Tuesday, June 30, 2009

Austria: First To Go- Again?

First Blood In Austrian Banking Apocalypse: Raiffeisen Withdraws "Capital Note" Offer
Or, Austria Once Again To Introduce The Great Depression!?!

By The Prudent Investor | 30 June 2009

[I have] had very serious thoughts about the gargantuan problems of tiny Austria's banking sector stemming from [its financial community's] overly euphoric attempts to 'recolonize' Austria's long gone empire [during the recently ended go-go-go years]. Since the end of 2007 bits and pieces of information began to confirm this blogger's suspicions that Austria will be really, really hard hit.

I am [now able to] provide specifics thanks to Zero Hedge's blogs providing references to [published] documents issued by Raiffeisen Zentralbank group. Here we go with a story that could not only happen in Austria but in every country with a small banking industry where everyone knows everybody else and compliance regulations are only valid during sparse official business hours from 8 AM to 3 PM. [[e.g., Iceland? See Frozen Assets: Those Poor Vikings!?!: normxxx]]

Zerohedge, a shooting star in the global blogosphere with millions of hits, first raised my attention last week when it published the prospectus for an exchange offer where RZB group offered to exchange its "€500 million non-cumulative subordinated perpetual callable step-up fixed to floating rate capital notes"in short— 'unsecured crap'— against some other unsecured crap called "non-cumulative subordinated perpetual callable fixed to floating rate capital notes" at 55 cents on the Euro. This 45% haircut was sexed up with a 15% coupon (coupon of old notes was 5.69%), but when one reads the fine print it sounded more like a pretty weak promise, as the fine print says RZB group has to pay that high coupon only if "it has enough resources to do so".

OMG, why don't we just go to the horse races straight away? The new notes were to be issued by RZB Finance (Jersey) IV limited, which is a 100% indirectly owned subsidiary of Raiffeisen Zentralbank AG (RZB) via Raiffeisen Malta Bank— also not exactly a plush bank— with €2,000 paid-up capital. A 'perpetual' note is an investment vehicle that never has to be redeemed by the issuer and therefore can only be resold in secondary markets— if bids exist for it.

RZB Jersey IV Ltd. has a paid up share capital of €2,000 and is 100% owned by Raiffeisen Malta bank, which also negatively stars with a paid-up share capital of €2,000. RZB Jersey's sole business is to raise hybrid capital for its parent RZB. Read all the details in the prospectus over at Zerohedge. Both companies losses in a total default of the new issue "worth" €275 million would be limited to that total €4,000 as much as I understand the complex web of finances.

So much about the recent past of this issue which had been made public on June 18. (Find all the details of the proposed exchange offer over at Tyler Durden's Zerohedge blog.) From here the story gets really hairy.

RZB issued a release on Monday, June 29, saying that it withdrew the offer for the exchange of the old into new "capital" (haha) notes. Having stored this release on my computer I first want to offer Zerohedge's suspicions why the issue was withdrawn.
  • Complete lack of investor interest

  • Concerns about what would happen once this lack of interest becomes public

  • Trouble with accountants

  • Rating agency getting back to the bank that this would be treated as a distressed exchange (as Zero Hedge speculated), putting the company into an 'Event of Default'.

But Tyler would not be Tyler if he did not also have some other possibilities for the withdrawal on his mind:

"Then again, the real reason is probably much more innocuous, and has to do with the bank discovering a buried gold treasure in its back yard which will be used to satisfy the several hundred billion in toxic assets as a result of chicken coups built in Transylvania at a 180% LTV (in probably a JV with GE Capital)"

There is nothing to add. Austria's [[entire?: normxxx]] banking sector is up to its ears in you know what, despite officials (worried about their pensions) saying otherwise.

For more about Austria's big role in the demise of Central Eastern Europe, financed with the money of depositors at those Austrian banks click on "Austria" e.g., to find more information and background about the possibility that Austria, not long ago considered the 6th richest country in the world, is in a good position to be the first Eurozone member that has to default. For more background— why every Austrian from baby to octogenarian— may be liable for up to €19,600 per capita thanks to bankers who saw only bonuses and nothing else— like, maybe, responsibility— read this post.

[ Normxxx Here:  Sounds like piffle compared with what our U.S. 'big' banks have committed us to! Good thing that all we have to do is print more dollars!  ]

Find all the details of the proposed exchange offer over at Tyler Durden's Zerohedge blog.

See also crisis

Thursday, June 25, 2009

In 'Foreclosure Limbo'

Not Paying The Mortgage, Yet Stuck With The Keys
Foreclosure Backlog Imperils Recovery

By Renae Merle, WP | 29 June 2009

A growing number of American homeowners are falling into financial limbo: They're badly behind on payments, but their banks have not yet foreclosed. The backlog of seriously delinquent mortgages, which so far affects about 1 million borrowers, is a shadow over hopes for a rebound in the nation's housing markets. It masks the full extent of the foreclosure crisis and threatens to depress prices even further just as some parts of the country are hinting at recovery. For lenders, it could portend even more financial losses tied to the mortgage meltdown.

"It just means foreclosure rates are going to keep rising," said Patrick Newport, an economist for IHS Global Insight. Rising mortgage delinquencies were at the root of the recession, and many economists say an economic recovery will be difficult until the housing market recovers and home prices stabilize. And even though a delayed foreclosure can be a blessing for some troubled homeowners, for others, it simply prolongs the financial distress, leaving them on the hook for the condition of the property. Even if they move out, they cannot move on.

"I have even begged them for a foreclosure," delinquent mortgage-holder Charlotte Jensen said. When she realized she couldn't save her Glen Allen home last year, she filed for bankruptcy, packed up her family and moved out. Nearly a year later, Bank of America has yet to take back the home.

During the first quarter of this year, the share of all homeowners seriously delinquent on their mortgage but not yet facing foreclosure more than doubled to 3.04 percent, or about $227 billion in loans. There was a total of $97 billion in such loans during the same period in 2008, according to Inside Mortgage Finance. In more prosperous times, the rate is much lower— it was less than 1 percent in the first quarter of 2007, according to the industry publication.

Some of the backlog reflects the inability of lenders to keep up with the swelling rolls of delinquent properties. "Lenders are having an immensely difficult time handling the capacity. They are torn between loan modification, short sales, foreclosures, and they are finding they can't do all these things at once, and do them well, so we're seeing a lot of things falling through the cracks," said Howard Glaser, a housing industry consultant and a housing official during the Clinton administration.

But some of the backlog also reflects an intentional slowdown in the pace of foreclosures as government and industry step up efforts to help borrowers who want to save their homes. Fannie Mae and Freddie Mac, the government-run mortgage financing companies, put a temporary moratorium on foreclosures late last year and many of the country's largest lenders followed suit. That gave some lenders more time to determine which borrowers could benefit from government help.

The glut of foreclosed homes on the market has already pushed down prices across the country. Existing-home prices fell another 16.8 percent in May compared with a year ago, according to industry data released yesterday. The overhang of homes in limbo means that foreclosure rates are likely to increase dramatically during the second half of this year and into 2010 as lenders work through the backlog, said Bob Bellack, chairman of Zetabid, which auctions foreclosed properties.

"Prices will fall to the point where you have equilibrium, and it won't reach that until there is no longer this foreclosure overhang," Bellack said. This could in turn put renewed stress on financial firms that carry mortgages or mortgage-backed securities on their books. As a general policy, many firms have been marking down the value of those assets as the loans become delinquent. But once the homes go into foreclosure and are sold, their value could decline even more, prompting another round of losses at financial companies.

For some homeowners, the foreclosure delays have provided needed breathing room to try to save their home, giving them a chance to live for free for a while or to work out a deal to save their property. "I think everyone has come to a realization that efforts to try to mediate are preferable to foreclosure right now," said David Berenbaum, executive vice president of the National Community Reinvestment Coalition, a nonprofit group.

But housing experts say that once borrowers are seriously delinquent— defined as 90 days overdue on a mortgage— some are too far behind to help or have already given up. According to a March report from NeighborWorks America, a large housing counseling group, 27 percent of homeowners who go to a housing counselor after missing three or four monthly payments end up in foreclosure. That figure jumps to 60 percent for those who have missed more than four payments before seeking help.

In better times, lenders tended to begin the foreclosure process after three months, said Guy Cecala, publisher of Inside Mortgage Finance. Now it is not unusual for it to take nine months for the process to begin, he said. "No one is in a rush, lender-wise, to deal with the property," he said. "If you have to sell at a loss, why rush?"

Lenders traditionally write down the value of the home six months after an owner stops making payments, but the total loss is not recorded until the property is sold in foreclosure, said Mark Zandi, chief economist of Moody's Economy.com. "Some may feel that the property is worth more than the market can bear at this time, and they are willing to wait until" the market improves, he said. "They don't want to sell it into a completely depressed market."

Once underway, the foreclosure process is governed by a hodgepodge of state and local laws and the time it takes to get through the process varies by place. The process can also vary based on the original lender, on the current owner of the loan and on whether the borrower has filed for bankruptcy. During the period that precedes final foreclosure, homeowners still have the legal obligations that come with ownership. Though in practice many borrowers who have stopped making mortgage payments may do little to look after a home.

