The Beggar’s Banquet

Chairman Ben Bernanke

Chairman

Board of Governors of the Federal Reserve System

Washington, D.C. 20551

 

Dear Ben: 

  

I hope you don’t mind the informality, but I feel like you should always be able to call your banker by his first name.

 

I noticed this morning that one of the factors in deciding to “rescue” Bear Stearns” was the possibility that they might file Chapter 11.  I am thinking of filing Chapter 11 too (I have less net worth than most of the people you bailed out over there, and I did not act with the stupidity and reckless abandon of Bear’s management).  Any chance you are willing to send $30 Billion my way too.

 

Thank you for your willingness to make sure I am as well taken care of as the deserving folks at Bear Stearns.

 

Respectfully yours,

 

John Q. Public

Where’s the Fire?

If you have read this Blog (or talked with me over time), you would know that I have been critical of policy and policy response from the Federal Reserve (as well as the Treasury).  I often refer to the Fed’s approach as ostrich economics.  Their short-sighted policies have dug us into a fine mess.  Across the entire spectrum, people have been suckered in hook, line and sinker.  This includes the average Joe who over-extended himself to buy the over-sized, over-priced home of his dreams.  Somewhat surprisingly, the list also includes sophisticated investment firms and major financial institutions, several of which have been brought to their knees.

The Federal Reserve, which is given the dual mandate of full employment and price stability, has found itself facing an economic landscape with more craters than the surface of the moon.  Let me list a few: Credit (Check. And not the type lenders do); Leverage (Too much); Liquidity (Not enough); Growth (Hard to find); Jobs (Even more scarce).  It sounds like a bad infomercial.  But wait, there’s more.  How about skyrocketing commodity prices, a collapsing currency and fiscal fissures at all levels of government.

Unable to confront both a deteriorating economy and rising inflation at the same time, the Fed has thrown everything it can think of (including the kitchen sink) to try and prop up the economy and protect our financial institutions.  Inflation is tomorrow’s problem.  Unfortunately, the policy equivalent of the firepower of the U.S. Navy has “barely” put a dent in the surface of the problem.  Only last week, one of our storied investment banks, Bear Stearns, was forced onto life support and then, in historic and questionable fashion, into the arms of JP Morgan.  I have much to say on this latest development, but I will leave it for another time and place.  I do not believe in bail-outs, but it is becoming abundantly clear at this point that there will be virtually no innocent bystanders if this vortex is not stopped.

Although I admit it begrudgingly, the Fed is directing its attention to the core of the problem: The deteriorating condition of our financial institutions.  The Fed, which has aggressively lowered rates and provided innovative financing facilities to financial intermediaries, is concerned with liquidity.  Their solution is reminiscent of the Japanese response to the problems that destroyed that economy twenty years ago.  It is more a “rearguard” action designed to allow time to do the healing.  But if Japan is any example, the healing process is glacial and time is the one thing we do not have.

As is suggested by Bear Stearns, I believe the problem faced by financial institutions is capital, or lack thereof.  Illiquidity and leverage are manifestations of this problem.  It is apparent that these struggling institutions need capital to survive.  Unfortunately, that is not enough.  Mere “survival” leaves our financial institutions in a state of suspended animation.  The economy will probably find itself in the same boat.  If the economy is to regain its’ footing, banks have to be part of the solution.  They will have to provide fresh funding to a wide array of end users, and this requires much stronger balance sheets.

If I were in the Fed’s shoes, I would insist that our major banks and financial institutions raise capital, a lot of capital.  I would also press lender’s to pass on to creditworthy borrowers some of the cost savings being provided by Federal Reserve policy.  Finally, I would try to persuade financial institutions to retain employees, even at the expense of reducing earnings.  To the extent that institutions balk at these suggestions, I would gently remind them that Fed initiatives have helped bottom lines significantly over the last nine months and will do so for the foreseeable future; and these initiatives are being done for the good of the economy as a whole, and not just for bank management, shareholders and debtholders.

One final thought.  In the last three decades, a number of crises have been resolved by Federal bailouts.  I would suggest that when general taxpayer dollars are used to prop up private institutions, taxpayers should also reap the benefits.

