A More Conservative Union

Obama's Double-Dealing Bank Tax

2010-01-20T01:15:00.002-03:00

Government Sachs, indeed.

Forget Goldman Sachs funding a housing bubble even while betting against it. Revisit the famous collapse of Long Term Capital Management, in which (according to a 2000 book by former Journal reporter Roger Lowenstein) Goldman used information gathered from its hedge fund client to bet against the client's positions.
Or revisit a column in this space, circa 1998, about Goldman holding a splashy event in Moscow to sell investors $1.25 billion in new Russian government bonds, which allowed Russia to pay off a $500 million loan to Goldman just before Russia defaulted on its international debts.
Goldman chief Lloyd Blankfein was understandably wide-eyed with wonder at last week's hearing of the Financial Crisis Inquiry Commission. He pointed out that the people on the other side of every Goldman housing-related trade were, for Jiminy Cricket's sake, professional investors.

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He might have added that Goldman bets against its clients every time it buys something they want to sell or sells something they want to buy. He might have suggested that any client who doesn't understand Goldman is looking after its own interests (just as Goldman expects the same of its client) is an idiot and has no business being in business.
He could have, but for an exquisite sense of decorum, also pointed out that one of the things hampering recovery is Washington's own record of double-dealing with respect to bank investors.
Hark back a few months to the shadow play of the Obama bank stress tests. Crediting themselves with mending the crisis, President Obama and Treasury Secretary Tim Geithner ruled that banks were on a solid footing because private investors would provide fresh capital and banks would be free to book profits and earn their way out of trouble.
That was then. Today it's politically convenient to bash banks for the very same profits, and to punish the very same investors with a new Obama bank tax. First, the government coaxes banks into buying back the government's TARP stake (and therefore government's share of future earnings). Then it turns around and helps itself to a chunk of those earnings anyway.
Hmmm. At least Goldman doesn't tell you "We're all in this together" and then sell you short (it just sells you short).
In fairness to Team Obama, this habit didn't begin with them. Hank Paulson and the Bush administration were also guilty of the occasional bait and switch. When Fannie Mae and Freddie Mac were struggling, Mr. Paulson suckered several big-name fund managers into investing in their shares, declaring the housing lenders "well capitalized," insisting their ownership "status" wouldn't change, even gilt-edging the invitation with a ban on short-selling Fannie and Freddie shares.
Bam! No sooner had investors acceded to his invitation than Fannie and Freddie's shareholders were railroaded off to the moral hazard hoosegow when the two were seized and their ownership wiped out.
Of course, Mr. Paulson had a global crisis on his hands and needed to keep congressional support for his bailout efforts. The only crisis facing Mr. Obama last week was the Massachusetts Senate race.
Here's what's really going on. Like Mr. Paulson before them, Messrs. Obama and Geithner are sticking it to bank shareholders simply because it's safe to do so (safer, say, than threatening the Chinese with losses on their massive holdings of Fannie and Freddie IOUs).
Aside from slightly raising the banks' cost of uninsured borrowing, the new Obama tax would do nothing to reduce the well-founded expectation of their uninsured creditors that they will be bailed out next time the banks get in trouble. Meanwhile, the only lesson the shareholders who just recapitalized the banks at Washington's behest can possibly learn is the moral hazard of trusting Washington.
Let's hope the crisis is over. Let's hope the banks don't soon need fresh infusions of equity to deal with more bad loans. If investors didn't get the message before, they've got it now: There will be no upside allowed. Anytime the sector starts to show signs of recovery, Washington can swoop in and grab the profits as a "responsibility fee."
This may be politically expedient given populist blowback over bank bonuses, but it's not a step toward a competitive, responsible banking sector that takes appropriate risks without looking for government handouts or bailouts. On the contrary, it's a formula for turning the banks into what Fannie and Freddie have become: profitless channelers of taxpayer-guaranteed money into whatever loss-making loans politicians happen to want made. Compared to that, give us Goldman every time.

Restoring Faith in Financial Markets

2010-01-19T01:45:00.002-03:00

It is time institutional investors exerted control over publicly held companies.

By JOHN C. BOGLE

'Investing is an act of faith." So I wrote in 1999, the very first sentence of my book, "Common Sense on Mutual Funds." But as 2009 ended, writing in the updated 10th anniversary edition after the passage of this turbulent decade, I concluded that "the faith of investors has been betrayed."
How so? Because the returns generated by our corporate stewards have often been illusory, created by so-called financial engineering and produced only by the assumption of massive risks. What's more, too many of our professional money managers have failed to act as vigilant stewards of the money that we investors entrusted to them.
In short, far too many of our corporate and financial agents have failed to honor the interests of their principals—the mutual fund investors and pension beneficiaries to whom they owed a fiduciary duty. The ramifications were widespread—for the failure of money managers to observe the principles of fiduciary duty played a major role in allowing our corporate managers to place their own interests ahead of the interests of their shareholders.
Over the relatively brief span of a half century, our institutional agents have come to be the dominant force in corporate America. Institutional investors held less than 10% of all U.S. stocks in the mid-1950s, 35% in 1975, and 53% a decade ago, and now institutional investors own and control almost 70% of the shares of U.S. corporations. Mutual funds own the predominant amount, 26%; private pension plans another 11% and government pension plans another 9%.

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The rise of agency ownership has been steady, and seemingly inexorable. But this revolution in equity ownership—it is no less than that—has been accompanied by many shortcomings, in part because it linked the agents of corporate America with the agents of investment America. As Leo E. Strine, vice chancellor of the Delaware Court, observed in a speech in 2007, "No longer are the equity holders of public corporations diffuse and weak . . . (they) represent a new and powerful form of agency, which presents its own risks to both individual investors and . . . the best interests of our nation." Yet, he noted, professional money managers are no less likely "to exploit their agency than the managers of corporations that make products and deliver services."

First, the folly of short-term speculation has replaced the wisdom of long-term investing as the star of capitalism. A rent-a-stock system has replaced the earlier own-a-stock system. In 2009, the average stock turnover appears to have exceeded 250% (changed hands two and a half times), compared to 78% a decade ago, and 21% barely 30 years ago.
Result: The momentary illusion of the price of a stock took center stage, replacing the enduring reality of the company's intrinsic value—the discounted value of its future cash flow. Our newly empowered agents ignored the famous warning of Benjamin Graham in "The Intelligent Investor" that "in the short run, the market is a voting machine; in the long run, it is a weighing machine."
Two, the financial sector became the driving force in the U.S. economy. During the past decade, revenues of stock exchange firms (excluding trading gains or losses) rose to an estimated $375 billion from $200 billion, and mutual fund fees and expenses rose to nearly $100 billion from $47 billion. The higher these intermediation costs, of course, the lower the returns to investors as a group. Alas, in this Alice-in-Wonderland world of the financial markets, the investor feeds at the bottom of the food chain.
Three, innovation became the buzzword of the era. But innovation was dominated by complex new products, such as credit default swaps and collateralized debt obligations, designed to make money for Wall Street firms rather than for their clients. Former Federal Reserve Chairman Paul Volcker recently opined that the only financial innovation of the era that created value was the ATM. (He has also agreed that the index fund created substantial value for investors.)
Four, all of this speculative market activity and costly marketing activity seemed to lead institutional money managers to ignore the realities that drove the balance sheets and income statements of the companies held in their portfolios, a striking failure of professional security analysis. "Financial engineering" was left to run rampant and "anything goes" seemed to be the rule in the quest to meet earnings guidance. The late Robert Bartley, long-time editor of this newspaper, got it right when he wrote in The American Spectator (Dec. 2003-Jan. 2004), "true profits are represented by cash—a fact—rather than reported profit—an opinion."
Five, absent the check of their institutional owners, corporations pushed executive compensation to unprecedented heights. From 42 times the average worker's salary in 1980, the compensation of the typical chief executive of a U.S. corporation now approaches a staggering 400 times the average worker's salary. Despite the collapse in corporate earnings during the recent financial crisis, there are few signs that executive compensation has been significantly affected.
While many social forces contributed to these aberrations in capitalism, the dominance of our new agency system played the major role. Regulation alone will not be sufficient to correct these gross abuses, for the self-interest of our agents, abetted by powerful and well-financed lobbyists—paid for, finally, by the very corporate and mutual fund shareholders whom new regulations are designed to serve. There are few regulations that smart, motivated, targets cannot evade.
The process of restoring the faith of investors must begin with a demand that the agent/owners of investment America stand up for the rights of their principals/beneficiaries. What we need is congressional action to establish a federal principle of fiduciary duty—encapsulated by the phrase "no man can serve two masters."
This principle will require institutional managers (1) to act solely in the interests of their shareholders and beneficiaries; (2) to observe due diligence and professional standards in their investment practices; (3) to honor their responsibilities as owners by active participation in corporate governance; and (4) to eliminate conflicts of interests in their activities.
Together, these standards would require the giant financial institutions of investment America to behave as owners of corporate America, actively voting proxies in the interests of their principals; playing a role in dividend payouts and executive compensation as well as in mergers and acquisitions; limiting (or even eliminating) excessive stock options; and demanding the independence of directors from management (including the separation of the roles of chief executive and board chairman).
In addition, policy makers ought to be considering structural changes that would enhance the role of investors and diminish the role of speculators. For example, granting longer-term (say, two- to five-year holders of stock) extra voting rights and/or a higher dividend; a federal transfer tax on securities transactions; or a tax on short-term realized capital gains (say, shares held for less than six months), applicable to taxable as well as tax-exempt investors such as IRAs.
As the new year and the new decade begin, it is time to restore the faith of investors in our interlinked corporate and financial systems. This is not a task for the fainthearted, or for the impatient.
Early in 2002, I called for the creation of a Federation of Long-Term Investors, in which institutional investors—including the giant index fund managers who alone hold some 15% of U.S. stocks—would join together to force these long-overdue changes and exert their ownership power over our publicly-held companies.
Then, I found few allies. Today, perhaps, this is an idea whose time has come.
Mr. Bogle is founder and former chief executive of the Vanguard Group. The 10th anniversary edition of his "Common Sense On Mutual Funds" was published by Wiley last month.

Obama Unveils $90 Billion Bank Tax With Sharp Words

2010-01-15T01:35:00.002-03:00

By JONATHAN WEISMAN and DAVID ENRICH

European Pressphoto Agency

President Barack Obama describes his plan to impose a tax to recoup taxpayer expenditures for the financial-sector bailout.

President Barack Obama unveiled his proposed $90 billion bank tax Thursday with some of his toughest rhetoric yet toward Wall Street, saying: "We want our money back, and we're going to get it."
The president's tough line dovetails with a political push by Democrats to capitalize on anger over bonuses and profits from banks that benefited from taxpayer bailouts during the nadir of the financial crisis.
Democratic leaders responded cautiously to the proposal, mindful that the president's pledge last year to retrieve bonuses paid to American International Group executives has yet to be fulfilled, according to senior leadership aides. One senior Democratic aide said the House wouldn't move forward on the tax proposal until leaders there were sure the Senate would follow suit.

Banks will be hit by a new tax that targets institutions that rely on short-term borrowing, such as Goldman Sachs, Morgan Stanley, and Citigroup.

While much of the banking industry is up in arms over the proposed tax, the impact would likely be a relatively modest dent to the companies' profits.
The 10-year assessment on bank liabilities—dubbed the Financial Crisis Responsibility Fee—would fall most heavily on the nation's top six banking companies: Citigroup Inc., J.P. Morgan Chase & Co., Bank of America Corp., Goldman Sachs Group Inc., Morgan Stanley and Wells Fargo & Co. Each would likely face an annual bill of $1 billion or more, with Citigroup and J.P. Morgan facing the largest liabilities, likely more than $2.4 billion apiece.
Betsy Graseck, a banking analyst at Morgan Stanley, estimated the tax would shave roughly 5% from top banks' bottom lines this year.
The White House pushed hard against opposition to the tax. The president spoke of "obscene bonuses" and the "twisted logic" of bank executives who oppose the tax. White House spokesman Robert Gibbs suggested the banks were trying to pass the tab for their woes to taxpayers.
Industry officials warned that the new tax could constrain bankers' ability to make new loans, which could hurt the economy. In addition, some analysts cautioned that the plan could encourage banks, to reduce their exposure to the fee, to shift more assets and liabilities into the types of off-balance-sheet vehicles that helped sow the seeds of the financial crisis.
Democratic political strategists say the president's plan could box in Republicans who are trying to harness the popular rage at Wall Street bailouts, but won't support a tax increase.

Financial Crisis Responsibility Fee

Read President Obama's proposed Financial Crisis Responsibility Fee

If Republicans oppose the tax, Democrats will accuse them of siding with bankers bailed out by taxpayers. If GOP candidates side with the president, they risk alienating antitax activists who are bringing renewed passion to the party.
"If you want to be on the side of the big banks, this is a great country. You're free to do so," Mr. Gibbs said.
Republican strategists saw no such trap. They focused their attention on the people who they say will ultimately pay the tax's tab: consumers facing higher bank fees and small businesses blocked from loans.
"Making it harder for families and small businesses to save, invest and hire would be the latest in a number of tone-deaf policies coming out of the Democratic Congress," said Ken Spain, spokesman for the National Republican Congressional Committee, which oversees House campaigns for the GOP.

