Think Again
Dec 17, 2008
By Tara Kyle

Wondering what people on the Arab Street think about Iraqi shoe thrower Muntadhir al-Zeidi? If by Arab Street, you mean the bright, palm-lined walkways of the American University of Beirut—not shelled out Baghdad or poverty-stricken Gaza—here’s one answer.

Students there—a group that, in general, can be characterized as affluent, upwardly mobile, English-speaking, and in many cases, Christian—don’t look or sound too different from young Americans.  To see what they think about the outburst, check out this video, produced as part of a package on the Lebanese reaction to the incident for the Huffington Post.

Beirut is a paradox within the Arab world. In many ways, life there resembles life in the West, with more beaches and bars and fewer burkhas. According to Pew’s Global Attitudes project, 51 percent of Lebanese hold favorable views of the U.S., compared with 22 percent of Egyptians and 19 percent of Jordanians.

However, bitterness toward the U.S. for its role in Iraq and acquiescence to the 2006 Israeli incursions still runs rampant, especially in the city’s Hezbollah-run southern suburbs.

While these students might not think much of George W. Bush, their distaste for American presidents isn’t universal. Jimmy Carter, who has drawn fire stateside for his fervently pro-Palestinian views, won fans last week when he was in town to discuss his upcoming book, We Can Bring Peace to the Holy Land, Hezbollah wasn’t as impressed. The group declined an invitation to meet the ex-president.
Photo by Ramzi Haidar/Newscom

Dec 03, 2008
By Alan Stoga

At a time when Americans are more worried about toxic assets than toxins, today’s release of the Graham Commission Report puts bioterrorism back on the national worry list. Created by the Congress in response to the 9/11 Commission, the report begins with a stark warning:

The Commission further believes that terrorists are more likely to be able to obtain and use a biological weapon than a nuclear weapon. The Commission believes that the U.S. government needs to move more aggressively to limit the proliferation of biological weapons and reduce the prospect of a bioterror act.

Commission Chairman Bob Graham, a former senator from Florida, told CNN yesterday that “the consequences of a biological attack are almost beyond comprehension. It would be 9/11 times ten or a hundred in terms of the number of people who would be killed.”

While “proliferation” usually brings to mind images of loose nukes in the former Soviet Union or rogue scientists working in secret labs, Graham and the Commission have something much closer to home in mind: the inadequate policing of the Bush administration’s massive increase in funding for bioterrorism research.

Since 9/11 and the subsequent anthrax attacks, the U.S. government has spent $50 billion on civilian biodefense. As one scientist described the process to Marcus Stern of ProPublica (published in FLYP), “there was just a frenzy (of government contractors) at the feeding trough,” which has led to an ever-increasing number of labs and scientists working on incredibly dangerous pathogens.

The idea, of course, was to identify and produce vaccines that would protect Americans against attack. The result, however, was what Dr. Richard Ebright of Rutgers University—and a noted expert on chemical biology—described in an email to Marcus Stern as “a dramatic increase in the risk of deliberate or accidental release of bioweapons agents.”

The Graham Commission is a bit more diplomatic, pointing to the increased risk of accidents or “intentional misuse by insiders.”

Ebright put it differently: “The response to the 2001 anthrax attacks has involved increasing the number of U.S. bioweapons agents laboratories more than 20 fold…This does not make sense. No more than increasing the number of flight schools, increasing the number of flight school trainees, and developing advanced, next-generation tactics for air piracy would make sense as a response to the 9/11 attacks.”

As former Secretary of the Navy Richard Danzig told the Graham Commission, “only a thin wall of terrorist ignorance and inexperience now protects us.”

In light of that judgment, the biggest surprise in the Commission’s report is the failure to recommend a moratorium on new research spending. The mad rush to research has potentially put too much of the nation’s security in the hands of graduate students and researchers at hundreds of sites around the country.

