Thursday, April 30, 2009

“The Obama Economic Team is a disgrace”

Jesse said it here: In Observance of Barack Obama's 100th Day In Office...

Or in the words of Tyler Durden (pseud.), Barack Obama—Bush Lite.

Please read yesterday’s revised post for where this administration is taking us.

See also Obama's 100 days - the mad men did well – John Pilger

Wednesday, April 29, 2009

Debt and income inequality (with additions 4/30)


  • Note the similarity between the graphs of income inequality and debt/GDP.
  • It took a war, not just a depression asset price collapse reducing wealth inequality, to reduce income inequality last time, supporting the hypothesis that a new social contract is required to cure this ill.  The war brought people more income equality, the New Deal didn’t.  Without the motivation to band together to fight a common enemy like the Nazis will Americans tolerate deficits of 13 percent of GDP and inevitable tax increases, when there is no equalization of the income distribution and the highly compensated continue to receive outsized rewards?  This is the great risk to the social fabric, and why I think the social contract is [widely perceived to be, which is the same thing as being] broken.
  • All households took on more debt in the national run-up since 1980, but lower income households took on much more in a attempt to “keep up” with higher income groups.  Median household income stagnated relative to mean income during this period (U.S. Census Bureau).  The bottom half is deleveraging, implying that their standards of living will fall further behind the top income classes, implying further rending of the social fabric.
  • Fixing the banks won’t fix this; in fact, it will exacerbate the current quasi-feudal situation.


Source:  Emmanual Saez’ home page.  The income measure is personal tax return based, so is roughly based on household income.


Source:  Credit Suisse


Source:  Boston Fed

Investment and “animal spirits”

Calculated risk has a nice treatment of The Investment Slump.  We have found that investment as a percentage of GDP tracks very closely with our “animal spirits” measure.  Now, even we are having a little trouble believing our own model’s forecast of a bottom in second quarter, but hope springs eternal.  Anyway, here’s what the history looks like:

The next “animal spirits” forecast will be published after the unemployment rate comes out.  We can only hope that the upticks seen recently in consumer confidence (as we forecast) signal that our forecast of a major turning point in the economy is accurate. 

Links 4/29

  • Fixing bankrupt systems is just the beginning – Martin Wolf, FT h/t Yves
  • The fight for 17% of the U.S. economy (Forbes) – h/t Zero Hedge.  While reading this keep in mind that every other developed country with a nationalized health care system enjoys better health at a substantially lower cost than Americans have.

Springtime ruminations

For the really big picture it’s helpful to think in terms of “Finite-time singularity in the dynamics of the world population, economic and financial indices” (arXiv:cond-mat/0002075), Sornette and Johansen’s exploration of the idea that humanity is at “the end of the growth era.”  The implication of their analysis is that “this crisis” will go on for decades until a “phase change” of human behavior is accomplished to a new attractor, which could be benign or nasty, brutish and short, depending on how humanity decides to conduct itself.

Strauss and Howe’s imaginative and weirdly prophetic The Fourth Turning (1997) explores the present crisis as the latest in a series of crises in Anglo-American history.  I’ve posted about their theories and their prophesies from the mid-1990s that caught so much of what has happened since.  In a narrative sense they were truly uncanny.  See The Crisis at the End of the Saeculum and Onward to Ekpyrosis, Death and Rebirth of American….  A site that nicely summarizes the nature of the crisis and the authors’ prescriptions for behavior going into this crisis is found here and here.  A few snippets from the latter:

How does America Prepare? 1

Prepare Values

The goal is to forge values that uplift the culture.  Leaders need to look to unite and not divide based on stark ideologies.   If we move towards the later it can cause a lot of damage.  The goal is to generate a values structure that can be bought into by the majority of Americans so that we can pull together as a country and not get pulled a part.

Prepare Institutions
Public institutions may be challenged to support us during the crisis.  Therefore, it is important to cut out and simplify the government structures without threatening their infrastructure.  The authors state we should look at state and local governments as policy testers - that can test new solutions quickly to see if they have impact on emerging problems.

Prepare Politics
Bottom line - come together!  We do not have the luxury of partisanship - Republicans and Democrats must forge a partnership that bluntly defines the problems we face and works together to forge solutions.

Prepare Society
If this turning comes to pass it will require a level of public sacrifice as well as teamwork.  Start now to get involved on a local level and encourage your children to get involved in their communities.  Ultimately we must refocus on becoming involved citizens in a positive way.

Prepare Youth
As with World War II - the brunt of this crisis will fall on the shoulders of those born from 1982 on (the Millennial Generation).  We need to invest in our youth and ensure even the most needy are prepared to take on their role to be the muscle behind our emergence from the Fourth Turning.

Prepare Elders
Except for the very old - it will be likely that we will need to cut back on elder care and create the expectation that elders will have to be more self-sufficient.  If the economy continues to sour and is a central outcome of the turning - then we will likely not be able to rely on social security.  The key is to up our savings and be prepared to live far more simply.

Prepare the Economy
It is likely during the Fourth Turning that we will face “extreme shocks” to our economy.  Asset values are likely to drop, unemployment will likely grow, the industrial structure will be strained and we may deal with issues of inflation or deflation.  Therefore, we must work on correcting certain fundamentals without pushing for performance levels we might have come accustomed to during the good times.  Again, we need to encourage citizens to save.

Prepare Defense
We must be prepared for anything!  Expect the worst and be flexible enough to mobilize where and when we have to.

Ultimately - the authors say these are modest steps yet they indicate that during the Third Turning  we can only do some things to prepare because there is no way of knowing what we will turn on.

Preparing As Individuals 2

Rectify classic Virtues
During a time of crisis people will look to those in their communities they can count on.  This is because communities are drawn together more and are more active about supporting each other to get through difficult times.  Your reputation will be key to being included in this support.  This means people will be more attentive to how you keep your word, how you roll up your sleeves and how much they feel you can be counted on.

Converge with Your Community
This relates to the item above.  Yet, the point is to get involved and to stay plugged in to your local community.  At the depth of the crisis you might have to actually chose whether you are more aligned to your local community versus the national one.  It would be good to start now so that the structure of support is in place.

Bond by Strengthening Personal Relationships of all Kinds
Having a strong network will be critical.  Your personal relationships will be harbors for support, giving, and receiving encouragement.  Face to face contact will also be more important - with your family, employees, friends, and others who can provide support.

Prepare Yourself and Your Children for Teamwork
The time hibernating in our homes will be over.  The goal will be to get out and get involved in community projects that support the whole’s well being - not just your own.  Expect and encourage your children to get more involved in community service.

Look to Your Family For Support
Your ultimate safety net will be your extended family.  If you do not have strong connections or have lost them due to the hustle and bustle of life - make an effort to reconnect and strengthen those ties.

Prepare for the Weakening of Public Support
Today’s level of public support could be weakened during “The Fourth Turning.”  The two things to focus on are making sure you are saving plenty of extra money (even if it means reducing your lifestyle) and ensuring you are vital and healthy. Being financially and physically healthy will reduce your stress during this time.

Diversify Everything You Do
The people who will do best during a time of crisis are the generalists.  Many businesses will be challenged to remain relevant so consider the skills you have an  how they can be applied in other ways.  Assume that safety nets (medicare, social security and pensions) could totally be shredded.  Look at your investments and make sure they are diversified as well.  “Enter the turning understanding your cash flow, diversified savings and some liquid assets.  Really know where your money is.”


