What AIG Wants . . .

As predicted in EBR months ago, the "G30" organization, which cooked up a plan to codify all the gambling tactics such as credit default swaps and collateralized debt obligations that have helped cause the unnecessary and sad turmoil of the past two years, is going to have the Obama administration support their plan to continue to allow "too big to fail financial firms" to exist, to allow these toxic derivatives to continue to exist, but to enlarge government which will allegedly "regulate" them better.

While Paul Volcker is associated with the G30, the real leader is Jacob Frenkel.  He is (was?) a senior executive at a large multinational financial firm that has recently been in the news because of certain bonuses.  Care to guess?  Obviously, AIG.  So a group led by an AIG exec, and is apparently sponsored by Riskmetrics, which wants to make more money by purporting to manage financial risk, is going to get its way.  Whatever AIG wants, AIG gets, apparently.  

It is easy to forget that S&L's were regulated and then collapsed, banks and financial companies are and have been regulated, etc.  Regulation of crooks does not work.  What did work was Glass-Steagall.  Bring it back.  And channel FDR, who repeatedly inveighed against letting banks ever get too large again.  He was right.  Ban over-large banks.  Ban credit default swaps.

Banking should be simple, safe, boring, etc. 

We need a re-examination of modern finance, not AIG's recommendation to regulate our industry so we can outfox our regulators again.  We also need to re-examine why there should be insurance for other than small depositors of banks.  Australia, which until the current crisis had no depositor insurance, has never had a bank failure.  The way it is now, it is easy for a couple to put a million dollars into the same bank with somewhat different account titling and have it all insured by the FDIC, even if the couple knows the bank is in financial trouble.  Any couple with a million dollars can afford to do a little homework and deposit that money with a financially strong bank and not have the system guarantee such a large amount of money.  If that couple wants absolute security, it can buy Treasuries directly. 

Financial bubbles are historically rare events, yet we have had the bursting of two of them this decade.  This can only be in relation to the corruption that I heard about personally near the end of the Clinton presidency from a very, very well-connected individual from a very, very well-connected family, which was that his family, which had been well-connected for generations, had never seen Washington so corrupt as then, in a bipartisan manner.  Bull markets can occur and go to excess, but it takes regulatory forbearance (or worse) to allow a bubble to be blown to the size that its crash is heard round the world.

This is why we have seen no Pecora Commission to investigate matters.  

People have begun to realize that Bernie Madoff was no isolated loon.  The American International Group, which in some sense has written the regulatory proposal that Tim Geithner is presenting today, outdid him.  And Madoff at least "paid" dividends.  AIG hardly even deigned to pay other than completely nominal dividends until the jig was nearly up, and then in a desperate attempt to keep investors on board, it began a program of dividend increases.

The stock market made its final bottom of the 2000-2003 bear market at about 7500 about six years ago.  That would roughly relate to 9000 Dow points in today's depreciated dollars.  So, in real dollars (the only kind that economists use), stocks are still well below the 2002-3 lows.  A form of futures in stock dividends forecasts an over 40% decline in dividends in the next two years. So on the most fundamental aspect of investing- income stream on the invested funds- stocks appear to face major headwinds, as well as having a weak chart pattern.

In contrast, stocks were fundamentally undervalued relative to Treasuries for a long period from the 1940s into the 1960s, when secure (in retrospect) and rising dividends, often in the 5-7% per year range, contrasted with 3% or lower Treasury rates.  This situation does not exist today, even without adjusting for the expected substantial dividend cuts.

What is the one financial asset that has continually trended upward ever since the Internet/stock bubble burst in 2000?

Gold.

Copyright (C) Long Lake LLC 2009

Complacency Already?

What a difference 20% makes!

EBR's proprietary Bloomberg.com video review is flashing its first contrary warning signal in some time.

Here are summaries of the headlines of each of the six different featured videos as of now:

1.  Geithner says the USD remains the reserve currency (Whew!);

2.  Corcoran's Liebman bullish on housing;

3.  Someone named Pinalto predicts recession will end this year (this passes for bullish nowadays);

4.  Bob Doll of Blackrock says stocks are in a bottoming process (he alone is a marvelous contrary indicator);

5.  Someone with the wonderful name of Brynjolfsson likes the Fed's move to purchase Treasuries (forty years ago I would have wanted some of whatever he's smoking!);

and perhaps best of all, the  inscrutable:

6.  "Grose Says Globalfoundries Meets Licensing Requirements".

So we have 5 of what passes for bullish comments given that the MSM now accepts that the economy is actually in a banana, and one "huh?" video caption.  That's problematic.

In addition, there may be some confusing language coming out of various commentators.  CR of Calculated Risk stated today:

. . . And that means the recession is moving to the lagging areas of the economy.

It is not clear what CR means by that, but whether or not the stock market has bottomed, it is highly unlikely that the economy has bottomed.  In other words, the economic indicators that predict the course of the economy months out are predicting that conditions will get much worse.

For example, the Economic Cycle Research Institute's coincident indicators are only down 5% year on year.  However, ECRI's indicators that look forward many months are down 24% year on year, and one year ago they were already down 10% year on year.  This about 34% decline in total of their leading indicators is by far a record for this organization that began operations in the late 1940s.  What it says is that there is likely much worse to this economic banana coming than has ever occurred since the Great Depression, and we have already witnessed the implosion of the U. S. housing and auto industries, plus of course the bankruptcy and bailouts of essentially all of the leading financial companies in the country.

Sheila Bair added to the optimism as quoted yesterday:

FDIC’s Bair Says Signs of Credit ‘Thawing,’ Banks Making Money 

By Steve Geimann

March 24 (Bloomberg) -- Federal Deposit Insurance Corp. Chairman Shiela Bair said steps to help the financial industry are working, and some banks are starting to make money.

“We are seeing some signs of thawing,” Bair said in an interview on Bloomberg Television. “Many banks are making money.

‘‘I’m starting to get more optimism,’’ Bair said. 