Maybe the best way to do that would be to take a deep breath, consolidate results, and make security the point of the exercise—not an unintended casualty.

Nov 24, 2008
By Alan Stoga

The continuing financial meltdown has claimed another victim: Barack Obama’s declaration that there is only one president at a time. But the unrelenting unraveling of the economy and its accelerating collapse—coupled with increasingly incompetent crisis management by the Bush administration—has forced the president-elect’s hand.

Plan A was to build the new government from Chicago, with the same kind of steady pace and focus that has characterized the Obama campaign for the past two years. Let Bush and Treasury Secretary Henry Paulson play out the string, while the new administration took shape. Obama seemed to be channeling Franklin Delano Roosevelt, who famously declined Herbert Hoover’s invitation to co-manage the Depression during the 1932 transition.

Then, reality intervened.

First, the collapse of auto sales in October and November meant the almost inevitable bankruptcy of at least one automaker (and possibly all three) before Christmas. It is unknown what that would mean for the economy, but it certainly would not be trivial. The auto industry directly employs 240,000 workers (and indirectly another 5 million), provides 2 million people with health care and supports the pensions of 775,000 retirees.

Second, Paulson’s announcement that his bailout fund would not be used to buy bad loans—or much of anything else that hasn’t already been committed—again panicked the debt markets. And his declaration a few days earlier of “I believe the banking system has been stabilized” didn’t help.

Third, investors essentially rejected Citigroup CEO Vikram Pandit’s proposed strategy to rebuild the nation’s largest bank. Although Citi is still too big to fail, it may also be too big to save. An AIG-like bailout would be truly massive; a forced merger would just make the size problem worse; and breaking up takes time. The latest capital injection of taxpayer money, coupled with guarantees on $300 billion of bad assets is only a stopgap for a bank that still lacks a viable business model.

Fourth, the lame duck session of Congress failed to do anything other than extend unemployment benefits. The debate over what to do about the auto industry effectively stopped anything else from happening.

Throw in the usual end-of-administration blues, plus the mess at Treasury, and Obama was forced to cancel Plan A.

The president-elect still can’t govern for two months, but he has started to move. First, Obama announced the core of his economic policy and the key players on his economic team—long before anyone (including the president-elect) expected. The next step will be to negotiate a deal so that legislation can start moving as soon as the new Congress is sworn in.

So what does Obama’s New Deal look like?

He wants a massive stimulus package to jump-start the economy with a two-year program to create 2.5 million jobs, heavy investment in renewable energy (and green jobs), financial support for the auto companies in return for significant restructuring (which probably will include transferring pension costs away from the companies), significant tax cuts for the middle class and no near-term tax increases for the wealthy.

The package will inevitably grow as January 20 approaches and as the economy further sinks. But New York Sen. Chuck Schumer is already calling for stimulus of $500 to $750 billion.

Does anyone bid one trillion?

Nov 14, 2008
By Alan Stoga

President Bush can’t help himself.

With the Treasury racing from half-baked solution to half-baked solution, with bankers lining up for a second round of no-strings attached handouts, with the Big Three automakers all but bankrupt and with the economy crashing, it somehow seemed to him like a good time to provide a defense of the American economy.

“Free-market capitalism,” he told the usual audience of Wall Street types yesterday, “is the engine of social mobility—the highway to the American Dream.”

Of course, escalators go up as well as down. With combined unemployment and underemployment approaching 12 percent, housing and credit card defaults accelerating, General Motors about to run out of cash and scarce credit squeezing all but the largest banks and companies, for many the American Dream is already an American Nightmare.

Even more amazing, President Bush essentially took no responsibility for economic mismanagement, neither chronic under-regulation nor the doubling of the national debt to $10.5 trillion. The closest he got was “because of outdated regulatory structures and poor risk management practices, many financial institutions in America and Europe were too highly leveraged.” Of course, he didn’t point out that he and his appointees at the SEC, Federal Reserve and other regulatory agencies were responsible for the dramatic weakening of the regulatory framework over the past eight years.