Tuesday, April 28, 2009

Items of interest 4/28

Via:  Baseline Scenario 

Pierre Bourdieu, Tim Geithner, and Cultural Capital 

France in the 1960s and 1970s was the source of a tremendous amount of new philosophical, literary, and critical thinking - Foucault, Derrida, Lévi-Strauss, Baudrillard, Barthes, etc. But in my opinion, the most important member of that intellectual generation was the sociologist Pierre Bourdieu. In Distinction, Bourdieu’s best-known work, he described how economic class is reinforced by cultural capital: economic elites create cultural distinctions, and pass on to their children the ability to make those distinctions, in order to use cultural sophistication as a means of perpetuating class dominance. This may sound abstract, but think about the example that is the subject of Bourdieu’s The Love of Art: museums. Upper-class parents take their children to fine art museums and teach them how to talk about Rembrandt, Monet, and Picasso; later in college, job interviews, and cocktail parties, the ability to talk about Rembrandt, Monet, and Picasso is one of the markers that people use, consciously or unconsciously, to identify people as being from their own tribe. (Note that democratizing museums - making them open to anyone - doesn’t undermine cultural capital, because the key is not looking at paintings, but learning how to talk about them.)

We used the term “cultural capital” in our Atlantic article as a way of describing the influence of Wall Street over Washington. By this, we meant that one of the primary means by which Wall Street got its way in Washington was by creating and propagating the understanding - among sophisticated, educated, cultured people, as opposed to “populists” or the “rabble” that showed up at anti-globalization protests - that what was good for Wall Street was good for the country as a whole. We didn’t mean to say that old-fashioned campaign contributions and lobbying did not play an important role. (We did, however, say that we thought out-and-out corruption of the Jack Abramoff variety was probably a minor factor - not because we have any insider knowledge one way or the other, but simply because such criminal behavior was simply unnecessary given the other levers available.) But I don’t think that implicit quid pro quo bargaining is a sufficient explanation, because I believe it entirely possible that there are honest politicians and civil servants who really, truly believe that they are acting in the public interest when they come to the aid of the largest banks.

Tim Geithner may very well be such a man. […]

Can you say, “sense of entitlement”?  This sort of astute social observation, coming from someone inside the Eastern Establishment, but with experience observing the social structures of many countries, carries immense weight.  Thank you James Kwak.  The social contract in America needs to be reconstituted.  President Obama’s great promise to bring this about is not off to a good start.  It is well to remember that Obama’s mother worked for the Ford Foundation, as did Geithner’s father.  Obama’s primary loyalties may be to his socioeconomic class.

Via:  Zero Hedge

Sam Zell: "Very Few CRE Financings In 2003-2007 Are Above Water"

Posted by Tyler Durden at 9:09 AM

Following up on the theme Zero Hedge discussed that the vast majority of commercial real estate backed loans have negative equity, real estate tycoon Sam Zell yesterday, in a presentation to the Milken Institute, said that "you have a scenario today where you have very few '03 to '07 financings that are above water. You have more debt than you have value." As owners of these properties have more debt than value, sales of properties over the next two to three years will be minimal as none of them would result in a deleveraging. Instead Sam Zell says "investors will buy distressed debt as these properties go into foreclosure." […]

This goes to the heart of the CRE problem: as no owners of negative equity properties are motivated to sell (why contribute equity to force a sale), existing properties will merely see continuing declining cash flows with no underlying property ownership exchanges, until either the loan defaults or the borrower (REIT xyz) files for bankruptcy as interest costs overwhelm cashflows. The last fact is the reason why Scott Minerd, CEO of Guggenheim partners said "Equity players have every reason to keep playing for time." That explains all the recent REIT dilution actions, who, together with any investors who "dollar cost average down" on their REIT positions, are merely hoping the U.S. government will be successful in reinflating the housing and rent bubbles yet again and property values rise above loan values, resulting in at least nominal equity value. For investors who like betting on those kinds of odds, Craps or even Black Jacks may be a better expression of risk appetite.

Deflationary pressures continue in CRE, and residential awaits the next round of rate resets.  It’s going to take a while for any inflation to get going.

Monday, April 27, 2009

The business cycle to come

  • Quarterly outlook – Hoisington & Hunt  h/t Mish.  MV=PQ.  We all know the inflation from massive money creation will come, the question is when.  If it picks up before the next election, my guess is the Fed will get to determine whether we get hyperinflation and Obama (wait to tighten after the election), or recession and a return to the Republicans (tighten before the election, yield curve inverts, recession before election).  See also The Age of the Fiat Currency: A 38-year experiment in inflation on why gold and the dollar may fare well in the future.  (See yesterday’s post for why the dollar….)
  • Larry Summers’ New Model – Baseline Scenario.  Maybe if we support the zombie banks the economy will stay sluggish through the next election, and our team will win.

Whatever happens, it is likely that our forecasting model will see it from a year ahead (recent update).  Even though this recession is accompanied by a debt-deflation and a globally synchronized downturn, making it different from other recessions, it was forecast correctly (actually our model showed difficulties beginning in 2006).

However, if “animal spirits” do not improve measurably by the Michigan Sentiment index over the next several months, the implication is that the determinants of “animal spirits” have changed fundamentally.  Basically people will have been too shaken by volatility to get their mojo back.  Under normal circumstances (i.e., the last two recessions) even though unemployment continues to rise, “animal spirits” recover at the bottom of the business cycle, which we are still forecasting to occur in second quarter.

Sunday, April 26, 2009

Bankrupt Euroland and the rise of Chimerica

Via: Telegraph

The capital well is running dry and some economies will wither

The world is running out of capital. We cannot take it for granted that the global bond markets will prove deep enough to fund the $6 trillion or so needed for the Obama fiscal package, US-European bank bail-outs, and ballooning deficits almost everywhere.

By Ambrose Evans-Pritchard
Last Updated: 8:49AM BST 26 Apr 2009

Unless this capital is forthcoming, a clutch of countries will prove unable to roll over their debts at a bearable cost. Those that cannot print money to tide them through, either because they no longer have a national currency (Ireland, Club Med), or because they borrowed abroad (East Europe), run the biggest risk of default.

Traders already whisper that some governments are buying their own debt through proxies at bond auctions to keep up illusions – not to be confused with transparent buying by central banks under quantitative easing. This cannot continue for long.

Commerzbank said every European bond auction is turning into an "event risk". Britain too finds itself some way down the AAA pecking order as it tries to sell £220bn of Gilts this year to irascible investors, astonished by 5pc deficits into the middle of the next decade.

US hedge fund Hayman Advisers is betting on the biggest wave of state bankruptcies and restructurings since 1934. The worst profiles are almost all in Europe – the epicentre of leverage, and denial. As the IMF said last week, Europe's banks have written down 17pc of their losses – American banks have swallowed half.

"We have spent a good part of six months combing through the world's sovereign balance sheets to understand how much leverage we are dealing with. The results are shocking," said Hayman's Kyle Bass.

It looked easy for Western governments during the credit bubble, when China, Russia, emerging Asia, and petro-powers were accumulating $1.3 trillion a year in reserves, recycling this wealth back into US Treasuries and agency debt, or European bonds.

The tap has been turned off. These countries have become net sellers. Central bank holdings have fallen by $248bn to $6.7 trillion over the last six months. The oil crash has forced both Russia and Venezuela to slash reserves by a third. China let slip last week that it would use more of its $40bn monthly surplus to shore up growth at home and invest in harder assets – perhaps mining companies.

The National Institute for Economic and Social Research (NIESR) said last week that since UK debt topped 200pc of GDP after the Second World War, we can comfortably manage the debt-load in this debacle (80pc to 100pc). Variants of this argument are often made for the rest of the OECD club.

But our world is nothing like the late 1940s, when large families were rearing the workforce that would master the debt. Today we face demographic retreat. West and East are both tipping into old-aged atrophy (though the US is in best shape, nota bene).

Japan's $1.5 trillion state pension fund – the world's biggest – dropped a bombshell this month. It will start selling holdings of Japanese state bonds this year to cover a $40bn shortfall on its books. So how is the Ministry of Finance going to fund a sovereign debt expected to reach 200pc of GDP by 2010 – also the world's biggest – even assuming that Japan's industry recovers from its 38pc crash?