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Not all Democrats came on board. Sen. Kirsten Gillibrand, a New York Democrat, said she opposed the proposed tax, saying it "could disproportionately affect New York City's economic recovery, which relies on a growing financial-services industry."
If approved by Congress, the tax would force about 50 banks, insurance companies and large broker-dealers to collectively pay roughly $90 billion over 10 years.
Under the plan, a 0.15% tax would be levied on liabilities and would apply to a range of firms that received taxpayer assistance, excepting the Detroit auto makers. The tax would be levied on total assets, minus a type of capital considered high quality, such as common stock, and disclosed and retained earnings.
The nation's large regional banks would face smaller fees than their Wall Street counterparts, based on the composition of their balance sheets.
Some Democrats want to go further. Rep. Peter Welch (D, Vt.) has proposed a 50% tax on bonuses over $50,000 at any financial firm that took federal assistance during the financial crisis. That would be on top of the president's tax, he said.
"When people are robbing a bank, it's time to stop them," he said in an interview.
The president's plan could let some of the steam out of such proposals, while still giving Democrats a line of attack for the midterm elections.
White House officials said the president was serious about his bank-tax proposal, which has been under discussion since August. A provision inserted in the legislation authorizing the Troubled Asset Relief Program required the administration to come up with a way to recover money spent to save the financial system.
Investors shrugged off news of the proposed fee. Shares of most banks inched upward Thursday, with the KBW Bank Index climbing about 1.6%.
Analysts say the impact could be muted if the fee is tax-deductible, an issue that hasn't been addressed by the Treasury Department.
Still, it is the latest in a string of recent federal initiatives that could erode bank profits. In November, the Federal Reserve announced rules, set to take effect in July, that will bar banks from charging certain overdraft fees without explicit consent from their customers. And other changes that could be costly to the banking industry continue to work their way through Congress, such as legislation that would impose new restrictions on the trading of derivatives.
—Deborah Solomon contributed to this article. Write to Jonathan Weisman at jonathan.weisman@wsj.com and David Enrich at david.enrich@wsj.com

Bashing Bankers Is a Political Duty

2010-01-13T01:46:00.002-03:00

But don't overlook the fact that taxpayers are making out on the bailout too.

If you would know why bankers are enjoying a large and controversial deluge of annual bonuses, look no further than the monthly report of the New York State Comptroller's Office. The economy may be in the dumps, but Wall Street enjoyed record profits of $50 billion in the first nine months of last year—"nearly two and a half times the previous annual peak in 2000."
"Profitability," adds the state of New York, "has soared because revenues rose while the costs of doing business—particularly interest costs—declined" (in other words, thank you Federal Reserve).
That $50 billion may seem odd in relation to Wall Street's reported bonus pool of $90 billion, but compensation isn't paid out of profits, it's paid out of revenues. Goldman last year paid out about 44% of revenues as compensation, Citigoup about 30%. In contrast, an auto company pays out about 11% of revenues, but an auto company consumes a lot of other inputs—glass, steel, energy, advertising, aluminum—whereas Wall Street has only two inputs: smarts and money.

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Bonuses are a dominant part of compensation because Wall Street firms pay a large chunk of compensation as variable comp, for which the word bonus has been used. Now some firms are paying larger fixed salaries just so the public won't hear the word bonus.
But look at it this way: The $90 billion that will be distributed to employees is but a sliver of the massive capital Wall Street is sitting on. One firm, Goldman, cares for $880 billion, Citi another $1.9 trillion, JP Morgan another $2 trillion. Much of the nation's paper wealth rebounded sharply last year from depressed values after (choose your reason) Americans overbet on housing or the federal government briefly fumbled public trust in its ability to protect the financial system.

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Do bankers deserve it? Of course not. Do you deserve your good looks, good health or good luck in choice of parents and/or country you were born in?

Compensation in our society is not set by Henry Waxman and a committee of Congress, but as a matter of legal and instrumental obligation under circumstances of market competition. A firm's management, with its own interests strongly in mind, ultimately decides how much of a firm's revenue to spend pleasing the highly mobile employees who do the work of pleasing the firm's highly mobile clients and investors.
But didn't taxpayers bail out the financial system, so don't taxpayers deserve the bonuses? No. Taxpayers (aka voters) were acting in their own interests in bailing out the system. They weren't doing anybody a favor. Furthermore, government already stands to collect about 50% of any Wall Street cash bonuses in the form of income tax (which explains why the subject is of interest to the New York state comptroller).
What's more, despite a casual imputation that taxpayers were the suckers at the table, taxpayers did not, as commonly alleged, "spend" money to bail out the banks. They traded one claim for another. Mostly, they traded claims they printed (dollars) for claims on real assets, such as housing, commercial property and industrial equipment.
Taxpayers effectively acquired these assets on a bet that taxpayers' own intervention would raise their value, which had previously been depressed at least partly by fears that taxpayers wouldn't intervene. That bet has proved a good one so far (as bets often do when you control the outcome). Even the most notorious of the exchanges that taxpayers engaged in—dollars for securities held by Goldman Sachs that had been guaranteed by AIG—are accruing profits on the balance sheet of the Federal Reserve.
In fact, yesterday the Fed, whose balance sheet is about the size of Citigroup's, reported whopping profits for 2009 of $52 billion—just a few billion shy of what Wall Street as a whole is likely to report for the year. (All this throws a mocking light on the Obama administration's claim yesterday that a new tax must be imposed on banks to "recoup" bailout costs.)
None of this means Americans don't have an ancient and abiding interest in subjecting bankers to scorn. A rough socialism is fundamental to civilization: The most beautiful virgin must be sacrificed to make the other virgins feel better—a service politicians are especially keen to provide when the alternative might be looking at their own role in the reckless risk-taking of banks and homebuyers.
Still, looking at Washington's own role would be a good idea, since taxpayers' success (so far) in catching the falling knife is certainly no reason to repeat the experiment.

The Geithner AIG Story

2010-01-13T01:45:00.002-03:00

Those emails and 'systemic risk.'

Timothy Geithner is back in piñata mode, with House Oversight Chairman Edolphus Towns asking him to testify next week about bailout giant AIG. By all means Members should swing away at the Treasury Secretary, but only if they focus on the right questions.
The trigger for the Towns hearing is the release of emails between the Federal Reserve Bank of New York and AIG in November and December 2008. The New York Fed urged AIG to limit disclosure of its deal to buy out derivative trading partners at 100 cents on the dollar. But since AIG went ahead and disclosed it anyway, this line of inquiry doesn't get to the heart of the taxpayer interest.
Likewise, asking if Mr. Geithner helped write the emails to AIG will simply allow him to continue avoiding the bigger questions: Why did he believe AIG could not fail? Why should he receive more authority to declare firms systemically important, when he will still not fully explain his previous multibillion-dollar judgments in the name of countering "systemic risk"?
Mr. Geithner was president of the New York Fed when it began sending what has become $182.3 billion in taxpayer assistance to AIG in September 2008. Much of this money was used to meet collateral calls from big banks that had bought AIG's credit default swaps. AIG had resisted handing over more collateral. But once Mr. Geithner was in charge of AIG, the cash flowed freely to these bank counterparties.

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Treasury Secretary Timothy Geithner

The Fed and AIG ultimately bought the underlying securities at par. This was not only much more than the counterparties might have received from a bankrupt AIG, but even a healthy AIG would never have handed over so much cash in the midst of a panic in which cash was king. Mr. Geithner's New York Fed demanded the 100-cents on the dollar deal for these counterparties, and it demanded that their identities be kept secret. The Journal nonetheless reported this sweet deal and the names of some beneficiaries, including Goldman Sachs, in early November 2008, but taxpayers had to wait months before AIG finally released the full story.

Given the sweet deal and the fact that Mr. Geithner sought to keep secret the identities of the beneficiaries, logic would suggest that the AIG intervention was intended as a bailout for these counterparties. Supporting this conclusion is the fact that Mr. Geithner has sold his plan to regulate derivatives as a way to prevent such problems in the future. Yet when asked directly by the inspector general for the Troubled Asset Relief Program why he opted to buy out the counterparties at par, Mr. Geithner said "the financial condition of the counterparties was not a relevant factor."

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Then last November, he suggested that the systemic risk was in AIG's traditional insurance business. "AIG was providing a range of insurance products to households across the country. And if AIG had defaulted, you would have seen a downgrade leading to the liquidation and failure of a set of insurance contracts that touched Americans across this country and, of course, savers around the world," he said. So which was it?
Taxpayers also still haven't been told why there couldn't have been any sunshine on Mr. Geithner's beloved AIG counterparties. If some of them really would have failed, with systemic consequences, why not announce that they were all getting a deal to bolster liquidity and allow them to resume lending? That is exactly what regulators had just done in October 2008 by naming recipients of TARP capital injections.
On the other hand, if the counterparties weren't the systemic risk, then what's the argument for regulating derivatives?
The evidence builds that AIG's "systemic risk" wasn't a mathematical answer to a rigorous and thoughtful review of data, but rather a seat-of-the-pants judgment by regulators in a panic. If that is the case, someone should ask Mr. Geithner why the American people should give him even more authority to make more such judgments from his hip pocket—with little public scrutiny.
Under the House regulatory reform, Mr. Geithner would chair a new Financial Services Oversight Council. The council could declare virtually any company in America a systemic risk, making them eligible for intervention on the taxpayer's dime. The law firm Davis Polk reports that since this council is not an agency, it will not be subject to the Administrative Procedure Act, the Freedom of Information Act or the Sunshine Act, among other laws intended to allow citizens to scrutinize government.
It's difficult to learn and apply the lessons of AIG because the New York Fed has done so much to conceal them. Mr. Towns appears to be getting closer to the truth, deciding yesterday to issue subpoenas focused on the New York Fed's decision-making, as opposed to whatever it told AIG to say in public. Let's hope lawmakers explore what the "systemic risk" actually was—and why Mr. Geithner should get nearly open-ended power to define it again.

U.S. Chamber warns of 'double-dip' recession because of Dem policies

2010-01-12T22:14:00.000-03:00

By Ian Swanson - 01/12/10 09:44 AM ET

U.S. Chamber of Commerce President Tom Donohue warned the U.S. faces a double-dip recession because of the taxes and regulations under consideration by the Democratic Congress and President Barack Obama.

“Congress, the administration and states must recognize that our weak economy simply could not sustain all the new taxes, regulations and mandates now under consideration. It’s a sure-fire recipe for a double-dip recession, or worse,” Donohue said in a speech providing the Chamber's outlook for 2010.

Donohue said the lawmakers should not let former President George W. Bush's tax cuts expire at the end of year and lambasted Democratic efforts on healthcare and financial regulatory reform as well as climate change.
If the tax cuts are allowed to expire, “we will likely end up with even bigger deficits and greater economic misery,” Donohue said.
Many tax lobbyists expect Congress to extend the cuts for people with lower tax rates, but to allow higher rates to be reimposed on those in the top bracket.

He also faulted Obama and Democratic lawmakers for not doing more to create jobs.

Donohue criticized a separate tax on banks floated by the administration on Monday, and said that the rationale for any tax increases would be increased spending, not lowering huge budget deficits exacerbated by the recession.

“We are talking about a massive tax increase in a very weak economy — a tax increase whose clearly intended purpose is not to reduce the deficit, but to pay for more spending,” he said.

He also promised the Chamber would be more involved in the 2010 midterm election than it has been in any other before, and will hold accountable lawmakers who vote against the group's priorities.

Donohue’s speech follows a year in which the nation’s leading business lobbying group consistently butted heads with the Democratic White House, particularly on Obama’s keystone issues of healthcare and climate change.

The Chamber stumbled at times. Several high-profile members, including Apple, left the Chamber because of the group’s opposition to Obama’s pursuit of climate change legislation. Nike quit the Chamber’s board of directors over the same issue, publicly complaining that the business group was not representing all of its members on the issue.

In October, pranksters pretending to be Chamber officials held a fake press conference announcing the group had shifted its stance on climate change. Chamber officials trekked to the National Press Club after a wire service issued an incorrect story based on a fake news release put out by a group known as The Yes Men.

On healthcare, Donohue said the legislation under consideration by Congress would do nothing to rein in costs and was a prescription for “fiscal insolvency and an eventual government takeover of American healthcare.”

He said the House climate bill would raise energy costs and kill jobs.

Donohue also blasted the administration’s policies on trade, hitting it for not sending to Congress pending deals negotiated by the Bush administration with South Korea, Colombia and Panama.

“We need a bold and aggressive trade policy, something we don’t have today,” he said.

The Chamber is predicting the economy will grow at a rate of about 3 percent in 2010. The business lobby has set out a goal of creating 20 million new jobs over the next 10 years.

Economy Still Bleeding Jobs

2010-01-09T01:47:00.002-03:00

By JUSTIN LAHART

Employers cut another 85,000 jobs last month, dashing hopes of a turnaround in employment, even as the U.S. economy grows.

With December's losses, there were 7.2 million fewer jobs than in December 2007, when the recession began. Although the unemployment rate was unchanged at 10% from November, that's only because many workers stopped looking for work and weren't counted in the numbers. A broader measure of unemployment, including those who have quit job hunting as well as those working part time because they can't find full-time work, remained about the same at 17.3% in December from 17.2% in November.
December's dismal job figures, reported by the Labor Department Friday, demonstrate that companies remain skittish about hiring even as their outlooks improve. Economic figures released so far suggest that gross domestic product -- the broadest measure of the value of goods and services produced by the economy -- grew at a 5.4% rate in the last three months of 2009, according to Macroeconomic Advisers, a St. Louis forecasting firm.
United Parcel Service Inc. raised its fourth-quarter earnings target Friday, but the shipping company also said it will cut 1,800 jobs.
"We've come to realize that with technology and management systems, we can manage larger geographic areas than ever before," said UPS spokesman Norman Black.

Even once jobs come back, the unemployment rate may continue to rise. To keep up with a growing population, the economy needs to add about 100,000 jobs a month just to keep the unemployment rate stable.
Moreover, many people have stopped looking for work in response to the poor jobs environment. As a result, they don't show up in the Labor Department's tally of the unemployed.
In fact, a key reason why the unemployment rate didn't increase in December was that work force declined by 661,000. As a result, as the labor market improves, and people re-enter the work force and begin looking for work, the unemployment rate could rise.
Stocks edged higher Friday, with disappointment over the jobs report offset by expectations that the news would keep the Federal Reserve from raising rates. The Dow Jones Industrial Average rose 11.33 points to 10618.19.
The labor market isn't deteriorating nearly as quickly as in the first half of 2009, when it lost an average of 560,000 jobs a month. And most economists believe the economy will begin generating jobs within the next few months.
Nevertheless, the economy has been growing since the middle of 2009, and the fact that job losses have continued for so long points to a tepid recovery in the labor market. Revised figures showed that the economy added 4,000 jobs in November -- the first month of job gains since the recession began -- instead of the 11,000 job loss that was initially reported.