Bush’s speech isn’t a bad summary of the benefits of free markets in general, though it bears little resemblance to the world in which we are now living. Undoubtedly, it was partially motivated by the usual effort to rewrite history common to every soon-to-be-retired president. But it also was intended for the ears of the 19 heads of government arriving for the weekend G-20 economic summit.

The summit itself is a mistake that can produce nothing more than a crowded photo-op for Bush’s scrapbook.

On the one hand, it is irrelevant since Bush cannot commit the country beyond January 20. On the other, the headline purpose of reforming the international monetary system can’t possibly be accomplished, or even launched in a weekend when there has evidently been almost no real preparatory work.

Bush should have resisted the call to arms from French President Nicolas Sarkozy and British Prime Minister Gordon Brown, whose overheated declaration to domestic political audiences led directly to Bush’s convening of the G-20.

In fact, Bush’s real challenge this weekend is to try to turn this away from a bash America fest. This won’t be easy, since many people around the world—and probably most of the leaders at the Washington summit—are persuaded that the global crisis was made in America. That probably means this weekend’s meeting is, at best, the start of a process.

What would success look like?

Sherle R. Schwenninger of the New America Foundation told FLYP that a successful summit process would do two things. First, he says, the U.S. needs other countries to do more “to shore up their banking systems” and to “put in place serious stimulus packages” to prevent further economic deterioration.

Second, once markets and the global economy have stabilized, we need “the rest of the world to pull together with the United States in a major world economic recovery.”

Odds are that both tasks will have to wait for January 20.

Nov 12, 2008
By Alan Stoga

No one can possibly doubt that General Motors is headed toward the abyss.

  • Since 2004, GM has lost more than $70 billion, including $27 billion so far this year.

  • In October, GM’s sales were 45 percent below last year’s total. On a per capita basis, that figure is the lowest since World War II.

  • On October 1, the company had about $16 billion in cash, and needs a minimum of $11 to $14 billion to operate. Last quarter, it used almost $7 billion.

  • GM’s long-term debt totals $33 billion. If the company’s financial condition continues to deteriorate, lenders can demand repayment of $6 billion at the end of the year.

  • The stock has fallen 85 percent this year. The whole company could be bought for roughly $3 billion—if anyone wanted it.

Ford and Chrysler are on the same slippery slope. Without government intervention, the only question is which company declares bankruptcy first.
And there is no possibility that this will wait for Barack Obama’s inauguration on January 20.

The Treasury has already rejected the most likely short-term solution: give the industry access to $50 billion of the $700 billion bailout.

Since Paulson has reversed himself on every other aspect of the crisis, he will probably change his mind on this one, too, especially since a GM failure would put lots of jobs at even greater risk, deliver a severe blow to what’s left of consumer confidence and cause yet more financial losses. (Among other potential impacts, speculators have written $32 billion worth of credit default swaps insuring against bankruptcy, with a net exposure of $4.5 billion.) After all, would you buy a car from a bankrupt company?

Terry Tamminen, author of Lives Per Gallon: The True Cost of Oil Addiction, doesn’t agree with GM Chairman Rick Wagoner that soaring gas prices early this year and the current credit squeeze have largely caused the industry’s problems. He points out that Toyota and Honda have been facing the same conditions, but aren’t at death’s door.

However, Tamminen believes that a big bailout check with no conditions—of the kind already given to many of the banks—would be a mistake. He wants new management and new strategies. Most of all, he wants the American auto companies to respond to what consumers need and want: “fuel efficient cars that pollute less.”

That doesn’t seem like asking too much.

Watch FLYP’s interview with Terry Tamminen.

Nov 10, 2008
By Alan Stoga

Secretary Paulson’s original $700 billion, 11-page bailout proposal included virtually no oversight, accountability or conditionality, or well-defined purpose. At the time, it looked like one more demand for unlimited authority and a bottomless checkbook from the administration that brought us the $2 trillion war on terror.