When Ms. Bair has to come on Bloomberg to tell you of her mood (optimistic), you must pretend that you have ice water in your veins and resist this blandishment with all your strength.  Her own agency, the FDIC, is facing bankruptcy (the Gov't will bail them out). Whether or not she is lying through her teeth about her mood is irrelevant.  Sheila Bair is worried about much more than the level of the stock market or the price of gold.  She simply wants the banking system to survive in a way that it did not in 1930-33, when one of every three banks went bust.  Whether the Dow hits 4000 in the meantime is irrelevant to her.

Copyright (C) Long Lake LLC 2009

 

Non-Defense Durable Goods Orders Plummet Year on Year

Manufacturing information is out from the Government.  The headline the Gov't wants you to see is that new orders for durable goods rose 3.4% from January.  

However, what the press release mentions but does not highlight are the following two statistics:

Compared with one year earlier, shipments were down 19.5%, and excluding defense orders, they were down 21.1%.  

New orders were down 28.4% year on year, and were down almost 30% (29.6%) excluding defense.

Think of the irrelevance of a 3% month to month gain in the face of this cataclysmic decline.  If the value of a stock dropped from 100 to 70 in one year, how good would you feel if in the thirteenth month you owned it, the price rose to 72?

Also, in what is becoming much too common for comfort, in the larger category of all manufactured goods (not just durable goods), new orders volume was revised downward by $5 Billion, to $347 Billion.  Why is it that all the revisions are downward?

Let us remember that February 2008 was not some wild boom time.  For new non-defense order to be down 30% year -on-year is unbelievable.  The term "recession" appears inadequate, thus this blog channels Herb Stein from the Ford Administration and calls this downturn a banana.  

In the face of numbers such as this, and failed government bond auctions today in the U. K. and recently in Germany, Governments are going to have to tighten their belts and share the pain.

How can anyone believe that the markets will let the U. S. Government throw vast sums of money into financial companies as well as auto manufacturers without the pain being felt by the owners (shareholders) of those companies and those who have been getting interest payments by lending money to those companies (bondholders)?  And even if the markets would allow it, what is fair about such a scheme?

The truth is that we need to rebuild our economic and financial structures by consuming less than we produce.  That's the old-fashioned way:  you earn money (profits or wages), then you save what you can, then you try to do productive things with the savings.  You don't help yourself by borrowing money from poor Chinese and you certainly get nowhere by simply printing it.

Copyright (C) Long Lake LLC 2009

Another Call for a Pecora Commission

The following call for a new version of the Pecora Commission escaped by notice till now. William Black was a senior regulator during the S&L debacle and is now an associate professor at the U. of Missouri.  In "Why is Geithner Continuing Paulson's Policy of Violating the Law?" (Feb. 23, 2009) he wrote:

Whatever happened to the law (Title 12, Sec. 1831o) mandating that banking regulators take "prompt corrective action" to resolve any troubled bank? The law mandates that the administration place troubled banks, well before they become insolvent, in receivership, appoint competent managers, and restrain senior executive compensation (i.e., no bonuses and no raises may be paid to them). The law does not provide that the taxpayers are to bail out troubled banks. Treasury Secretary Paulson and other senior Bush financial regulators flouted the law. (The Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) are both bureaus within Treasury.) The Bush administration wanted to cover up the depth of the financial crisis that its policies had caused.

Mr. Geithner, as President of the Federal Reserve Bank of New York since October 2003, was one of those senior regulators who failed to take any effective regulatory action to prevent the crisis, but instead covered up its depth. He was supposed to regulate many of the largest bank holding companies in the United States. Far too many of these institutions are now deeply insolvent because the banks they own are deeply insolvent. The law mandated that Geithner and his colleagues place troubled banks in receivership long before they became insolvent. Why are the banking regulators, particularly Treasury Secretary Geithner, continuing to disobey the law?

We need a Pecora investigation

We can understand now why the administration and so many committee chairs are virulently opposed to the single most essential step we need to take to diminish future crises -- a modern Pecora investigation. Pecora was the prosecutor hired by the Senate banking committee to investigate the misconduct that helped cause the Great Depression. You must vigilantly study past failures to learn causation and to enact remedies. If we were dealing with a crisis of airplane crashes and someone opposed studying the causes of the failures we would (correctly) label him a lunatic. Congress largely stopped conducting meaningful oversight hearings of financial regulation during the Bush administration. The results were horrific. It appears that only intense public pressure will suffice to overcome congressional and administration resistance to a Pecora investigation. I hope readers will add their voices to this call.

This blog called months ago for a modern version of the Pecora Commission.  Senator Shelby of Alabama has joined that call recently.  

Britain ruled the world's financial system throughout the 19th century.  It had no banking crises.

The U. S. has had two major banking crises in the past twenty-or-so years.  Why?

The fixes proposed are alleged by Mr. Black to be illegal and also designed to allow criminals to avoid prosecution:

We have a law that says when banks are at or near insolvency private shareholders should be eliminated unless we can arrange a transaction that has no cost to the FDIC. Receiverships produce "private institutions." The FDIC manages the failed institution only long enough to get it in shape to be sold at the least cost to the taxpayers. Receiverships end unnecessary bailouts of private shareholders, reducing the cost to the FDIC, as the law requires. Receiverships place banks back in the hands of new shareholders. Geithner has so twisted the framing of this issue that he is warning that a cheaper, more effective means of resolving failed banks used under President Reagan is some alien form of socialism that President Obama must slay before it destroys capitalism. Geithner is channeling Rove when he conflates receiverships with "nationalization."

Secretaries Paulson and Geithner subverted the PCA law by allowing failed banks to engage in massive accounting fraud (which also means they are engaged in securities fraud). Treasury is telling the world that resolving the failed banks will require roughly $2 trillion dollars. That has to mean that the failed banks are insolvent by roughly $2 trillion. The failed banks, however, are reporting that they are not simply solvent, but "well capitalized." The regulators flout PCA by permitting this massive accounting and securities fraud. (Note that by countenancing this fraud they make it extremely difficult to ever prosecute these elite white-collar frauds.)

Under the current Obama-Geithner plan, all the burden falls on taxpayers, except for the minor exception that dividends on common stock have been cut.  An obvious and major subsidy is inherent in the bailout proposal, as it guarantees above-market pricing for the bad securities the financial institutions hold.  Further, there are massive conflicts of interest here.  Blackrock, in which Bank of America has a substantial stake, is going to be a major bidder (read purchaser) of these securities.  How on earth can Blackrock be allowed to take part in this?