Robin Hood and the Friar’s Tax Rebate

If you should ever decide to go to the website of the IRS ( www.irs.gov/taxstats/index.html  ), you will find a wealth of statistics on the U.S. taxpaying population.  The last year listed is 2005.  Now you may question the sanity of anyone voluntarily glancing at these numbers, but you do get some interesting results.  To begin with, there were a tad more than 90 million individual returns filed that year.  Of these filers, roughly 68 million had taxable income (after credits) of $75,000 or less.  On this income, this taxpaying group paid cumulatively $179.6 Billion in taxes.  If it sounds like a lot to you, consider this.  In the current rush to provide aid to the economy, our wonderful legislators decided to return over $150 Billion to taxpayers; most of this going to lower income earners.  Assuming that 2007 is similar (and there is no reason assume otherwise), this means that net of this tax rebate, roughly 2/3rds of all taxpayers will not owe any taxes.

I find it hard to understand why so many people think the tax system unfairly favors the wealthy, or the near wealthy.  Robin Hood and Friar Tuck could not do better if they tried.  

Letter to Secretary Paulson and Chairman Bernanke

Mr. Henry Paulson

Secretary of the Treasury

1500 Pennsylvania Avenue, N.W.

Washington, D.C. 20220

 

Chairman Ben Bernanke

Chairman

Board of Governors of the Federal Reserve System

Washington, D.C. 20551

 

Dear Secretary Paulson and Chairman Bernanke:

 

Over the years, I have been very conservative in my financial decision-making.  I assiduously avoided incurring debt that I could not repay.  (In fact, I pay off all amounts on credit cards at the end of each month, since the interest rate always exceeds the return on money).  I refused to become involved in the speculative folly of the equity bubble of the late 1990’s.  I also did not put myself in harms way by over-leveraging myself in real estate in recent years.  My approach meant that, in the early stages of these boom-bust cycles I did not participate in the fun.  However, I also avoided the pain and suffering of those caught holding the bag.  At least I thought I avoided the consequences.  Recent events suggest otherwise.

 

Please understand, I do not like seeing people hurt.  But I also do not believe that the solution should unfairly tax those who, because of luck or foresight, managed to avoid the debacle; or those who, because of determination and fortitude, actually managed to navigate through the same minefield. Furthermore, any solution should not allow the possibility that aid recipients end up better positioned than those who did not put themselves in harms way, or those who managed to struggle through on their own.

            

Sincerely,

 

Fool Me Once, Shame On You; Fool Me Twice…

Most of those who ask my opinion on the maelstrom in the capital markets know that I believe (rather too strongly) that the prior Chairman of the Federal Reserve bears a significant part of the responsibility for the financial distress many are now encountering.  I won’t repeat the litany of errors here.  But I do have a new mistake to add to the list…Behavioral Economics.  A more popular description is the “Greenspan Put”.

Over the years, we were treated to Greenspan Alchemy in any number of variations.  There was, however, always a similar plot.  Something good would happen in the economy.  Something too good.  The stock market would appreciate in an unprecedented fashion.  Housing prices would soar, spurring record construction.  Everyone could get a mortgage, irrespective of financial condition or income.  Commodity prices exploded.  In sophisticated jargon, we experienced bubbles.  One after the other.  Even Bazooka Joe couldn’t have made the Final Four.  In each instance, this financial wizard would demur if called upon to intercede at an early stage.  In his own mind, it was not this bartender’s responsibility to take away the punchbowl.  In fact, he did not want to stop refilling everyone’s cup.  According to the Chairman, the Fed was not positioned to anticipate bubbles, nor was it positioned to prevent or moderate them (even if easy credit was at the heart of the problem).  However, the Central Bank would be happy to provide the Alka Seltzer for the guaranteed hangover.

Over the years, we were taught, collectively, that financial exagerration was, at worst, an inconvenience and, at best, a “buying opportunity”.  Time and again, like a perfect Pavlovian experiment, we were taught to wag our tongues and tails when in pain.  The “Greenspan Put” was the perfect Milkbone Dog Biscuit.

Unfortunately, it was a bad lesson.  And a lesson learned that may be responsible for this mess.  Leaks in the Sub-Prime balloon started showing up several years ago.  In the early stages, it prompted little concern at any level.  Most importantly, financial institutions saw no reason to react.  As the problems grew, the same behavior continued.  In fact, I would not be surprised if the first few bumps were not viewed as buying opportunities.  As things progressed, problems grew.  But, hey, the Fed was there and they would get aggressive.  Almost nothing was done to prepare for the coming tsunami.  Assets were not sold, debt and leverage was not reduced, duration was not shed.  The system’s response function was broken.  It was a perfect Pavlovian response.  Most of us did what we were taught to…Ignore reality.  We are drowning in it now.