It turns out that the lack of detail was probably rooted more in the Treasury’s failure to anticipate the crisis than in the Bush administration’s characteristic arrogance toward the Congress. And that failure is Paulson’s: he has been wrong on the economy and on the markets all year.

Take a look, for example, at the Wall Street Journal’s excellent reporting today on how the Battling Bickersons of economic policy—Paulson and Bernancke—bounced from crisis to crisis over the past months.

Why else has the Treasury been playing catch up at every twist and turn of the crisis? Why else have the Treasury’s policies been so wrong—from the too long held belief that the markets and the economy were OK, to the Fannie and Freddie “bazooka,” to letting Lehman fail, to a massive bailout that had to be changed almost as soon as it was passed, to still not getting AIG right.

Remember the Congressional hearings? Days of testimony about “reverse auctions” and “hold-to-market pricing” and the urgent need to buy mortgage-backed securities. Worried senators and congressmen were assured that buying bad loans would bring relief to Main Street.

Yet, two months after the bailout was passed, not a dollar has been spent on buying up bad mortgage loans or securities. Instead, Paulson’s team almost immediately pivoted to pouring billions of dollars directly into the banks, even though the secretary repeatedly had rejected that approach. Even worse, the Treasury has been giving capital to banks—on better terms than they could get anywhere else—with practically no strings attached and with the new capital essentially being used to buy other banks.

Where did that come from? What happened to bailing out Wall Street in order to help Main Street?

A case can be made—and many economists were making it before the Congress voted for the bailout—that buying bad loans would be an inefficient way to bailout the banks. But there is no case to provide banks with taxpayers’ money on preferential terms and without asking for management changes, curtailing dividends or changing risk management practices. That’s not socialism; it’s what any private equity investor would demand.

Does anyone other than Paulson believe that the financial crisis can be staunched simply by giving more money to the guys who ran the banks into the ground in the first place?

Nov 03, 2008
By Alan Stoga

NASSIM NICHOLAS TALEB (author of The Black Swan): “I don’t know if we’re entering the most difficult period since—not since the Great Depression, since the American Revolution.”
PAUL SOLMAN (National Public Radio): “The most serious situation we’ve been in since the American Revolution?”

Ten days ago, Nassim Taleb—who wrote The Black Swan: The Impact of the Highly Improbable—told NPR that we might be closer to the beginning of the global financial and economic turmoil than to the end. He said that the Treasury’s strategy of combining banks and other financial institutions into ever-larger organizations is creating the risk of a truly system-shaking event. He said we might have a black swan—something that can’t exist, because nothing in your experience that tells you it can—paddling towards us.

And that was after the Lehman collapse.

Lehman’s bankruptcy triggered the freeze-up of credit markets and created the need for the Paulson bailout—and all the other efforts—to keep the credit markets liquid and the big banks solvent.

However, Taleb was saying that it might not be enough or, perhaps, that the governments are fighting the last war…and not even preparing for the next.

As we describe in FLYP, the problem is that a vicious cycle of global deleveraging, credit re-pricing, and contracting consumer demand is creating new casualties practically every day. Banks, companies and households are shedding debt. Borrowers are increasingly unable to raise the money they need at rates they can afford. Foreclosures and bankruptcies are rising. And the pace at which the economy is slowing continues to accelerate: projects and purchases that seemed to make sense even a month ago are now being cancelled.

No one knows when this cycle will spin itself out.

Sure, the Treasury and Federal Reserve’s massive interventions are starting to work. The largest banks are again willing to trade with each other and companies like General Electric can get short-term credit. On the other hand, almost everybody else is being badly squeezed.

Nevertheless, that’s not a black swan. Until 17th-century European explorers found black swans in Australia, everyone (at least everyone in Europe) knew that swans could only be white.