U.S. Unemployment: Historical View

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The Shifting Job Market

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Prior to the 1990s, the job market tended to recover alongside the overall economy after recessions. But in the recoveries that began in 1992 and 2001, jobs were slow to return. That was partly because firms facing increased global competition became even more focused on keeping costs down. Improved technology allowed companies to produce more with fewer workers. Rising profit margins and large productivity gains suggest that many companies are keeping tight control over labor costs -- one reason Federal Reserve officials believe that this recovery, too, will produce spotty job growth in its early stages.
"The employment picture overall has improved, and the outlook is certainly much brighter than one year ago," Eric Rosengren, president of the Federal Reserve Bank of Boston, said in a speech Friday. But he warned that "many firms are not yet ready to do new permanent hiring."
Lackluster job growth means downward pressure on wages and inflation and gives the Fed room to keep rates low. Manufacturers kept shedding jobs last month, though at a slower pace. Manufacturing payrolls fell by 27,000, compared with a drop of 35,000 a month earlier, the smallest loss in two years.
"We've gotten a little busier than six months ago, but it's nothing to be overly impressed with yet," said William Bachman, CEO of Bachman Machine Co. in St. Louis. The company, which makes plastic and metal parts mainly for the automotive industry, employs 89 workers, down from 125 a year ago.
Though Mr. Bachman believes business will continue to pick up, he doesn't expect to be hiring soon. "Not for the next three months, anyway," he said.

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“ Wow. I was expecting a slight gain, what with the seasonal hiring that usually takes place over the holidays. I am very apprehensive in regards to what January number will end up being. ”

— Jordan Martin

In the construction sector, hammered by the housing bust, the labor market worsened, with 53,000 jobs lost, compared with a November loss of 27,000. Nearly a third of the jobs lost were in the kinds of heavy-construction and engineering projects that much of the government's economic-stimulus efforts are directed at creating, said Michael Carey, an economist with Calyon Securities in New York. "It seems like it should be working the other way," he said.
Jeff Frankenfield's general-contractor business was growing by about 20% a year until October 2007. That's when "my phone stopped ringing," he says. "The consumer totally stopped spending money on remodeling." Now, instead of hiring and overseeing laborers to remodel homes in the San Francisco Bay area, he's doing such work himself, and earning about 30% less. "I kind of swallowed my pride because I need to pay bills," he says, adding that the competition for carpentry jobs is intense.
"People are shopping out the contractors," he says. "I did a job last year, a kitchen remodel, and the woman had nine estimates. Typically people get just two or three."
In brighter spots of the report, the temporary-help sector added workers for the fifth month, with 46,500 jobs gained. Gains in temporary employment often signal increases in overall hiring: Employers hire temps in the initial stages of recovery until they are confident the upturn will be sustained.
Tig Gilliam, CEO of Adecco North America, the largest staffing company in the U.S., said his firm is beginning to see more employers moving toward promoting temporary workers to full-time positions.
—Sarah E. Needleman, Jon Hilsenrath and Jennifer Levitz contributed to this article. Write to Justin Lahart at justin.lahart@wsj.com
Corrections & Amplifications:
Average hourly earnings rose to $18.80 from $18.77. An earlier version of this article incorrectly said average hourly earnings had risen from $18.74.

Washington and the Fiscal Crisis of the States

2010-01-08T01:16:00.002-03:00

The strings on federal stimulus money are making it harder for states to cut spending and balance their budgets.

By RICHARD RAVITCH

As one whose interest in public service stems largely from the conviction that government can make a positive difference in people's lives, I have found the past year a paradox. From the financial crisis to health-care reform, the federal government has taken on challenges that urgently need to be addressed. Yet despite these actions—and sometimes because of them—the states, which provide most of the services that touch citizens' lives, are in their deepest crisis since the Great Depression. The state crisis has become acute enough to belong on the federal agenda.
New York State faces a budget deficit that could climb to $8 billion or $9 billion in fiscal year 2010-11 and the state could face another deficit in 2011-12 of about $14 billion to $15 billion. The causes of the larger deficits down the road include a drop off in federal stimulus funds, an increase in Medicaid costs, and the planned expiration of a state income tax surcharge, as well as the state's underlying structural deficit.
New York is in a tough spot, but few other states are immune from large and growing deficits. According to the Center on Budget and Policy Priorities, the states have faced and will face combined budget shortfalls estimated at $350 billion in fiscal years 2010 and 2011. Past experience suggests that these deficits will continue even if a national economic recovery takes hold. Moreover, we do not know how robust the recovery will be or what shape it will take. We know only that it will not spare the states the necessity of making acutely painful fiscal choices. New York and other states face draconian cuts in public services, higher taxes, or, more likely, a combination of both.

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•Review & Outlook: States and the Stimulus
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The federal stimulus has provided significant budget relief to the states, but this relief is temporary and makes it harder for states to cut expenditures. In major areas such as transportation, education, and health care, stimulus funds come with strings attached. These strings prevent states from substituting federal money for state funds, require states to spend minimum amounts of their own funds, and prevent states from tightening eligibility standards for benefits.
Because of these requirements, states, instead of cutting spending in transportation, education, and health care, have been forced to keep most of their expenditures at previous levels and use federal funds only as supplements. The net result is this: The federal stimulus has led states to increase overall spending in these core areas, which in effect has only raised the height of the cliff from which state spending will fall if stimulus funds evaporate.
Until recently, some people predicted that the stimulus funds would not evaporate—that instead the federal government would rescue the states once more with another stimulus bill. But the prospect of this kind of help looks doubtful as an increasing number of lawmakers in Washington worry about the federal deficit and seem intent on taking serious steps to rein it in.
If those steps include neglecting the fiscal situation facing the states, the country could be headed for fiscal problems that are larger than the ones we face now. We are in a time of extraordinary economic change and Washington is struggling with the sometimes-conflicting demands of the federal deficit and the unemployment rate. But the states' growing deficits present their own urgent national problem that the federal government must place in the balance.
Federal policy makers do not have the option of assuming that the state fiscal crisis is temporary or will cure itself without further involvement by Washington. This crisis reflects the growing long-term pressures on the states from the health-care needs of an aging population and the maintenance needs of an aging infrastructure. Moreover, the $3 trillion municipal bond markets have begun to notice the states' deficits: Moody's recently downgraded the bond ratings of Arizona and Illinois because of the deficits those states face. The rating agency says it is waiting to see whether New York will reduce its budget gaps and has warned the state against trying to do so solely through one-time actions.
It seems almost inevitable now that the states' fiscal problems will have further effects on capital markets, possibly as soon as next spring and summer. If more cracks appear in the capital markets that handle municipal bonds, the U.S. Treasury and the Federal Reserve will be faced with an unattractive set of options: They can allow those markets to deteriorate or use federal tax dollars to shore them up and thereby increase the federal deficit.
It is safe to say that one way or another events will force federal policy makers to spend money in response to state deficits. Federal officials shouldn't wait for an emergency to begin to address two questions: Which services should the federal government provide and which should the states provide? And how should the costs of these services be split among federal, state, and local tax bases?
For example, Medicare, not Medicaid, is the primary payor of health-care costs for the elderly and disabled. About 17% of Medicare beneficiaries are low-income and, thus, also receive varying levels of state Medicaid benefits. These "dual eligible" beneficiaries account for some 40% of state Medicaid spending.
For these beneficiaries, the current system is a nightmare: They disproportionately suffer from chronic diseases but must navigate two separate bureaucracies and sets of rules in order to receive care. For the states, this system is a costly burden. From the perspective of a rational health policy, the system is an anachronism. It developed when Medicare did not provide income-based aid and did not have income-based information about those it served. Medicare now provides such aid and has the information and capacity to provide these benefits more effectively, with more potential for cost containment, than the current system.
A federal takeover of services to dual eligibles would cost about $70 billion per year. For many states, a share of this amount would be the difference between chronic fiscal crisis and a chance at structural budget balance. After the Troubled Asset Relief Program and health-care reform—with the cost of the latter estimated by the Congressional Budget Office at almost $900 billion from now through 2019 and $1.8 trillion in the 10 years from 2014 through 2023—the bill for such a takeover does not seem huge or disproportionate to the relief it would provide to state budgets.
Those of us responsible for the states' budgets have the unpleasant duty of imposing greater burdens on our citizens before we can reach legitimate balance between revenues and expenditures. It is not unreasonable for us to hope that federal policy makers will treat our state deficit problems with the same seriousness with which they are now preparing to address the national deficit.
Mr. Ravitch, a Democrat, is the lieutenant governor of New York.

Big Business Creates Jobs Too

2010-01-07T01:46:00.002-03:00

Many small businesses fail. And innovating can be easier with corporate backing.

By ETHAN PENNER

A major focus of both political parties is job creation. Underlying the discussion is a glorification of the merits of the "small business" at the expense of "big business." The commonly quoted statistic from the Small Business Administration (SBA) is that 65% of all new jobs are created by small businesses, defined as any business employing 500 people or fewer. Armed with that bias, and appealing to populist sentiment, there is growing support in Washington for tax reforms aimed at helping small businesses by cutting the taxes they pay or by offering them tax breaks for new hires.
But here is what many people do not realize: 99.7% of all companies in America meet the SBA's definition of small business. This implies that the remaining 0.3% of American companies—big business—create 35% of all new jobs in this country. While cutting taxes in general is always a good idea for kindling economic vitality, ignoring the important role that big business plays in job creation is a short-sighted mistake.
Given the aforementioned statistic, combined with the fact that most low-paying companies fit into the small business definition, it is not a stretch to conclude that large companies are disproportionately responsible for creating both higher paying and stable jobs. Small companies clearly create jobs, and occasionally these companies provide stable, long-term employment. But the large majority of jobs created by this group are both very low-paying and highly unlikely to be around for the long term. According to the SBA, 56% of all startups fail within their first four years of operation.
It is actually within large companies that an entrepreneur can find, already in existence, much of what it takes to insure a venture's success. This includes the capital required to fund startup costs, the marketing presence to create a near-instant reach to customers, and the standing required to gain trust of both vendors and customers. The two largest bond fund managers in the world, Pimco and Blackrock, were born inside of existing large companies—Pacific Mutual Life and Blackstone, respectively—and flourished under entrepreneurial leadership. Blackrock then went on grow immensely after it was sold to Mellon Bank.

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Associated Press

Apple Computer, a great example of a small company success, at one point was solely focused on computers. Yet in the past several years Apple's success has been driven by many new business lines including the iPod and iPhone. These product-line successes illustrate how a big company can entrepreneurially exploit its brand name, related technological expertise in the industry, access to capital, and sales and marketing reach. There is no doubt that if someone tried to launch either the iPhone or the iPod from his garage the results would not be what they have been for Apple.

In my own career I've had a number of opportunities to build new businesses within existing big companies. In 1993, with financial backing from Nomura Securities, my partners and I built a commercial real estate finance business in which we applied securitization techniques to the market in a comprehensive way for the first time.
At our peak we directly employed approximately 500 people around the country and indirectly many more. At Nomura we were credited with having inspired the creation of the Commercial Mortgage-Backed Securities (CMBS) market, which peaked in 2007 at $230 billion in new issue volume that year. As a consequence, we directly created thousands of high-paying jobs and helped to create many more jobs indirectly through the related services required to serve the new market (including legal, accounting, and rating agency and more).
Recently I joined CB Richard Ellis Investors, another large company, to build a new business line addressing the financing needs of the commercial real estate industry. My partners and I have been seeded with some capital from our parent company along with many other extraordinary benefits that have allowed us to jumpstart our operation in a challenging business environment. We've hired about a dozen people thus far and our plan calls for significant growth which, if we are successful, will lead to the creation of many new jobs. Perhaps, as was the case with Nomura, our success will inspire other companies to follow in our footsteps and many more jobs will be created.
In sum, if the government wants to spur the creation of stable and high-paying jobs it would do well not to neglect big business when establishing policy.
Mr. Penner is executive managing director of CBRE Investors and the founder and president of CBRE Capital Partners.

Why Taxing Stock Trades Is a Really Bad Idea

2010-01-06T01:27:00.000-03:00

Everyday investors shouldn't be punished for a subprime fiasco fueled by Fannie Mae and Freddie Mac.