Japan is the first country to face a shrinking workforce in absolute terms, crossing the dreaded line in 2005. Its army of pensioners is dipping into the collective coffers. Japan's savings rate has fallen from 14pc of GDP to 2pc since 1990. Such a fate looms for Germany, Italy, Korea, Eastern Europe, and eventually China as well.

So where is the $6 trillion going to come from this year, and beyond? For now we must fall back on the Fed, the Bank of England, and fellow central banks, relying on QE (printing money) to pay for our schools, roads, and administration. It is necessary, alas, to stave off debt deflation. But it is also a slippery slope, as Fed hawks keep reminding their chairman Ben Bernanke.

Threadneedle Street may soon have to double its dose to £150bn, increasing the Gilt load that must eventually be fed back onto the market. The longer this goes on, the bigger the headache later. The Fed is in much the same bind. One wonders if Mr Bernanke regrets saying so blithely that Washington can create unlimited dollars "at essentially no cost".

Hayman Advisers says the default threat lies in the cocktail of spiralling public debt and the liabilities of banks – like RBS, Fortis, or Hypo Real – that are landing on sovereign ledger books.

"The crux of the problem is not sub-prime, or Alt-A mortgage loans, or this or that bank. Governments around the world allowed their banking systems to grow unchecked, in some cases growing into an untenable liability for the host country," said Mr Bass.

A disturbing number of states look like Iceland once you dig into the entrails, and most are in Europe where liabilities average 4.2 times GDP, compared with 2pc for the US. "There could be a cluster of defaults over the next three years, possibly sooner," he said.

Research by former IMF chief economist Ken Rogoff and professor Carmen Reinhart found that spasms of default occur every couple of generations, each time shattering the illusions of bondholders. Half the world succumbed in the 1830s and again in the 1930s.

The G20 deal to triple the IMF's fire-fighting fund to $750bn buys time for the likes of Ukraine and Argentina. But the deeper malaise is that so many of the IMF's backers are themselves exhausting their credit lines and cultural reserves.

Great bankruptcies change the world. Spain's defaults under Philip II ruined the Catholic banking dynasties of Italy and south Germany, shifting the locus of financial power to Amsterdam. Anglo-Dutch forces were able to halt the Counter-Reformation, free northern Europe from absolutism, and break into North America.

Who knows what revolution may come from this crisis if it ever reaches defaults. My hunch is that it would expose Europe's deep fatigue – brutally so – reducing the Old World to a backwater. Whether US hegemony remains intact is an open question. I would bet on US-China condominium for a quarter century, or just G2 for short.

Saturday, April 25, 2009

Saturday selected links

From naked capitalism:

Expert on Wealth Wins a Top Economics Honor Wall Street Journal. My comment:  see also “The Wail of the 1%” below.
IMF Emerging Markets Veteran on the U.S. James Kwak
Day 3 of the "Why Won't #Krugman Post On Bill Black?" Lambert. Yves’ comment: The MSM, and Krugman appears to be falling in line, is treating Black like radioactive waste.  My comment:  Krugman lives too close to New York and is still attached to Establishment respectability, for all his post-’Sixties power-to-the-people affect.  Get over it Paul—forget the models and forget New York society.  If we don’t start seeing social justice out of Washington, the coming crack-up will be uglier than necessary.

Crucify them! Will Obama the Appeaser allow prosecution?  Doubtful.

John Kerry is Half-Right About Torture  George Washington
Let the Criminal Indictments Begin: Paulson, Bernanke, Lewis  Mish

From the your-taxes-are-going-up department (Windows Live formatting):

The Wail of the 1% – New York Magazine 
Ten Myths About Budget Deficits and Debt – Heritage Foundation

Friday, April 24, 2009

Heading toward a crack-up

I responded to a comment on America close to the tipping point with a remark that I am operating under the hypothesis that America is heading toward a crack-up, as we are crushed by debt.  In this I am informed by long-wave theory, especially as set forth in the work of Strauss and Howe (see The Crisis at the End of the Saeculum and Onward to Ekpyrosis, Death and Rebirth of American... for starters).

And we all suffer from “fatigue fatigue,” as the comedy of errors in Washington dazes us with new trillions of dollars of our future earnings thrown away every other day… and as a classical liberal who believes that a society that mistreats its poor is doomed, I feel the pain of the neo-liberals who want ever-bigger stimuli… but watching the government’s handling of the banking crisis I’ve lost confidence in the government to spend any more of my money wisely.  And I do think the IMF has a point about debt implosions—and they only address government debt.  Household debt has quadrupled over the past 50 years, from about 25 percent of GDP to close to 100 percent.  Federal debt has doubled since 1980 from about 20 percent to now over 40 percent of GDP.  Financial sector debt has risen since 1974 from about 20 percent of GDP to almost 120 percent.  Nonfinancial business debt has risen from about 55 percent to about 75 percent of GDP (source).  Looking at the total debt situation suggests the IMF had blinders on.  But as we’ll see in a moment, what’s “on the books” is only the tip of the iceberg.

It’s useful to review the big picture, which the New York Times presents neatly in this interactive graphic,

Adding Up the Government’s Total Bailout Tab

I do believe the country as we know it will cease to function sometime within the next five to ten years, and it will be necessary for Americans to make life-and-death choices about where they spend their tax dollars and what kind of country they want to have.  Food and shelter and useful work for citizens have got to come first, but if current trends continue—which are exacerbating already pronounced income inequality—feudalism for the masses may result.  We are currently deflating, especially if assets prices are considered—and the ravages of hyperinflation may be next.

Your government is asleep at the wheel.  A financial catastrophe would seem to be already baked in.  It’s time to communicate to your elected representatives that they need to start focusing on how the American people are going to come through the upcoming crisis—the current one is just the warm-up.  It’s time for a basic safety net of health insurance for all and a poverty level dole. 

Thursday, April 23, 2009

Thought for the day on Shakespeare’s birthday (Google is spacing out…)

OF SYRACUSE: Upon my life, by some device or other
The villain is o'er-raught of all my money.
They say this town is full of cozenage,
As, nimble jugglers that deceive the eye,
Dark-working sorcerers that change the mind,
Soul-killing witches that deform the body,
Disguised cheaters, prating mountebanks,
And many such-like liberties of sin:
If it prove so, I will be gone the sooner.
I'll to the Centaur, to go seek this slave:
I greatly fear my money is not safe.

“The Comedy of Errors,” William Shakespeare, Act I, scene ii.

When you hear a politician or representative of a large financial institution say that it is necessary for the health of the economy that some big financial institution requires their losses to be subsidized by the United State government, it is a false statement.  Here’s why:

  • Subsidizing the losses is like throwing money away or burning it, and making the taxpayer work to replace it.  Subsidizing the loss doesn’t make it go away, it just prevents the financial institution from recognizing it properly.

  • Subsidizing losses will not stimulate bank lending.  Lending is slow because the economy is in a depression.  Banks are understandably cautious.  Lending slowed down after the last two recessions. 

  • Letting the public burn its money through a “public-private partnership” is just another way of subsidizing the losses, throwing good money after bad.  This program will be manipulated to the benefit of a small group of big financial firms, those in trouble and some others, but the end result is the same:  your government will take some of your future earnings and burn it, and tell you to work to replace it.  The financial institutions involved will feel no pain.

  • What about the capital hole that may result in some financial institutions?  Let them absorb their own losses and go out of business if they deserve to.  That’s the way capitalism works.  There are enough healthy banks around to pick up the slack.  If people are hurt in the process, help them directly.

  • What about stimulating the economy?  Won’t helping the financial institutions get over their losses help the economy grow?  No, just the opposite, it will retard the economy, because subsidizing losses is wasting money.  If you want to stimulate the economy, help out the unemployed with public sector jobs or a poverty level dole and health coverage while they look for a private sector job.  Those dollars will be spent.  We’re beyond arguments about socialism vs. capitalism, so get over that.  Either we take care of each other or we don’t.  What we’ve had the past 30 years is socialistic welfare for the rich, bare knuckles capitalism for working people.