By definition, you only recognize a black swan when you finally see one. But you can think about where to look for one. In the current crisis, one place to start might be to look at the unexpected (and still largely unexplained) ongoing deterioration of AIG.

Surprisingly, AIG has used about $84 billion of the $123 billion rescue package that saved the company from collapse in September. (The company had actually borrowed even more, but repaid about $5 million last week, when it was allowed to raise another $21 billion using a cheaper Fed guarantee program.)

This massive need for cash apparently reflects rapid deterioration in AIG’s portfolio of exotic financial instruments. These include insurance against default—so-called credit-default swaps—of mortgage-backed securities, the toxic assets that include pieces of subprime and other mortgages. As housing prices fall and foreclosures rise, bond defaults (or even the threat of defaults) are forcing AIG to put up cash against the insurance policies it wrote.

AIG’s potential exposure is massive: it wrote $447 billion of credit-default swaps. If even a fraction goes bad, the Treasury rescue would be overwhelmed.
Credit-default swaps work like life or fire insurance. In this case, lenders are buying insurance against the possible failure of a government or company to pay its debts. However, there are three big differences from the kind of insurance.
•    First, the credit-default market is entirely unregulated, thanks in large part to Phil Gramm and Alan Greenspan (see FLYP: Who Let the Dogs Out?). Some of the institutions that sold credit-default swaps —which include banks, hedge funds and insurance companies—might not have the resources to pay. Literally, no one knows.
•    Second, companies that sell credit-default swaps in turn buy other default swaps to offset their risk. This creates a worldwide chain of insurers and insured—and immense complexity.
•    Third, the market is massive: the gross value of credit-default swaps is at least $54 trillion (down from $62 trillion at the start of the year).

So, if a lot of companies (think General Motors) or governments (think Iceland) begin to default, the cost would be enormous. Even short of default, as the chance of defaults rise because of the weakening global economy, companies (like AIG) who wrote credit-default swaps are obligated to raise cash to show they could pay if they had to. That means selling more stocks (and other assets), which drives markets lower—and creates more uncertainty.

That might be why Taleb concluded his NPR interview this way:

“Now you understand why I’m worried. I hope I’m wrong. I wake up every morning—actually, I don’t wake up every morning now. I start to wake up at night the last couple of weeks hoping that I’m wrong, begging to be wrong. I think that we may be experiencing something that is vastly worse than we think it is.”

– Alan Stoga

Oct 27, 2008
By Alan Stoga

As the economy plunges into recession and the leverage cycle grinds on, the line up at the Treasury’s bailout window grows longer. What was originally supposed to be a fund to buy bad mortgages and mortgage backed securities is morphing into the financial equivalent of “bring me your tired, your poor, your huddled masses yearning to be free.”

First, Treasury Secretary Paulson switched gears and carved out $250 of the $700 billion for new bank equity. Half of the 250 went to eight banks, including several which initially refused the offer. Although Congress seems to think these equity injections were supposed to stimulate new lending—remember, “helping Wall Street will help Main Street?”—the bankers have been pretty clear they have little appetite to write new loans while the economy collapses.

In fact, bank consolidation seems to be central to Paulson’s playbook, even if he never shared that idea with either the Congress or the public. Last week, Pittsburgh-based PNC Financial used $7.7 billion of bailout money to buy National City Bank, and the Treasury is apparently encouraging other combinations.

It’s not only the banks that see an opportunity to use Uncle Sam’s money. Insurance companies, with more than their share of toxic assets, are estimated by the IMF already to have lost $160 to $250 billion. Many of them are already asking for access to what’s left of the $700 billion bailout.

But the line doesn’t stop with financial institutions. GM is considering merging with Chrysler, perhaps on the theory that merging two failing companies will create one that is truly too big to fail. Even the combination itself, apparently, would require federal participation to make financial sense.

