC’s action may create a domino effect affecting other firms and other structured finance products. There’s also the worry that this regulatory move may rattle the recovery and bring uncertainty back to the market.

“Credit markets are seeing a sizeable impact from the Goldman news,” said Bill Larkin, a portfolio manager at Cabot Money Management, in Salem, Mass. “The question is, has the S.E.C. discovered what may have been a common practice across the industry? Is this the tip of the iceberg?”

* * *

The SEC’s move marks “an escalation in the battle to expose conflicts of interest on Wall Street,” said Chris Whalen of Institutional Risk Analytics in a note to clients. “Once upon a time, Wall Street firms protected clients and observed suitability … This litigation exposes the cynical, savage culture of Wall Street that allows a dealer to commit fraud on one customer to benefit another.”

The timing of this suit could not have been better – with the Senate about to consider what (if anything) it will do with financial reform legislation. Bill Black expects that this scandal will provide the necessary boost to get financial reform enacted into law. I hope he’s right.

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Financial Crisis Inquiry Disappointment

April 15th, 2010 Posted in Uncategorized

Apr, 15 2010

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April 15, 2010

The Financial Crisis Inquiry Commission (FCIC) has been widely criticized for its lame efforts at investigating the causes of the financial crisis. As I pointed out on January 11, a number of commentators had been expressing doubt concerning what the FCIC could accomplish before the commission held its first hearing. At this point — just three months later — we are already hearing the question of whether it might be “time to pull the plug on the FCIC”. Writing for the Center for Media and Democracy’s PRWatch.org website, Mary Bottari posed that question as the title to her critical piece, documenting the commission’s “lackluster performance”:

The FCIC is a 10-person panel assembled to report on the meltdown to President Obama later this year. The New York Times reported last week what was becoming increasingly obvious: the commission was in shambles. The commission waited eight months before having its first hearing. A top investigator resigned due to delays in hiring staff, no subpoenas have been issued and partisan infighting means few new documents have been released that would aid reporters in piecing together the crime scene, even if FCIC investigators are not up to the task. Worse, it seems like the majority of staff have been borrowed from the complicit Federal Reserve.

These problems were on full display in last week’s hearings. The three days of hearings were marked by some heat, but little light.

The FCIC’s failure to issue any subpoenas became a major point of criticism by Eliot Spitzer, who had this to say in a recent posting for Slate :

The Financial Crisis Inquiry Commission has so far been a waste. Some momentary theater has been provided by the witnesses who have tried to excuse, explain, or occasionally admit their role in the cataclysm of the past two years. While this has ginned up some additional public outrage, it hasn’t deepened our knowledge about what critical players knew or did. There is a simple reason for this: The commission has not issued a single subpoena. Any investigator will tell you that you must get the documentary evidence before you examine the witnesses. The evidence is waiting to be seized from the Fed, AIG, Goldman Sachs, and on down the line. Yet not one subpoena.

Rather than accept Robert Rubin’s simple disclaimers about Citigroup, why hasn’t the FCIC combed through the actual communications among the board, the executive committee, the audit committee, and the risk-management committee? Why hasn’t the FCIC collected AIG’s e-mails with the Fed and Goldman Sachs? Unless the subpoenas are issued, we will lose the chance to make the record.

As Binyamin Appelbaum pointed out in The Washington Post back on January 8, if a financial reform bill is eventually passed, it will likely be signed into law before the mid-term elections in November – one month before the FCIC is required to publish its findings. As a result, there is a serious question as to whether the commission’s efforts will contribute anything to financial reform legislation. Given the FCIC’s unwillingness to exercise its subpoena power, we are faced with the question of why the commission should even bother wasting its time and the taxpayers’ money on an irrelevant, ineffective exercise.

Although Mary Bottari’s essay discussed the possibility that the FCIC might still “get its act together”, the cynicism expressed by Eliot Spitzer provided a much more realistic assessment of the situation:

Americans have been betrayed by Washington over financial reform. Our leaders have failed to get the evidence, failed to push back when clearly inadequate explanations were provided, and failed to explore the structural reforms that will work. Pretend tears will drip from bankers’ eyes after the consumer protection agency is created. Then their wolfish teeth will slowly break into a grin, the pure delight that Washington has failed to do anything meaningful to restructure the banking sector.

Just when it was beginning to appear as though we might actually see some meaningful financial reform find its way into law, we have been reminded that Washington has its own ways – which benefit the American public only by rare coincidence.

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Financial Reform Might Actually Happen

April 12th, 2010 Posted in Uncategorized

Apr, 12 2010

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April 12, 2010

The long-overdue need for financial reform is finally getting some serious attention in Washington. As banking lobbyists continue to grease palms in the Senate, we are beginning to hear a number of novel ideas from some clever commentators, focused on preventing another financial crisis.