By DONALD L. LUSKIN AND CHRIS HYNES

The Democrat-dominated Congress has come up with a new way for President Obama to violate his campaign pledge to not raise taxes on families earning less than $250,000 per year. It's a tax on securities transactions—trading in stocks, options, futures and so on.
And why not single out trading for special taxation? We levy special taxes on tobacco, alcohol and other vices. Except that trading isn't a vice. The exchange and hedging of business interests is a virtuous—and utterly essential—activity in a free economy.
But you'd never know it from the angry anticapitalist rhetoric of the tax's proponents. Rep. Peter DeFazio (D., Ore.), who introduced the House bill establishing the tax—positions it as retribution for "the Bush administration's cowboy capitalism, markets know best, deregulation at all cost policies." Sen. Tom Harkin (D., Iowa), who introduced a similar Senate bill, says, "We need a shift in priorities in this country to ask not what America can do for Wall Street, but ask what Wall Street can do for America."
Are you just an ordinary American who trades stocks? You probably don't think of yourself as having much to do with "Wall Street," or of your trading as a vice that ought to be singled out for a special tax. And you surely don't think of yourself as someone who caused the recent financial crisis, which was, as Rep. DeFazio says, "brought on by reckless speculation in the financial markets."
If anything, you probably think of yourself as a casualty of the crisis, not its cause. Why should a stock market investor like you—or for that matter, even an investor literally on Wall Street—pay a tax as punishment for a crime of which you were the victim, not the perpetrator? The crisis was caused by excesses in the mortgage industry, led by government-sponsored entities such as Fannie Mae and Freddie Mac. How did stock transactions—or transactions in options or futures—have anything to do with this crisis?
The proposed tax would apply to commodity transactions as well. So here we find another class of victims being punished. When excesses in the mortgage market blew up the world economy in 2008, commodity investors were hammered as prices plunged in everything from crude oil to gold to corn. Many of them were ordinary businesses—far from Wall Street—trying to hedge themselves against the rising cost of energy.
To be fair, the tax would apply to credit default swaps, which were closely associated with the excesses in mortgage speculation. But if it's going to apply to stocks—which had nothing to do with the crisis except to be its victim—then why does the tax, as proposed by Rep. DeFazio, not apply to bonds? It was the bond market, not the stock market, that was the conduit for hundreds of billions of dollars of dodgy subprime mortgages. Could this possibly be related to the need for the federal government to issue Treasury bonds from here to eternity to finance the looming deficits from the cornucopia of programs being cooked up in Congress?
Setting aside the critical issue of why certain types of securities are singled out for tax, and others are not, the tax as currently proposed does not even succeed in fairly targeting speculators as opposed to investors. In fact, like most tax schemes, it is riddled with arbitrariness and capriciousness.
Suppose you buy a stock, and you hold the position for 20 years. You're an investor. Suppose the person who sold it to you was a day trader—who might end up buying the stock again 10 minutes later from someone else and then selling it after an hour. You both pay the same tax.
As proposed, you wouldn't have to pay a tax to buy or sell mutual funds. Yet mutual funds themselves would have to pay the tax on any trades they make in stocks. So as the owner of the mutual fund, you still end up paying the tax. According to the Investment Company Institute, the average turnover for stock-market mutual funds in 2008 was 60%, which would add up to a lot of taxes.
Transactions in retirement accounts would be exempted. So a corporation that invests to provide pensions to retired workers won't face higher costs. But a retired individual who has just sold his business and is living off the invested proceeds will pay the tax.
And don't believe the proponents of the tax when the say it's so small you'll never notice it. At one quarter of 1%, that would be a cost of $0.33 on a share of IBM. If you were to buy or sell $100,000 worth of IBM (or any stock), the tax would be $250. Single taxpayers would get an annual exemption of that amount. But trade again, and you're taxed $250. Again, another $250. Over and over. Each time, that's about 20 times the commission that a typical online broker would charge you to make that trade—yes, the greedy broker, the one on Wall Street.
More fundamentally, the proponents of the tax seem not to have thought through what effects it might have on America's global competitive position as the world's pre-eminent stock market. They simply wave away any concern with a flourish of moral indignation. Last summer, when Britain's Financial Services Authority Chairman Adair Turner proposed a trading tax for the United Kingdom, and set in motion a global movement toward such a tax, he called trading "socially useless."
We shouldn't have to "socially" justify any lawful activity. But surely it is "socially useful" to let free people transact freely, without regulators and legislators micromanaging them. If anything, given the spectacular failure of every regulatory authority and legislator to detect and deter the abuses in mortgage markets that led to a near-meltdown of the global economy, it is their activities that would appear to be "socially useless" and deserving of a special tax.
It's Economics 101 that the free actions of market participants cause supply and demand to reach equilibrium. And isn't that what investors—indeed, even speculators—do? Don't they try to buy things they think are cheap and sell things they think are expensive? Can they do it as well when facing the dead-weight costs of a transaction tax?
If not, then trading volume in our stock markets will fall. Beyond the tax, everyone—investor and speculator, great and small—who buys or sells stocks will pay more to transact in markets that are less liquid. And they will transact at prices that are not set as efficiently. In such a world, markets would necessarily be more risky, and the cost of capital for business would necessarily rise. The consequence of that is that innovation, growth and jobs would necessarily fall. That would be the full and true cost of the trading tax being proposed.
Mr. Luskin is chief investment officer at Trend Macrolytics LLC. Mr. Hynes is chief executive officer of Hynes Capital.

The Biggest Losers

2010-01-04T02:13:00.002-03:00

Behind the Christmas Eve taxpayer massacre at Fannie and Freddie.

Happy New Year, readers, but before we get on with the debates of 2010, there's still some ugly 2009 business to report: To wit, the Treasury's Christmas Eve taxpayer massacre lifting the $400 billion cap on potential losses for Fannie Mae and Freddie Mac as well as the limits on what the failed companies can borrow.
The Treasury is hoping no one notices, and no wonder. Taxpayers are continuing to buy senior preferred stock in the two firms to cover their growing losses—a combined $111 billion so far. When Treasury first bailed them out in September 2008, Congress put a $200 billion limit ($100 billion each) on federal assistance. Last year, the Treasury raised the potential commitment to $400 billion. Now the limit on taxpayer exposure is, well, who knows?

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Associated Press

The firms have made clear that they may only be able to pay the preferred dividends they owe taxpayers by borrowing still more money . . . from taxpayers. Said Fannie Mae in its most recent quarterly report: "We expect that, for the foreseeable future, the earnings of the company, if any, will not be sufficient to pay the dividends on the senior preferred stock. As a result, future dividend payments will be effectively funded from equity drawn from the Treasury."

The loss cap is being lifted because the government has directed both companies to pursue money-losing strategies by modifying mortgages to prevent foreclosures. Most of their losses are still coming from subprime and Alt-A mortgage bets made during the boom, but Fannie reported last quarter that loan modifications resulted in $7.7 billion in losses, up from $2.2 billion the previous quarter.
The government wants taxpayers to think that these are profit-seeking companies being nursed back to health, like AIG. But at least AIG is trying to make money. Fan and Fred are now designed to lose money, transferring wealth from renters and homeowners to overextended borrowers.
Even better for the political class, much of this is being done off the government books. The White House budget office still doesn't fully account for Fannie and Freddie's spending as federal outlays, though Washington controls the companies. Nor does it include as part of the national debt the $5 trillion in mortgages—half the market—that the companies either own or guarantee. The companies have become Washington's ultimate off-balance-sheet vehicles, the political equivalent of Citigroup's SIVs, that are being used to subsidize and nationalize mortgage finance.
This subterfuge also explains the Christmas Eve timing. After December 31, Team Obama would have needed the consent of Congress to raise the taxpayer exposure beyond $400 billion. By law, negative net worth at the companies forces them into "receivership," which means they have to be wound down.
Unlimited bailouts will now allow the Treasury to keep them in conservatorship, which means they can help to conserve the Democratic majority in Congress by increasing their role in housing finance. With the Federal Reserve planning to step back as early as March from buying $1.25 trillion in mortgage-backed securities, Team Obama is counting on Fan and Fred to help reflate the housing bubble.
That's why on Christmas Eve Treasury also rolled back a key requirement of the 2008 bailout—that Fan and Fred begin shrinking the portfolios of mortgages they own on their own account, which total a combined $1.5 trillion. Risk-taking will now increase, so that the government can once again follow Barney Frank's infamous advice that the companies "roll the dice" on subsidies for affordable housing.
All of which would seem to make the CEOs of Fannie and Freddie the world's most overpaid bureaucrats. A release from the Federal Housing Finance Agency that also fell in the Christmas Eve forest reports that, after presiding over a combined $24 billion in losses last quarter, Fannie CEO Michael Williams and Freddie boss Ed Haldeman are getting substantial raises. Each is now eligible for up to $6 million annually.
Freddie also has one of the world's highest-paid human resources executives. Paul George's total compensation can run up to $2.7 million. It must require a rare set of skills to spot executives capable of losing billions of dollars.
Where is Treasury's pay czar when we actually need him? You guessed it, Fannie and Freddie are exempt from the rules applied to the TARP banks. The government gave away the game that these firms are no longer in the business of making profits when it announced that the CEOs will be paid entirely in cash, though it is discouraging that practice at other big banks. Who would want stock in the Department of Housing and Urban Development?
Meanwhile, these biggest of Beltway losers continue to be missing from the debate over financial reform. The Treasury still hasn't offered its long-promised proposals even as it presses reform on banks that played a far smaller role in the financial mania and panic. Senate Banking Chairman Chris Dodd (D., Conn.) and ranking Republican Richard Shelby recently issued a joint statement on their "progress" toward financial regulatory reform, but their list of goals also doesn't mention Fannie or Freddie.
Since Mr. Shelby has long argued for reform of these government-sponsored enterprises, their absence suggests that Mr. Dodd's longtime effort to protect Fan and Fred is once again succeeding. It would be worse than a shame if, having warned about the iceberg for years, Mr. Shelby now joins Mr. Dodd in pretending that these ships aren't sinking.
In today's Washington, we suppose, it only makes sense that the companies that did the most to cause the meltdown are being kept alive to lose even more money. The politicians have used the panic as an excuse to reform everything but themselves.

Mandatory Usury in One Lesson

2010-01-03T02:57:00.002-03:00

How Congress dictated a 79.9% interest rate.

'You might have less-than-perfect credit and we're OK with that," read an October credit-card solicitation from South Dakota-based First Premier Bank. The interest rate, however, will strike some as usurious: 79.9%. That's a more than eightfold increase from the 9.9% the bank previously collected for a similar card.
Wait, wasn't Congress supposed to have passed legislation against predatory lending? As a matter of fact, yes. The whopping rate increase is First Premier's way of complying with the Credit Card Accountability, Responsibility and Disclosure Act of 2009. Among other provisions, that law prohibits fees of more than 25% above a card's credit limit. First Premier has been offering an account with a $250 limit and annual fees of $256. By law the latter figure must come down to $75. To compensate for the lost $181 in fees, the bank is raising the rate by 70% of $250, or $175, a year.
If it sounds like a rotten deal either way, it is—if you have good credit. But if you don't, the cost may be worth it to re-establish your rating. Banks that lend money to customers with poor credit histories have to charge more to cover the extra risk. If Congress makes this impossible, banks will respond by refusing to lend to such customers, so that it will be harder for them to re-establish their creditworthiness.
Banks can't be expected to give money away, even if Congress is in the habit of doing just that. Unlike lawmakers, banks and other businesses can collect revenues only by offering something of value in return.

Markets fail. That’s why we need markets.

2009-12-30T18:25:00.000-03:00

It may sound odd, but only free and open markets, not government regulation, can quickly and effectively clean up the mess that markets sometimes make.

By Arnold Kling and Nick Schulz / December 28, 2009

Arlington, Va.; and Washington Two camps have fought the political and philosophical battle for influence over the economy in the United States for the past 100 years. They differ in their views over the nature of markets and government. And both are wrong.
One camp makes it sound as if markets can do no wrong. Their views were ascendant in the 1920s and again in the 1980s.
The other camp argues, “Markets fail, and that’s why we need government.” The idea is that markets are prone to excesses and imbalances and need the thoughtful, steadying hand of government to protect consumers and investors from flaws and uncertainties of the market. This camp believes that wise technocrats can and will bring order to the markets.
In the wake of the financial crisis that gave way to the broader economic downturn, the advocates of government involvement in the economy are once again on the march and traditional defenders of markets are in retreat. And so we have seen government advance its role with partial ownership of many big banks, with a take-over of automotive firms, with a large “stimulus” program, with proposals for cap-and-trade for carbon emissions, and with a major initiative on healthcare.
The traditional defenders of free markets have had a rough time getting a hearing lately. After all, it certainly appears as if markets don’t work in any meaningful sense. The Dow rises and plummets in harrowing fashion, the housing market balloons and then craters, financial services firms teeter on the edge of extinction one minute and swing to record profitability the next.
Surely, government can do better.
Or can it? Over the past two generations, a different view of markets and government has begun to emerge, one whose moment may have arrived. It is a view that believes both traditional camps have overlooked some important aspects of markets.
What’s more, it is a view that, if embraced, helps reinterpret market gyrations and government interventions in a way that better reflects reality. The view is subtle, but it has a profound influence on how the public and policymakers should think of markets and, ultimately, the role of government in the economy.
This view can be summarized as “Markets fail. That’s why we need markets.”
This seemingly paradoxical view is based on several overlapping strands of research in economics as it pertains to development, history, technology, business expansion, and new-firm formation. According to this view, entrepreneurs at work in the economy – in finance, high tech, manufacturing, services, and beyond – are constantly experimenting, creating new business models, techniques, and technologies that upend the established order of things.
Some new technologies and innovations are genuine improvements and are long-lasting welfare enhancers. But others are the basketball equivalent of pump fakes – they look like the real deal and prompt market actors to leap hastily into action, only to realize later that their bets were wrong.
Given this dynamic, markets are unpredictable, prone to booms and busts, characterized by bouts of exuberance that are rational or irrational only in hindsight.
But markets are also the only reliable mechanism for sorting out this messy process quickly. In spite of the booms and busts, markets drive genuine long-run innovation and wealth creation.
When governments attempt to impose order on this chaotic and inherently risky process, they immediately run up against two serious dangers.
The first is that they strangle new innovations before they can emerge. Thus proposals for a Consumer Financial Protection Agency, a systemic risk regulator, a public health insurance plan, a green jobs policy, or any attempt at top-down planning may do more harm than good.
The second danger has to do with the nature of political economy. Politics creates its own kind of innovators who can be as destabilizing to markets as market actors themselves – but in far more pernicious ways.
Economists call these political entrepreneurs “rent-seekers.” Rent-seekers gain wealth, not by creating it, but by channeling it through political favors. Examples include government-sponsored monopolies, “targeted” tax breaks for special industries, and legislative loopholes inserted by lobbyists.
The boom in housing and mortgage securities that ended so badly was fueled by government policies that were encouraged by rent-seekers in the real estate, home building, and mortgage finance industries.
Rent-seekers aren’t partisan. They used President Bush’s push for an ownership society to promote sketchy mortgage products. Before that, they used President Clinton’s push for a fairer economy to compel banks to make loans to poorer neighborhoods. In both cases, rent-seekers turned political slogans into profit, but at a steep cost to society when the boom ended.
The response to the current economic crisis has perpetuated and even intensified this process, as hundreds of billions of dollars of taxpayer funds have been used to prop up the very firms that took such reckless risks. The bigger the bad bet, the bigger the bailout.
This gets to the key difference between markets and governments. When innovation-driven excesses and imbalances are recognized in the marketplace, the system can correct itself quickly. This is less the case when government policy failure occurs.
Because political failure is less publicly tolerable than market failure, the temptation becomes for policymakers to avoid acknowledging their role in creating or perpetuating problems. Or they double down on bad bets. So rather than recognize the government’s central role in the housing boom and bust and quickly changing its ways, we see the federal policy apparatus continuing to throw good money after bad in the mortgage market and on Wall Street.
Markets fail; but they learn from their failures. That’s why we need markets. Government can promise to guarantee our prosperity; but only markets can really deliver.
Arnold Kling is an economist with the Mercatus Center’s Financial Markets Working Group at George Mason University. Nick Schulz is DeWitt Wallace Fellow at the American Enterprise Institute for Public Policy Research. They are coauthors of “From Poverty to Prosperity: Intangible Assets, Hidden Liabilities and the Lasting Triumph Over Scarcity.”