Hopefully it is not too late and we learn our lesson.  Maybe Ben Franklin put it best…”An ounce of prevention is worth a pound of cure.”

Commentary on Deflation

In 2002, the Federal Reserve published an analysis of the deflationary spiral in Japan. The attached link is a commentary on that piece.

Deflation

Demographics and the Election

There is not a day that passes without a vast analysis of the relative merits of a Clinton or Obama Presidency.  One claims to have more experience.  Another claims to be the voice of change.  Both think they are qualified to answer the telephone at 3 A.M. (or any other time of day).  With votes in short supply, each candidate is claiming to be the person best positioned to win the general election.

Is there any other factor that may favor one of these candidates?  I believe so.  Age.  I am referring to the age of the voting pool, not the age of the candidates (who, by Constitutional mandate, at the very least are nearing middle age).  Although it has dropped under the radar screen, the Senator from Illinois has garnered enormous support from young voters.  If this pattern holds, and there is no reason to suppose it won’t, demographics suggest that the elapse of time makes Senator Obama ever more formidable.

Why?  As of 2006, the US Census Bureau estimated that there were 21.3 million people between the ages of 15 and 19.  Using 2004 and 2005 data, this extrapolates to 22 million people in this age group now.  Therefore, there are roughly 4.4 million 17 year olds.  By the time of the general election, eight months hence, almost 3 million new voters will be eligible to vote (my own daughter being one of them).  If the primaries are any indication, Senator Obama will have a lot more support come election time.

Just one observer’s thoughts.

Isolationism May Not Be By Choice

In the last few years, there has been lots of chatter about the US becoming isolationist.  The attached chart is the price movement of the US Dollar against a basket of the major currencies. As you can see, against this basket, our currency has lost over 30 percent of its value in the last 7 years.  At this pace, isolationism will happen by necessity rather than choice, since most of us won’t be able to afford the cost of food and lodging if we venture offshore.  Then again, if you look at the chart of the CRB (shown in an earlier posting), you may feel you can’t afford to live here either.

http://thoughtngine.files.wordpress.com/2008/03/sg20080306327971.gif  (USD Index)

(Source Bloomberg)

Zero For Too Many

We are not terribly tolerant of failure.  A CEO who disappoints investors and the markets often finds plenty of time to read by the fireside. A coach or manager who can’t win finds his ears ringing from boos and is soon nothing more than a spectator.  Yet, when it comes to something of real significance, like the overall performance and management of our economy, we seem quick to ignore poor performance.  Surprisingly, we also seem comfortable believing that the captain who ran this ship aground is capable of once again making her seaworthy.  I must admit, I don’t understand why.

Let me first start with our Central Bank.  Under the stewardship of its former Chairman, we were treated to a number of asset bubbles that, cumulatively, eroded the foundation of our economic systemic.  The last bubble, the Housing and Sub-Prime Mortgage crisis, is perhaps emblematic of how we should remember his long tenure.  His successor, a former Fed Governor and Chairman of the Council of Economic Advisors, admittedly walked into this buzz saw.  However, he has not distinguished himself by performance either.

Let’s take a look at the Fed’s current batting average. The housing industry is in shambles; losses in home equity are staggering; foreclosures are occurring at the fastest pace in a generation; the entire debt capital market system is in disarray; enormous writedowns are threatening the stability and viability of many financial institutions; from the peak, equities have lost approximately 15% of their value; the industrial economy is now slowing; jobless claims are exploding; the cost of goods, including many of our basic necessities, is rising rapidly; and, the US Dollar, long the reserve currency of the world, continues to depreciate.  So, as best I can tell, the Federal Reserve’s batting average is zero.  And it is not because they have been to the plate only once or twice.  They have had plenty of opportunities to swing at the ball.  They are basically Zero For Too Many.  I do not want to walk away hoisting all the blame on the Federal Reserve.  Other members of the team have not managed to get a hit either.  The Treasury Secretary, who has oversight of much of the financial and economic system, has a hand in this mess.  So does Congress and a number of other regulatory oversight bodies.

Given the breadth and depth of the problems confronting us, we must recognize that we will not be able to get out of the cellar without making wholesale changes.  The manager needs to go.  The players need to go.  The playbook needs to go.  It is time to clean house.  It will take time and patience, but it can be done.  However, we need to turn to someone who inspires confidence; basically, we have to find a manager with a winning record.  If this were a baseball team, Mr. Steinbrenner would know what to do.

The CRB is Flashing Red