On April 9, John Mauldin published a thought-provoking essay entitled, “Reform We Can Believe In”. At one point in the piece, Mauldin considered the question that has been hanging over our heads for the past eighteen months:

What happens if we do nothing?

What happens when we have the next credit crisis, when a major sovereign government defaults, as I think will happen? It will be a body blow to many banks, especially in Europe. Once again, we could have banks worried about lending to each other or taking letters of credit, which would be a disaster for world trade and the recovery we are now in.

That we (and Europe and Britain) have taken so long to enact real reform has the potential to really put the world at risk. In the next crisis, we will not have the tools available to stem the tide that we did the last time. Rates are already low. Do you think we could pass another TARP? The Fed’s balance sheet is already bloated. It could get much worse unless we get financial reforms that have some bite.

All this debating about a consumer protection agency and where it should be and all the other trivia is wasting time. Fix the big things. Credit default swaps. Too big to fail. Leverage. Then worry about the details.

Although I left out Mauldin’s suggestion to “leave the Fed alone” from that last paragraph, his essay contains a fantastic explanation of how the Federal Reserve System is organized. Best of all, Mauldin spent plenty of time reflecting on Milton Friedman’s suggestion that we program a computer to set monetary policy, instead of leaving that authority with the Fed:

Let me be clear. There are a lot of things not to like about the Federal Reserve System. I think it was Milton Friedman who said we would be better off with a computer determining monetary policy. A quote from an interview with him is instructive. When asked “Do you still think it would be a good idea to have a computer run monetary policy?” he answered:

“Yes. Of course it depends very much on how the computer is programmed. I am not saying that any computer program would do. In speaking of that, I have had in mind the idea that a computer would produce, for example, a constant rate of growth in the quantity of money as defined, let us say, by M2, something like 3% to 5% per year. There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare.

“In any event, the computer program would certainly prevent any major disasters either way, any major inflation or any major depressions. One of the great defects of our kind of monetary system is that its performance depends so much on the quality of the people who are put in charge. We have seen that in the history of our own Federal Reserve System.

Another perspective on financial reform came from Jim McTague in the April 12 edition of Barron’s. He began with the remark that both the House and Senate reform bills lack adequate measures for “efficient and intelligent policing”. Nevertheless, the solution he embraced was simple:

The aptly named Richard Vigilante, who recently co-wrote a book called Panic with Minneapolis-based hedge-fund legend Andrew Redleaf, suggests this approach: Force all firms managing other people’s money to publish their investment positions in detail before the market opens; this would include hedge funds. Then, the short sellers could punish ineptness before it spreads by betting heavily against a particular institution’s stupid decisions.

“Bankers would hate it. It’s their worst nightmare,” says Vigilante, whom I met with at Firehook bakery on Washington’s Farragut Square. If the system had been in place in 2006, short sellers would have stamped out the smoldering subprime mania before it had a chance to spread, he asserts.

His suggestion is both brilliant and a model of simplicity — it could protect consumers against all kinds of risky financial products — but it will never become reality.

Bankers would scream about the need to protect their proprietary-trading information. And, as was the case with health-insurance “reform,” Congress is bent on ramming a bill, no matter how flawed, through the legislative sausage works in order to mollify an uncommonly angry electorate before Nov. 2. To entertain new ideas at this juncture, even good ones, would upset the ambitious timetable.

Like health care, the new financial regulatory regime is built atop the cracked masonry of the old one. The same flatfoots who were on patrol when the subprime caper went down will be given larger beats to walk. They will be overseen by a brain trust, a Council of Regulators, culled from their ranks, who, like chemical sniffers, would seek to uncover systemic threats to the volatile financial system. In fact, COR is the core of the whole scheme.

The proposal for a Council of Regulators has drawn a good deal of criticism, primarily because it would be chaired by the Treasury Secretary. Matthew Bishop and Michael Green, authors of The Road From Ruin, had this to say about a Council of Regulators in a recent Huffington Post piece:

Indeed, with the Treasury Secretary in the chair, would this council really face down the political leaders and try to stop an emerging bubble spreading a feelgood factor across the nation (as bubbles do, before they burst)? Even in his pomp Alan Greenspan knew that a Fed chairman couldn’t risk being too gloomy about the economy and keep his job. What chance then of a Treasury Secretary, a cabinet member, being so bold?

Rather than another layer on top of the dysfunctional existing regulatory system, America needs to sweep away its absurd proliferation of regulators and replace them with a powerful super regulator, independent of day-to-day politics and empowered to do the job properly.