  • But what can I do?  I’m only a citizen in a country with a government that doesn’t listen to me!

    • Call you Congress people at the number on the left.  The operator will connect you.  Scream your head off.  They can’t put us all on the no-fly list.

Here is Simon Johnson:

The Baseline Scenario

What happened to the global economy and what we can do about it

The Missing Witness

with 51 comments

Yesterday’s JEC Hearing on Too Big To Fail did not include any financial industry representatives.  This surprised me - surely they want to go public with their views on the future structure of the financial system?  Obviously, they have great behind-the-doors access on Capitol Hill, but surely it is not in their interest to have right, left, and center piling on with regard to breaking up Big Finance?  Yesterday, Thomas Hoenig, Joseph Stiglitz, and I were in complete agreement on this point, and my idea of using antitrust measures against major banks seemed to gain traction during and after the hearing.

Apparently, the committee invited a number of leading people from the industry (i.e., individuals who generally articulate the case for big banks) and they were all too busy to attend (Update: this statement is incorrect; the potential witnesses who were unable to attend are academics).  This is a curious coincidence, because someone else - in an unrelated initiative - has been trying to set up a discussion involving me and people from the Financial Services Roundtable and/or the American Bankers Association, to be held at the National Press Club, but their calendars are completely full (i.e., there is literally no day that works for them, ever).

There has been some counterargument - e.g., against our Atlantic article on American oligarchs - from people who wish to defend the way that big finance currently works, but so far this has been quite limited in the public domain.  The most pushback so far probably came from Carlos Gutierrez (Commerce Secretary, 2005-09), who argued Monday on CNBC that our argument is “somewhat sensationalist” and that it would lead to a wholesale and unproductive assault by government on the finance industry (i.e., an application of the Economics of Vilification).

But of course our argument, both in the Atlantic and more broadly, is not against finance per se.  In fact, we’ve received some strong expressions of support from within the financial sector - just not particularly from firms that are Too Big To Fail - as well as from many in the risk-taking entrepreneurial sector.  And here Thomas Hoenig - President of the Kansas City Fed, with long experience regulating, winding down, and generally overseeing banks; and very far from being a sensationalist - absolutely nailed it towards the end of yesterday’s hearing.  My recollection of his exact wording is: whenever you have banks that are too big to fail, you will get oligarchs (yes, he said oligarchs).

Monday, April 20, 2009

Recommended reading 4/20

Sunday, April 19, 2009

America close to the tipping point

Recently released IMF analysis (via Telegraph)  indicates that federal debt/GDP ratios in excess of 60 percent tend to become deflationary black holes.

"The impact becomes negative for debt levels that exceed 60pc of GDP," said the Fund.

While no countries were named, this would raise questions about Japan, Germany, France, Italy and ultimately Britain and the US after their bank rescues.

The IMF said the US is at the epicentre of this crisis just as it was in the Depression, setting the two episodes apart from normal downturns. However, the risks are greater this time. "While the credit boom in the 1920s was largely spec­ific to the US, the boom during 2004-2007 was global, with increased leverage and risk-taking in advanced economies and many emerging economies. Levels of integration are now much higher than during the inter-war period, so US financial shocks have a larger impact," it said.

The IMF said the global financial system is still under acute stress, with output tumbling and inflation falling towards zero in key nations. "The risks of debt deflation have increased," it said.

Abrupt halts in capital flows can have "dire consequences" for emerging economies, it said. Eastern Europe has already suffered the effects, with a 17.6pc fall in industrial production in February. The region is highly vulnerable to the credit crunch since it owes more than 50pc of its GDP to Western banks.


The U.S. nominal GDP is about $14 trillion, the gross federal debt is $10 trillion, or 71 percent (the ratio is 46 percent if debt held by the public is used.  (I am not going to go into the issue of which number is “correct,” but the latter is most commonly used.)  Neither of these debt figures, both from fourth quarter 2008, include any of the multifarious bailout commitments.  Just adding a projected $2 trillion fiscal deficit for 2009 to the debt and assuming no growth in GDP takes the ratio using debt held by the public squarely to 60 percent.

Obama’s budget will tip America into a debt-deflationary downward spiral if the IMF is right.  No wonder the American public is slow to warm up to the stimulus plan—and why the public views the banking bailouts as throwing good money after bad.

The American people have a low opinion of government spending and contracting programs.  We read creditable stories about missing billions in Iraq and missing trillions throughout the federal budget.  We have seen how this administration has furthered Wall Street’s class warfare on the American people in its handling of the banking “bailout.”  President Obama looks more and more like a fiscal Manchurian candidate.

So, again, I propose a “middle way”:  let the objective be to take care of the American people, not to achieve some figment of “potential output.”  The Democrats may have good intentions, but they’re listening to the wrong economists, Keynesians who have been out of power for too long and who now are listening to a scribbler of 70 years ago (that they read in their halcyon graduate school days), a Keynes, most of them seem not to realize, who was preaching to an America that was the largest creditor nation in the world, not the greatest debtor.

Let the economists go yell at China, today’s great creditor nation.  China seems to be listening.


IMF links via Econbrowser:

MF World Economic Outlook

Saturday, April 18, 2009

Wall St spin grows over stress test results

Even the Financial Times fell for the spin in this article, when they let go unchallenged the following statement by a “senior banker” (Jamie, don’t be bashful):

“The government is torn,” said a senior banker. “They have an unpalatable choice between declaring that the banking system is uniformly healthy, which would cause laughter in the market, and saying that some banks need further capital injections, which at this stage can only come from Uncle Sam.”

What’s wrong with this statement?  The way corporate capitalism works is like this:

The government doesn’t recapitalize anyone until all private party claimants have been wiped out, or in the case of preferred or common equity, wiped out and debt converted to equity.  And let the bad banks fail, and their business go to banks that are not “too big to fail.” [corrected 4/20]

Scream your head off to your elected representatives if those pirates Summers and Geithner try to take any more of your and your children’s money with more taxpayer bailout!

Via:  Financial Times

Wall St fears grow over stress test results

By Francesco Guerrera and Edward Luce

Published: April 17 2009 22:00 | Last updated: April 17 2009 22:00

With less than three weeks to go before Washington releases the results of its “stress tests” of the nation’s 19 largest banks, most of Wall Street appears to be in need of Prozac.

Rising panic over how the results will be released has raised fears the results could lead to another collapse of confidence in the battered financial sector. Among other concerns, there is uncertainty over how the federal government will release the results, whether it will publish one aggregate number, or a bank-by-bank breakdown.

In addition, there are concerns as to whether Washington will have the capital to plug any hole it reveals. Wall Street executives believe that some banks will almost certainly require a capital injection, even though Washington is thought unlikely to brand any bank as “failed”.

Although the rules would give banks six months to raise capital from the market before turning to Washington, few believe troubled institutions will have that much time. As one banker said this week: “Once it is known that an institution needs money following the stress tests, they will have about six minutes, rather than six months, to raise the money.”

Banking stocks have performed well in recent weeks as good first-quarter results and some positive signs on the economic front allayed investors’ worst fears over the future of the industry.

However, executives fear that the release of the stress test results, scheduled for early May, could make it apparent the US banking system is split between a small group of relatively healthy companies, such as Goldman Sachs and JPMorgan Chase, and a large cohort of weaker ones.

In addition, if the stress tests force the government to inject capital into ailing institutions such as Citigroup and Bank of America, the move could spook investors and reawaken worries over the nationalisation of some of the nation’s largest banks.

“The government is torn,” said a senior banker. “They have an unpalatable choice between declaring that the banking system is uniformly healthy, which would cause laughter in the market, and saying that some banks need further capital injections, which at this stage can only come from Uncle Sam.”