"During that period, where the property is in limbo, until there has been a sale of the property, the homeowner is still the owner, technically," said John Rao of the National Consumer Law Center. "It used to be that they wanted to foreclose as quickly as possible. … [Now] it's like this [is a] hot potato that nobody wants". Even seriously delinquent borrowers can restart negotiations with lenders to stay in their homes with a modified mortgage or persuade them to accept a short sale, which involves a homeowner selling the property for less than the outstanding mortgage balance and then turning the proceeds over to the lender to satisfy the loan.

Jay Brinkmann, chief economist for the Mortgage Bankers Association, said his industry is doing its best to work through the backlog while carrying out federal foreclosure prevention programs. "If a lender has a house that they know they will have to sell eventually," he said, "they almost always want to sell it as quickly as possible because of the interest cost of holding the loan on the books, in addition to costs like taxes, keeping the grass cut and other maintenance". But, more than ever, foreclosure has become an unattractive outcome for lenders.

"What we're seeing more and more right now are cases of a lender threatening foreclosure and the foreclosure sale is canceled at the last minute," said Jeanne Hovenden, a Richmond bankruptcy attorney, who handled Jensen's case. "It's more like the lenders don't want to own any more real estate and are using foreclosures as a pressure tactic". The Jensens bought their home in 1999 and were able to make their payments comfortably until refinancing. Since moving out last July, they have not received a foreclosure sale notice even after hiring an attorney to encourage Bank of America to speed up the process.

Jensen visits her home weekly to ensure it hasn't been vandalized or taken over by squatters. She pays landscapers to keep the lawn mowed. When the home caught fire in January, the police department knocked on the door of her new home, confused about whether to notify her or the bank. When neighbors complained about the mess left from the fire, Jensen returned to clean up.

A Bank of America spokeswoman, Jumana Bauwens, said the delay was caused, in part, by the fire. She said the home has since been referred to foreclosure. "The company makes every attempt to find a home retention solution for a borrower before proceeding with a foreclosure," she said.

For the Jensens, the delay has extended a painful period. "There was a sense of responsibility that until someone says we no longer own that property, we wanted to make sure it's handed off correctly," Jensen said. "We could have walked away like everyone else and said, 'We don't care.' But we loved our neighbors and our neighborhood. We hold ourselves responsible."

Wednesday, June 24, 2009

Just 5 ETFs… !?!

ETF Expert: Just 5 ETFs… And You're Set?
Buy-N-Hold Silliness Still Carries On…

By Gary Gordon | 22 June 2009

You'd have thought that the 2000-2002 bear that ravaged portfolios in the first half of the decade would have stifled buy-n-hold, asset allocation forever advocates. Alas… "simpleton" journalists and "commission-based, keep-your-assets" advisers continued to push the ridiculous notion that you refrain from selling. Certainly, the 2008-2009 bear that dehumanized investors must have put an end to the silliness, right? After all, assets from stocks to bonds to commodities to real estate demonstrated that buying-n-holding any investment type is far too risky; plainly speaking (writing), there isn't a magical asset allocation percentage that diversifies a portfolio away from life-changing losses.

It's pretty surprising, then, that:
(1) Bogle of Vanguard fame,
(2) "defrocked-a-decade-ago" Motley Fool and,
(3) Money Magazine

…have each thrown their respective fishing lines directly into the winds of change. It's surprising because more successful marketing machines began changing their tunes a long time ago. Think Suze Orman… a reformed buy-n-holder.

Bogle, founder of Vanguard, has raged against the ETF machine for nearly 10 years because ETFs seemed to be challenging Vanguard's indexing dominance. Of course, Vanguard was smart enough to develop 40+ ETFs of their own, ignoring the founder's disdain and cementing their place as one of the top financial institutions. Keep in mind, just because ETFs are tradeable like individual securities, an indexer can still choose to be a passive buy-n-hold, one-time asset allocator. ETFs just make it easier for an investor to buy or sell at a price point that one desires… something Bogle thinks leads investors to make poor "timing" decisions.

(Note: Ask any Vanguard 401k investor how happy they were to have restrictions and penalties for leaving or entering mutual funds. The disincentive, as well as the public pressure to "hang in there," caused millions of people to lose half of their retirement savings! Say "No" to ETFs, Mr. Bogle… really?)

The idea that any financial institution knows what's better for the "average" investor such that it artificially restricts trading activity, something that Bogle thinks is a 'good' thing, is intrusive, oppressive and insulting. What happened to freedom of choice? If an ETF investor wishes to hold on, he/she can. If an exchange-traded index fund investor wishes to sell, he/she should have that ability— and not be penalized!)

Not everyone is against ETFs anymore. Yet I find it ironic that the kings of 'foolish buy-n-holding' of individual stocks, the Motley Fool, who softened their tone after the 2000-2002 bear market ruined their reputation, are now talking up ETFs.

Here in 2009, they've put forth the "only" ETFs you will ever need:
  • SPDR Trust (SPY)

  • Vanguard Small Cap (VB)

  • iShares MSCI EAFE Index (EFA)

  • Vanguard Emerging Markets (VWO)

  • iShares Barclays Aggregate Bond (AGG)
So this covers the investment universe, does it? Any asset allocation for any risk level, the folks at Motley Fool claim.

An "all-in-one" aggregate bond fund that is effectively dependent on intermediate U.S. treasuries flies in the face of scores of important bond and income possibilities. Where to begin? Short, medium, corporate bonds diversify in the way that small cap stocks diversify from large-cap stocks alone. Munis, inflation-protected, foreign bonds, emerging market bonds, and yes… high quality mortgage backed. How can the world of bond investing be minimized to AGG… albeit, an excellent core holding?

Do I even need to go further with the income that's not presented above? I guess there's no need for domestic REITs or foreign REITs. Perhaps we can forget about the buy-write option income approach. Preferreds? Convertibles? Why… they must be a waste, according to Motley Fool "journalist/investors".

As for stocks, I am a big fan of Vanguard Emerging Markets (VWO). Yet to minimize the importance of China and Brazil is ludicrous. And to minimize the criticality of small-cap funds like China Small Cap (HAO) and Brazil Small Cap (BRF) is near-sighted at best. At the very least, you think these folks might have at least served up SPDR International Developed Small Cap (GWX) as having relevance like U.S. small caps do. And do I even need to mention the failure to include commodities?????

Money Magazine is equally shameful, if for no other reason than that the advice seems wholly to change issue by issue. In "ETF Investing Done Right," the writer(s) of this July 2009 piece claim that you need just 5 ETFs to get your diversified mix of 60% stocks, 40% bonds. Ironic, since the magazine's late 2007 mixes typically showed 70%-75% stock appropriate for most. By April 2008, it shifted to 50% stock and 50% income. Now it's 60%/40%?

Keep in mind, these are no systematic rebalancing or recommended asset allocation changes taking place in the magazine. Each presentation is offered as a 'buy-n-hold', leave-it-alone 'solution' for 'moderate' risk tolerance. Pick up the magazine one month, get a "cure-all". Pick it up another month, find an entirely different "cure-all".

Below is Money's "ETF Investing Done Right" for July 2009:

1. Vanguard Total Stock Market (VTI) 35%
2.Vanguard FTSE All-World excl U.S. (VEU) 20%
3. Vanguard Total Bond Market (BND) 30%
4. Vanguard Real Estate Inv Trust (VNQ) 5%
5. iShares Lehman TIPS Bond Fund (TIP) 10%
I could "tee off" on Money Magazine for its failure to identify two of the most powerful forces in diversification: foreign bonds and commodities. For foreign bonds, one could use the SPDR Lehman International Treasury Bond ETF (BWX) and for commodities, one could employ the services of the Powershares Total Commodity Index (DBC). Naturally, it doesn't make much sense to get too wound up about weak presentations from has-beens and/or media mainstreamers. As easy as ETFs are to use, a serious investor needs to take a bit more interest in what he/she does. 'Buy-n-hold', one-time asset allocating is never sensible… and 5 ETFs won't cover your retirement life adequately.

If you'd like to learn more about ETF investing… then tune into "In the Money With Gary Gordon." You can listen to the show "LIVE", via podcast or on your iPod.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Inflection Point?

Have We Reached An Inflection Point In Economics History?

By Chris Nelder | 22 June 2009

For my Energy and Capital article this week, I deconstruct the inflation/deflation debate, and conjecture that we may have reached an inflection point in economic history, where the price at which energy is high enough to sustain new production is the same price at which things become too expensive, leaving us no option but to downsize.

"Indeflation" and Energy

A fierce debate now rages among economists, investors, pundits and the puppetmasters of fiscal policy: What’s next, inflation or deflation? Has the most massive money-printing spree in history successfully stimulated the global economy and put it back on an upward course with rising inflation? Or are we still in a global downturn, temporarily masked by the stimulus, with prices, wages and employment still falling?

A comforting 30%-40% gain in the major stock market indexes since the March lows has given renewed confidence to the "green shoots" trumpeters who dominate the airwaves and the press.