Prepare for a Keynesian Hangover

2009-12-30T02:07:00.002-03:00

Our government's spending orgy will haunt us in 2010.

By BENN STEIL

In 2008, as the U.S. economy teetered under the weight of years of reckless credit expansion, the Bush administration decided against proposals to sweep out the bad debts from the banking system and then fix the regulatory structure—an approach based on tried and tested models from the S&L crisis and other financial crises.
We will pay the price for this decision in 2010. That's because the Obama administration and the Federal Reserve are plowing forward with Plan B: Nationalize credit creation and "stimulate" the private sector by spending in its stead.
Richard Nixon's famous line, "We're all Keynesians now" never seemed more apropos. With the budget deficit at an eye-popping $1.4 trillion, and on track to stay above $1 trillion indefinitely, Berkeley economist Brad DeLong writes breezily in his Nov. 30 blog that "anything that boosts the government's deficit over the next two years passes the benefit-cost test—anything at all."
On the monetary side, the fireworks have been even more spectacular. Since the financial crisis of late 2008, the Fed has flooded the globe with newly conjured dollars in an unprecedented no-holds-barred effort to prod private credit expansion. Watching the booms in the markets for distressed debt, junk-rated corporate bonds and poor-country sovereign bonds since the summer, one might be forgiven for concluding that the Fed had succeeded well beyond its expectations, and that the market's flight to safety had given way to a flight to Vegas. Yet "the truth is that policy should be piling on," Princeton economist and New York Times columnist Paul Krugman writes in his Nov. 25 blog, "not looking for the exit."
Fed Chairman Ben Bernanke wants it both ways. On the one hand, he regularly reminds the market that he's already found the exit: continuously lending out its securities short term in order to soak up cash. The so-called reverse repo market through which this would be done is probably too small for the task of controlling inflation. But such a softly-softly approach is much more attractive politically than actually collapsing the Fed's bloated balance sheet, which would require dumping hundreds of billions of dollars of stockpiled mortgages.
On the other hand, Mr. Bernanke continues to berate the banks for failing to lend while the government continues to do so with heroic abandon.
Former Salvadoran finance minister Manuel Hinds points out in the latest issue of International Finance that banks have indeed been shirking on their day job of transforming increased deposits into increased private-sector credit. But they haven't quit entirely. In fact, they've funneled significant new funds into nonbank financial institutions—which have not lent them on. What's happening is that U.S. banks have been behaving exactly like developing country banks during earlier crises, such as Indonesian banks in the late 1990s—raising lending to their worst borrowers to keep them alive, lest the banks themselves collapse from their borrowers' defaults.
For U.S. banks, these zombie borrowers are their affiliated financial entities set up to manage so-called off-balance-sheet activities—such as the famous SIVs (structured investment vehicles) created by Citigroup and others during the boom. Thus, the massive fiscal and monetary bailouts of the banks have served to worsen the credit misallocation that led to the general economic collapse in 2008.
What is the right solution? The same one that most observers, including the U.S. government, backed until late 2008: Get the bad assets off of the banks' balance sheets. Banks will continue to use accounting gimmicks for window dressing, but as long as they know the truth—that their assets remain seriously impaired—they will continue to starve far too many sound commercial ventures.
Those who insist that the government buying up soured private assets amounts to an unacceptable bailout should be reminded that the market-driven alternative is called bankruptcy. Unfortunately, this option is now considered too politically toxic.
So what we're left with is the type of government-sponsored orgy of spending and money creation that Washington used to condemn with all-knowing righteousness when undertaken south of the border. But the effect of our doing it is far more consequential, since America possesses the exorbitant privilege of minting not only its own but the world's money.
As we move into 2010, no doubt the horns will be blowing for the long-awaited U-shaped recovery. I suspect it won't be long before we realize we've drunk too much, and that the second dip of a W-shaped recession awaits us.
Mr. Steil is director of international economics at the Council on Foreign Relations and co-author of "Money, Markets, and Sovereignty" (Yale University Press, 2009).

Adjusted for Inflation, Dow's Gains Are Puny

2009-12-28T03:13:00.002-03:00

By E.S. BROWNING

Many investors realize that stocks have been among the worst investments of the past decade. But they may not realize quite how bad the decade was, because most people forget about the effects of inflation.

Despite its 2009 rebound, the Dow Jones Industrial Average today stands at just 10520.10, no higher than in 1999. And that is without counting consumer-price inflation. In 1999 dollars, the Dow is only at about 8200 and would have to rise another 28% or so to return to 1999 levels. Using today's dollars and starting at 10520.10, the Dow would have to surpass 13460 to get back to its 1999 level in real, inflation-adjusted terms.
Controlling for inflation takes extra work and makes stock gains look punier, so it is easy to see why stock analysts almost never do it. The media almost never do it either.
But other things do get measured in real dollars. When economists report whether the economy is growing, they account for inflation. When analysts judge long-term gains in commodities such as gold or oil, they often adjust for inflation, noting that gold hit a record this month in nominal terms but remains far from its 1980 record in real terms. Because analysts almost never do the same with stocks, it leaves investors with an exaggerated view of their portfolios' performance over time.
"Looking at returns on a nominal basis can be very misleading," says Richard Bernstein, a former chief investment strategist at Merrill Lynch who is launching a New York money-management firm called Richard Bernstein Capital Management. He checks inflation-adjusted performance to monitor investments' real value.

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Bloomberg News

Traders work on the floor of the New York Stock Exchange in New York, U.S., this summer.

A few analysts trying to get a better perspective on investments' performance have taken to measuring the Dow in a variety of unconventional ways. Gold bugs look at the Dow based on gold prices, which makes its performance look much worse over the past decade. Europeans and others with international investments sometimes measure the Dow's return in euros. That makes the Dow look worse since 2006, a time when the euro has been rising. The dollar's recent rebound has helped make the Dow look a little better against the euro and gold, however.

Mr. Bernstein says some investors saving for education expenses compare returns to tuition inflation. If the portfolio doesn't rise as fast as education expenses, these investors reason, they will need to boost contributions. The same is true for someone saving for retirement expenses or for future medical costs.
Garrett Thornburg, founder of Thornburg Investment Management in Santa Fe, N.M., calculates what he calls "real-real" returns, adjusting stock performance not only for inflation but also for real-world drags such as taxes and fees.
Nominally, a dollar invested in the stocks of the Standard & Poor's 500-stock index at the end of 1978 had blossomed to $22.88 at the end of 2008, including dividends, a sweet gain even after the 2008 meltdown. But once estimates of inflation, taxes and costs are removed, he figures, the investment was worth only $3.76.
All of this might be enough to put investors off stocks entirely, until they consider the long-term alternatives. Measured over the 1978-2008 period, rather than over just one decade, stock performance in real-real terms actually is better than that of just about any other major investment class, Mr. Thornburg found: 4.5% a year. Stocks' ability to keep up with inflation over the very long haul may be their best selling point.
In real-real terms, stocks did better over that period than municipal bonds (2.5% a year), long-term government bonds (2% a year) and corporate bonds (0.2% a year). Real-real home prices were unchanged over those 30 years. Both short-term government bonds and commodities suffered losses. (Mr. Thornburg has experience investing in all these areas, although his mortgage affiliate went bust in last year's housing collapse.)
Figuring out how to adjust for inflation can mystify some investors, although the Internet now offers several Web sites that quickly adjust numbers for inflation and some mutual funds and independent mutual-fund analysis services calculate returns adjusted for fees and taxes.

Reuters

Some analysts measure the Dow against the performance of gold, which further dents the record of the blue chips over the past decade. Above, gold bars in Mumbai earlier this month.

Prof. William Hausman at the College of William & Mary long has urged the media to offer people inflation-adjusted stock charts. He says newspapers and analysts frequently point to the Dow's 2007 record of 14164.53 and talk about how far the Dow would need to climb to return to that level. In inflation-adjusted terms, however, the Dow in 2007 never quite surpassed its 2000 record, Prof. Hausman calculates. To return to an inflation-adjusted record now, he adds, the Dow would need to break 15000.
"It really puts in perspective how stocks are doing," he says.
Stock analysts sometimes like to note that the Dow today is worth 27 times its value at its 1929 pre-crash peak, meaning that even if you bought at the worst moment, your stock still would be way up over time. In inflation-adjusted terms, however, the Dow today is only a little over twice its 1929 peak, according to Ned Davis Research.

Lately, some investors have gotten interested in measuring the Dow in gold rather than dollars. Gold has rebounded since 1999, and the fascination with the yellow metal has made investors start thinking of it again as a currency.
Ned Davis, the founder of Ned Davis Research, referred to gold as "real money" in a recent report and published charts of bonds, home prices and stocks measured in gold rather than dollars. Even with gold's swoon in recent days, the Dow looks a lot weaker over the past decade measured in gold than in dollars.
Of course, it is possible to find a hot investment that dwarfs the Dow's gains over any period, which makes many analysts question the value of adjusting the Dow for gold's gains. Such skepticism doesn't stop gold's supporters from pointing out how much weaker the Dow looks when measured in "hard" money.
In 1997, the Dow looked strong at 40 times the dollar value of an ounce of gold, notes John Hathaway, who oversees more than $5 billion at the Tocqueville Gold Fund at New York's Tocqueville Asset Management. With gold's rebound since 1999, the Dow now is worth about nine times an ounce of gold, meaning simply that gold has performed a lot better than the Dow.
For those who like bandwagons, that suggests that it is time to buy gold. For those who like to buy things when they are cheap, it suggests that gold was cheap in 1997, and stocks have gotten cheaper since, at least when they are measured against gold.
Write to E.S. Browning at jim.browning@wsj.com

Citigroup Untarped

2009-12-23T02:05:00.002-03:00

The megabank remains the biggest challenge to Washington's muddle-through approach to the banking crisis.

Once again Citigroup looks like the sad sack of the bunch as banks exit TARP, thanks to its poorly orchestrated capital raising and the government's abortive attempt to sell down its own stake last week. But it pays to remember what a bad idea TARP capital injections were in the first place.
The nature of the problem was first apparent, ironically, in the rush of healthy banks to join Citi and friends under the so-called Troubled Asset Relief Program, fearing the lack of an imprimatur as a bank Washington had decided would not "fail."
That dynamic ran in reverse last week as banks rushed to pay back TARP money and shed the onus of government support. Bank of America had to be hurried out because Bank of America was looking for a CEO, and couldn't find one or pay one as long as it was laboring under Washington's populist pay restrictions.
Acknowledging TARP's perverse impact on Bank of America's CEO dilemma, Treasury and FDIC could hardly pretend it wasn't deleterious for Citi and Wells Fargo's ability to run their own businesses. Terms were quickly hammered out to let them escape too.

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Citi CEO Vikram Pandit

Voila, a scheme designed to strengthen confidence in the financial system had become the opposite, in compounding fashion.

In and of itself, of course, there was nothing urgent about returning the government's capital. Warren Buffett, Wells Fargo's biggest shareholder, certainly made it clear he would prefer the bank rely on earnings to rebuild capital rather than selling cheap stock to the public to repay Uncle Sam. Rushing the paybacks only increases pressure on the other wobbly legs of Washington's bailout stool, which include regulatory forbearance (i.e., regulators gaming their own capital standards) and the Fed's loose-money policy, which may not be doing much for job creation but is certainly having a marvelous impact on financial industry profits.
Let's have a moment of realism: Policy toward these giant banks always had as its primary goal saving the government from having to take them over and run them, as it has (wretchedly) AIG. It was to avoid the disaster of nationalization.
Legs one and two (plus the FDIC's guaranteeing of bank debts) were always sufficient to meet this goal and keep the giant banks stumbling along under private management and control. TARP capital injections were not only superfluous but invited the calamity they were meant to avoid, with politicians running rampant in the hallways. Take the cautionary example of Fannie and Freddie, which today are not being "conserved' in federal conservatorship but are being used to prop up home prices. For the banks, exiting TARP at least reduces the risk of similar corruption.
Citi, though, is an especially borderline case. Citi was sued last week by its big investor Abu Dhabi, presumably the Arab state's way of expiating the classic sin of trying to catch a falling knife. Abu Dhabi's "rescue" of Citi with a $7.5 billion investment in late 2007 sent the stock market up 200 points. At the time Hank Paulson had just floated his idea for a "super SIV," a thinly disguised bailout of Citi.

