Think Again
Oct 16, 2008
By Alan Stoga

 

It didn’t take much to pop the euphoria that followed last weekend’s massive global bank bailout: a few bits of data that remind everyone that the American economy is rapidly contracting, and the stock markets head south with a vengeance.

How many times can Paulson’s bailout fail before any money has actually been spent?

Admittedly, that’s unfair; stock market surges or crashes are the wrong litmus test for what governments have done so far. At least the Americans and the Europeans acted, after months of hoping the problems would manage themselves.

But, we need to recognize that we are far closer to the beginning of the solution than to the end.

First, all the headline actions of the weekend (plus the $700 billion) had one purpose: to build a fence around maybe 20 major U.S. and European financial banks. Those banks—and some others, if possible—are the appointed survivors of the financial nuclear winter that continues to rage.

Since a week ago, several of those banks looked like they might follow Bear Stearns, Lehman Brothers, Merrill Lynch, Washington Mutual and Wachovia into extinction. That is an enormous accomplishment, but it could not possibly end a financial crisis whose root cause is a recklessly over-leveraged financial system. The ring fencing was no more than the first installment in an effort to manage the pace at which the de-leveraging is taking place.

Second, the rest of the financial system has, so far, been left to fend for itself. Insurance companies (other than AIG), pension funds, institutional investors and—above all—hedge funds are all potentially on the endangered species list. Many of them can’t wait for the government to act, as they desperately need cash to cover margin calls or fund withdrawals. That makes them motivated sellers—whether the market is going up or down.

The Financial Times is reporting that the $2 trillion hedge fund industry had withdrawals of at least $43 billion last month, and that outflows are probably running at a higher rate in October. According to a JP Morgan analysis, $43 billion in cash withdrawals would represent $115 billion in asset sales, since hedge funds used so much borrowed money to goose returns.

This means that every time the market tries to rally, there will immediately be sellers who simply need cash. Until that dynamic is exhausted (or the government changes the rules), it is hard to imagine any kind of sustained market recovery.

Third, the collapse of stock values around the world has real-life consequences. America may not have much of a savings rate, but millions of retired people have been living off of their savings, and millions more depend on investments to finance college costs and other extraordinary expenses. Those funds are badly depleted—but the needs remain. Again, whole classes of sellers who will sell at any price.

The point is that saving some banks is a good first step, but no more than a first step.

 

– Alan Stoga

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Oct 10, 2008
By Alan Stoga

Even before the Treasury has spent a single dollar of its $700 billion fund, the markets have pronounced Paulson’s bailout as dead on arrival. All of the criticisms are right: the original proposal was too arrogant, delaying passage; the target should have been building bank equity, not buying bad loans; the Fed already had adequate authority to handle the bad debt problem, and so on.

But they also all miss the core point. Unwinding the excessive securitization and runaway use of leverage is too large and complex a problem for the technicians. Since there is no way to reverse engineer what regulators had allowed to happen, there is no way—at least within the parameters of government-as-usual—to avoid the catastrophe being generated as hedge funds (among others) liquidate their portfolios at any price in order to meet obligations. It is causing market prices to wildly overshoot, thereby causing yet more damage.

What is individually rational is producing collective madness.

Letting the downward spiral run its course as central bankers and finance ministers launch more bailouts and liquidity programs would be the modern equivalent of Hooverism. It isn’t working and could actually be making the problem worse.

It’s time for a New New Deal.

Instead of a bank holiday, we need a market holiday. Instead of closing banks, we need to close hedge funds. Only those that are solvent should be allowed eventually to reopen under federal regulation and guidance. We need to nationalize and liquidate the credit-default swap market, using the federal government’s power (and threat) of eminent domain as necessary. Instead of stretching out mortgage maturities, we need to rework interest rates and payment schedules to keep people in their houses and cash flowing to service the mortgages. That will take extraordinary action—as it did after 1932—and extraordinary caution to ensure that contract law is not permanently undermined.

And, of course, we need a profound revision of the financial regulatory system, from one based on rules to one based on principles. A rules-based system has proven too easy for smart financiers to manipulate, with disastrous results.

That amounts to radical surgery, but the patient is already on the operating table, and in cardiac arrest.