Regardless of what the final product will include – one thing is becoming increasingly likely: Some semblance of financial reform legislation will eventually become enacted. It won’t be perfect but anything will be better than what we have now. (Well, almost anything . . .)

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Getting It Reich

April 8th, 2010 Posted in Uncategorized

Apr, 08 2010

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April 8, 2010

Robert Reich, former Secretary of Labor under President Clinton, has been hitting more than a few home runs lately. At a time when too many commentators remain in lock-step with their favorite political party, Reich pulls no punches when pointing out the flaws in the Obama administration’s agenda. I particularly enjoyed his reaction to the performance of Larry Summers on ABC television’s This Week on April 4:

I’m in the “green room” at ABC News, waiting to join a roundtable panel discussion on ABC’s weekly Sunday news program, This Week.

*   *   *

Larry Summers was interviewed just before Greenspan. He said the economy is expanding, that the Administration is doing everything it can to bring jobs back, and that the regulatory reform bills moving on the Hill will prevent another financial crisis.

What?

*   *   *

If any three people are most responsible for the failure of financial regulation, they are Greenspan, Larry Summers, and my former colleague, Bob Rubin.

*   *   *

I dislike singling out individuals for blame or praise in a political system as complex as that of the United States but I worry the nation is not on the right economic road, and that these individuals — one of whom advises the President directly and the others who continue to exert substantial influence among policy makers — still don’t get it.

The direction financial reform is taking is not encouraging. Both the bill that emerged from the House and the one emerging from the Senate are filled with loopholes that continue to allow reckless trading of derivatives. Neither bill adequately prevents banks from becoming insolvent because of their reckless trades. Neither limits the size of banks or busts up the big ones. Neither resurrects the Glass-Steagall Act. Neither adequately regulates hedge funds.

More fundamentally, neither bill begins to rectify the basic distortion in the national economy whose rewards and incentives are grotesquely tipped toward Wall Street and financial entrepreneurialism, and away from Main Street and real entrepreneurialism.

Is it because our elected officials just don’t understand what needs to be done to prevent another repeat of the financial crisis – or is the unwillingness to take preventative action the result of pressure from lobbyists? I think they’re just playing dumb while they line their pockets with all of that legalized graft. Meanwhile, Professor Reich continued to function as the only adult in the room, with this follow-up piece:

Needless to say, the danger of an even bigger cost in coming years continues to grow because we still don’t have a new law to prevent what happened from happening again. In fact, now that they know for sure they’ll be bailed out, Wall Street banks – and those who lend to them or invest in them – have every incentive to take even bigger risks. In effect, taxpayers are implicitly subsidizing them to do so.

* * *

But the only way to make sure no bank it too big to fail is to make sure no bank is too big. If Congress and the White House fail to do this, you have every reason to believe it’s because Wall Street has paid them not to.

Reich’s recent criticism of the Federal Reserve was another sorely-needed antidote to Ben Bernanke’s recent rise to media-designated sainthood. In an essay quoting Republican Senator Jim DeMint of South Carolina, Reich transcended the polarized political climate to focus on the fact that the mysterious Fed enjoys inappropriate authority:

The Fed has finally came clean. It now admits it bailed out Bear Stearns – taking on tens of billions of dollars of the bank’s bad loans – in order to smooth Bear Stearns’ takeover by JP Morgan Chase. The secret Fed bailout came months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, even months before Lehman Brothers collapsed. The Fed also took on billions of dollars worth of AIG securities, also before the official government-sanctioned bailout.

The losses from those deals still total tens of billions, and taxpayers are ultimately on the hook. But the public never knew. There was no congressional oversight. It was all done behind closed doors. And the New York Fed – then run by Tim Geithner – was very much in the center of the action.

* * *

The Fed has a big problem. It acts in secret. That makes it an odd duck in a democracy. As long as it’s merely setting interest rates, its secrecy and political independence can be justified. But once it departs from that role and begins putting billions of dollars of taxpayer money at risk — choosing winners and losers in the capitalist system — its legitimacy is questionable.

You probably thought that Ron Paul was the only one who spoke that way about the Federal Reserve. Fortunately, when people such as Robert Reich speak out concerning the huge economic and financial dysfunction afflicting America, there is a greater likelihood that those with the authority to implement the necessary reforms will do the right thing. We can only hope.

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Still Wrong After All These Years

The Poisonous Bailout

Doctor Doom Writes A Prescription

Too Cute By Half

Failed Financial Reform And Failed Justice

Unrealistic Expectations

The Goldman Fallout

Financial Crisis Inquiry Disappointment

Financial Reform Might Actually Happen

Getting It Reich

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