But grayer and wiser heads in the investing community— like Dave Rosenberg, John Mauldin, Nouriel Roubini, Gary Shilling, Peter Schiff, and Dave Cohen— have a more bearish view. The financial sector must now 'deleverage', they argue, which means liquidating assets, repaying debt, saving instead of borrowing, and contracting in general. In their view, the process will take years, not months, and what we have seen since March is a classic bear market rally.

Consider the data Rosenberg offered in a commentary last week in support of his deflationary thesis:
  • Residential real estate still sports a 12-month supply of unsold inventory, and housing starts have staged a very weak recovery this spring.

  • Every major industry posted a decline in May. Industrial production had its seventh decline in a row in May, to a level last seen 11 years ago. The Institute of Supply Management (ISM) index, a measure of manufacturing activity and a proxy for tech spending, is still falling.

  • Employment slid in May to greater depths than were seen in the last two recessions, and "real organic personal income" fell for the second time in the last three months. Ultimately, recessions don’t end without rising employment, meaning consumers with money to spend.

  • Prices are generally still falling. The Producer Price Index (PPI), used to evaluate wholesale price levels, is down 37% year-over-year "to a 50-year deflation low of -5.0."

There are other signs that this spring’s green shoots may be browning. The Consumer Price Index (CPI), the Labor Department’s key measure of inflation, has fallen 1.3% over the past year, the largest decline in nearly 60 years, mainly due to the 27.3% crash of the energy index component. Meanwhile, the consumer remains beaten and bruised.

As my colleague Steve Christ pointed out last week, U.S. household net worth fell by $1.3 trillion in the first quarter, and household wealth is down 21.6% from its 2007 peak. Commercial real estate is contracting painfully, with prices plunging and vacancies and defaults soaring. Meanwhile, consumer credit defaults are still rising, even as rising interest rates have snuffed out the resurgence in home-buying.

Liquidity in the credit markets remains a problem as well. Banks simply aren’t lending out the Fed’s forced injection of fantasy capital. Indeed, they are entirely intent on paying it back as quickly as the Fed will let them, on the heels of secondary stock offerings and other measures they have taken to raise capital and reduce their exposure. (For a personal anecdote, I called Discover card two weeks ago to take advantage of a recent 1.8% promotional offer on balance transfers they had sent me, and was told that they aren’t accepting any more balance transfers right now, from anybody, period.)

On the whole, I think the case for deflation and contraction is well made.

Commodity Inflation

At the same time, food and energy prices have been rising rapidly. Oil has rocketed from the low $40s to the low $70s in just four months, a roughly 71% gain. Soybeans rose about 50% over the same period, with most other grains gaining similarly. Normally, this would suggest inflationary fears, and indeed it has apparently drawn hedge fund money off the sidelines, out of bonds, and back into energy and commodities. (Energy analyst Dave Cohen did a great study of speculation in the current commodity cycle last week in "Bad Signs, New Bubbles.")

I don’t want to make too much of the commodity resurgence, however. The market continues to price oil inversely to the dollar, and the dollar’s fall has been echoed almost perfectly by oil prices:

The dollar’s decline can be viewed as the proper result of printing trillions of dollars out of thin air, without new assets to back it— the inflationary thesis.


On the whole this year is looking a great deal like last year across the energy and commodities sector, with the same sort of inflation. But there is an important difference this year: The economy and the consumer are sick, very sick. Gasoline at $3 was a nuisance last year, but this year it really hurts. Perhaps we should be zooming out on this picture, and considering the 'affordability' of oil. Consider this 60-year chart from the blog of "Mr. Excessive," which tells quite a different story:

The 'affordability' of oil, as measured by the S&P500, peaked in 1999, and has been in decline ever since. Oil prices began rising sharply at that time, as the early effects of peak oil began to be seen. Global conventional oil production has been flat since 2005, despite a tripling of prices.

So is it to be inflation or deflation?

My pal Gregor Macdonald argued this question elegantly on his blog in April, and in a recent conversation asserted, I think rightly, that it’s not an either-or question. In fact, we’re seeing inflation (of prices) and deflation (of assets) simultaneously. Investor guru Doug Fabian has termed this "indeflation" and Izabella Kaminska of FT Alphaville has called it "compartflation."

Instead of just looking at the dollar and inflation, we should consider that, as former International Petroleum Exchange head Chris Cook argued on The Oil Drum, energy is the only real currency. Our fiat money is but a distorted representation of it, and that energy is declining in real terms as oil, natural gas, and coal all become progressively harder to extract and of lower energy content.

Are We At An Inflection Point?

We now appear to be bumping our heads against an invisible ceiling, where the decline in real energy meets our pain tolerance for high prices. When gasoline hit $4 last year, it created real demand destruction because people simply couldn’t afford it with their evaporating dollars. Likewise, the spike in natural gas and coal prices ultimately translated into such high prices for basic building materials like cement and steel that demand was curtailed.

It now seems possible that we have reached an inflection point in economic history, where the price at which energy is high enough to sustain new production is the same price at which things become 'too expensive', leaving us no option but to downsize.

Academics including Charles Hall, Cutler Cleveland, and Howard Odum have explored the relationship between primary energy and economic growth exhaustively. Hall and his graduate student David Murphy graphically depict where we are now as follows:

Source: Murphy, D. and C. A. S. Hall (in press). "Year in Review— EROI or Energy Return On (Energy) Invested." Ecological Economics

Until we understand this key point, we are going to continue to go through wrenching cycles such as we experienced over the last year. Spiking energy and commodity prices lead to destruction of the economy, which then gathers itself at a lower overall level until prices spike again, and back around the wheel we go. Even as energy use declines, the ceiling will get lower and lower, and it will take more and more money to buy the same things.

No amount of tinkering with monetary policy can change that. Unlike money, BTUs can’t be printed out of thin air. Unfortunately, neither the Fed nor Congress seems to have learned this lesson. The Fed still thinks that tweaking interest rates, buying bonds, forcing banks to keep the fantasy money, hiding the stress test results and the like can somehow ease us into a manageable recovery.

A few bright bulbs in Congress suggested last week that we exchange 70 million barrels of light sweet crude oil from the Strategic Petroleum Reserve (SPR) for an equivalent amount of lesser quality heavy sour crude, in an effort to dampen oil prices. Aside from being a fundamentally bad idea, I continue to believe such a move would be utterly ineffectual. The maximum official rate at which the SPR can be drawn down is four million barrels per day, but I suspect the actual rate would be far lower. In any case, the price difference between the two grades of oil is fairly small, and the value of the swap would virtually disappear within a flow of 84 million barrels a day of globally priced oil.

The other bit of new legislation, a "Cash for Clunkers" bill that passed last week, also appears to be completely toothless. I supported the idea until I learned the anemic requirements of this bill. It would offer $3,500 vouchers for a mere 2 mpg gain in fuel economy for light trucks and SUVs, and $4,500 for a 5 mpg improvement. Cars would only need to gain 4 to 10 mpg to qualify.

Suffice to say that I still have very low expectations that our national leadership will offer any tangible, effective methods to reduce our consumption of petroleum significantly. I certainly do not see them coming to grips with the near-certainty that by 2012, the world’s oil supply will go into terminal and relentless decline.

On the international scene, finance ministers for the Group of Eight (G8) expressed 'concern' over the influx of capital into the commodity sector after their meeting last weekend. In a communiqué, the group stated,
"Excess volatility of commodity prices poses risks to growth. We will consider ways to improve the functioning and transparency of global commodity markets, including considering IOSCO [the International Organisation of Securities Commissions] work on commodity derivative markets."
Ministers have asked the International Monetary Fund (IMF) and the International Energy Agency (IEA) to suggest new ways to monitor and regulate the oil markets, in an effort to limit speculation and dampen future volatility.

If done very carefully [[and apolitically? : normxxx]], such an effort could moderate the boom-bust cycles ahead, and give the world a crucial measure of slack in which we can sustain the long term investment horizon needed to transition to a 'renewable' energy infrastructure. If done hastily or badly [[or largely to satisfy political constituents: normxxx]], it could starve the energy markets of capital, or cause other unintended and probably worse effects.

I think that as it is now constituted, the market is inadequately equipped to face this inflection point of 'indeflation', and history is no longer a useful guide. We’re entering uncharted territory with the risk of peak oil still priced at approximately zero.

So what does all this mean for investors?

First, long-term investing in a 'diversified portfolio of stocks' is probably not going to be a good strategy for a long time to come (if ever); it’s time to play defense and look for low-risk yield. Second, it means that investing in oil and commodities will continue to be the name of the game for many years, but investors must watch the signs I have identified here carefully to know when it’s time to dive in and when it's time to jump out, as we churn through these cycles under a dropping ceiling. And third, it means that we all need to learn to live at a lower level, eliminate debt, build savings, and buckle up for a long and bumpy ride.

Until next time,




The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Tuesday, June 23, 2009

Have Stock Markets Run Away From Reality?

Have Stock Markets Run Away From Reality?

By Prieur Du Plessis | 16 June 2009

The predictions of the members of the Barron’s mid-year Roundtable discussion over the weekend were in agreement that the March lows of the stock markets would not be broken. This reminded me of one of the famous "Investment Rules" of Bob Farrell, legendary former chief stock market analyst at Merrill Lynch. Rule # 9 stated: "When all the experts and forecasts agree, something else is going to happen."