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It didn't fly. Abu Dhabi was about three rescues too early. It would take several more attempts by the triumvirate of Mr. Paulson, Tim Geithner and Ben Bernanke before Citi was seemingly stabilized, and by then Abu Dhabi was deeply underwater.
We say "seemingly" stabilized because Citi's floundering exit from TARP last week has destabilized it again. Vikram Pandit, Citi's CEO, is trying to rebuild its business the best he way knows how, i.e. not too different from Citi's previous business. That's presumably why he considers it essential to escape TARP so he can pay Wall Street-style bonuses in competition with Goldman Sachs and Morgan Stanley (and Bank of America and JP Morgan).
Washington chose not to dismantle Citi, so it should have expected no less. Oh well. In a crisis, politicians will look around for businesses "too big to fail," and any conceivable Citi would likely fit the bill, as it has since the 1970s. This problem may not be fixable, but what are fixable are the deeper antecedents of last year's troubles.
Fewer banks would have inflicted such damage on themselves if not for the government's role, eight ways from Sunday, in encouraging Americans to incur housing debt, with direct subsidies, tax incentives and the use of Fannie and Freddie to channel China's surpluses into a U.S. housing boom.
If the word "bubble" has any valence at all, it describes what happens to asset prices when the public believes it has been granted a one-way bet. Sadly, much of the history written in the past 14 months had redounded to the salvation of parties who will be tempted to make the same mistake again.

A God of the Copybook Headings

2009-12-22T01:28:00.000-03:00

The uncommon wisdom of George Melloan.

In the Carboniferous Epoch we were promised abundance for all;
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy;
And the Gods of the Copybook Headings said: "If you don't work, you die."
—Rudyard Kipling
In a couple of days, the Senate will give its 60 ayes to the largest expansion of government since the Great Society. The Obama administration is proposing a third round of fiscal stimulus, because the first two worked so well. And Ben Bernanke is, without irony, Time's Person of the Year.
All of which is a reminder that, unlike vampires, there's no driving a stake through the heart of a bad idea. Karl Marx will always be with us, at least at the New Yorker. So will Jean-Jacques Rousseau, the patron saint of environmentalists even if they don't know it. And so will John Maynard Keynes, godfather of Obamanomics. History is only repeated as farce to those who either have forgotten it or enjoy the sick humor of a disaster foretold.
Then again, as George Melloan reminds us in "The Great Money Binge: Spending Our Way to Socialism," just as bad ideas never quite go out of fashion, neither do good ones. Readers looking for an antidote to this season's political gloom will find more than the full dose in this splendid book.
Mr. Melloan was, of course, the writer of this column for many years, one of the labors in a career at the Journal that spanned 54 years as a reporter, editor and commentator. Among the benefits of a long career is a long memory and an imperviousness to intellectual fads. In Kipling's terms, he is one of the Gods of the Copybook Headings—the unfashionable keepers of hard truths about which we must occasionally be reminded.

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Associated Press

John Maynard Keynes

In today's economy, the hard truth is that we can't spend, consume, manipulate and inflate our way to general prosperity—as opposed merely to the enrichment of Democratic Party interest groups. This was the dominant economic model of the 1970s, with results that were once well known. "The Great Money Binge" makes short work of the theory:

"Demand-side economics holds that the economy derives its momentum from consumption, and it is of little moment if that consumption is financed by credit," he writes. "But if that were true, everyone could merrily use his credit card to supply his wants and never have to work. Maybe there's a logical flaw there somewhere."
The great strength of Mr. Melloan's book is to show, in exacting detail, not only how we came to our current crisis—thank you, Barney Frank, Chris Dodd, Alan Greenspan and Tom DeLay—but where that logical flaw is destined to take us again.
The alternative is supply-side economics, which, for all the invective heaped upon it, boils down to the inescapable fact that "consumption must be paid for with production"—that if you don't work (i.e., produce) you die (i.e., can't consume). The obviousness of this is so manifest that the real wonder is how it has escaped the grasp of otherwise intellectually competent people.
Perhaps more interesting is how it didn't escape the grasp of Mr. Melloan, one of whose principal achievements was his role—along with the late Bob Bartley—in turning the Journal's editorial pages into the great disseminator of supply-side thinking. Mr. Melloan chalks it up to his background as the son of an Indiana yeoman farmer for whom there was nothing abstract about the words property, production and market. "We Journal editors were a rather proletarian lot to be promoting capitalism," he writes. "We were not the voice of big business, as our critics glibly called us at the time, but exponents of free-market capitalism, an economic system that allows any individual to build a business and compete with the big boys. The two things are definitely not the same."
But what Mr. Melloan doesn't say is that he is also an heir to the antisophistic tradition of Western philosophy—stretching from Socrates to Paul to William of Ockham to Jean-Baptiste Say to Karl Popper—that insisted that truth was more likely to be found in simplicity than complexity. No surprise, sophists of every age have attacked this tradition (sophistically) as "simplistic," and people like Mr. Melloan have had to endure it.
Yesterday, President Obama made the remarkable observation that "we can't continue to spend as if deficits don't have consequences, as if waste doesn't matter, as if the hard earned tax dollars of the American people can be treated like Monopoly money." Maybe he's finally learned, as Kipling taught,
That after this is accomplished, and the brave new world begins
When all men are paid for existing, and no man must pay for his sins,
As surely as Water will wet us, as surely as Fire will burn,
The Gods of the Copybook Headings with terror and slaughter return!
Then again, maybe the president finally got around to reading George Melloan.

Banks Don't Belong in the Student Loan Business

2009-12-18T01:59:00.002-03:00

They get billions in federal subsides that can provide financial aid to needy students.

By ARNE DUNCAN

Since I arrived in Washington, I've been looking at every line item in the budget of the U.S. Department of Education with two questions in mind: Is this program helping students learn? And is it a good use of taxpayer money? In the case of the Federal Family Education Loan (FFEL) program, the answer to both questions is no.
Under the current FFEL program, banks make loans to students. While those students remain in school, the federal government pays the interest on their loans; otherwise the interest accrues. Once the borrowers leave school or graduate, the lending agency collects on the loans. But if the student defaults, my department pays back the loan—plus the interest owed. The FFEL program, in short, is a great deal for bankers but a terrible one for taxpayers.
Over the next decade, according to the Congressional Budget Office, the Education Department is slated to subsidize banks to the tune of $87 billion to enable them to make federal student loans. All of this money would be put to better use providing financial aid directly to millions of needy students who want a college education. The Education Department will be able to accommodate the new loans through an existing federal public-private partnership, Through that partnership, the federal government makes loans directly to students and uses companies that will provide better service to borrowers at a lower cost to taxpayers
Critics contend that the government is trying to nationalize a private industry and do away with competition. Our real aim is to simply stop using banks as the middle man for student loans.
The banking industry would continue to compete in the marketplace to finance mortgages, business start-ups, and other forms of credit. But we are intent on stopping subsidies to bankers who make student loans at no risk because they know the federal government will bail them out in case of default.
By working with private sector companies with expertise in the field, we are prepared to initiate all new student loans in the existing federal Direct Loan program. Right now, the Education Department already owns and services 80% of the student loans made last year. It owns such a high volume of loans chiefly because it had to take emergency action in 2008 to ensure students had access to loans when lending in the nation's credit markets was frozen.
Our experience handling the bulk of student loans makes me confident in our capability. This year alone, an additional 500 colleges and universities joined the Direct Loan program. Just last month, the department's independent inspector general's office issued a report documenting that the Education Department had taken the right management steps so that all loans can be serviced by the Direct Loan program.
In a recent survey by the National Association of Student Financial Aid Administrators, schools that have made the switch to direct lending overwhelmingly reported the conversion was easy and quick. That is just one reason why that association of financial aid experts, along with organizations representing the nation's largest public and private universities, community colleges and college students, support the department's Direct Loan proposal.
The private sector would continue to play an important role in servicing loans. Last summer, the department's Federal Student Aid Office awarded contracts to four companies to service federal student loans, following an intense competition among the best companies in the loan servicing business. These companies are paid more when borrowers are in good standing, and those that keep defaults down and provide the best customer service will be given the most work.
We are preparing to make the switch to direct loans as easy as possible for colleges and universities. We appreciate their feedback, and their ideas will help us transition smoothly from FFEL to direct loans once Congress has passed a bill authorizing the switch to 100% direct loans
As for the $87 billion we'll save from ending the troubled FFEL program, the administration seeks to use that money for important programs that will improve our economic future. We propose to substantially increase scholarships in the Pell Grant program and other financial aid for low-income students. We would start new programs to raise college graduation rates and strengthen our community colleges. We will expand our investment in early childhood education. Plus, $10 billion would be set aside to reduce the deficit.
Now is the time to allocate resources to students—not to banks—so they have access to college and other educational opportunities. We cannot in good conscience let $87 billion in subsidies go to banks when our students desperately need financial help to realize the dream of getting a college education.
Mr. Duncan is the U.S. secretary of education.

The 100 Years Chip War

2009-12-18T01:58:00.002-03:00

The FTC piles on Intel, after a settlement

When computer chip rivals Intel and Advanced Micro Devices announced an agreement last month to end their legal disputes, Intel CEO Paul Otellini expressed hope that it would provide "some level of comfort" for regulators. What rational oasis did he think he was living in?
This week the Federal Trade Commission sued Intel, alleging that the industry leader has stifled competition to strengthen its market dominance. According to the feds, Intel has used "threats and rewards" to prevent computer makers like IBM from buying chips from competitors. The FTC also claims Intel has blocked these manufacturers from marketing computers with non-Intel chips. It's worth noting that several of the companies that Intel is accused of muscling are every bit as big as Intel—and in the case of Dell and Hewlett-Packard, bigger in revenue terms.
But the real problem with the government's case is the lack of evidence that consumers have in any way been harmed by Intel's practices. The FTC is tasked with protecting the interests of consumers, not competitors. And consumers are benefiting from an intensely competitive and highly innovative computer chip industry.
Data from the Bureau of Labor Statistics show that between 2000 and 2006—a period that includes Intel's supposed monopolistic behavior—the quality and performance of microprocessors improved while prices fell at an annual rate of 48.9%. Over the same period, the prices of related items such as personal computers, storage devices and software also decreased. The typical goal of anticompetitive corporate behavior is to raise prices, yet computer products that cost thousands of dollars a few years ago now cost hundreds.
Intel doesn't deny that it competes aggressively for customers, or that it offers deep discounts and rebates to win business. But these actions are pro-competitive, and the courts have consistently ruled that so long as Intel is pricing its products above cost, its business practices are lawful. Over the past two decades the Supreme Court has repeatedly rejected antitrust challenges to above-cost price cuts.
Settlement talks between Intel and the government reportedly stalled when regulators insisted on remedies that would turn the company into something resembling a public utility. The lawsuit states that the FTC seeks a remedy "[r]equiring Intel to make available technology . . . to others, via licensing or other means, upon terms and conditions as the Commission may order." The government also wants to micromanage how Intel prices its products and prevent it from offering better deals to its best customers. The company understandably concluded that such conditions "would make it impossible for Intel to conduct business."
The government's intervention here is both unprecedented and unnecessary. The bulk of the charges are recycled complaints first made by Intel's main rival, AMD, more than four years ago. But the deal reached last month resolved all of their differences and was approved by both boards.
Antitrust laws exist to promote business and price competition, not to protect less successful competitors. And the competition among microprocessor makers has rarely been more ferocious. The FTC is proposing remedies in search of a problem, and harassing a successful U.S. company in the bargain.

Obama vs. the Banks

2009-12-17T01:41:00.000-03:00

Why make risky loans when you can exploit the Fed-Treasury interest rate spread?

By GERALD P. O'DRISCOLL JR.

Over the weekend, President Barack Obama went on the offensive against Wall Street for not lending more to Main Street. On CBS's "60 Minutes," the president declared, "I did not run for office to be helping out a bunch of fat cat bankers on Wall Street." He was joined on the Sunday morning circuit by his chief economic adviser, Lawrence Summers, who echoed the message of intimidation.
Wall Street fat cats are always a convenient political target, but bankers are responding to the incentives generated by the economic policies of the Treasury and the Federal Reserve. First and foremost is the Fed's policy of near-zero interest rates.
What this means is that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for "an extended period." That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.
Why would a banker take on traditional loans, which even in good times come with some risk of loss? In today's troubled times, only the best credits will be bankable. Meanwhile, financial institutions are happy to service their new, best customer: the U.S. Treasury. That play on the yield curve is open to banks of all sizes.
The Fed's policy makes sense if the goal is restoring bank profitability by generating cash flow. It is a terrible policy if the goal is fueling small business, the engine of economic growth and job creation. Large, nonfinancial corporations have access to banks. They can also tap the public credit markets and have access to internally generated funds. Not so for small business, which depends heavily on banks for credit.
Since the financial crisis began, the Fed has worked in tandem with the Bush/Paulson Treasury and now with the Obama/Geithner Treasury. One must assume its policies have the administration's approval. That puts the administration's policies at war with its stated goals. Larry Summers is a first-rate economist and must understand the economic incentives those policies have created. In short, the weekend interviews, along with the president's meeting with bankers on Monday, was political theater.
While the public is upset with $10 million to $20 million banker bonuses, public policy should focus on what is generating them. The largest banks have had their risk appetites whetted. They are not looking to traditional lending, but to proprietary trading and a renewed commitment to innovative financial products. But as Obama adviser and former Fed Chairman Paul Volcker noted, financial products such as credit default swaps and collateralized debt obligations brought the economy to the brink of disaster. It is excessive risk-taking by Wall Street that is generating the profits from which the bonuses are being paid. Curb the former and you curb the latter without government planning of banker pay.
Has recent experience taught the leaders of large financial institutions the need to curb their risk appetite? Not really. The lesson they have learned is that presidents of both parties, the Fed and Congress will come to their rescue when they get in trouble. Under a vague set of ideas, scarcely a theory, some banks are viewed as too big to fail. They will be propped up, bailed out and generally protected from the consequences of their own bad decisions. That generates incentives to engage in excessively risky activities.
A few bankers lost their jobs or quit in the aftermath of the financial crisis, but that small risk is evidently one most of Wall Street's fat cats will accept. Mr. Obama may not have run for president in order to reward them, but that is the effect of his policies.
Sending scarce resources to major banks in the form of funds from the Troubled Asset Relief Program (TARP), ultra-low interest rates, and the Fed's targeted credit schemes has diverted needed capital from real, productive activity. Now the politicians feel the public's anger and are complaining about the lack of lending and the size of executive compensation. If Congress wanted banks to lend and to limit pay packages, it should have put those in as conditions in the TARP legislation.
The TARP was hastily arranged, poorly designed and badly executed. Nonetheless, Congress acted in haste and now gets to repent at leisure. Meanwhile, the totality of the policies to aid the major financial institutions is delaying the recovery of the broader U.S. economy and the hiring of its unemployed workers.
Mr. O'Driscoll, a senior fellow at the Cato Institute, was formerly a vice president at the Dallas Federal Reserve Bank and a vice president at Citigroup.