If you would like to see more current commentary on the Obama-Geithner bailout plan, Mish has had a recent series of posts that are harshly critical, most recently wondering how on top of all the mess he has made as head of the New York Fed for years and now as Treasury Secretary, Mr. Geithner can request sweeping powers to bail out or close down whatever companies he wants with minimal checks and balances ("Geithner's Arrogance Knows No Bounds").

Finally, now that the headlines have moved away from AIG, the compensation diversion is petering out in the Senate.  This has been a largely successful tactic so that there was no focus on the real scandal, the tens of billions of dollars that went to AIG's gambling buddies (many of them foreign) to make them whole dollar for dollar.

The Fed today is beginning open-market purchases of Treasuries.  Also in the news is that the sale of 40-year bonds by the Government of the United Kingdom failed to attract bids for as much as was on sale, thus representing a failed auction for the first time in 14 years.

In the U. S., production of automobiles and homes is at levels last seen decades ago.  Even if they rebound, so what?  As with so many other matters, this is just not supposed to happen. Period.

This is such an extreme environment that in deciding what to do with investments, business tactics and strategy, and the like, reasoning from historical analogy makes less sense than usual.

Copyright (C) Long Lake LLC 2009

Tuesday Afternoon Markets Update

Well, there's been a bit of sturm und drang in the markets lately.  Barack Obama may already be in the stock market's history book:

The S&P 500’s gain yesterday pushed the index’s increase since sinking to a 12-year low on March 9 to 22 percent, the steepest two-week advance since 1938.

The S&P 500 needed only 10 days to enter a bull market after taking seven weeks to fall 20 percent and give President Barack Obama a bear market.

Who knows how many more swoons and surges the next 46 months will see?

The financials are strong recently, but among the big 4 banking companies, only JPM has definitively penetrated its 50 day moving average; WFC, BAC and C remain in confirmed downtrends.  So are AXP and GE.  The large cap financial with a promising chart is NTRS, which has penetrated its 200 day MA and for which the 50 day MA is in an uptrend, unlike JPM.

Fundamentally worrying re the financials is the recent hype, which elicited these comments in a Bloomberg.com article this morning:

Already, some banks are bragging that they are starting to make money on an operating basis from trading profits and bigger lending margins.. .

It could create even more chaos in the financial system if some banks gave back the TARP money, only to howl soon after that they still needed it after all. "We see another $1.5 to $2 trillion of as yet unrecognized losses from U.S. assets still to hit global financial sector balance sheets and challenge its institutions," said Daniel Alpert, a managing director of Westwood Capital.

"The near daily announcements over the past two weeks, by money-center banks and finance companies, that they are making money this year on an operating income basis, have become borderline irresponsible, relative to continued deterioration in value of the assets on their balance sheets and the continuing impact of a worsening recession," he added.

It smells like a manipulated rally in the financials.  Any bank that is not booking operating profits when its cost of money is close to zero should be liquidated on a variety of grounds.  The Fed is guaranteeing operating profits.  Solvency, however, is not so simple, even with the Geithner gift (TARP III or whatever you call the latest bailout plan).

The major technical problem with the stock market is the almost complete disappearance of leadership.  Last year, at least we had WMT and MCD.  These are at best starting over.   This year, everything takes its turn moving up and, to date, collapsing.  Especially weak is Procter & Gamble (PG), which is worrisome.

Fundamentally, with the economy definitely in a severe downturn, where oh where can the cash come from to fuel a lasting rally?  It would seem that the Fed and the Feds are much too busy keeping the financial system afloat and trying to gin up some inflation- anywhere- to create so much money that much of it seeps into stocks.

Re Treasuries, what can you say about a Fed that is so desperate to accommodate the Feds' borrowing needs that it feels it needs to print money to help create a market for the world's most tradeable notes and bonds?  The classic response is to sell if you happen to own the specific securities that they are buying.  However, Bernanke et al are no dummies.  Do they really intend to generate big losses by buying Treasuries at expensive prices?  A conundrum, to be sure . . .

Gold remains in an uptrend but feels a bit tired and temporarily overexposed to the public, and has characteristics of MCD before it rolled over.  Diversified accounts definitely want exposure to gold, but physical possession is emphasized.  A significant drop in the gold price, even if much higher prices are in the offing, is a strong possibility in a future liquidity panic a la last year's panics.

Silver actually has a stronger chart than gold.  Each metal can be heavily manipulated both on the short and long sides.  When cash silver outperforms cash gold in a basically deflationary environment for raw materials, as has been the case for the past 3 months, I want to look for the rat even if I can't smell it, and not chase any rallies.  The only reason gold is priced where it is versus other commodities is as an alternative currency, not as an inflation hedge, so silver outperforming gold as the world economies nosedive appears illogical.

Longer term, the very bright SocGen strategist James Montier recently wrote this about gold:

Of course, recently everyone has been talking about gold (not hugely surprising given that it is up some 30% since late October) - something that makes me nervous. However, gold is institutionally massively under-owned, so whilst it may have been moving up the list of attractive assets of individual investors (if the EFTs are anything to go by) and sensible hedge funds (such as the likes of Greenlight, Paulson, Third Point, Eton Park and Hayman), the mainstream institutional appetite for it has remained depressed.

Overall, these are headline-driven, governmentally-influenced markets which ultimately will follow the rules of markets in that they will seek fair value, but in the short term are impossible to trade with any confidence without receiving a phone call from that certain someone with a name such as Timothy or Ben.

Copyright (C) Long Lake LLC 2009

Banksters of the World Unite: Set Our Bonuses Free

I woke up truly intending to comment on markets and hardly at all on the Treasury banking scheme, but there is simply enough good new stuff on it that for all intents and purposes proves that the "rip-off" characterization used in my quick take on the plan mid-day yesterday is correct, that one more post appears appropriate. 