Meanwhile, many stock markets [June 15] registered their worst single-session percentage losses in a month. [[Didn't do so well on June 22, either. : normxxx]] Commodities also faced heavy profit-taking, but government bonds rallied and the US dollar strengthened against a basket of currencies. "We could be seeing one of those occasional all-change signals in short-term trends," said David Fuller (Fullermoney).

Richard Russell, veteran writer of the daily Dow Theory Letters, commented on Monday:
"I’m of the opinion that this bear market rally is in the process of topping out. When a counter-trend rally tops out within an ongoing primary bear market, the odds are that the stock market will break to new lows during the period ahead. That means that the stock market will break below its March 9 lows in coming weeks. A violation of the March 9 lows would be a shocker to most investors, and it would be a forecast of an even worse economy coming up."

As mentioned Sunday, 14 June, the S&P 500 had recently been mapping out a trading range between 925 and 950, as shown in the chart below. The 15 of June's close of 924 [[895 on close of 23 June: normxxx]] took the Index below the bottom of the range. As stock markets have started to show exhaustion (also seen from the low volume characterizing the last few days’ increases), the odds are that this could be more than a "false alarm".

Source: StockCharts.com

An analysis of the moving averages of the major US indices shows all the indices still trading above their respective 50-day moving averages, but the Dow Jones Industrial Index has again fallen below the key 200-day line, rejoining the Dow Jones Transport Index. With the exception of the Nasdaq Composite Index, all the indices are below the early January peaks. Importantly, the levels from where the rally commenced on March 9 should hold in order for base formations to remain in force.

Click Here, or on the image, to see a larger, undistorted image.

Based on pronouncements at last weekend’s meeting of the Group of Eight finance ministers, "green shoots" seem to be wilting somewhat, leaving investors questioning whether the recent reflation trade has not been getting ahead of itself. The "less-bad-than-expected" school of thought is largely based on survey data such as the Purchasing Managers Indices (PMIs). It therefore makes for interesting reading to revisit the historical relationship between the PMI and stock market movements. The example below shows the US composite (services and manufacturing) PMI plotted together with the 12-month percentage change in the S&P 500.

Source: Plexus Asset Management and I-Net Bridge

For some fun with numbers, I have done a regression analysis of the two series, resulting in an R2 coefficient of 0.76. Applying the regression results to a range of PMI assumptions, the expected changes in the S&P 500 are as shown in the table below.

Click Here, or on the image, to see a larger, undistorted image.

The figures show that a "pessimistic" scenario of a stagnant PMI would result in a decline of 23.4% in the S&P 500 (i.e. an index level of approximately 700). Even a "realistic" scenario of gradually increasing the PMI by 1% per month between now and November would still result in the S&P 500 being 8.7% lower by the end of November. Interestingly, the stock market seems overpriced under all scenarios over the next few months and only reaches positive territory again in August under the "very optimistic" scenario and in November under the "optimistic" scenario.

And lastly, John Murphy (StockCharts.com) concurs, remarking:
"As good as the spring rally has been, I believe the market is still in need of some corrective action (or consolidation) before moving substantially higher. V bottoms are extremely rare. W bottoms are a lot more common. So are head and shoulder bottoms. It seems unlikely that the market will continue to rally in a straight line. More basing activity is most likely needed. And that’s going to require more time."

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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Signs Of The Times? Supply And Demand.
The Supply Of Stock Is Mushrooming— A Bearish Sign

By Mark Hulbert, Marketwatch | 23 June 2009

ANNANDALE, Va. (MarketWatch)— What bear market?

Notwithstanding the carnage the stock market suffered between October 2007 and March of this year— the worst since the Great Depression— corporations' share issuance departments are partying like it's 1999. In fact, firms have recently issued far more shares of their stock (either through initial public offerings or secondary offerings) than they did even in the go-go years of the late 1990s and at the top of the Internet bubble in early 2000.

That's not good news, from a contrarian point of view: The stock market historically has tended to perform poorly following periods in which firms have flooded the market with more shares. Prior to May, according to TrimTabs Investment Research, the highest level of share issuance in a given month was $38 billion. May blew that record out of the water, with a monthly total of $64 billion. Furthermore, that blistering pace has continued during the first two weeks of June, according to TrimTabs.

How bad an omen is this corporate eagerness to offer its shares to the investing public? Looking back through recent history, TrimTabs found that there have been just 12 months since 1998 in which total new corporate offerings totaled at least $30 billion. The average return for the S&P 500 index (SPX) over the 90 days following those months was a loss of 4%.

Dissecting the data further, TrimTabs next focused on those months in which not only did total corporate issuance exceed $30 billion, but also those in which total corporate share purchases were less. The S&P 500's average 90-day return following those months was a loss of 7%. This more-narrowly-defined subset applies to today, unfortunately. According to TrimTabs, corporate new offerings since the beginning of May have been nearly five times greater than corporate purchases.

The recent surge in the supply of shares has also caught the attention of Ned Davis, the eponymous head of Ned Davis Research. He has found through his research that it is optimal not to focus on monthly totals but instead on a rolling 13-week window. On this basis, according to Davis, recent corporate issuance has been exceeded historically only by two other occasions— early 2000 and early 2008. Those were "not great times to buy stocks," Davis notes dryly.

Davis also draws an even more ominous parallel to the recent corporate rush to sell stock: "This high level of [recent] supply is one of the key characteristics of the monster rally in November 1929 - April 1930." From April 1930 through the low in July 1932, of course, the Dow Jones Industrial Average (INDU 8,331) fell by 86%. For the record, I should point out that Davis, despite these ominous portents, remains cautiously bullish for the short-term, since many of his other indicators suggest that this rally has further to run.

But TrimTabs is quite bearish, recommending that clients be 50% short U.S. equities. "Stock prices are going to fall hard," they predict.

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.


Investor Sentiment: "Dumb Money," "Smart Money" Indicators
Click here for a link to ORIGINAL article:

By Guy M. Lerner, The Technical Take | 14 June 2009

The "Dumb Money" indicator is shown in figure 1. The "Dumb Money" indicator looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investor Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put call ratio.

Figure 1. "Dumb Money"/ weekly

Click Here, or on the image, to see a larger, undistorted image.

[ Normxxx Here— Note:   The best statistical evidence is that the "Dumb Money" is simply a reflection of the market action over the preceding 1-6 months, exponentially weighted (ie, with greater weight given to the more recent market moves). ]

For the record, the "Smart Money" indicator is shown in figure 2. The "smart money" indicator is a composite of the following data: 1) public to specialist short ratio; 2) specialist short to total short ratio; 3) SP100 option traders.

Click Here, or on the image, to see a larger, undistorted image.

  M O R E. . .


Friday, June 19, 2009

First Quarter Wipe Out

First Quarter Wiped Out $1.3 Trillion For Americans

By Jeannine Aversa, AP | 11 June 2009

WASHINGTON— The brute force of the recession earlier this year turned back the clock on Americans' personal wealth to 2004 and wiped out a staggering $1.3 trillion as home values shrank and investments withered. Net worth, or the value of assets such as homes, checking accounts and investments minus debts like mortgages and credit cards, declined 2.6 percent in the first three months of the year, the Federal Reserve said Thursday.

Those months were some of the worst of the recession so far for job losses, and the stock market sank to its lowest point of the year in March. Since then, some signs suggest the economy is stabilizing. Still, partly because of the carnage earlier in the recession, Americans are putting plans on hold until the economy improves.

While families worked harder, their wages continued to decline. Middle-class families are working harder and earning less today than they were eight years ago. Median household income, adjusted for inflation, has declined $333 from $50,566 in 2000 to $50,233 in 2007 (the latest year for which we have data) [U.S. Census Bureau, Income, Poverty, and Health Insurance Coverage in the United States: 2007 (August 2008)]. Between 2000 and 2007, the government's measure of take-home pay (median weekly earnings) increased by a mere 0.3 percent (adjusted for inflation), compared with 7.7 percent growth between 1989 and 2000 (the last comparable business cycle) [Joint Economic Committee analysis of U.S. Department of Labor, Bureau of Labor Statistics (January 9, 2009].

Employment compensation has lagged behind productivity gains. While the productivity of the American worker (output per hour) rose by 19.08 percent between the fourth quarter of 2000 and the third quarter of 2008, average hourly compensation (wages plus benefits, adjusted for inflation) increased by only 6.3 percent during this period [Joint Economic Committee analysis of U.S. Department of Labor, Bureau of Labor Statistics (January 9, 2009)]. In sum, Americans are working harder— and more productively— but are not receiving proportionally increased rewards for their hard work [Edward Teach, "A Productive Debate," CFO Magazine (December 31, 2006)].

As a result, income equality has expanded. The New York Times reported that: "an outsized share of productivity growth, which expands the nation's total income, is going to Americans at the top of the income scale. In 2005… the top 1 percent of Americans— whose average annual income was $1.1 million— took in 21.8 percent of the nation's income, their largest share since 1929" [Editorial, "Economic Life After College," New York Times, p. A18 (June 11, 2007)]. According to the Wall Street Journal, "[s]ince the end of the recession of 2001, a lot of the growth in GDP per person— that is, productivity— has gone to profits, not wages" [Greg Ip, "Wages Fail to Keep Pace With Productivity Increases, Aggravating Income Inequality," Wall Street Journal p. A2 (March 27, 2006)].