Designing and managing such a solution would take a president with a strong political mandate—but also a strong Congress and Judiciary to provide checks against the abuse of such concentrated economic authority. Are either McCain or Obama up to playing FDR?

– Alan Stoga

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Oct 03, 2008
By FLYP Staff

Not a good week for the Europeans. Banks in Belgium (Fortis), the U.K. (Bradford and Bingley), Germany (Hypo Real Estate) and France (Dexia) all needed government bailouts. Economic activity continued to deteriorate throughout the region, and economic confidence in the Eurozone countries reached its lowest level in seven years. By week’s end, even central bankers were forced to acknowledge that the game is over: European Central Bank head Jean Claude Trichet admitted his “inflation above all else” policy is dead, and interest rates will soon be cut.

Welcome to the global financial crisis.

But, not yet to the global bailout. Even as Congress passed the fattened Bush bailout (which is open to any institutions with significant U.S. business), the first attempt at a European counterpart failed. French President Nicolas Sarkozy had hoped to use a weekend summit with the Germans, Italians and British to get agreement on a 300 billion euro fund to bail out European financial institutions. However, German Chancellor Angela Merkel effectively vetoed the idea, at least for the time being.

One ironic footnote: apparently, some Germans like bailouts. The Financial Times today reported that German carmakers are pushing Washington for a slice of the $25 billion package authorized last week by Congress. The auto industry bailout is disguised as an effort to promote green technology, so Daimler’s CEO, Dieter Zetsche has unleashed his lobbyists on the Energy Department to get German carmakers included.

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Oct 02, 2008
By FLYP Staff

Question: How to make a $700 billion bailout more palatable to congressional naysayers who object to saving bankers from loans they never should have made?

Answer: Raise the price tag to $850 billion, by spreading the government giveaways well beyond Wall Street.

Or, at least, that’s what you do if you are the Senate in an election year.  Yesterday’s 74 to 25 passage of the bailout bill—cloaked in overheated rhetoric about stopping the impending economic implosion—was turned into “business as usual” by senators who saw an unexpected opportunity to pass tax cuts that had seemed destined to have to wait for the new Congress.

So, in addition to making the Treasury the bad loan buyer of last resort, the Senate extended the business research and development tax credit, expanded the child tax credit, reduced the impact of the alternative minimum tax, provided tax breaks for natural disaster victims and renewed tax incentives for solar and wind energy projects.

Christmas in October!

All that adds up to an estimated $150 billion in cuts over ten years.  Additionally, the Senate bill includes some offsetting tax increases that are supposed to raise around $44 billion. These mostly target politically unpopular hedge funds and oil and gas companies.  

For a country already living far beyond its means—which is the root of the problem that produced the financial crisis—the Senate vote demonstrated that Washington doesn’t yet get it.

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Sep 30, 2008
By Alan Stoga

The recovery of the U.S. stock market on Tuesday sent mixed signals to Washington: either market participants believe that the president will be able to persuade reluctant congressmen to pull the Paulson plan back from the brink, or they understand the Treasury and Federal Reserve will simply continue the bank-by-bank and loan-by-loan bailout that has been underway for months if it fails.

Of course, there is another possibility: maybe the market’s recovery is simply what traders call a dead cat bounce. If so, it was a pretty big dead cat.

What is clear is how we got to this point: the White House and congressional leadership miscounted when they scheduled Monday’s ill-fated vote. They were completely surprised when about a dozen conservative Republicans voted against the bill, which in turn led some Democrats to run for cover.

Essentially two-thirds of the Democrats voted for and two-thirds of the Republicans voted against the bill. The “no” votes fit broadly into four bunches:

•    Republicans and Democrats from states hardest hit by the housing crisis—California, Florida, Arizona—who want more taxpayer relief, in particular modification of the bankruptcy law to exempt first homes;
•    very liberal Democrats who want more oversight and who want to see “Wall Street” excesses somehow punished;
•    very conservative Republicans who want less of everything that is in the proposal (at the extreme, they want to reduce taxes to encourage new bank capital formation);
•    Republicans and Democrats in competitive races who just don’t want to vote for an unpopular bill.

The far left and the far right agree on one thing: anything that could be good for bankers is bad for the country.