Bankers who have been involved in the stress tests say the authorities are leaning towards publishing fairly detailed results in early May, possibly as early as May 4. In addition, the Fed plans to release a “white paper” next week setting out the methodology behind the tests.

However, bankers say that over the next fortnight the Federal Reserve, which is carrying out the tests, is likely to tell the banks of its conclusions and give them time to respond – a process that could lead to further adjustments to the actions to be taken as a result of the tests. It could also intensify lobbying by the banks for differential treatment.

The picture is complicated by pressure that stronger institutions, such as Goldman Sachs and JPMorgan, are applying to the Treasury to permit them to repay the troubled asset relief funds they received from the government – not least to escape the conditions Congress has attached to them.

The Treasury appears to be split about the best way forward with some arguing for early repayment, which would showcase the success of the programme, and others arguing it would risk an embarrassment down the line if the economy deteriorated and the banks had to return for further assistance.

In addition, by repaying early, the banks would have escaped the strings imposed by Congress on Tarp recipients, while still benefiting from other government assistance, including debt guarantees. “These are legitimate concerns,” said Douglas Elliott of the Brookings Institution. “One way round them would be to get Goldman Sachs and JPMorgan to agree to continue to adhere to the conditions that apply to Tarp recipients.”

Wednesday, April 15, 2009

“The Quiet Coup” started in 1980

The estimable Martin Wolf’s very mildly critical piece on Simon Johnson’s “The Quiet Coup” article in The Atlantic propagates the misperception, in my view, that fixing the capital structures of the banks is going to reinvigorate lending.  As I've pointed out before, lending is slow and is likely to remain so because the economy is depressed.  As I read it, though, Wolf seems to be saying that the financial oligarchy in the U.S. is somehow more high-minded and bipartisan than that in Russia, to which Johnson compares the U.S.—while acknowledging  a resemblance to an emerging country. This seems to me a distinction without a difference.  In Russia they don’t have meaningful parties—and some would say, neither do we! 

Ronald Regan (or his shape-shifting persona) initiated three trends in 1980:  bust the federal budget, run up massive deficits and blame it on Congress; deregulate the financial markets so tricksters waving copies of papers by Merton and Miller could make billions leveraging up the corporations; and banks could soak the lower classes striving to keep up with subprime loans; then, with bipartisan support, repeal Glass-Steagall so the financial tricksters could add a bevy of stupid banks, insurance companies, and international investors to the class of suckers to whom they sold AAA securitized, magically transmuted subprime debt; and then create an off-the-books casino of side bets on the above, the infamous credit default swaps, and let anyone sell them whether they could honor them or not, because everyone knew “real estate prices never fall”; and of course, as the capstone, lower tax rates on the most highly compensated Americans as Wall Street was extracting gobs of wealth from ordinary Americans, with special treatment for employees of hedge funds.  Cover this all with a veneer of phony Christianity and free market capitalism, with a wink and a nod, and you’ve got a quiet coup.  American-style.  The Russians could never do this.

Wolf states correctly that a significant portion of recent growth was merely debt being converted to GDP that got at least a year or two ahead of true trend growth.  He correctly states that having financial institutions too big to fail is socialism (he might have chanted, “privatization of gains, socialization of losses”).  But he conveys, to me, at least, the impression that fixing the banks is somehow necessary to stimulate the economy.  The banks can continue to lend if insolvent if the feds tell them they can, it’s fiat money; the problem is credit demand. 

Using inclusive measures of unemployment the number of unemployed or seriously underemployed (and probably working poor) people in the country is over 20 million.  Only a small portion are covered by unemployment insurance, and most probably don’t have health insurance.  The safety net is full of holes.  This is barbaric.  If the federal government wants to instill confidence in the United States of America, fixing the banks is not the place to start.  Giving people a helping hand, giving them a poverty level dole while they’re looking for a new job, one created by the private economy and not by a wasteful and probably corruptly awarded government contract (“use it or lose it” is not the way to go here), is in my humble opinion the best way to prop up aggregate demand and instill confidence in the social contract in America.  The bad banks will ultimately have to fail, but fixing them does nothing to prop up aggregate demand—and bailouts are literally wasting tax dollars that would enter spending one-for-one if spent on a viable safety net.  This is principles level economics, and yet the well-heeled debaters never seem to see those below….  (Watch Titanic again, it’s so brilliant—and that Hollywood screwed James Cameron on it is bitterly appropriate.)

Is America the new Russia?

By Martin Wolf

Published: April 14 2009 21:47 | Last updated: April 14 2009 21:47

Is the US Russia? The question seems provocative, if not outrageous. Yet the person asking it is Simon Johnson, former chief economist at the International Monetary Fund and a professor at the Sloan School of Management at the Massachusetts Institute of Technology. In an article in the May issue of the Atlantic Monthly, Prof Johnson compares the hold of the “financial oligarchy” over US policy with that of business elites in emerging countries. Do such comparisons make sense? The answer is Yes, but only up to a point.

“In its depth and suddenness,” argues Prof Johnson, “the US economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets.” The similarity is evident: large inflows of foreign capital; torrid credit growth; excessive leverage; bubbles in asset prices, particularly property; and, finally, asset-price collapses and financial catastrophe.

“But,” adds Prof Johnson, “there’s a deeper and more disturbing similarity: elite business interests – financiers, in the case of the US – played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse.” Moreover, “the great wealth that the financial sector created and concentrated gave bankers enormous political weight.”

Now, argues Prof Johnson, the weight of the financial sector is preventing resolution of the crisis. Banks “do not want to recognise the full extent of their losses, because that would likely expose them as insolvent ... This behaviour is corrosive: unhealthy banks either do not 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 cycle.”

Does such an analysis make sense? This is a question I thought about during my recent three-month stay in New York and visits to Washington, DC, now capital of global finance. It is why Prof Johnson’s analysis is so important.

Unquestionably, we have witnessed a massive rise in the significance of the financial sector. In 2002, the sector generated an astonishing 41 per cent of US domestic corporate profits (see chart). In 2008, US private indebtedness reached 295 per cent of gross domestic product, a record, up from 112 per cent in 1976, while financial sector debt reached 121 per cent of GDP in 2008. Average pay in the sector rose from close to the average for all industries between 1948 and 1982 to 181 per cent of it in 2007.

In recent research, Thomas Philippon of New York University’s Stern School of Business and Ariell Reshef of the University of Virginia conclude that the financial sector was a high-skill, high-wage industry between 1909 and 1933. It then went into relative decline until 1980, whereupon it again started to be a high-skill, high-wage sector.* They conclude that the prime cause was deregulation, which “unleashes creativity and innovation and increases demand for skilled workers”.

Deregulation also generates growth of credit, the raw stuff the financial sector creates and on which it feeds. Transmutation of credit into income is why the profitability of the financial system can be illusory. Equally, the expansion of the financial sector will reverse, at least within the US: credit growth and leverage masked low or even non-existent profitability of much activity, which will disappear, and part of the debt must also be liquidated. The golden age of Wall Street is over: the return of regulation is cause and consequence of this shift.

Yet Prof Johnson makes a stronger point than this. He argues that the refusal of powerful institutions to admit losses – aided and abetted by a government in thrall to the “money-changers” – may make it impossible to escape from the crisis. Moreover, since the US enjoys the privilege of being able to borrow in its own currency it is far easier for it than for mere emerging economies to paper over cracks, turning crisis into long-term economic malaise. So we have witnessed a series of improvisations or “deals” whose underlying aim is to rescue as much of the financial system as possible in as generous a way as policymakers think they can get away with.