Economists at the National Bureau of Economic Research concluded that: "[t]o the extent that the productivity growth 'explosion' of 2001-2004 was achieved by cost-cutting, layoffs, and abnormally slow employment growth… the historical link between productivity growth and higher living standards falls apart. Not only have the bottom 90 percent of American workers failed to keep up with productivity growth, many have been harmed by it" [Ian Dew-Becker and Robert J. Gordon, Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income (December 2005) p. 62]. Indeed, the average income for 80 percent of American households has fallen since 2000 after adjusting for inflation.

According to the Joint Economic Committee, changes in income over the past year have been regressive, with the average income of the bottom fifth declining two-an-a-half times more than the top fifth. "As a result of this pattern of losses at the bottom and gains at the top, income inequality is now greater" than it was before 2001 [Joint Economic Committee analysis of U.S. Department of Labor, Bureau of Labor Statistics (January 9, 2009)]. Earnings for workers with college degrees are declining. The Wall Street Journal observed that "a four-year college degree, seen for generations as a ticket to a better life, is no longer enough to guarantee a steadily rising paycheck" [Greg Ip, "The Declining Value of Your College Degree," Wall Street Journal (July 17, 2008)].

In addition, the Los Angeles Times reported that: "[w]age stagnation, long the bane of blue-collar workers, is now hitting people with bachelor's degrees for the first time in 30 years. Earnings for workers with four-year degrees fell 5.2 percent from 2000 to 2004 when adjusted for inflation, according to White House economists… Not since the 1970s have workers with bachelor's degrees seen a prolonged slump in earnings during a time of economic growth… trends for people with master's and other advanced degrees… have found that their inflation-adjusted wages were essentially flat between 2000 and 2004" [Molly Hennessy-Fiske, "That Raise Might Take 4 Years to Earn as Well: Those with bachelor's degrees are finding their incomes stagnate despite a growing economy," Los Angeles Times p. A1 (July 24, 2006)]. And, U.S. Census data indicates that "the number of college graduates earning below the poverty line has more than doubled in the past 15 years to almost 6 million people" [AP, "College degree may not be enough to protect against poverty" (April 29, 2007)].

B. Smith, a conductor for a Chicago commuter rail line, is in no hurry to buy cars for two of his children. He spent $260,000 to build his suburban Chicago home about 10 years ago and watched its value spike to $380,000 in January 2008. Today, it stands at about $310,000. "I'm still ahead, but I'm not as ahead as I was before," he said. "Even if things improve, such a dramatic evaporation of wealth will probably make Americans more thrifty down the road," said Scott Hoyt, senior director of consumer economics at Moody's Economy.com.

"The bulk of consumers alive today have not experienced declines in wealth like this," Hoyt said. "They are already turning thrifty, and it will stay that way beyond the short term. This has been a significant learning experience". Americans' personal savings rate zoomed to 5.7 percent in April, the highest since 1995. And the amount in savings— $620.2 billion— was the most on records dating back to January 1959.

One way to save: Maurice Boler, a management consultant, said he does many repairs himself on his Indianapolis home rather than pay someone else. "I just take a little bit longer," said the 53-year-old father of four, three of whom live at home. Even if the economy recovers and starts to thrive again, he said he probably won't break out the credit cards again. "It's really not about stuff," he said. "Stuff is nice, but life is not about how much more stuff can we get."

According to the Fed report, the biggest damage to wealth in the first quarter came from the sinking stock market. The value of Americans' stock holdings dropped almost 6 percent from the final quarter of last year— in a market that was already brutal. The Wall Street slide that began in 2007 wiped out more than half the value of the U.S. stock market, but many investments have bounced back. Since the end of the period covered by the Fed report, the Standard & Poor's 500 stock index is up 20 percent.

Rick Thompson, 77, a retired broker from Huntingdon Valley, Pa., isn't losing sleep over the economy or the stock market despite seeing his net worth edge lower in recent months. He and his wife, Faith, own the four-bedroom house where they've lived for 40 years. It may have lost some of its value, but not much, he said. A conservative investor, he shifted most of their portfolio from stocks to bonds in late 2007, when the then-soaring market made him uneasy.

He admits the recession has weighed on his psyche, but the rise in stocks since early March has lifted his spirits. Thanks to the Wall Street rally, they are going ahead with plans for a trip to Europe next year. Another hit to household net worth in the first quarter came from falling house prices. The value of real-estate holdings fell 2.4 percent, according to the Fed report.

Collectively, homeowners had only 41.4 percent equity in their homes in the first quarter, the lowest on records dating to 1945, as Americans fell behind on mortgages or entered foreclosure. That was down from 42.9 percent in the fourth quarter. The Case-Shiller national home price index, a closely watched barometer, last month estimated that house prices dropped 7.5 percent during the first quarter and have fallen more than 32 percent from their 2006 peak.

While the first quarter was ugly, the hit to Americans' net worth was worse late last year. In the October-December period, it fell a record 8.6 percent, according to revised figures. That was the largest drop in records dating to 1951. If Americans continue to spend— no guarantee— Fed Chairman Ben Bernanke and other economists say they think the recession will end late this year. But if shoppers hunker down and cut spending again, that could delay any recovery. Late last year, Americans cut spending at the fastest rate in 28 years.

On Thursday, there was encouraging news: Retail sales rose slightly in May following two straight monthly declines, the Commerce Department reported. And the number of newly laid-off workers filing for unemployment fell to the lowest number since late January. Nationally, first-time jobless claims dropped by 24,000 from the previous week. But the number of people claiming benefits for more than a week rose by 59,000 to 6.8 million— the highest on records dating to 1967. Kathy Bullard, a librarian in Providence, R.I., said she plans to be even more frugal in the coming months. At 58, with a 10 percent pay cut coming on July 1 and her pension plan frozen, she doesn't expect to buy more new clothes or books anytime soon.

"I have no idea what my net worth is," she said. "It would probably just depress me."

Thursday, June 18, 2009

The Quiet Coup: Economy

The Quiet Coup: Economy

By Simon Johnson, May 2009 Atlantic

Simon Johnson, a professor at MIT’s Sloan School of Management, was the chief economist at the International Monetary Fund during 2007 and 2008. He blogs about the financial crisis at baselinescenario.com, along with James Kwak, who also contributed to this essay.

The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government— a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.

Image credit: Jim Bourg/Reuters/Corbis

One thing you learn rather quickly when working at the International Monetary Fund is that no one is ever very happy to see you. Typically, your "clients" come in only after private capital has abandoned them, after regional trading-bloc partners have been unable to throw a strong enough lifeline, after last-ditch attempts to borrow from powerful friends like China or the European Union have fallen through. You’re never at the top of anyone’s dance card.

The reason, of course, is that the IMF specializes in telling its clients what they don’t want to hear. I should know; I pressed painful changes on many foreign officials during my time there as chief economist in 2007 and 2008. And I felt the effects of IMF pressure, at least indirectly, when I worked with governments in Eastern Europe as they struggled after 1989, and with the private sector in Asia and Latin America during the crises of the late 1990s and early 2000s. Over that time, from every vantage point, I saw firsthand the steady flow of officials— from Ukraine, Russia, Thailand, Indonesia, South Korea, and elsewhere— trudging to the fund when circumstances were dire and all else had failed.

Every crisis is different, of course. Ukraine faced hyperinflation in 1994. Russia desperately needed help when its short-term-debt rollover scheme exploded in the summer of 1998. The Indonesian rupiah plunged in 1997, nearly leveling the corporate economy. That same year, South Korea’s 30-year economic miracle ground to a halt when foreign banks suddenly refused to extend new credit.

But I must tell you, to IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess— exports must be increased, and imports cut— and the goal is to do this without the most horrible of recessions.

Naturally, the fund’s economists spend time figuring out the policies— budget, money supply, and the like— that make sense in this context. Yet the economic solution is seldom very hard to work out. No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.

Typically, these countries are in a desperate economic situation for one simple reason— the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit— and, most of the time, 'genteel'— oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its 'captains of industry'.

As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon— correctly, in most cases— that their political connections will allow them to push onto the government any substantial problems that arise. In Russia, for instance, the private sector is now in serious trouble because, over the past five years or so, it borrowed at least $490 billion from global banks and investors on the assumption that the country’s energy sector could support a 'permanent' increase in consumption throughout the world economy. [[Matches our 'permanent' increase in the price of houses myth quite well… 'If the price of houses had only kept growing, we would still be flying high!': normxxx]]

As Russia’s oligarchs spent this capital, acquiring other companies and embarking on ambitious investment plans that generated jobs, their importance to the political elite increased. Growing political support meant better access to lucrative contracts, tax breaks, and subsidies. And foreign investors could not have been more pleased; all other things being equal, they prefer to lend money to people who have the implicit backing of their national governments, even if that backing gives off the faint whiff of corruption.