Which leaves the open question: can this bailout be bailed out?

The problem is that the changes to Paulson’s initial my-way-or-the-highway proposal were crafted to try to meet the needs of just enough congressmen and senators to squeeze through the process. Meeting the demands of legislators in any of the first three categories above would lose too many other votes. Moreover, any legislation still has to pass the Senate where a big conservative Republican defection would horribly embarrass Sen. McCain, who has no choice but to vote for the bill.

The only practical possibility is to make some minor changes and then bring pressure on those who voted against the legislation because they thought it might cost them at the polls in five weeks.

With any new vote delayed until Thursday at the earliest because of the Jewish holidays, most congressmen are undoubtedly hearing about how unpopular this bill has become. And conservative commentators are being brutal in their commentary, adding to the pressure.

For example, Lou Dobbs is almost as hysterical about the bailout as he usually is about illegal immigrants: “It’s absolutely obscenely irresponsible of House Speaker [Nancy] Pelosi, Treasury Secretary [Henry] Paulson, President Bush, Sen. Harry Reid, the leader of the Senate; for these people to be clucking about like hysterical—so hysterically. It really must stop…These Congress people are all at home in their home districts—nearly every one of them—and they’re hearing an earful. The American people don’t want to hear this nonsense about $700 billion to bail out financial institutions."

That kind of noise will make the next vote even tougher. Moreover, the bailout is hostage to the fact that its chief architect, Secretary Paulson, is more a symbol of the problem than a likely crusader for a fair solution.

In fact, if President Bush really wanted to change the game, he would fire Paulson and bring in someone with wide political and economic credibility and, in turn, ask the Congress to suspend its own political bickering. But this highly partisan and highly unpopular president lacks the moral authority—and certainly the inclination—to do either.

If Washington remains in its business-as-usual mindset, the odds the Paulson plan passes are barely better than 50/50—and dropping with every point the Dow rises.

What happens if the legislation fails?

The short answer is, probably nothing much different than has been happening: more bank interventions and consolidations, more need for the Fed to pump out liquidity, more incentive for investors to trade stock for cash and less new credit.

However, all of this will happen even if the bailout passes through Congress.

At its core, the Paulson plan is a framework to soften the hard landing that is inevitable as the markets and economy recover from years of financial recklessness. If the plan passes, we would have a more formal, more predictable and more technically legal process in the short run. If it fails, the Federal Reserve will continue doing what it has been doing: taking bad loans from the banks in the hopes that they can eventually start functioning like banks again.

Thus, the passage or failure of Paulson’s bailout plan has more to do with confidence than with reality. It would be a symbol that someone is in control of what appears to be a situation that is fundamentally out of control.

At best, it would slow—but not stop—the pace at which the U.S. economy is contracting. American consumers are retrenching, overseas markets are weakening, state and local governments are cutting spending and increasing taxes, and even well-capitalized businesses are delaying most new investments.

Admittedly, there is a big difference between a recession and a depression, and between a one- or two-year slowdown and the kind of stagnation that gripped Japan for a decade after their own financial meltdown. Clearly, Washington should be focused on avoiding the worst and not suggesting that it can prevent the inevitable.

This is where the election comes in. Only a new president and Congress with new mandates can build a credible solution. Just as Hoover’s efforts to cope with financial collapse had to be reshaped by Roosevelt, whatever Bush engineers—particularly in the weeks before an election—will have to be redone by his successor.

– Alan Stoga

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Aug 01, 2008
By FLYP Staff

Doesn’t it seem a bit strange that our politicians are locked in a seeming death struggle over whether to drill for more oil in ecologically sensitive places at the same time that scientists have pretty much agreed that consuming too much oil is what produces the most ecological damage?

Even stranger, if the surge in oil and gasoline prices has shocked Americans into driving less, switching to higher mileage cars and generally looking for ways to reduce their energy consumption, why are politicians of both parties frantically searching for the holy grail of lower prices? Senator Harry Reid, taking a cue from Stephen Colbert, declared that “Democrats are the party of drilling!” in an attempt to capture the low ground from the Republicans.

Not to worry: the Republicans, on the campaign trail and in the Congress, have made it clear they won’t give up without a fight.