I agree with the critique of the policies adopted so far. In the debate on the Financial Times’s economists’ forum on Treasury secretary Tim Geithner’s “public/private investment partnership”, the critics are right: if it works, it is because it is a non-transparent way of transferring taxpayer wealth to banks. But it is unlikely to fill the capital hole that the markets are, at present, ignoring, as Michael Pomerleano argues. Nor am I persuaded that the “stress tests” of bank capital under way will lead to action that fills the capital hole.

Yet do these weaknesses make the US into Russia? No. In many emerging economies corruption is egregious and overt. In the US, influence comes as much from a system of beliefs as from lobbying (although the latter was not absent). What was good for Wall Street was deemed good for the world. The result was a bipartisan programme of ill-designed deregulation for the US and, given its influence, the world.

Moreover, the belief that Wall Street needs to be preserved largely as it is now is mainly a consequence of fear. The view that large and complex financial institutions are too big to fail may be wrong. But it is easy to understand why intelligent policymakers shrink from testing it. At the same time, politicians fear a public backlash against large infusions of public capital. So, like Japan, the US is caught between the elite’s fear of bankruptcy and the public’s loathing of bail-outs. This is a more complex phenomenon than the “quiet coup” Prof Johnson describes.

Yet decisive restructuring is indeed necessary. This is not because returning the economy to the debt-fuelled growth of recent years is either feasible or desirable. But two things must be achieved: first, the core financial institutions must become credibly solvent; and, second, no profit-seeking private institution can remain too big to fail. That is not capitalism, but socialism. That is one of the points on which the right and the left agree. They are right. Bankruptcy – and so losses for unsecured creditors – must be a part of any durable solution. Without that change, the resolution of this crisis can only be the harbinger of the next.

*Wages and Human Capital in the US Financial Industry 1909-2006, January 2009,

US financial sector

Monday, April 13, 2009

A modest proposal: ignore macroeconomists

Much as I like Paul Krugman for his post-‘Sixties punk affect and basically good liberal heart, I think the country would be better off if the President and Congress ignored everything he and every other liberal macroeconomist said about fixing the economy and followed one simple principle instead:

Take care of the American people.

Now, conservatives do not subscribe, generally, when it comes to welfare or helping common people.  Historically they have favored welfare for the rich, usually through tax breaks for the highly compensated or through wars that expend the cannon fodder of the lower classes and line the pockets of the sultans of the military-industrial complex.

What I’m arguing is that given the fact that the country has more debt than it will be able to pay off all the talk about deficit spending to close output gaps is nonsense.  The last time debt/GDP got this high we had a Depression.  I don’t see why it should be different this time.  We achieved a level of output that was unsustainable.  The output gap is relative to a fiction.

Also, it is a fundamental truth that domestic aggregate demand begins with consumption, which drives investment demand.  Of course, there’s also government spending, but we’ll come to that.

So if you want to stimulate aggregate demand, give money to people who will spend it, like the unemployed.  We have about 15 million people who fall into that category.  Provide them with health benefits, so the stress of their situation doesn’t show up in health care costs in the future.  I favor a poverty level dole and free health care for the unemployed and working poor. 

One thing that doesn’t stimulate aggregate demand is buying bad loans from banks at inflated prices and putting it on the taxpayers’ tab.  A lot of that debt needs to be written of, the sooner the better.

What about lending?  Lending is slow because the economy is in a depressed state.  Bank commercial and industrial lending declined after the last two recessions and can be expected to do so this time.  But there are healthy banks out there who are still lending, and many smart businesses know who they are.  Look at who’s increasing lending to find out who these banks are.

Don’t need any tax cuts, but could probably raise taxes on incomes in the top 1% substantially without cramping their style much.  And get rid of the obscene “hedge fund exemption.”

We’re looking at some very rough times ahead, a decade of crises as bad or worse than the current one.  We’ve got to get our objectives right before we spend any more money. 

Take care of the people and the economy will take care of itself, will even self-organize.  It’s a “middle way” not likely to win support from either party.

No more macroeconomist philosopher kings arguing about stimulus packages that will go through corrupt contracting processes, no more Wall Street robber barons.  But this approach would require the American people to have more control over their government than have now.

Gotta have a dream.

“America is breaking down, breaking down, breaking down…”

Via:  Boston Globe

Read the whole thing.

Until last year, Harvard Law School professor Elizabeth Warren was perhaps best known for her writing on bankruptcy and consumer finance. But last fall, she was appointed chair of a newly created Congressional Oversight Panel, which is charged with keeping tabs on the $700 billion bailout of the financial sector - an effort formally known as the Troubled Assets Relief Program. Warren was recently interviewed by Globe deputy editorial page editor Dante Ramos, who prepared the following edited excerpts.

A: I see this as an insiders/outsiders problem.

The insiders, the investment bankers and other financial services specialists, have a system that works very well for them. The problem is they're now using the outsiders' money to fund that system. Their system has collapsed. AIG is not functional without substantial taxpayer dollars. And the insiders don't seem to have appreciated the seismic shift in their world when they need money, gifts, subsidies from outsiders.

Anyone who thinks that they can take tens of billions of dollars of taxpayer money and continue to operate business as usual lives in a fantasy world that I don't understand. Culture clash? No! This is not a culture clash. This is not about taxpayers who don't get it. This is about people who think [in a] fantasy, that their world is prosperous and continues to create value that can be parsed out privately, when they are relying on huge subsidies from the taxpayer. It's just wrong!

Q: What's the connection between the squeeze that consumers are feeling and the financial bailout that you're now charged with trying to scrutinize?

A: I bring a very different perspective to the bailout than those who spent the last dozen years in the financial services industry. I believe that ultimately, the banks exist to serve the American people. Not vice versa. We cannot have a vibrant economy without a strong and reliable banking system, but it is impossible to save the banking system independently of saving the American family.

The whole Treasury program began as a top-down analysis: Large financial institutions are at risk of failing; how can we prop them up? We might have asked a different series of questions: Large financial institutions are failing; how do we make sure that there are some financial institutions to keep the economy going forward while we let the failures go? There was a real focus on saving all of the institutions rather than a focus on saving enough of a system to keep it workable for the underlying economy.

Saving everyone is a lot more expensive than saving the minimal number to keep the economy functional.

Every time I do the paperwork for the panel and note a $10 billion expenditure, I think about how many schools that might have built, how many hospitals that might have updated. Those dollars are not just ink on a page. They're real. …

Sunday, April 12, 2009

Alan Blinder, Eastern establishment shill, out of his depth (or in it)

Blinder’s column in the New York Times today, Restore Order and Win a Financial War, is so bad on so many levels it’s hard to know where to start.  Academic economists, especially macroeconomists, tend not to know much finance.  They’re also incredibly naive about how the political economy works.  They think like philosopher kings, believing that their scientifically-reasonable, multiplier-driven prescriptions will be carried out to the letter.  Blinder argues in this column that everyone should just shut up and get with the government’s program, because there’s a plan and the plan is to win the war… are you beginning to sense the rhetorical drift here?  Sounds like fascism to me.  He doesn’t say anything about how corporate finance works to assign and price risk, the order of seniority from debt to preferred to common.  Financial people gag when they hear the government is going to deal with bank insolvency by having the taxpayers buy the bad debt at inflated prices to make the banks’ balance sheets look good, instead of letting the shareholders and then the preferred holders and then the bondholders take the hit like they’re supposed to in capitalism.  No, Alan Blinder is content just to say, “Do what you are told, you must sacrifice, not your betters, you sheeple…..”  Is he consulting to a hedge fund too?  And let’s not “rehabilitate” the shadow banking system, let’s open them up to the bluest of skies and never let them hide in the shadows again.

As regular readers know, the solution is to use full disclosure on the banks, wipe out shareholders or convert them to debt as necessary, wipe out creditors as necessary, and use a minimum possible amount of taxpayer dollars to recapitalize the banks.  The way to “win the war” is to provide income support and health services to the unemployed, and to bootstrap American health care and education to internationally competitive levels.  We’re already bankrupt, many would say, we don’t have the trillions needed to bail out bank bondholders.  Yes, there’s a plan, Professor Blinder—a bad one.  Bank lending is soft because the economy is soft, and it will be until the American people can generate aggregate demand.  Propping up bank bondholders will only delay that day. 