But inevitably, emerging-market oligarchs get carried away; they waste money and build massive business empires on a mountain of debt. Local banks, sometimes pressured by the government, become only too willing to extend credit to the elite and to those who depend on them. Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms.

The downward spiral that follows is remarkably steep. Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s "public-private partnerships" are relabeled "crony capitalism". With credit unavailable, economic paralysis ensues, and conditions just get worse and worse.

The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions— now hemorrhaging cash— and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.

Squeezing the oligarchs, though, is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or— here’s a classic Kremlin bailout technique— the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms.

Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk— at least until the riots grow too large. Eventually, as the oligarchs in Putin’s Russia now realize, some within the elite have to lose out before recovery can begin. It’s a game of musical chairs: there just aren’t enough currency reserves to take care of everyone, and the government can never afford to take over private-sector debt completely. [[Or, at least, not without Zimbabwe-style inflation.: normxxx]]

So the IMF staff looks into the eyes of the minister of finance and decides whether the government is serious yet. The fund will give even a country like Russia a loan eventually, but first it wants to make sure Prime Minister Putin is ready, willing, and able to be tough on some of his friends. If he is not ready to throw former pals to the wolves, the fund can wait. And when he is ready, the fund is happy to make 'helpful' suggestions— particularly with regard to wresting control of the banking system from the hands of the most incompetent and avaricious "entrepreneurs".

Of course, Putin’s ex-friends will fight back. They’ll mobilize allies, work the system, and put pressure on other parts of the government to get additional subsidies. In extreme cases, they’ll even try subversion— including calling up their contacts in the American foreign-policy establishment, as the Ukrainians did with some success in the late 1990s. Many IMF programs "go off track" (a euphemism) precisely because the government can’t stay tough on erstwhile cronies, and the consequences are then massive inflation or other disasters.

A program "goes back on track" once the government prevails or powerful oligarchs sort out among themselves who will govern— and thus win or lose— under the IMF-supported plan. The real fight in Thailand and Indonesia in 1997 was about which powerful families would lose their banks. In Thailand, it was handled relatively smoothly. In Indonesia, it led to the fall of President Suharto and economic chaos.

From long years of experience, the IMF staff knows its program will succeed— stabilizing the economy and enabling growth— only if at least some of the powerful oligarchs who did so much to create the underlying problems take a hit. This is the problem of all emerging markets.

Becoming A Banana Republic

In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets, up to now): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay.

This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding in the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people. But there’s a deeper and more disturbing similarity: elite business interests— 'financiers', in the case of the U.S.— played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse.

More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them. Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better— in a "buck stops somewhere else" sort of way— on the flow of savings out of China.

Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing 'efforts to promote broader homeownership'. And, of course, it is axiomatic to everyone that the regulators responsible for "safety and soundness" were fast asleep at the wheel. But these various policies— lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership— all had something in common.

Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits— such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998— were ignored or swept aside. The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful.

The boom began with the Reagan years, and it only gained strength with the follow-on deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made [the whole area of] bond trading much more lucrative [[and exciting, as all of those exotic derivative securities and 'insurance' vehicles were added.: normxxx]]

The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.

Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent.

Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007. The great wealth that the financial sector created and concentrated gave bankers enormous political weight— a weight not seen in the U.S. since the era of J.P. Morgan (the man).

In that latter period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers— no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression. The reemergence of an American financial oligarchy is quite recent.

The Wall Street–Washington Corridor

Of course, the U.S. is unique. And just as we have the world’s most advanced economy, military, and technology, we also have its most advanced oligarchy. In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts.

Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption— envelopes stuffed with $100 bills— is probably a sideshow today, Jack Abramoff notwithstanding. [[He just shows how backwards the Republicans still are; ah, "for the good old days!" : normxxx]] Instead, the American financial industry gained political power by amassing a kind of cultural capital— a 'belief system'. Once, perhaps, 'what was good for General Motors was good for the country.' Over the past decade, the attitude took hold that what was good for Wall Street was good for the country.

The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington 'insiders'— on both sides of the aisle— already believed: that large financial institutions and 'free-flowing' capital markets were crucial to America’s position in the world. One channel of influence was, of course, the flow of individuals between Wall Street and Washington.

Robert Rubin, once the co-chairman of Goldman Sachs, served in Washington as Treasury secretary under Clinton, and later became chairman of Citigroup’s executive committee. Henry Paulson, CEO of Goldman Sachs during the long boom, became Treasury secretary under George W. Bush. John Snow, Paulson’s predecessor, left to become chairman of Cerberus Capital Management, a large private-equity firm that also counts Dan Quayle among its executives. Alan Greenspan, after leaving the Federal Reserve, became a consultant to Pimco, perhaps the biggest player in international bond markets.

These personal connections were multiplied many times over at the lower levels during the past four presidential administrations, strengthening the ties between Washington and Wall Street. It has become something of a tradition for Goldman Sachs employees to go into public service after they leave the firm. The flow of Goldman alumni— including Jon Corzine, now the governor of New Jersey, along with Rubin and Paulsonnot only placed people with Wall Street’s worldview in the halls of power; it also helped create an image of Goldman (inside the Beltway, at least) as an institution that was itself almost a form of public service.

Wall Street is a very seductive place, imbued with an air of power. Its executives truly believe that they control the levers that make the world go round. A civil servant from Washington invited into one of their opulent conference rooms or offices, even if just for a meeting, could be forgiven for falling under their sway. Throughout my time at the IMF, I was struck by the easy access of leading financiers to the highest U.S. government officials, and the 'interweaving' of the two career tracks.

I vividly remember a meeting in early 2008— attended by top policy makers from a handful of rich countries— at which the chair casually proclaimed, to the room’s general approval, that the best preparation for becoming a central-bank governor was to work first as an investment banker. A whole generation of policy makers has been mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true. Alan Greenspan’s pronouncements in favor of unregulated financial markets are well known. Yet Greenspan was hardly alone.

This is what Ben Bernanke, the man who succeeded him, said in 2006:
"The management of market risk and credit risk has become increasingly sophisticated. … Banking organizations of all sizes have made substantial strides over the past two decades in their ability to measure and manage risks."

Of course, this was mostly an illusion. Regulators, legislators, and academics almost all assumed that the managers of these banks knew what they were doing. In retrospect, they didn’t. AIG’s Financial Products division, for instance, made $2.5 billion in pretax profits in 2005, largely by selling underpriced [[who knew!?!: normxxx]] insurance on complex, poorly understood securities. [[As it turns out; no one "understood" these securities!: normxxx]]

Often described as "picking up nickels in front of a steamroller," this strategy is reasonably profitable in ordinary years, but catastrophic in bad ones. As of last fall, AIG had outstanding insurance on more than $400 billion in securities. To date, the U.S. government, in an effort to rescue the company, has committed about $180 billion in investments and loans to cover losses that AIG’s 'sophisticated' [[ie, unintelligible: normxxx]] 'risk modeling' had said were virtually impossible. [[One of thoser events that occur only once or twice in 'the lifetime of the universe'. Lucky us! : normxxx]]

Wall Street’s seductive power extended even (or especially) to finance and economics professors, historically confined to the incredibly cramped, poorly furnished, and understaffed offices of universities and the hot pursuit of Nobel Prizes. As mathematical finance became more and more 'essential' to practical finance, professors increasingly took positions as consultants or partners at financial institutions. Myron Scholes and Robert Merton, Nobel laureates both, were perhaps the most famous; they took board seats at the hedge fund Long-Term Capital Management in 1994, before the fund so famously flamed out at the end of the decade. But many others beat similar paths.

This migration gave the stamp of academic legitimacy (and the intimidating aura of intellectual rigor) to the burgeoning world of high finance. As more and more of the rich made their money in finance, the 'cult of finance' seeped into the culture at large. Works like Barbarians at the Gate, Wall Street, and Bonfire of the Vanitiesall intended as cautionary tales— served only to increase Wall Street’s mystique. Michael Lewis noted in "Portfolio" last year that when he wrote Liar’s Poker, an insider’s account of the financial industry, in 1989, he had hoped the book might provoke outrage at Wall Street’s hubris and excess.

Instead, he found himself "knee-deep in letters from students at Ohio State who wanted to know if I had any other 'secrets' to share. … They’d read my book as a how-to manual". Even Wall Street’s criminals, like Michael Milken and Ivan Boesky, became larger than life. In a society that celebrates the idea of making money, it was easy to infer that the interests of the financial sector were the same as the interests of the country— and that the winners in the financial sector knew better about what was good for America than did [[those 'lackluster', 'nose-to-the grindstone': normxxx]] career civil servants in Washington.