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Jul 21, 2008
By FLYP Staff

While many people around the world seem obsessed with the U.S. presidential election, when FLYP took the temperature on the attitude to the American presidential election on the streets of Lahore, we found plenty of folks who could care less.
About half the people we approached were entirely uninterested in the U.S. elections. There are two reasons for this. First, a sense of fatalism prevails among many Pakistanis. Second, Pakistan’s own growing list of problems: food and power shortages, inflation, a collapsing stock market, terrorism and the conflict in the tribal regions for which many Pakistanis blame the U.S.
Rokshana Yusaf, a 25 year old college student in Lahore, summed it up this way: “It doesn’t make a difference to us what happens in the U.S. because we have so many problems here. We have load shedding [power outages] and water problems everyday. I try to study for my exams each night and I can’t because we have no electricity.” And Tariq Hussein, a 25 year old traffic cop who is struggling to make ends meet with a wife and two kids, told us that “it doesn’t make a difference who comes to power. They all have the same policies for third-world countries like Pakistan.”
These attitudes were reflected in Pew’s Global Attitude Survey. Only 10 percent of respondents held favorable views of Barack Obama. Low, but good compared to the 7 percent for Bush and 6 percent for McCain.

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Jul 16, 2008
By FLYP Staff

As part of our look around the world at how people in different countries are thinking about the U.S. election, we took a camera to the street in Bangkok and asked people about their hopes and expectations for the next American president. They clearly hope that, whoever wins, the new president will decisively manage the U.S. economy in a way that will resonate around the world.

Take a look at our video and share your impressions.

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May 27, 2008
By FLYP Staff

Hillary’s most recent “I can’t believe you think I meant what I said moment” was her invocation of Bobby Kennedy’s murder to justify staying in the Democratic race: “We all remember Bobby Kennedy was assassinated in June.” The remark was bad enough on the surface. Dig deeper and it gets worse. 1968 was, of course, a year of chaos in American politics, and most everywhere else. After Kennedy was killed, the Democrats eventually chose Hubert Humphrey as their candidate under anything but democratic circumstances. The result was Richard Nixon’s election. Humphrey, Lyndon Johnson’s vice president, entered the race too late to compete in any primaries. Kennedy and Eugene McCarthy had waged a long battle for the nomination, largely focused on stopping the Vietnam War. But the powers-that-be, led by Chicago Mayor Richard Daley, wanted an establishment candidate, regardless of how people had voted in the primaries. Looks like Clinton is trying to channel Hubert Humphrey forty years later. Who is her Dick Daley?

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May 19, 2008
By FLYP Staff

Bill and Hillary Clinton are among the consummate politicians of our era. If you start with that premise, then Hillary Clinton’s imitation of the Energizer Bunny must be more than just not knowing how to leave the stage. There are at least 3 possibilities: 1. Can’t win if you don’t play. In the YouTube age of politics, any mistake can be instantly magnified into a campaign changer. While Barack Obama is unlikely to have a “macaca” moment, Hillary’s strategy could be to stick around hoping for a bigger mistake than “bitter” whites or for the emergence of another Rev. Wright from Obama’s past. 2. Go with the odds. One of the best ways to become president is to start as vice president. Sure, Obama and Hillary undoubtedly despise each other after a long, bitter campaign. But so did Kennedy and Johnson, the last two sitting senators to share a ticket and win. Perhaps Hillary’s end game is to leverage her supporters’ rabid enthusiasm into a unity ticket. That would probably require keeping her search for superdelegates alive until the convention. 3. Make Machiavelli proud. The last third of Hillary’s campaign has sounded much more like a Republican attack ad than like a Democratic intramural. The Clinton delegate counters may have concluded long ago that the 2008 nomination was a lost cause. So why not stick around and help defeat Obama? John McCain would be the oldest first term president in the nation’s history, so actuarial tables alone—never mind the mess that George Bush will leave behind—suggests that his re-election could be a challenge. If Obama loses, Hillary inherits the party (maybe). Of course, there is also the possibility that the Clintons have simply lost their magic, or that she is working through the five stages of (political) death: anger, denial, bargaining, depression and acceptance. If so, this will go on long after the last primary votes are cast on June 3.

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