One of the deans of financial/economic blogging is "Calculated Risk" (www.calculatedriskblog.com).  "CR" is as fair-minded as any financial blogger I have seen.  Here is his post from late last night.  ("Tanta" is his now-deceased former partner in the blog, and a mortgage specialist, as you will guess when you see the part relating to her.)  It would appear that CR has turned against the Treasury proposal.  CR's post from 10:19 PM March 23:

Austan Goolsbee, of the White House Council of Economic Advisers responds to Paul Krugman on Hardball. (ht (= hat tip) David)

A couple of comments: Goolsbee claims "if the private guy makes money, the government makes money. If the private guy loses money, the government loses money." Goolsbee is correct on an individual pool, but investors can buy multiple pools and Nemo has an excellent example of how the investors can make money, and the government lose money. 

Goolsbee should read that example.

At 4:40 Goolsbee essentially agrees with Krugman's column:

[T]he Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.

It's not a complete one-way bet on any individual pool because the investors do put a small amount of money down - and that small amount is at risk. But Krugman was referring to the non-recourse debt and he is correct.

BTW, Tanta once ripped Goolsbee - very funny: Dr. Goolsbee: I’ll Stop Impersonating an Economist If You Quit Underwriting Mortgage Loans 

DoctoRx again.  CR's post references Nemo's "Self-Evident" blog, which, in two parts, dissects the math of the giveaway.  It's readable, for those with real interest in the details.

Note that the giveaway is both to the financial institutions and the buyers of their garbage.  The losers are everyone else.

The Wall Street Journal also has a telling article today, "Obama Dials Down Wall Street Criticism".  Here are some quotes.  I especially like the mention of Rahm Emanuel's recent career choice (NOT community organizer!).

WASHINGTON -- The Obama administration, after months of criticizing Wall Street, has been scrambling to woo top bankers and financiers to back its latest bailout plan.

 (Ed:  "Woo" = "bribe", money being the only language banksters respond to.)

The administration's initial approach contrasted with those of the last two White Houses. Robert Rubin left Goldman Sachs Group to become one of Bill Clinton's top economic advisers, and convinced the new president that what was good for Wall Street was good for America. Under President George W. Bush, the administration "looked up to and admired Wall Street," says one banker. "The Obama folks don't even like us."

(DoctoRx here.:  But that's all over now.  Hundreds of billions in Federal money is much better than "like".  It's true love.)

Goldman Sachs President Gary Cohn saw the contrast in person when he visited Chief of Staff Rahm Emanuel in early March. Goldman executives wanted to be part of the dialogue reshaping their industry, according to one Goldman executive. Instead, Mr. Emanuel lectured about how Wall Street "mispriced risk" and then expected Uncle Sam to pay the price for it. "My shareholders are called taxpayers," said Mr. Emanuel, who had previously worked for about two years as an investment banker.

The article concludes:

The banks' message: If you want our help to get credit flowing again to consumers and businesses, stop the rush to penalize our bonuses.

(DoctoRx here.:  That's why they call them banksters!)

The Administration has put lipstick on the TARP pig.  This pig is worse in many ways more porcine than the initial Paulson-Senate "TARP I" bailout pig, in which at least in theory the Government had as much chance of making money as losing it but where Wall Street had only a minor middleman role, and from which Congress and Paulson quickly ran away.  But to be a bankster means never having to say you're sorry and never ever stop working to take other people's money.

Once again the Government is siding with the giant financial companies rather than ordinary citizens. In the people vs. the powerful battle, the powerful win again.  We are getting Hoover when we need FDR.  

Any surprise why Wall Street voted "Aye" yesterday?

But for taxpayers, the correct word is . . .

"Oy!".

Copyright (C) Long Lake LLC 2009 

More on Treasury's Plan for Toxic Assets

Given its importance, perhaps there are some people who would like a summary of comments across the Web on the Obama-Geithner plan to deal with bad assets on the books of large complex financial companies.

Now that I have read numerous comments, I remain appalled.  Please see, e.g., Krugman's analysis in the first section below.  The taxpayer is taking almost all the risk for only half the upside.  Better the taxpayer take all the risk for all the upside.  Even better, the bond holders need to pay.  That's simply how it is in business.  

Two of the leading sites for commentary are Nouriel Roubini's RGE Monitor (subscription required) and the real estate-oriented blog, Calculated Risk (www.calculatedriskblog.com).

Here are excerpts from each website presenting opinions.  In addition,   First, from RGE Monitor:

• Reactions:

• FT Alphaville: At the heart of this complex plan is liquidity, which Geithner has identified as both the problem and the answer. Increase liquidity and assets price will rise towards fair value, banks’ capital ratios will improve and they will start lending again. What if value of assets is low because of reduced cash flow expectations--> see also 'Fire-Sale' Vs. 'Hold-to-Maturity' Prices: Is The FASB Yielding To Pressure From The Industry? 
  
• Alea: The plan is good in theory as private investors have no incentive to overpay because they are in a first-loss position. However, there is likely to be a gap between the mtm value of the toxic assets and what a rational investor would pay, reducing or eliminating the incentive for banks to participate. Only the truly cash-starved banks will jump.
• Blog comments: private investors will take long positions in the selling banks’ stocks (or other long positions in derivatives) and will then have an incentive to grossly overpay for the securities in this program. They’ll gladly take some losses in this program to boost their other positions outside the program.  
  
• Krugman: Huge taxpayer subsidies to the private sector are involved: Suppose that there’s an asset with an uncertain value: there’s an equal chance that it will be worth either 150 or 50. So the expected value is 100. But suppose that I can buy this asset with a non-recourse loan equal to 85 percent of the purchase price. How much would I be willing to pay for the asset? The answer is, slightly over 130 [in a competitive auction.] Why? All I have to put up is 15 percent of the price — 19.5, if the asset costs 130. That’s the most I can lose. On the other hand, if the asset turns out to be worth 150, I gain 20. So it’s a good deal for me.
• cont.: Another way to say this is that by financing a large part of the purchase with a non-recourse loan , the government is in effect giving investors a put option to sweeten the deal.
• John Mauldin (via TechTicker): I'm in the hedge fund business myself but as a taxpayer I don't believe Treasury should subsidize hedge funds.

Next, from CR's post, first showing commentary from Wells Fargo (surprise, they like having money thrown at them) and then CR's personal comments:

“My gut reaction is that this is an excellent plan. This plan will go a long way toward getting banks in better position to lend more aggressively and break the deleveraging feedback loop that is now in place."
Scott Anderson, senior economist, Wells Fargo

I think this is a myth that banks will lend "more aggressively" once the toxic assets are off their balance sheets. To whom? Perhaps Anderson is making the moral hazard argument here - maybe he is saying since the banks (and their investors) are being bailed out with above market prices for toxic assets that they will once again engage in risky lending. I hope that isn't his argument. 