April 12, 2009

Economic View

Restore Order and Win a Financial War


MANY Americans are bewildered, aggrieved and even angry about the financial shenanigans that led to the current mess — and about the seemingly unending stream of government bailouts. They should be.

A bunch of wealthy, supposedly smart financial “experts” made irresponsible bets that went bad, pushing our economy to the brink and taking the rest of us down with them. Millions of people worldwide have already lost jobs. Millions more will. And taxpayers are being handed monstrous bills for mistakes that were not their doing.

It is maddening that hardly any of the miscreants have been punished, not to mention that many remain well paid. But foolishness is not a crime, and most of them broke no laws. Perhaps worse, a host of safeguards that were supposed to protect us — from corporate boards and ratings agencies to regulators and elected officials — all failed. To add insult to injury, hardly anyone has apologized for the disaster, or even explained how we got into it and how we plan to get out.

Let me try the latter.

In the bubble era, even sophisticated people deluded themselves into believing that home prices would soar indefinitely and that lending risks were minimal. On those weak foundations, a huge house of cards was built. Wall Streeters designed a hideously complex financial system to enrich themselves. Financial institutions took on far too much debt. People signed mortgages they could ill afford and did not understand. Regulators, the Bush administration and Congress looked the other way. The bubble grew until it burst.

Much of this shouldn’t have happened. But we are where we are, and the urgent priority is to extricate ourselves from this mess as quickly as possible, with minimal damage. Here’s how I conceptualize the master plan.

American policy makers are fighting a two-front war. On the eastern front, they are battling a shortage of demand, as traumatized households and businesses pull in their horns. Less spending by some people means fewer jobs for others who, in turn, curtail their own spending. Keynes diagnosed this vicious recessionary spiral in the 1930s, and we are now in the midst of the worst one since then.

Fortunately, we know how to fight a demand shortage — with more government spending, tax cuts and lower interest rates. That is why Congress enacted a huge fiscal stimulus in February and why the Federal Reserve has cut interest rates to virtually zero. But the cure takes time, and we are still sliding downhill. Depending on how long and deep the recession gets, we may need more firepower. But at least policy makers know what to do — and are doing it.

The western front is vastly more complex. All economies run on credit, and ours developed an extreme dependency. Largely through their own failings, banks have been seriously damaged. Bankers are paralyzed by fear of further loan losses and shrinking capital that might subject them to regulatory penalties — or worse. One way or another, the banks must be restored to health and emboldened to lend.

How? The Fed has made huge loans to banks and flooded them with cash. But the banks also need capital, and private money is not stepping up to the plate. That was why Henry M. Paulson Jr., the former Treasury secretary, decided to devote the Troubled Asset Relief Program to injecting capital into banks last fall. I disagreed with both his decision and the way he executed it. But there was a rationale for what he did, and the current Treasury secretary, Timothy F. Geithner, will eventually be back for more money for this purpose.

But banks are just part of the problem. Much modern lending is securitized by the so-called shadow banking system — a complex web of interlocking, sometimes mysterious capital markets. Invisible to most people, it is crucial to getting credit to mortgagees, credit card holders and businesses. And while the financial implosion wounded the banks, it decimated the shadow banking system.

The most obvious — but not the only — disasters stem from mortgage delinquencies, fears of more, and consequent uncertainty about the values of mortgage-related securities. Bringing these markets back to life is one rationale for both the administration’s foreclosure mitigation programs and its public-private investment programs. It is also a principal rationale for many of the Fed’s unprecedented lending and money-creation activities.

Thus the war plan has four essential components that hang together logically: stimulating aggregate demand, limiting foreclosures, rescuing (most of) the banks and rehabilitating the shadow banking system. Three of the four are in place. We await Mr. Geithner’s bank rescue plan, which, I hope, will be some version of the good bank-bad bank idea I mentioned here last month.

Unfortunately, the administration seems to have a penchant for complexity in designing its programs, and I certainly would not defend all the details. But it’s essential that citizens see through the trees to the forest. All this taxpayer money is being put at risk for a good, simple reason: Victory in a two-front war requires winning on both fronts. We won’t defeat the recession unless we restore some financial order.

Countries do unpalatable things in wartime, and collateral damage is common. So it is here. The impending federal budget deficits are monstrous. The Fed is printing money like mad. People who deserve punishment are receiving help instead. The government’s investment partnerships may enrich some investors.

There will be time to address these problems later. For now, the nation must focus single-mindedly on winning the war. There really is a plan.

Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.

Saturday, April 11, 2009

Saturday stock market strategy


Every time the 10-year P/E on the S&P 500 has fallen from the first quintile to the fourth, it has ultimately continued to the fifth and bottomed in the single digits.

And recall that the current P/E of the S&P 500 on trailing earnings is ~100:

And don’t forget to review Zero Hedge’s comment on the current market.

This is research, not investment advice. Use at your own risk.

Slowing down

Via: New York Times


See also “A Tale of Two Depressions”  and “Animal spirits in America, April 2009”

Friday, April 10, 2009

Maybe the Tories who went north were just better stock…

This will put a smile on your face.  ht Jesse

Trailing P/E on the S&P 500—wow, what a bull market!

Added April 11:  See also Zero Hedge on the coming black swan of black swans.  Zero Hedge provides as close to an insider’s view of our corrupted financial system as any web site I know.

Making Banking Boring

Via:  Paul Krugman in the New York Times

Krugman gets it right when he says that if we don’t reform banking and financial services now, it will be the face of crises to come.  As I wrote in the last “animal spirits” update, this is the most likely scenario.  Just as it took roughly a dozen years (1971-1982) and four recessions to wring the ‘Sixties guns and butter inflation out of the economy, will probably take a decade to reform financial services—unless the crisis becomes even more acute, and somehow the political will is mustered to do it sooner.  If the economy is tanking in 2012, the Republicans will take over.  Would Senator Shelby (R, Alabama, chairman of the Senate Banking, Housing and Urban Affairs Committee) still be as much of a hawk on banking as he says he is today?  With people like Larry Summers around a banking oligarch hardly needs a Republican government to get what he wants out of the government.  The banking crisis could turn Obama and any number of his successors into one-term presidents (remember Jerry Ford and Jimmy Carter, both of whom were whipped by inflation).  Barack Obama is no Franklin Roosevelt, so far, at least.  But hope springs eternal.

Making Banking Boring


Published: April 9, 2009

Thirty-plus years ago, when I was a graduate student in economics, only the least ambitious of my classmates sought careers in the financial world. Even then, investment banks paid more than teaching or public service — but not that much more, and anyway, everyone knew that banking was, well, boring.

In the years that followed, of course, banking became anything but boring. Wheeling and dealing flourished, and pay scales in finance shot up, drawing in many of the nation’s best and brightest young people (O.K., I’m not so sure about the “best” part). And we were assured that our supersized financial sector was the key to prosperity.

Instead, however, finance turned into the monster that ate the world economy.

Recently, the economists Thomas Philippon and Ariell Reshef circulated a paper that could have been titled “The Rise and Fall of Boring Banking” (it’s actually titled “Wages and Human Capital in the U.S. Financial Industry, 1909-2006”). They show that banking in America has gone through three eras over the past century.

Before 1930, banking was an exciting industry featuring a number of larger-than-life figures, who built giant financial empires (some of which later turned out to have been based on fraud). This highflying finance sector presided over a rapid increase in debt: Household debt as a percentage of G.D.P. almost doubled between World War I and 1929.

During this first era of high finance, bankers were, on average, paid much more than their counterparts in other industries. But finance lost its glamour when the banking system collapsed during the Great Depression.