U.S. National Debt Tops Debt Limit

2009-12-17T01:14:00.000-03:00

Updated 5:45 p.m. ET

The latest calculation of the National Debt as posted by the Treasury Department has - at least numerically - exceeded the statutory Debt Limit approved by Congress last February as part of the Recovery Act stimulus bill.

The ceiling was set at $12.104 trillion dollars. The latest posting by Treasury shows the National Debt at nearly $12.135 trillion.

A senior Treasury official told CBS News that the department has some "extraordinary accounting tools" it can use to give the government breathing room in the range of $150-billion when the Debt exceeds the Debt Ceiling.

Were it not for those "tools," the U.S. Government would not have the statutory authority to borrow any more money. It might block issuance of Social Security checks and require a shutdown of some parts of the federal government.

Pending in Congress is a measure to increase the Debt Limit by $290 billion, which amounts to six more weeks of routine borrowing for the federal government. (The House just passed the increase, though the Senate has yet to act. It is expected to approve the measure.)

Republicans and conservative Democrats blocked moves by House leaders to pass a $1.8 trillion dollar increase in the Debt Limit so the Democratic majority would not have to face the embarrassment of raising the Debt Limit yet again before next November's midterm elections.

The Debt Limit has been raised about a hundred times since 1940, when it was $49 billion - about five days worth of federal spending now.

The White House projects a record $1.5 trillion dollars deficit this year alone, and a 5-year deficit total of $4.97 trillion.

The Debt figure goes up and down on a daily basis based on government borrowing and revenue. Technically, not all of the National Debt is subject to the Debt Limit - a small percentage is exempt.

A Nation That 'Builds Things'

2009-12-16T02:04:00.000-03:00

It's time to recognize we have trade competitors, not partners.

By DAN DIMICCO

With the official unemployment rate at 10% and the real unemployment rate over 18% (accounting for people who can only find part-time employment or have given up looking for work), it's clear that job creation should be the country's top priority. That is why I firmly believe we need additional economic stimulus. But this time we need to do it the right way.
Here are three steps we can take that will move the economy forward without increasing the federal budget deficit. These steps will also dramatically reduce our trade deficit, promote genuine rules-based free trade, and position us to remain the world's leader.
•Replace foreign sources of energy with domestically produced energy. Oil imports account for about half of our trade deficit. Government policy must encourage drilling for oil and natural gas, foster the construction of dozens of new nuclear power plants, and help develop multiple forms of renewable energy like wind, solar and biomass.

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Powering the economy with domestic oil and natural gas will not increase carbon emissions more than if we use imported fuels. But it will create millions and millions of jobs—great jobs in energy infrastructure and domestic manufacturing.
Tax revenues will pour in from all directions because of a massive effort to achieve energy independence. Increased domestic oil and gas production will thus reduce our budget deficit, national debt and interest payments on the debt, as well as our trade deficit.
It will take decades to transition to a low-carbon economy. But getting there does not require taxpayer dollars. It does require a cooperative effort by government and the private sector that would allow for the necessary increase in domestic exploration and production, and the building of more distribution infrastructure such as natural gas pipelines on a scale that will enable us to replace foreign energy sources, while we transition to a low-carbon economy.
• Balance our trade deficit. We need to correct the mercantilist and predatory trading practices of our principal trading competitors—yes, competitors not partners. These countries such as China won't be partners until they stop using opportunistic and illegal trade practices like currency manipulation, illegal subsidies and border-adjusted taxes (especially the value-added tax).
Ending these trade distortions will result in a resurgence of domestic manufacturing. It will also foster long-term, balanced, and healthy trade relationships.
This should be part of an overall government effort to refocus itself as a champion of U.S.-based manufacturing and the American middle class. This undertaking will be a major shift from recent decades, when the government ignored this responsibility.
• Rebuild outdated and unsafe infrastructure. The American Society of Civil Engineers has stated earlier this year that we need to spend $2.2 trillion over the next five years to improve our country's roads and bridges. The money to do so can come from unspent funds from the stimulus bill passed earlier this year, and from some of the revenues that will come from increasing our domestic energy production.
These policy changes by our government—in conjunction with leadership and financing from the private sector—will drive the creation of the more than 20 million jobs we need to rebuild our economy, our country, and our middle class. They will get us back to being a nation that makes and builds things.
We are being called to address and succeed at resolving the current economic crisis. Make no mistake: We must change our direction as a country for the betterment of current and future generations of Americans and, as a result, the rest of the world.
Let's seize this opportunity as one country—the government and private sector working together to overcome the greatest economic crisis since the Great Depression.
Mr. DiMicco is chairman and CEO of Nucor Corporation, a steel producer based in Charlotte, N.C.

Producer Price Jolt

2009-12-16T02:02:00.002-03:00

What was that about deflation again?

The Federal Reserve's Open Market Committee meets today, and right on time. Yesterday's producer price report showed that wholesale business prices rose 1.8% in November, or a 6.3% annual rate over the past three months and 2.4% over the past year.
The news hit markets with a jolt, because investors have become accustomed to the Fed's assurances that it must keep interest rates at their current historic lows for an "extended period" because the only real economic risk is deflation. Investors reacted by sending bond prices down sharply, as they wondered if the Fed may have missed its bet and will have to change course sooner than it has advertised.
Fed Chairman Ben Bernanke is notoriously stubborn, at least when he's easing money. And no doubt someone at the Fed will point out that if you remove food and energy from yesterday's report, then producer prices rose by only 0.5%. However, this is the same "core" price rationalization the Fed used earlier this decade to keep monetary policy too easy for too long. Deflation was another siren song that the Fed used in 2003 and 2004 to build the credit mania that led to the bubble, the blowoff and recession.
Like $1100 gold and $70 oil amid weak global energy demand, the producer price report is a warning that the Fed should already have begun to move back to a noncrisis monetary stance. This does not mean "tightening" in any normal definition of that word. Moving from near-zero rates to 1% would not be moving to a restrictive policy. It is the equivalent of slowing down from 200 miles per hour to 180 or 160. A more careful monetary policy will help the Fed's credibility and reduce the chances that the recovery is later cut short by an abrupt shift in policy.

Debt Fears Rattle Europe

2009-12-16T02:00:00.002-03:00

By MARCUS WALKER

The euro tumbled as debt woes spread around the euro zone from Greece, where pledges of austerity and fiscal rigor failed to stem growing fears that the Continent's economic recovery could be derailed.
The euro fell as low as $1.4505 on Tuesday, its lowest level since early October. New worries about Austrian banking also roiled markets, with rumors of trouble at an Austrian lender with shaky investments in Eastern Europe following Monday's surprise nationalization of another Austrian bank at the behest of the European Central Bank.

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Bloomberg News

A pedestrian makes a purchase with a 50 euro note in a shop in Frankfurt.

Greece is just "the tip of the iceberg," said Norbert Barthle, budget spokesman for the ruling Christian Democratic Union of German chancellor Angela Merkel. The exploding budget deficits of weaker economies have forced Germany and other financially stronger countries to think about how to shore up other members of the euro zone against a potential financial-market rout.

Portugal, Ireland, Italy, Greece and Spain, a group traders have disparagingly dubbed "PIIGS," all have huge budget deficits and very low growth prospects, which means their debt is on course to rise further, fast.
The countries' wages and costs have steadily risen, but as euro-zone members they can't respond by devaluing their currency, a problem that strains the bonds tying together the currency bloc. Their soaring deficits are testing the credibility of the euro zone's so-called stability pact, in which governments promise not to spend wildly.
"Greece is seen in the market as an example of what may happen to other countries in the euro zone," says Diego Iscaro, economist at IHS Global Insight in London. "Europe has a lot of treaties but no clear mechanism for how to deal with such cases."
So far, attempts by Athens to assuage the market's concerns have fallen short. Late Monday, Greek Prime Minister George Papandreou promised to cut his country's budget deficit from nearly 13% of gross domestic product this year to under 3% -- the euro zone's cap -- in four years. "We must change or sink," Mr. Papandreou said.
Greek bond prices did sink Tuesday, as investors reacted with disappointment to the absence of austerity measures in the speech. The interest yield on Greek 10-year bonds reached more than 2.5 percentage points higher than ultrasafe German bond yields in Tuesday's trading, up from around two percentage points the day before. Other euro-zone government bonds reacted less sharply, but risk premiums for most weaker euro-zone members have risen in the past month.

Greek Finance Minister George Papaconstantinou visited Berlin and Paris Tuesday to try to reassure governments and markets; he next visits London and Frankfurt. Mr. Papaconstantinou told reporters in Paris he wasn't discussing a bailout.
In an earlier interview, the finance minister said he understands the risk if the newly elected Socialist government can't show by early 2010 that a decisive overhaul of public finances is under way. He expects to have to borrow just over €50 billion ($73.22 billion) from bond markets next year.
"There is a scenario in which the market dries up" for Greek bonds, he said. "I wouldn't say it's completely out of the question, but it's not likely by any stretch of the imagination." If it happens, Greece would have to go to fellow European Union member countries or the International Monetary Fund for loans, which would come with stringent conditions. "I don't want to be the finance minister who took Greece to the IMF," Mr. Papaconstantinou said.
EU officials, publicly and privately, stress that Greece is unlikely to need a bailout provided it follows its words with actions. The treaty on monetary union banned bailouts of euro members, but senior European officials say there are ways around it. One option would be a loan from a financially strong country such as Germany.
EU authorities including the ECB would prefer the euro zone handle any assistance internally. But German Chancellor Angela Merkel would favor the IMF as the source of funds, says a senior aide. (Similar divisions were evident when the EU and IMF bailed out Hungary last year.) An IMF-led package might be politically more humiliating for Greece, but better for the credibility of the euro-zone's no-bailout clause, and thus for fiscal discipline in the zone over time, analysts say.

Mr. Papandreou called IMF Managing Director Dominique Strauss-Kahn last week, Greek officials say -- but only to discuss the overall situation, not to ask for aid. The two men know each other well, these officials said.
In much of southern Europe, declining competitiveness is linked to structural flaws including heavy and inefficient bureaucracy. Recent growth in Spain and Greece depended heavily on construction and consumer bubbles. Italy and Greece have particularly dysfunctional public administrations and chronic tax evasion.
"It's hard to see how Italy, Spain and Portugal are going to generate enough growth" to rein in their debts, says Simon Tilford, chief economist at the Center for European Reform, a London think tank.
Ireland's economy is more flexible, and Ireland's younger population makes growth easier to achieve, but Ireland is suffering from the weakness of the British pound and U.K. economy, a major Irish market.
So far the Greek government has shied away from deep cuts in state spending and wages that Ireland announced to tame its deficit. EU governments, financial markets and credit-rating agencies are piling pressure on Greece to flesh out its promises with a concrete plan by January.
But the prospect of Greek austerity has already sparked protests by pensioners, students and public-sector unions in the past two weeks, and officials fear a wave of social unrest.

Austrian Bank Stress Hits Currencies

Politicians and financial markets "want to make us wear an Irish costume," says shipyard worker and labor leader Theodoros Koutras. Mr. Koutras's Communist-backed union confederation, the All Workers' Militant Front, aims to mobilize hundreds of thousands of workers in a nationwide strike on Dec. 17 Thursday.
Greece had no problem selling bonds in November, despite riling markets by stating that this year's budget deficit would be nearly 13% of GDP -- twice the previous government's estimate only weeks earlier.
Prime Minister Papandreou, attending an EU summit in Brussels on Friday, said massive inefficiency and "widespread corruption" are keeping investment away and hobbling the economy.
Athenian cafe owner Costas, who gave only his first name, testifies to that. He says he's had to budget about €10,000 in bribes to various public agencies that he says wouldn't give him various permits he needs until after his new cafe opened for business last month. He is still waiting for a permit to put out chairs and tables.
The government admits it doesn't know exactly how many people work for it. That's partly due to a history of haphazard hiring by politicians who have traditionally rewarded supporters with public-service jobs.

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Bloomberg

Greece's finance minister George Papaconstantinou

A hiring spree in the month before the election brought in thousands of salaried "trainees" who have no posts and in many cases no office to go to, according to the finance ministry.

Public servants often leave work at 2 p.m., and "many are doing a second job in the afternoon, very often without declaring their second income for tax," says Evangelos Antonaros, a conservative legislator who was the previous government's spokesman.
The gray economy extends to the education system, where many Greek students pay on the side to fill in holes left by lackluster teaching. Katerina Karamatsiou, a young Athenian, recalls her high-school physics teacher telling the class: "What's the point in teaching you? You all go for private tuition after school anyway." He offered such after-hours, tax-free tuition himself, she says.
Mr. Papaconstantinou says such experiences are common in public services. "When you have to pay doctors in public hospitals with an envelope of money, then there is no public system," he says. As a result, he says, many Greeks ask themselves: "So why pay taxes?"
Despite the government's campaign to persuade Greeks that the old ways can't go on, many believe the media and financial speculators are exaggerating the country's problems. Greece, says shopkeeper Athanasia Katsigianni, "is like a creme caramel: Always trembling, but it stays standing."
—Brian Blackstone in Frankfurt, Alkman Granitsas in Athens and Andrea Thomas in Berlin contributed to this article. Write to Marcus Walker at marcus.walker@wsj.com

Banker Baiting 101

2009-12-15T02:00:00.002-03:00

Obama's latest populist turn won't help the recovery.