The key problem with the Geithner plan is that it incentivizes investors to pay more than market value for toxic assets by providing a non-recourse loan and with below market interest rates. (See Krugman on the price impact of a non-recourse loan). The investors do not receive this incentive, the banks do. And the taxpayers pay it, so this is a transfer of wealth from taxpayers to the shareholders of the banks.

Finally, I take the liberty of posting all of a somewhat lengthy commentary from the blog Information Arbitrage (www.informationarbitrage.com), because this blogger, Roger Ehrenberg, also presents his own plan and how it is superior, in his view, to Treasury's plan:

March 23, 2009

The PPIP: It's NOT the Liquidity, Stupid. It's the Marks.

You can say something about the current Administration: they are really trying. The recently released Public-Private Investment Program ("Program") details show both a lot of thought and some really good ideas. Unfortunately, the essence of the Program and its messaging are still missing the boat on a few important fronts. The main issue: the Government perceives the problem to be one of investor liquidity and the ability to finance broken asset portfolios. The problem is that they are wrong. It is all about banks not wanting to own up to inflated balance sheet values. But here are some other problems with the Program and its positioning:

• Still enamored with short-term stock market movements. Larry Summers stated that the Administration is "gratified" by the stock market's reaction to the Program. Why, oh, why, do Senior Government officials, especially those with ostensibly high IQs, say such stupid things? Guys, the focus should be on doing the right thing for the long-term, not on what will goose the market for a day or two. And while Summers et al claim to be all about the long term, then why do they keep on talking about stock market reactions to policy decisions? If there is one thing we know for sure, it's that the market is very, very jittery and volatile, and is apt to make sharp moves in response to almost any news. While the Dow could rally 500 points today, it could just as easily fall 500 points if liquidity fears rear their ugly head, another bank runs into trouble, populist rantings by Congress spook the markets, Pandit is given a long-term employment contract, etc. Bottom line: the Administration needs to stop talking about and caring about short-term stock prices. Stock prices are not unlike the Treasury yield curve: easy to manipulate on the short-end, difficult if not impossible to impact for a sustained period on the long end.     

• Forgetting the appetite of the supply side. The Program, with all the benefits provided to approved buyers - equity matching funds, cheap leverage, etc. - lists only a single line when addressing a key weakness: Participant Banks don't actually have to participate. Participant Banks can submit portfolios for auction, Approved buyers can line up, valuation firms can estimate the worth of portfolios submitted for auction, buyers can submit their bids and Participant Banks can say: no. I fail to see how the Program is a material departure from the current landscape, except for the fact that the Government is providing cheap financing. The buyers are still running equity risk regardless of the 1-1 Government match (as they should), and will only submit bids that reflect their assessment of risk and return. This may result in prices that are still far out-of-line with current bank carrying values, causing banks to reject the highest bids in a move to avoid further asset write-downs. So even a protracted auction process could result in a whole lot of nothing. What does Larry Summers think a failed auction will do to stock prices? I shudder to think.

• Perpetuating entrenched and failed managements. The Program is a vehicle for helping broken firms liquify broken asset portfolios. What it doesn't do is help broken firms get rid of broken managements that got us into these problems in the first place. In the rush to protect major lenders from going out of business (and protecting stockholders and debtholders in the process), the US taxpayer is given scant protection from the cadre of poor leadership teams that led firms into troubled waters. Why is AIG the sole whipping boy for the Government when plenty of other firms were complicit in damaging the financial system? While legacy AIG management deserves much of the scorn they've received, most broken bank executives have gotten off with nary a scratch. This I do not understand.

• Not reflecting the true magnitude of the Government's involvement in the numbers. If I read the materials properly, it seems as if the only money being counted against TARP are the equity matching funds being provided. What about the leverage being guaranteed by the FDIC? Depending upon the values realized for the purchased portfolios, those guarantees might come into play, increasing costs well beyond the equity commitments. This is more an issue of truth-in-advertising. While yes, having the private sector side-by-side is a good thing, the Government via the FDIC is providing the debt guarantee. If this isn't incremental exposure to the US taxpayer, then I don't know what it is. This needs to be clearly factored in as an explicit cost of the Program. 

My program, as discussed many, many times on this blog, is different than PPIP in one major respect: it does not rely upon the banking sector's willingness to participate; it forces the issue. Maybe banks will finally be willing to separate themselves from loan and securities portfolios at prices less than their marks. But I don't think so. The Government's plan is predicated upon the assumption that a lack of investor liquidity is the issue. But they are wrong. The issue has almost nothing to do with investor appetite and everything to do with banks avoidance of facing into the market values of their portfolios. And when push comes to shove, they will beg off and avoid selling into auctions that will validate the inadequacy of their capital positions and invalidate the quality of their marks. The only way they will do do is by force. This means Good Bank/Bad Bank, Crisis Style. 

Why is the Government wasting so much time and taxpayer money dancing around the issue? If my read of the situation is wrong and the Program is a smashing success, I'll be the first one to say so on this blog. But if my perception is right - the same perception I've had for, oh, nine months - then I'd like Treasury, the Fed, the FDIC and the President to move quickly to address the toxic asset issue once and for all. The PPIP contains many of the mechanics necessary to pull of Good Bank/Bad Bank: the main difference is compelling the supply side - the big, broken banks - to participate. Guarantee depositors funds without limit. But say goodbye, stockholders. Goodbye, unsecured debtholders. Goodbye, loser managements. Hello private investment in Good Banks. Hello, private investment in Bad Bank assets with profit sharing along with the US taxpayer at current market levels. Can't we just skip the PPIP and go straight to this? Because we know who will participate in my program: Everybody.

Copyright (C) Long Lake LLC 2009

Geithner Unveils Public-Private Rip-Off Plan

Treasury has finally come clean with its latest plan to save its friends in the financial community, which can be viewed at www.treas.gov/press/release/tg65.htm.

Here are some preliminary thoughts, pending a review of commentary from various sources.