Faith in free financial markets grew into conventional wisdom— trumpeted on the editorial pages of The Wall Street Journal and on the floor of Congress. From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies that is, in hindsight, astonishing:

• 'insistence' on 'free' movement of capital across borders;

• the repeal of Depression-era regulations separating commercial and investment banking;

a congressional ban on the regulation of credit-default swaps;

major increases in the amount of leverage allowed to investment banks
[[30 times became common, from the much more sedate 15 times— commercial banks were only allowed 10 times— and (wholly unregulated) hedge fund leverage rose to as much as 100 times in some extreme cases (50 times being more usual): normxxx]]

• a
"light" (dare I say invisible?) hand at the Securities and Exchange Commission in its regulatory enforcement
[[think Bernie Madoff: normxxx]];

• an international agreement to allow banks to measure their
own riskiness
[[this was done because it was felt that financial innovation was in such a revolution, that regulation by those 'pedestrian' and 'lackluster' government regulators was both impossible (they'd never keep up with those WS 'quants') and merely burdensome (who knew better than those WS 'quants' how to manage risk among the various strains of exotica that went under the heading of 'financial instruments'): normxxx]];

• and an
intentional failure to update regulations to keep up with the tremendous pace of financial innovation.

The mood that accompanied these measures in Washington seemed to swing between nonchalance and outright celebration: finance unleashed, it was thought, would continue to propel the (world) economy to ever greater heights.

America’s Oligarchs And The Financial Crisis

The oligarchy and the government policies that aided it did not alone cause the financial crisis that exploded last year. Many other factors contributed, including excessive borrowing by households and lax lending standards out on the fringes of the financial world. But major commercial and investment banks— and the hedge funds that ran alongside them— were the big beneficiaries of the twin housing and equity-market bubbles of this decade, their profits fed by an ever-increasing volume of transactions founded on a relatively small base [[dare I say, 'tiny'?: normxxx]] of actual physical assets. Each time a loan was sold, packaged, securitized, and resold, banks took their transaction fees, and the hedge funds buying those securities reaped ever-larger fees as their holdings grew.

Because everyone was getting richer, and the health of the national economy depended so heavily on growth in real estate and finance, no one in Washington had any incentive to question what was going on. Instead, Fed Chairman Greenspan and President Bush insisted metronomically that the 'FIRE'[1] economy was 'fundamentally sound'. The tremendous growth in complex securities and credit-default swaps was considered "evidence" of a healthy economy where risk was being distributed safely.

In the summer of 2007, signs of strain started appearing. The boom had produced so much debt that even a small economic stumble could cause major problems, and rising delinquencies in subprime mortgages proved the stumbling block. [[Which, ironically, was simply due to the fact that the increase of housing prices had merely slowed as the mortgage brokers simply ran out of warm bodies to sell houses to! So, all those in over their heads found that they could not (or any longer) 'refinance' and simply "walked away": normxxx]] Ever since, the US and other G7 financial sectors and central governments have been behaving exactly the way one would expect them to, in light of past emerging-market crises.

[ Normxxx Here:  For a while, the Euro Bank tried to resist— power in Europe, sans the UK, is not so concentrated in the financial sector as here or in the UK. But, in the end they are increasingly being persuaded to 'get on board' the piecemeal 'bailout program' by increasingly nasty local riots and 'events', and the bad examples of the UK and the US.  ]

By now, the princes of the financial world have of course been stripped naked as leaders and strategists— at least in the eyes of most Americans. But as the months have rolled by, financial 'elites' have continued to assume that their position as the economy’s favored children is safe, despite the wreckage they have caused. Stanley O’Neal, the CEO of Merrill Lynch, pushed his firm heavily into the mortgage-backed-securities market at its peak in 2005 and 2006; in October 2007, he acknowledged,
"The bottom line is, we— I— got it wrong by being overexposed to subprime, and we suffered as a result of impaired liquidity in that market. No one is more disappointed than I am in that result."
[[Not even "chagrined"!?!: normxxx]] O’Neal took home a $14 million bonus in 2006; in 2007, he walked away from Merrill with a severance package worth $162 million, although it is presumably worth much less today.

In October, John Thain, Merrill Lynch’s final CEO, reportedly lobbied his board of directors for a bonus of $30 million or more, eventually reducing his demand to $10 million in December. He withdrew the request, under a firestorm of protest, only after it was leaked to The Wall Street Journal. Merrill Lynch as a whole was no better: it moved its bonus payments, $4 billion in total, forward to December, presumably to avoid the possibility that they would be reduced by Bank of America, which would own Merrill beginning on January 1. Wall Street paid out $18 billion in year-end bonuses last year to its New York City employees alone, after the government disbursed $243 billion in emergency assistance to the financial sector. [["Have they no shame!?!" None. : normxxx]]

In a financial panic, the government must respond with both speed and overwhelming force. The root problem is uncertainty— in our case, uncertainty about whether the major banks have sufficient assets to cover their liabilities. Half measures combined with wishful thinking and a wait-and-see attitude cannot overcome this uncertainty. And the longer [an adequate] response takes, the longer the uncertainty will stymie the flow of credit, sap consumer confidence, and cripple the economy— ultimately making the problem much harder to solve. Yet the principal characteristics of the government’s response to the financial crisis have been delay, lack of transparency, and an unwillingness to "upset" the financial sector.

The response so far is perhaps best described as "policy by deal". When a major financial institution gets into trouble, the Treasury Department and the Federal Reserve engineer a bailout over a weekend and announce on Monday that everything is fine. In March 2008, Bear Stearns was sold to JP Morgan Chase in what looked to many like a gift to JP Morgan. (Jamie Dimon, JP Morgan’s CEO, sits on the board of directors of the Federal Reserve Bank of New York, which, along with the Treasury Department, brokered the deal.)

In September, we saw the sale of Merrill Lynch to Bank of America, the first bailout of AIG, and the takeover and immediate sale of Washington Mutual to JP Morgan— all of which were brokered by the government. In October, nine large banks were 'recapitalized' on the same day behind closed doors in Washington. This, in turn, was followed by additional bailouts for Citigroup, AIG, Bank of America, Citigroup (again), and AIG (again). [[So the Hummungous Banks and Brokers (HB&B) get ever bigger and fatter and "too big to fail"!: normxxx]]

Some of these deals may have been reasonable responses to the immediate situation. But it was never clear (and still isn’t) what combination of interests was being served, and how. Treasury and the Fed did not act according to any publicly articulated principles, but just worked out a transaction and claimed it was the best that could be done "under the circumstances". This was late-night, backroom dealing, pure and simple. [[Moreover, it has taken court action and subpoenas to drag out whatever information has been made public about what the Fed and Treasury are up to. Even congress is now issuing subpoenas to the Fed. (Remember, the Fed is not now nor ever has been a government body!): normxxx]]

Throughout the crisis, the government has taken extreme care not to "upset" the interests of the financial institutions, or to "question" the basic outlines of the system that got us here. In September 2008, Henry Paulson asked Congress for $700 billion to buy toxic assets from banks [[apparently the figure was literally arrived at by a back of the envelope calculation!: normxxx]], with no strings attached and no judicial [[or any other kind of: normxxx]] review of his purchase decisions. Many observers suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands— indeed, that is the only way that buying toxic assets would have helped anything. Perhaps because there was no way to make such a blatant subsidy politically acceptable, that plan was shelved.

Instead, the money was used to 'recapitalize' banks, buying shares in them on terms that were grossly favorable to the banks themselves. As the crisis has deepened and financial institutions have needed more help, the government has gotten more and more creative in figuring out ways to provide banks with outright subsidies too complex for the general public to understand. The first AIG bailout, which was on relatively good terms for the taxpayer, was supplemented by three further bailouts whose terms were more AIG-friendly.

The second Citigroup bailout and the Bank of America bailout included complex asset guarantees that provided the banks with insurance at [way] below-market rates. The third Citigroup bailout, in late February, converted government-owned preferred stock to common stock at a price significantly higher than the market price— a subsidy that probably even most Wall Street Journal readers would miss on first reading. And the convertible preferred shares that the Treasury will buy under the new Financial Stability Plan give the conversion option (and thus the upside) to the banks, not the government.

This latest plan— which is likely to provide cheap loans to hedge funds and others so that they can buy distressed bank assets at relatively high prices— has been heavily influenced by the financial sector, and Treasury has made no secret of that. As Neel Kashkari, a senior Treasury official under both Henry Paulson and Tim Geithner (and a Goldman alum) told Congress in March,
"We had received inbound, unsolicited proposals from people in the private sector saying, ‘We have capital on the sidelines; we want to go after [distressed bank] assets.’"
And the plan lets them do just that:
"By marrying government capital— taxpayer capital— with private-sector capital and providing financing, you can enable those investors to then go after those assets at a price that makes sense for the investors and at a price that makes sense for the banks."
Kashkari didn’t mention anything about what makes sense for the third group involved: the taxpayers.

Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change. As an unnamed senior bank official said to The New York Times last fall, "It doesn’t matter how much Hank Paulson gives us, no one [[Read: no bank: normxxx]] is going to lend a nickel until the economy turns". But there’s the rub: the economy can’t 'turn' until the banks are …willing to lend.

The Way Out

Looking just at the financial crisis (and leaving aside some problems of the larger economy), we face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector [[demonstrates its increasing ineptitude in the face of problems largely never experienced in the US before and: normxxx]] loses popular support.

Big banks, it seems, have only gained political strength since the crisis began. And this is not surprising. With the financial system so fragile, the damage that a major bank failure could cause— Lehman was small relative to Citigroup or Bank of America— is much greater than it would be during ordinary times.