The banking industry that emerged from that collapse was tightly regulated, far less colorful than it had been before the Depression, and far less lucrative for those who ran it. Banking became boring, partly because bankers were so conservative about lending: Household debt, which had fallen sharply as a percentage of G.D.P. during the Depression and World War II, stayed far below pre-1930s levels.

Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans.

After 1980, however, as the political winds shifted, many of the regulations on banks were lifted — and banking became exciting again. Debt began rising rapidly, eventually reaching just about the same level relative to G.D.P. as in 1929. And the financial industry exploded in size. By the middle of this decade, it accounted for a third of corporate profits.

As these changes took place, finance again became a high-paying career — spectacularly high-paying for those who built new financial empires. Indeed, soaring incomes in finance played a large role in creating America’s second Gilded Age.

Needless to say, the new superstars believed that they had earned their wealth. “I think that the results our company had, which is where the great majority of my wealth came from, justified what I got,” said Sanford Weill in 2007, a year after he had retired from Citigroup. And many economists agreed.

Only a few people warned that this supercharged financial system might come to a bad end. Perhaps the most notable Cassandra was Raghuram Rajan of the University of Chicago, a former chief economist at the International Monetary Fund, who argued at a 2005 conference that the rapid growth of finance had increased the risk of a “catastrophic meltdown.” But other participants in the conference, including Lawrence Summers, now the head of the National Economic Council, ridiculed Mr. Rajan’s concerns.

And the meltdown came.

Much of the seeming success of the financial industry has now been revealed as an illusion. (Citigroup stock has lost more than 90 percent of its value since Mr. Weill congratulated himself.) Worse yet, the collapse of the financial house of cards has wreaked havoc with the rest of the economy, with world trade and industrial output actually falling faster than they did in the Great Depression. And the catastrophe has led to calls for much more regulation of the financial industry.

But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

Thursday, April 9, 2009

Doubling down in the Empire of Death

CNN: Obama wants another $83 billion for Iraq, Afghanistan

Obomba has added ~$150 billion to Bush II’s military budget.  Gates said earlier this week he’s going to cut military spending….  (h/t

WASHINGTON (CNN) -- The Obama administration will ask Congress for another $83.4 billion to fund the wars in Iraq and Afghanistan through the end of September, Democratic congressional sources said Thursday.

President Obama's spending measure is likely to be the last supplemental request submitted to pay for the wars.

President Obama's spending measure is likely to be the last supplemental request submitted to pay for the wars.

The request is expected to pay for those conflicts for the rest of the 2009 budget year, two Democratic congressional sources said.

The money would bring the running tab for both conflicts to about $947 billion, according to figures from the Congressional Research Service.

More than three-quarters of the $864 billion appropriated so far has gone to the war in Iraq, the agency estimated.

Since taking office in January, President Obama has announced plans to shift troops out of Iraq and beef up U.S. forces in Afghanistan, where American troops have been battling al Qaeda and Taliban fighters since al Qaeda's 2001 attacks.

In a letter to House Speaker Nancy Pelosi, Obama said the situation in Afghanistan and neighboring Pakistan "demands urgent attention."

"The Taliban is resurgent, and al Qaeda threatens America from its safe haven along the Afghan-Pakistan border," Obama wrote in submitting the funding request.

"There is no question of the resolve of our military women and men. Yet, in Afghanistan, that resolve has not been matched by a comprehensive strategy and sufficient resources," Obama wrote.

About $75 billion of the latest request would pay for military operations, including $9.8 billion for body armor and protective vehicles and $11.6 billion to replace worn-out equipment. The rest would go to diplomatic programs and development aid -- including $1.6 billion for Afghanistan, $1.4 billion for Pakistan and $700 million for Iraq.

The request would also provide about $800 million for the Palestinian Authority, including humanitarian aid for Gaza, the Hamas-ruled territory that was heavily bombarded by Israel in December and January; $800 million to support U.N. peacekeeping missions in Africa; and $30 million to the Department of Justice to manage the closure of the U.S. prison camp at Guantanamo Bay, Cuba.

The supplemental spending bill is likely to be the last such request submitted to Congress to pay for the wars, White House spokesman Robert Gibbs said. While the Bush administration relied on supplemental spending bills to fund the conflicts, Obama began including war spending in his 2010 budget.

The president urged Congress to move quickly on the request "and not to use the supplemental to pursue unnecessary spending."

But Rep. Lynn Woolsey, a prominent anti-war Democrat, said the requested funding would "prolong our occupation of Iraq through at least the end of 2011," when U.S. troops are scheduled to leave the country, "and it will deepen and expand our military presence in Afghanistan indefinitely."

"Instead of attempting to find military solutions to the problems we face in Iraq and Afghanistan, President Obama must fundamentally change the mission in both countries to focus on promoting reconciliation, economic development, humanitarian aid, and regional diplomatic efforts."

Last month, Obama announced the United States plans to withdraw most of its troops from Iraq by the end of August 2010. A residual force of between 35,000 to 50,000 troops will remain until December 31, 2011. There are 142,000 American troops in Iraq now.

Obama has ordered the deployment of 17,000 troops to fight the Taliban in the south and east and 4,000 more to train Afghan troops.

Tuesday, April 7, 2009

Industrial production bottoming?

Industrial production turning points track the animal spirits variable turning points closely, and as animal spirits are forecast to turn up, we are forecasting a turn in industrial production in about midyear (green is forecast).


Deconstructing the “savings glut”

There is an old technique in mind control and psyops that involves accusing your enemy of exactly the sins you yourself are committing.  With its subtle invocation of gluttony, the accusation that the Chinese have created a “savings glut” to somehow take advantage of us poor innocent virtuously consuming Americans is a perfect example of this gambit, which I like to call perfectly symmetrical hypocrisy.

The gluttony was ours.  To accuse a nation as historically thrifty and hardworking as the Chinese of a “savings glut” is obscene.  It should stop.

Monday, April 6, 2009

Thinking about aggregate demand

The blogosphere is chockerblot with detail.  Here, I am going to try to get the Big Picture in as few words as possible:

  1. The reason the banks are not lending is weak credit demand, not toxic assets on their balance sheets.  C&I lending declined after the last two recessions and will do so again this time.
  2. The reason to put the bad banks into receivership and for for the bad banks’ creditors to take a big hit is that the U.S. has too much debt.  And the more bad real estate-related private debt is made a public obligation of the federal government, the faster the U.S. becomes a failed and bankrupt state.  Housing prices are not coming back… time to boot the oligarchs.
  3. The best way to partially replace lost consumption demand is through direct transfers of a poverty-level dole to the unemployed combined with the provision of health care services to avoid greater health costs in the future.  This will partially sustain the derived investment demands generated by consumer spending, which collapsed last fall (cars piling up at ports, etc.).
  4. There is no need for a tax cut for Americans of high enough status or lucky enough not to lose their jobs.
  5. The Bush II tax cuts on the highly compensated should be rolled back immediately.  And the “hedge fund exemption” should be wiped out.
  6. Other government spending increases should be restricted to projects that can be considered “investment spending” or capital formation, including human capital, such as public sector infrastructure or education.  The military budget should be pared back by several hundred billion dollars over time and the spending redirected to productive domestic investment.
  7. The 10-year budget should be brought into balance.  Here I agree with the Europeans, who are content to take care of their people and not to worry about economists’ figment of an “output gap,” and who have, in the case of the Germans, a visceral memory of hyperinflation.  The ever-bellicose United States, with its bloated military budget, seems to be daring the world to sell off the dollar, bankrupt us, and “provoke” us into occupying the Middle East and simply taking the oil that we are so addicted to.

Monetary policy meanwhile should remain as accommodative as possible while keeping inflation to 5% or less.

The world is in the middle of a transition to “the end of the growth era,” and the sooner we get that, the better off we all will be.  It’s a major adjustment—the largest in human history.