1.  If this is a good deal for big money investors, then the public should be allowed to participate, such as through an exchange-traded stock vehicle or a mutual fund.  The fact this is almost certain to not happen is strong evidence that this is a deal for the benefit of the big money financial community.

2.  The press release repeatedly describes the "legacy" securities as having dropped to "fire sale" prices.  Treasury is lying.  There are only fire sale prices after a fire or similar event, in which damaged goods or a damaged facility means that "everything" must go.  What we have here are securities which have potential buyers, but the owners of the securities, the large "banks" (more on that later) simply have used their political clout to avoid selling them at market prices.  These champions of the free market made horrendous decisions to put the dreck they sold around the world on their own balance sheets, and now they want the taxpayer to take them out of their positions.  But where's our bailout?

3.  The press release describes these large complex financial institutions as banks.  However, what they really are, to varying degrees, are gambling holding companies which have a subsidiary or two that engage in plain vanilla depository functions.  The old rule is that whoever controls the vocabulary controls the debate.  So, people will support helping "banks".

They would not support bailing out Citigroup, which engages in all sorts of systemically unimportant functions, principally gambling (usually with a stacked deck).

4.  Why do the owners of the corporate debt of these companies continue to be made whole?  Why should working people subsidize these investors whose investment is impaired?

5.  The FDIC is itself facing bankruptcy and will likely need a vast bailout.  This plan relies onan  FDIC backstop.  This in turn places further strain on the good guys, the plain vanilla community banks that tended to their knitting, who because they mostly only engage in traditional deposit-based banking functions, pay a much higher percentage of their revenues than does Citigroup, which derives most of its revenues from other functions, for which FDIC assessments do not come into play.

6.  Because private money is going to be leveraged with taxpayer/FDIC money, the private investors will overpay for the assets.

7.  The entire justification for this plan is wrong.  Taxpayers and the entire banking system are supposed to continue to throw lots of money at the very companies that finally lost at the roulette table, allegedly so that these companies can resume making profits by lending us our own money.  Let us keep our money in the first place.  Any assistance should go not to the money center villains but to the much more virtuous smaller banks, who never robbed their shareholders or the public and are well positioned to grow in a sound manner.

Copyright (C) Long Lake LLC 2009

Thoughts on the Vegetable Garden

Yesterday, the New York Times had an article, "Is a Food Revolution Now in Season?" on organic and local foods, keying off of the White House vegetable garden.

Here are some early paragraphs:

Although unit sales of organic food have leveled off and even declined lately, versus a year earlier, the mood among those crowded into the conference room was upbeat as they awaited a private screening of a documentary called “Food Inc.” — a withering critique of agribusiness and industrially produced food.

They also gathered to relish their changing political fortunes, courtesy of the Obama administration.

“This has never been just about business,” said Gary Hirshberg, chief executive of Stonyfield Farm, the maker of organic yogurt. “We are here to change the world. We dreamt for decades of having this moment.”

After being largely ignored for years by Washington, advocates of organic and locally grown food have found a receptive ear in the White House, which has vowed to encourage a more nutritious and sustainable food supply.

The most vocal booster so far has been the first lady, Michelle Obama, who has emphasized the need for fresh, unprocessed, locally grown food and, last week, started work on a White House vegetable garden. More surprising, perhaps, are the pronouncements out of the Department of Agriculture, an agency with long and close ties to agribusiness.

In mid-February, Tom Vilsack, the new secretary of agriculture, took a jackhammer to a patch of pavement outside his headquarters to create his own organic “people’s garden.” Two weeks later, the Obama administration named Kathleen Merrigan, an assistant professor at Tufts University and a longtime champion of sustainable agriculture and healthy food, as Mr. Vilsack’s top deputy.

Mr. Hirshberg and other sustainable-food activists are hoping that such actions are precursors to major changes in the way the federal government oversees the nation’s food supply and farms, changes that could significantly bolster demand for fresh, local and organic products. 

I am in complete sympathy with the goals of this movement.

In a real sense, you are what you eat.  The obesity "epidemic" is the greatest public health issue extant.  For example, the average 13-year old is more than 30 pounds heavier than in the 1960s. Maturity-onset diabetes and high blood pressure are beginning to afflict the young, things that were extreme rarities when I went to medical school.  All sorts of physical ills afflict obese or overweight people more than those of normal weight.  

Locally grown food should be encouraged on a variety of grounds.  The scientific case for organic foods is less clear, though all other things being equal, I would favor organic food in general; but the cost of organic food is greater and thus matters are not equal.

What has not come out of the White House regarding the garden is probably both too controversial to be said and may have no adherents amongst the First Couple is that the healthiest and most environmentally friendly solution to the cost and quality of our food is vegetarianism.

Cattle produce gigantic amounts of methane, a far worse greenhouse gas than CO2.  Vast amounts of inefficiency in energy and resource transfer occurs by growing vegetables to then be eaten by animals.  We can eat the vegetables ourselves, obtain all the protein we need, and thus lower our heart disease risk by at least 25%, help save Mother Earth, and take in fewer calories per bite, thus helping fight the obesity problem.

The cost of food and the economic cost of the overweight problem in America should and eventually may make the problems associated with meat production and consumption front and center.  Perhaps the White House garden will, as a vegetable garden, at least subliminally help bring that issue into people's minds.

Copyright (C) Long Lake LLC 2009  

Krugman: Obama Blowing His First and Last Chance to Set the Banking System Right

In the continuing effort to ignore the reality that the Fed/Feds have simply given tens of billions of dollars to AIG's gambling partners, many of whom were foreign bank(ster)s, apparently Sec'y Geithner is going to announce tomorrow rather than next month the administration's plan to give more money away to banks (and therefore to their employees, no matter how much they claim to hate their executives).

Why, I thought over a soy cappuccino, not make this a Krugman morning doubleheader? So, for those who don't have terminal bailout fatigue, here are some comments from his "Conscience of a Liberal" blog from yesterday on this plan, the title of which, for those who would like to read the whole post, is un-confusingly titled "More on the bank plan".

Why was I so quick to condemn the Geithner plan? Because it’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted. It’s basically a thinly disguised version of the same plan Henry Paulson announced way back in September.