And since GMAC, the company’s financing arm that is partly owned by Cerberus (the same private company that controls Chrysler), has cut back new car financing in order to save cash, it can’t be long before the automakers ask Washington for help make new car loans. That would be on top of the $25 billion Congress already gave Detroit to finance greener autos.

At this rate, Congress will soon have to make another deposit in Uncle Sam’s checkbook.

 – Alan Stoga

Oct 24, 2008
By Alan Stoga

Yale Professor John Geanakoplos has been thinking about leverage cycles for ten years. Nobody paid much attention on the way up; as long as housing prices rose, the whole securitization bubble seemed to make a lot of sense. Or, at least, to be making lots of people lots of money—which passed for the same thing.

Once the bubble burst, it took a bit of time for an aggressive, self-reinforcing deleveraging cycle to take hold. But there is no better explanation of the disaster unfolding in global markets.

Geanakoplos believes that “all leverage cycles end with (1) bad news creating more uncertainty and disagreement, (2) sharply increasing collateral margin rates, and (3) losses and bankruptcies among the leveraged optimists.”

Today, that means:

(1)    the continually expanding size of the expected impact of subprime loan defaults which has steadily driven down mortgage-based asset prices;
(2)    lenders are demanding more collateral, including higher down payments on whatever mortgages are still being made, but the most dramatic change in margins has come from the widespread downgrading of assets: many securities have gone from AAA to junk;
(3)    the IMF estimates that financial institutions have lost more than $700 billion this cycle, with at least another $750 billion to go.

His short set of solutions include governmental action on housing prices, restoration of more permissive margins on securities, and injection of more government equity either into individual firms or by directly buying assets.

Henry Paulsen and Ben Bernanke have so far focused only on the last of these. But it’s hard to see how anything will work until the fall of the housing market is contained.

Take a look at FLYP for a discussion of plans already being discussed in Washington.

– Alan Stoga

Oct 19, 2008
By Alan Stoga

“If you’ve got a squirt gun in your pocket, you may have to take it out…If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.” – Henry Paulson, July 2008

Paulson’s army now has more than $5 trillion worth of bazookas, if you count the FDIC promises to insure equity-like bank debt ($1.5 trillion) and non-interest bearing deposits ($500 billion); the Federal Reserve’s upcoming commitment to be the buyer of last resort for commercial paper ($1.6 trillion); and the Treasury’s guarantee of money market accounts ($500 billion). The government is also on the hook for the $700 billion bailout, and separate payouts or guarantees for Bear Stearns ($29 billion), AIG ($85 billion plus $38 billion), and Morgan Stanley ($9 billion).

In addition, the Federal Reserve has created eight new lending facilities during the past 14 months to provide hundreds of billions of relatively short-term financial support to banks.

Unfortunately, all that artillery has not been enough to stabilize markets. Bloomberg recently reported that the S&P 500, which moved more than 1 percent in ten of the 13 trading sessions in October, is on track for its most volatile month since 1929, and that Chicago Board Options Exchange Volatility Index is known (has tripled since the beginning of September).

These wild fluctuations reflect two factors: first, the partially forced and partially voluntary process of unwinding massive leverage throughout the global system, and second, the widespread uncertainty about who will win and who will lose in an economy defined, at least for the foreseeable future, by government intervention.

The global economy is caught in a vicious circle.

•    The more de-leveraging, the more casualties, as markets and companies built on excessive debt collapse.

•    The more casualties, the more intervention, as governments try to contain the damage.

•    The more ad hoc intervention, the more uncertainty about how the evolving system will work. (Even while President Bush insists that “government intervention is not a government take over,” New York Attorney General Andrew Cuomo’s shaming of AIG into canceling 160 conferences and a $10 million payout to its former CFO were only the first indications that bailouts inevitably have strings.)

•    The more uncertainty, the less growth, causing further damage to companies and markets.

The bottom line is that taxpayers are not only going to be feeling lots more pain, but are likely to end up buying lots more bazookas.

– Alan Stoga