The banks have been exploiting this fear as they wring favorable deals out of Washington. Bank of America obtained its second bailout package (in January) after warning the government that it might not be able to go through with the acquisition of Merrill Lynch, a prospect that Treasury did not want to consider. The challenges the United States now faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.

[ Normxxx Here:  There is just one major problem: these large banks have become so huge that it would take an army (literally thousands) of highly trained government agents to just oversee the operation!!! Naturally, they are nowheres to be had on such short notice— especially as the government has been 'downsizing', 'rightsizing', and otherwise hamstringing the financial regulators for some 28 years  ]

In some ways, of course, the government has already taken control of the banking system. It has essentially guaranteed the liabilities of the biggest banks, and it is their only plausible source of capital today. Meanwhile, the Federal Reserve has taken on a major role in providing credit to the economy— the function that the private banking sector is supposed to be performing, but isn’t. Yet there are limits to what the Fed can do on its own; consumers and businesses are still dependent on banks that lack the balance sheets and the incentives to make the loans the economy needs, and the government has no real control over who runs the banks, or over what they do.

At the root of the banks’ problems are the large losses they have undoubtedly taken on their securities and loan portfolios. But they don’t want to recognize the full extent of their losses, because that would likely expose them as insolvent. So they talk down the problem, and ask for handouts that aren’t enough to make them healthy (again, they can’t reveal the full size of the handouts that would be necessary for that), [[but are just enough to keep them upright just a little longer— at least until the current crop at the top retires: normxxx]].

This behavior is corrosive: unhealthy banks either don’t lend (hoarding money to shore up reserves) or they make desperate gambles on high-risk loans and investments that could pay off big, but probably won’t pay off at all. In either case, the economy suffers further, and as it does, bank assets themselves continue to deteriorate— creating a highly destructive vicious cycle.

To break this cycle, the government must force the banks to acknowledge the scale of their problems. As the IMF understands (and as the U.S. government itself has insisted to multiple emerging-market countries in the past [[— and not so emerging-market countries such as Japan: normxxx]]), the most direct way to do this is via nationalization. Instead, Treasury is trying to negotiate bailouts bank by bank, and behaving as if the banks hold all the cards— contorting the terms of each deal to minimize government ownership while forswearing government influence over bank strategy or operations. Under these conditions, cleaning up bank balance sheets is impossible.

Nationalization would not imply permanent state ownership. The IMF’s advice would be, essentially, scale up the standard Federal Deposit Insurance Corporation process. An FDIC "intervention" is basically a government-managed bankruptcy procedure for banks. It would allow the government to wipe out bank shareholders, replace failed management, clean up the balance sheets, and then sell the banks back to the private sector. The main advantage is immediate recognition of the problem so that it can be solved before it grows worse.

The government needs to inspect the balance sheets and identify the banks that cannot survive a severe recession. These banks should face a choice: write down your assets to their true value and raise private capital within 30 days, or be taken over by the government. The government would write down the toxic assets of banks taken into receivership— recognizing reality— and transfer those assets to a separate government entity, which would attempt to salvage whatever value is possible for the taxpayer (as the Resolution Trust Corporation did after the savings-and-loan debacle of the 1980s). The rump banks— cleansed and able to lend safely, and hence trusted again by other lenders and investors— could then be sold off.

Cleaning up the megabanks will be complex. And it will be expensive for the taxpayer; according to the latest IMF numbers, the cleanup of the banking system would probably cost close to $1.5 trillion (or 10 percent of our GDP) in the long term. But only decisive government action— exposing the full extent of the financial rot and restoring some set of banks to publicly verifiable health— can cure the financial sector as a whole.

This may seem like strong medicine. But in fact, while necessary, it is insufficient. The second problem the U.S. faces— the power of the financial oligarchy— is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break up the oligarchy.

[ Normxxx Here:  Seems to me FDR tried all that in 1933, but had only mixed success until 1937, when the stock market and economy crashed again (although the economy had never really recovered).  ]

Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs. Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical— since we’ll want to sell the banks quickly— they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.

This may seem like a crude and arbitrary step, but it is the best way to limit the power of individual institutions in a sector that is essential to the economy as a whole. Of course, some people will complain about the "efficiency costs" of a more fragmented banking system, and these costs are real. But so are the costs when a bank that is too big to fail— a financial weapon of mass self-destruction— explodes. Anything that is too big to fail is too big to exist.

To ensure systematic bank breakup, and to prevent the eventual reemergence of dangerous behemoths [[such as happened in the oil industry with Exxon, for example: normxxx]], we also need to overhaul our antitrust legislation. Laws put in place more than 100 years ago to combat industrial monopolies were not designed to address the problems we now face. The problem in the financial sector today is not that a given firm might have enough market share to influence prices; it is that one firm or a small set of interconnected firms, by failing, can bring down the [entire] economy. The Obama administration’s fiscal stimulus evokes FDR, but what we need to imitate here is Teddy Roosevelt’s trust-busting. [[Or maybe some of both! : normxxx]]

Caps on executive compensation, while redolent of populism, might help restore the political balance of power and deter the emergence of a new oligarchy. [[Salaries could be based solely on the size of the enterprise and 'incentive compensation' should be limited to special stock which must be held for a minimum of 10 years (or, say, for 5 years after leaving the firm).: normxxx]] Wall Street’s main attraction— to the people who work there and to the government officials who were only too happy to bask in its reflected glory— has been the astounding amount of money that could be made[[, especially in the short run, by deferring risks to the outyears— preferrably long after the 'risk taker' was long gone: normxxx]]. Limiting that money would reduce the allure of the financial sector and make it more like any other industry. [[Just like drug money!: normxxx]]

Still, outright pay caps are clumsy, especially in the long run. And most money is now made in largely unregulated private hedge funds and private-equity firms, so lowering pay would be complicated. Regulation and taxation should be part of the solution. Over time, though, the largest part may involve more transparency and competition, which would bring financial-industry fees down. To those who say this would drive financial activities to other countries, we can now safely say: fine.

Two Paths

To paraphrase Joseph Schumpeter, the early-20th-century economist, everyone has elites; the important thing is to change them from time to time [[not the individuals, but the sources of their prominence— eg, maybe back to manufacturing: normxxx]]. If the U.S. were just another country, coming to the IMF with hat in hand, I might be fairly optimistic about its future. Most of the emerging-market crises that I’ve mentioned ended relatively quickly, and gave way, for the most part, to relatively strong recoveries. But this, alas, brings us to the limit of the analogy between the U.S. and emerging markets.

Emerging-market countries have only a precarious hold on wealth, and are weaklings globally. When they get into trouble, they quite literally run out of money— or at least out of foreign currency, without which they cannot survive. They must make difficult decisions; ultimately, aggressive action is baked into the cake. But the U.S., of course, is the world’s most powerful nation, rich beyond measure, and blessed with the exorbitant privilege of paying its foreign debts in its own currency, which it can print. [[Apparently without limit! : normxxx]]

As a result, it could very well stumble along for years— as Japan did during its 'lost decade'— never summoning the courage to do what it needs to do, and never really recovering. A clean break with the past— involving the takeover and cleanup of major banks— hardly looks like a sure thing right now. Certainly no one at the IMF can force it. [[Nor anyone in our government— Democrat or Republican— apparently : normxxx]]

In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign.

Boris Fyodorov, the late finance minister of Russia, struggled for much of the past 20 years against oligarchs, corruption, and abuse of authority in all its forms. He liked to say that confusion and chaos were very much in the interests of the powerful— letting them take things, legally and illegally, with impunity. When inflation is high and rampant, who can say what a piece of property is really worth? When the credit system is supported by byzantine government arrangements and backroom deals, how do you know that you aren’t being fleeced?

Our future could be one in which continued tumult feeds the looting of the financial system, and we talk more and more about exactly how our oligarchs became bandits and how the economy just can’t seem to get into gear.

The second scenario begins more bleakly, and might end that way too. But it does provide at least some hope that we’ll be shaken out of our torpor. It goes like this: the global economy continues to deteriorate, the banking system in east-central Europe collapses, and— because eastern Europe’s banks are mostly owned by western European banks— justifiable fears of government insolvency spread throughout the Continent. Creditors take further hits and confidence falls further.

The Asian economies that export manufactured goods are devastated, and the commodity producers in Latin America and Africa are not much better off. A dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees. The baseline growth rates used in the administration’s current budget are increasingly seen as unrealistic, and the rosy "stress scenario" that the U.S. Treasury is currently using to evaluate banks’ balance sheets becomes a source of great embarrassment.

Under this kind of pressure, and faced with the prospect of a total national and global collapse, 'minds may become much more concentrated'.
Or, as Dr. Samuel Johnson expressed it so succinctly: "Nothing concentrates the mind so wonderfully as the prospect of one's own hanging in a fortnight."

The conventional wisdom among the 'elite' is still that the current slump "cannot be as bad as the Great Depression". This view is wrong. [[Dead wrong! What is really meant (and probably true) is that it will not be a 'replay' of the Great Depression. : normxxx]] What we face now could, in fact, be worse than the Great Depression— because the world is now so much more interconnected [and interdependant,] and because the banking sector is now so big.

We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances. If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. Let us hope it is not then too late.


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