So now we have a bank crisis. Is it the result of fundamentally bad investment, or is it because of a self-fulfilling panic?

If you think it’s just a panic, then the government can pull a magic trick: by stepping in to buy the assets banks are selling, it can make banks look solvent again, and end the run. Yippee! And sometimes that really does work.

But if you think that the banks really, really have made lousy investments, this won’t work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that’s the Swedish solution, it’s what we eventually did with our own S&Ls.

Now, early on in this crisis, it was possible to argue that it was mainly a panic. But at this point, that’s an indefensible position. Banks and other highly leveraged institutions collectively made a huge bet that the normal rules for house prices and sustainable levels of consumer debt no longer applied; they were wrong. Time for a Swedish solution.

But Treasury is still clinging to the idea that this is just a panic attack, and that all it needs to do is calm the markets by buying up a bunch of troubled assets. Actually, that’s not quite it: the Obama administration has apparently made the judgment that there would be a public outcry if it announced a straightforward plan along these lines, so it has produced what Yves Smith calls “a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for [I don't think I can finish this on a Times blog (expletive deleted)]”

Why am I so vehement about this? Because I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second. So it’s just horrifying that Obama — and yes, the buck stops there — has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.

DoctoRx again.

So, not only is Krugman horrified, but he has become one of a growing number of bloggers who are blaming the President himself for policies with which they disagree, rather than using such euphemisms as "Team Obama" or claiming that Obama is being given bad advice.

If Barack Obama's honeymoon did not end with last week's AIG public relations disaster, it may well end tomorrow.

Copyright (C) Long Lake LLC 2009

Yesterday . . . and Today

Yesterday, all my troubles seemed so far away

Now it looks as though they're here to stay

Oh, I believe in yesterday.

Suddenly, I'm not half the man I used to be

There's a shadow hanging over me

Oh, yesterday came suddenly.

-McCartney/Lennon

This post is about two yesterdays, the one we enjoyed 2 years ago and that left suddenly, pre-economic downturn; and the one America did not enjoy in the 1930s.

Dr. Paul Krugman had a brief blog on the current economic banana as compared with the Great D.  Considering that the major forward-looking indicators of economic activity predict much worse to come (and then currently predict several months of scraping along the bottom), the argument that what we are experiencing is not a milder version of the Great Depression may be very optimistic.

As Krugman explains at the bottom, to find the percentage decline in manufacturing for each downturn, multiply by 100 (12% decline for now vs. 27% then).  

Two more quick points.  One:  Our economy is less oriented to manufacturing now.  The current massive declines in exports of manufactured goods out of Asia demonstrate that the U. S. decline would have been much worse now had we not outsourced so much manufacturing.

Two:  There was a major  spurt in manufacturing in the 1920s, similar to that of the 1990s. Manufacturing and "non-house" consumption growth from 2002-7 were not at boom levels, thus a smaller fall-off in percentage terms would get to the same "baseline" or below trend levels. 

Here's the entirety of the Krugman posting from March 20:

The Great Recession versus the Great Depression

Reading this article about the global manufacturing plunge, I wondered: how does the current slump stack up against the early stages of the Great Depression? The US has consistent industrial production data back to 1919, so it’s a fairly straightforward exercise. Below is the change in industrial production, measured in logs, from the previous peak in 1929-30 and 2007-9.

At first, the current recession didn’t hit industrial production all that hard. But the pace accelerated dramatically last fall, so that at this point we’re sort of experiencing half a Great Depression. That’s pretty bad.

Clarification: Those are natural logs — sorry, economists use them so frequently I forgot to explain. So basically multiply by 100 to get the percent change.

Copyright (C) Long Lake LLC 2009 

Listen to Sweden

SWEDISH PRIME MINISTER FREDRIK REINFELDT:

'You can't think you can solve everything with taxpayers' money. Stimulus packages are already in place and taking us through this challenging time. We already have done a lot.'

In contrast, the Feds have decided to double down on their incoherent pretense that they love the banks but hate the bankers. Despite the diversionary witch hunt about AIG bonuses while not questioning the vastly greater giveaway to AIG, and imposing salary limits to a small number of executives under the TARP bailout plan, Treasury plans to expand the already trillion-dollar Federal Reserve TALF (Term Asset-Backed Securities Loan Facility) program.

The Fed, however, has conveniently exempted TALF from compensation limits.

All these Treasury and Fed programs represent employment for financial types.

We can learn a lot from the Swedes, who have been all over the place in their voyage into and somewhat out of socialism.

More precious than any given level of expenditures for cellphones, WIIs, movies, restaurant meals, two-five bathroom homes, etc., is the preservation of liberty and democracy as envisioned in the Declaration of Independence and the Constitution, as amended. Thus the greatest imperative is to protect the financial strength of the U. S. Government itself, while dealing directly with the growing homeless epidemic and the fiscal strains/crises at the state and local level.

One additional point.

The alacrity with which Congress imposed a 90% tax rate on these individuals at large financial companies is surprising and disquieting. Why no hearings? What's the rush?

This ginned-up AIG bonus "scandal", the payments for which were, a month ago, specifically allowed by the same "shocked" crowd that now is imposing this penalty tax rate, is so contrived that the suspicion has to be entertained that a la Hoover and then Roosevelt, much higher tax rates, perhaps at the same level, are going to be imposed on other "undeserving rich".

As more and more Ponzi schemes are uncovered all over the U. S. and the U. K., as Europe tries to have less of an increase in government involvement in the economy than does America, as the party in power in the U. S. points fingers within itself over the AIG flap, as Republicans join in the lynch mob, as corporatism continues to be official governmental policy, and as the economic Banana continues to inevitably worsen in the months ahead, all the geniuses who look to the great majority of post-Great Depression economic cycles to guide their decisions and recommendations are making a big mistake. The current crisis is more like the really bad scenes:

The stock market kept going down despite tremendous public angst all throughout 1973 and 1974, bottoming a full 24 months from the peak in December 1972 only after the Watergate and OPEC crises were completely decided and the Viet Nam crisis was almost completely over.
The about 32 month waterfall decline in 1929-32 and the 1973-4 stock market and economic fiascoes strike this observer as better historical examples.

The public's anger at the Big Government/Big Finance alliance is palpable and growing. This does not bode well for the markets in the short term.


Copyright (C) Long Lake LLC 2009

Bushbama as Hoover

I have been reading at out-of-print book titled, "Age of Depression".  In keeping with the current Age of Frugality, I obtained the book for free at www.scribd.com and thus the only costs associated with reading it are the electricity to power the computer and the minimal wear and tear on the computer itself.  Regardless of whether the current "Big Banana" of an economic slowdown approaches the horrors of the "Great" Depression, which the book points out was different from the other economic depressions that came before in this country, the macro aspect that this one is the first to stem from wildly speculative borrowing and lending practices, and actual and potential bank failures, makes the past worth reviewing.

The book, which appears as fair-minded to all parties as one could imagine, makes the point that Hoover believed in the trickle-down theory that the most important role for the Federal Government was to sustain the financial structure.

This is so "right-on" in relevance to the failures of the multiple Fed, Bush/Paulson and Obama/Geithner, and Congressional actions that it is scary.

In the Depression vein, perhaps the most widely-read book on the Great D ("The Great Crash of 1929") was written by John Kenneth Galbraith, a Canadian economist who helped administer wage-price controls during WW II for FDR and ended up a hugely influential liberal economist in the post-War era.

His son, James Galbraith, is another economist, and is similarly liberal.

In "No Return to Normal" in the current Washington Monthly, Dr. Galbraith fils implicitly accepts the argument made in this blog that we are looking at an emergency similar to, though currently milder than, the Great Depression, and argues for massive government spending.

His article is quite long and "important" and thus not an easy read.  Here is a partial summary with (of course) EBR editorial comments:

First, he argues that the Obama/Geithner team is far too enamored of the Larry Summers/Robert Rubin Hoover-like approach toward favoring the big financial institutions over direct assistance to individuals and smaller governmental units that are dealing in various ways with this economic Banana.

Ed:  Good for him!

He then goes on to praise World War II for helping the economy by forcing people to live so penuriously that they had to save and thus could spend later.  He proposes more of the same now, potentially for decades.

Ed:  This is wrong-headed.  Starve now, prosper later is his prescription.  Simpler and favored:  do take down the corrupt self-serving financial institutions that are basically vehicles to enrich the insiders by financializing everything they can, but create a balanced economy built upon savings but not to the level of non-consumption imposed by the Government on a suffering populace in the War.  

It is also wrong-headed in that he also perpetuates the myth that it was War spending that brought on prosperity.  Just ask any German or Japanese if they enjoyed post-War prosperity, even though their governments also spent big-time during the War.  No, Dr. Galbraith, War is Hell and is horrible for the economy.  Winning the biggest War in history and being essentially the only undamaged major economy did, however, allow the winner to enjoy the spoils.  It was the big win in the War in both the Western and Pacific fronts that brought prosperity to this country, which has now largely been squandered by decades of living beyond our means.

The Galbraith article goes on to say:  

A brief reflection on this history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around.

This is a direct attack on Barack Obama's own words, which have been criticized in this blog, that credit is the fundamental factor that makes the U. S. economy run.  Instead, the current answer, it is argued here, is profits and savings are the key to a successful capitalist economy.  Out of those efforts come the capital that can then be lent should there be worthwhile projects that deserve capital.  Unfortunately, Galbraith describes the current situation as well as the past:

During the 1930s public spending was large, but the incomes earned were spent. And while that spending increased consumption, it did not jumpstart a cycle of investment and growth, because the idle factories left over from the 1920s were quite sufficient to meet the demand for new output. 

Ed:  There are plenty of shopping malls, houses, condos, auto factories, domestic and foreign clothing suppliers, food growers (and too much food consumption), etc.  That is why less production is "OK" for now; in such times of adjusting to a more sustainable balance between production and ability to pay for that production, support for those who would like to work but can't find work due to the economic slack is important.  Just think of all the hundreds of billions of dollars spent on AIG, Citi, BofA, Deutsche Bank etc. by the Fed and the Feds that could have been spent directly on individuals.  It makes the blood boil.  It is the Hoover approach, and it continues under Barack Obama and a Democratic Congress.  Even the AIG bonus diversion is exactly wrong in that it deliberately ignores the vastly larger Federal payments to AIG and its (often foreign) counterparties, while penalizing the individuals involved, who at least have flesh and blood and may or may not have been responsible for the malfeasance at AIG.

The good doctor and I agree on one point that this blog has advocated, which is the importance of small-to-medium-sized banks that act conservatively, as many such banks have done over the past several years:

Ultimately the big banks can be resold as smaller private institutions, run on a scale that permits prudent credit assessment and risk management by people close enough to their client communities to foster an effective revival, among other things, of household credit and of independent small business—another lost hallmark of the 1950s. No one should imagine that the swaggering, bank-driven world of high finance and credit bubbles should be made to reappear. Big banks should be run largely by men and women with the long-term perspective, outlook, and temperament of middle managers, and not by the transient, self-regarding plutocrats who run them now.

He agrees with EBR and the non-partisan Economic Cycle Research Institute about the low risk of high inflation in the short to medium term:

Third, in the debt deflation, liquidity trap, and global crisis we are in, there is no risk of even a massive program generating inflation or higher long-term interest rates. That much is obvious from current financial conditions: interest rates on long-maturity Treasury bonds are amazingly low. . . They are . . . worried, as I am, that the larger economic outlook will remain very bleak for a long time.

Dr. Galbraith makes a lengthy justification, as do Paul Krugman and Nouriel Roubini, for massive deficit spending, near the end of his piece.  While he and I part company on that point, what is striking is how broadly across the political spectrum come the criticisms of the current Administration on its handling of the financial crisis and also how widespread are the fears of longer-term economic malaise. 

Dr. Galbraith and DoctoRx at EBR agree that the Bush-Obama approach of "large complex financial institution uber alles" and their policy of trying to resume unsound lending practices is a huge mistake.  

Until this huge mistake is corrected, it follows that from an investment standpoint, I just can't convince myself that becoming an owner American corporate enterprise through the rigged, insider-run casino known as the stock market is a prudent use of anyone's capital at prices anywhere near today's.

Copyright (C) Long Lake LLC 2009