The Obama Administration desperately wants a strong economic recovery, or so it says, but does it have any idea how to encourage one?
It says it wants job growth, but its policies keep raising the cost of creating new jobs. It says it wants small business to take risks, but it keeps reducing the rewards if those risks succeed. And it says it wants banks to lend more money, even as it keeps threatening to punish bankers if they make too many bad loans or make too much money.

***

The last contradiction is again on display as President Obama rolls out his latest populist blame-the-bankers campaign. This is becoming a White House financial staple. Recall how the President joined the Congressional posse amid this year's earlier AIG bonus uproar, until it threatened to run out of control. Later Mr. Obama targeted Chrysler's bond holders who weren't eager to accept the government's meager dictated terms. The bond holders rolled over, but everyone in financial markets got a message about what this Administration thinks about the sanctity of contracts.

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Associated Press

President Barack Obama meets with members of the financial industry in the Roosevelt Room of the White House in Washington, Monday, Dec. 14, 2009, to discuss the economic recovery.

Now, amid Democratic panic over 10% unemployment heading into an election year, the President is attempting a double populist play: Blame the bankers for causing the financial crisis and recession by lending too much, and blame them again for causing high joblessness now by lending too little.

"I did not run for office to be helping out a bunch of fat cat bankers on Wall Street," Mr. Obama said in an interview on CBS's "60 Minutes" on Sunday. "They're still puzzled why it is that people are mad at the banks. Well, let's see," he said. "You guys are drawing down $10, $20 million bonuses after America went through the worst economic year that it's gone through in—in decades, and you guys caused the problem. And we've got 10% unemployment."
He followed up that warm encouragement yesterday by hauling the bankers in to the White House to receive the command that "we expect an extraordinary commitment from them to help rebuild the economy."
This blame-the-bankers rhetoric is worse than a distraction as the recovery tries to gain solid footing and become a durable expansion. It risks obscuring two critical and related problems: Federal policy is discouraging both lending and borrowing.

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If there is a lack of lending by banks to small businesses, the President might consider cutting out the CEO middlemen and speaking directly to the regulators who work for him, as well as to the Federal Reserve Chairman he recently nominated for a second term.
Forcing banks to write down the value of small-business loans that are still performing has become the specialty of bank regulators who are now trying to make up for the bubble years. Whenever a commercial building serves as collateral, no matter the quality of the borrower, the loan becomes suspect.
The result is a reduction in bank capital, a disincentive to make the next loan and perhaps even a calling of the loan, forcing a sale of the property. Operating with perfect pro-cyclical precision, regulators who were asleep during the housing boom and its epidemic of liar loans now target current loans to companies with steady cash-flow. This does not encourage new lending.
Meanwhile, Fed Chairman Ben Bernanke's near-zero-rate interest policy encourages banks to borrow cheaply and then invest in safe long-end Treasurys instead of riskier commercial loans. The Obama Treasury has explicitly supported this Fed policy as a way for banks to play the yield curve to rebuild their balance sheets.
But if Mr. Obama wants the banks to lend more, he should tell the Fed to start to rein in its excessively easy credit now that the financial crisis is over and the economic recovery gains steam. The longer the Fed keeps rates artificially low, the longer banks will get used to this implicit subsidy and the rougher their adjustment when it inevitably ends. Meanwhile, weren't higher bank profits to raise capital a major goal of the bailout?
Regarding small business, not everyone agrees that lack of credit is the main economic problem. William Dennis of the National Federation of Independent Business says that for most small companies the problem is a lack of customers, not credit. "There aren't a lot of folks who want to borrow. Our challenge is getting people in the front door," he says.
A recent NFIB survey of small-business owners found only 10% reporting problems obtaining financing. The government's own data tell a similar story. The Federal Reserve reports that business loan demand remains at depressed levels, while data from the Federal Deposit Insurance Corporation show $6 trillion of unused lending commitments at FDIC-insured institutions.
Mr. Dennis reports that small-business owners are much more concerned about other Washington issues, namely the uncertainty created by the Obama policy agenda: When will the taxes arrive to pay for Washington's spending binge? How much will health-care reform cost? What will be the impact of cap-and-trade legislation to address climate change?

***

Mr. Obama summed up his White House meeting with the bank CEOs by once again blaming them for the financial crisis and suggesting that they have an obligation to support new regulation being written by Barney Frank (D., Mass.) and Senator Chris Dodd (D., Conn.).
You have to smile at that irony. No two Members of Congress did more to encourage the financial crisis, by preventing reform of the government-sponsored housing behemoths Fannie Mae and Freddie Mac. By ignoring Washington's role in creating the credit mania, Mr. Obama is hardly offering confidence that his financial reform efforts will prevent a repeat.
Yet none of this seems to count for much at a White House that is reading the polls and sees a political opening because bankers aren't popular. Someone in that power palace ought to consider that you don't encourage capitalism by beating up capitalists, and you aren't likely to encourage more lending by whipsawing lenders.

Keynesians Need Plan to Tame Debt Soon, Experts Say

2009-12-15T01:50:00.001-03:00

By Andy Sullivan

Bonds

WASHINGTON, Dec 14 (Reuters) - The U.S. government must craft a plan next year to get its ballooning debt under control or face possible panic in financial markets, a bipartisan panel of budget experts said in a report on Monday.
Though the government should hold off on immediate tax hikes and spending cuts to avoid harming the fragile economic recovery, it will need to make such painful changes by 2012 in order to keep debt at a manageable 60 percent of GDP by 2018, according to the Peterson-Pew Commission on Budget Reform.
Without action, investors could lose confidence in the United States, driving down the dollar and forcing up interest rates, said the former lawmakers and budget officials who crafted the report. That could cause a sharp decrease in the country's standard of living.
"We will be less free if we don't tackle this," said Jim Nussle, a Republican member of the commission who earlier served as a White House budget director and chairman of the budget committee in the U.S. House of Representatives.
The 34-member commission published its report as Congress was poised to raise the debt limit from its current $12.1 trillion level to allow the government to continue operating.
The national debt has more than doubled since 2001, thanks to the worst recession since the 1930s, several rounds of tax cuts and wars in Iraq and Afghanistan.
A looming wave of retirements over the coming decade is expected to make the situation worse.
The national debt currently accounts for 53 percent of GDP, up from 41 percent a year ago. That's likely to rise to 85 percent of GDP by 2018 and 200 percent of GDP by 2038 unless dramatic changes are made, the commission said.
The commission did not issue specific prescriptions but said tax increases and spending cuts would probably be needed.
It said Congress and the Obama administration should set specific targets each year, with automatic spending reductions and tax increases kicking in if they are not reached.
The Democratic-controlled Congress is unlikely to fix the problem on its own given the highly partisan atmosphere, commission members said.
"You've got to have a few Republican votes, and there have been none. And there has been no possible way in the current political system yet to find that sensible center," said former Democratic Representative Charlie Stenholm.
The commission backed the creation of an outside commission, similar to one used to close miliary bases, to create the necessary political cover.
Such a proposal is included in a crush of year-end legislation that could clear Congress this week but it is opposed by many key Democrats.
The United States must act to ensure that it does not join Dubai, Greece, and other countries that risk losing the confidence of investors, the commission said.
"It's imperative that we take action before the financial markets force us to," said Douglas Holtz-Eakin, a former Congressional Budget Office director who advised Republican John McCain's presidential campaign last year. (Editing by David Storey)

Bad or Good News Could Cause Market Trouble

2009-12-14T02:23:00.002-03:00

If this were an ordinary year, you'd be crazy not to buy stocks over the next few weeks, when the Wall Street pros typically gussie up their portfolios so they can show their customers just how smart they are.
But there's nothing ordinary about 2009 -- especially the last nine months.
Stock prices zoomed from their depths mainly on hopes that the economy was turning around (and it did improve somewhat).
Or was it because the labor market seemed to be doing better starting in the spring -- a fact that is now in dispute.
Maybe the market rallied simply because people saw other people making so much money that they just couldn't resist following the leader.
Whatever the reason, this much is clear: Stock prices have gone up a lot, for little reason, and investing in the market now isn't nearly as easy a call as it was last year.
If you've been monitoring this column for a while you'll know that I told readers to buy stocks last December but to get out in January. That was simply a calendar call: The pros usually buy reflexively at the end of the year when trading volume lightens and the market can be pushed around.
After the pros do that, they take a look at market fundamentals like corporate profits -- as they did in January -- and say, "Whoa, what the hell did I do?"
Then they retreat faster than the average person can.
I also wrote at the beginning of this year that the economy would start to look better -- not necessary be better -- in the spring because of seasonal adjustments to economic reports and a favorable quirk in how the Labor Department records its jobs data.
At the time, I said that these events could be used by Wall Street to boost stock prices. And that happened -- in spades.
For all of 2009, the Dow Jones industrial average is up a healthy 17 percent. But the gain from the lowest prices in March has been an amazing 57 percent.
To be sure, the index is still 27.5 percent off the all-time high it recorded in October 2007 and people still have massive losses.
But we are now a heck of a lot better than the 54-percent loss the market was suffering before the rally began last March.
Where will the market go next?
That's the problem: It could go down as quickly as it has gone up.
In the first place, most of the action lately seems to be coming from professional traders. Day trading by amateurs also appears to be picking up, if anecdotal evidence gleaned at bars and coffee shops is any indication.
But average buy-and-hold investors still don't seem to trust the market, and anyone who is venturing into stocks is doing so mainly because the Federal Reserve continues to punish savers with low interest rates, which help banks record profits.
If anyone wants a reasonable return on their investments, they have little choice than to become a stock-market speculator. A 57-percent gain in nine months' time looks a lot like another bubble, and this bubble may not be as durable as the last few.
A lot of things could go wrong, especially in an era where Washington feels obliged to spend money it doesn't have on stimulus programs that haven't worked before and which may not have any better luck this time.
But my biggest concern is that the stock market could be hurt if the economy weakens (bad for business), or if the economy strengthens.
The latter is the quickest road to concerns about a Fed tightening of interest rates, which, of course, would make other investments more competitive with stocks and rein in speculators.
Just look at what happened last Friday: The Labor Department reported an unexpectedly good employment situation in November and Wall Street didn't respond with the joy it should have had.
I've said this before, but I want to say it louder now -- be very careful if you get lured into the stock market.
That steady 1.5 percent interest you're getting from the bank could look pretty good if this hard-to-figure stock market decides to correct its latest excesses.
*
The other day at breakfast I ran into Louka Katseli, the economics minister of Greece, a country that is rumored to share Dubai's problems with making debt payments.
So, I asked, should Wall Street be concerned about Greece reneging on its debt?
Katseli, who was educated in the US and taught at Princeton, responded: "I would be more concerned about US debt." Touché!
*
An Irish bookie is taking bets on who will make the next 911 call from Tiger Woods' house.
Woods is the favorite at 6-to-4. The gardener is the long shot at 18-to-1.
Put me down for $10 on the paperboy, if cellphone calls from outside the house are counted.
The bookie, Paddy Power, thinks Ac centure -- a manage ment firm -- is a 9-to-4 favorite to drop Woods as its spokesman, followed by watch maker TAG Heuer at 3-to-1.
Titleist, which, of course has a lot of balls, is the least likely at 33-to-1.
john.crudele@nypost.com

Obama's policies risk another Depression

2009-12-14T02:16:00.000-03:00

Scott S. Powell and Ron Laurent

Light at the end of the tunnel or an oncoming train wreck?
In the panic following the insolvency of Fannie Mae, Freddie Mac and Lehman Brothers in September 2008, the American taxpayer was stampeded into bailing out AIG and Wall Street. We were told that $700 billion was needed to establish the Troubled Asset Relief Program (TARP) because the country faced nothing less than a collapse of its financial system.
Inexplicably after Congress passed it -- almost like a bait and switch -- TARP was directed at banks rather than troubled assets. A little more than a year later, TARP Inspector Neil Barofsky reports that AIG's $1.5 trillion in credit fault swaps did not, after all, pose systemic risk. So if we were misled about the TARP bailout, it seems appropriate to question other aspects of government intervention since unemployment, foreclosures and bank failures have risen.

Should we believe Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner that there is daylight at the end of the tunnel or could it be the beam of an oncoming locomotive pulling more economic wreckage?
The Fed is essentially out of bullets with the funds rate at 0 percent. Accommodative monetary policy may be necessary to revive economic activity, but it is neither sufficient nor without risk. Clearly help is needed from effective trade, fiscal and regulatory policy.
Trade policy is the first to consider since the decline in commerce during the Depression was largely due to the Smoot-Hawley Act's increased tariffs. Today, Washington is at odds with free trade, inserting a "Buy American" provision in the stimulus bill and pandering to labor unions.
The Obama administration has overlooked the importance of trade in other ways, such as the failure to get approved free-trade pacts already negotiated with South Korea, Columbia and Panama; new tariffs on Chinese tires and steel products; and letting our competitors race ahead in securing new free trade agreements.
Turning to fiscal policy next, historians recognize that the Hoover administration's sharp tax increases on personal, corporate, inheritance, gift and excise taxes -- all passed on and added to by Franklin Roosevelt -- were a defining feature of the Depression years. In this regard, the Obama presidency will be the first administration since Eisenhower to raise taxes during a recession.
In fact, campaign promises notwithstanding, Obama has one of the most ambitious tax increase agendas of any President. He proposes new taxes on health plans, surcharges on the wealthy, drug companies and device-makers, foreign-source earnings, capital gains, personal income, estate, financial transaction, carried-interest and energy -- through a cap-and-trade regime.
In addition, Roosevelt created an alphabet soup of new regulatory bodies and unprecedented regulations to redress business and investment excesses following the stock market crash of 1929. In a new script of the old play, Washington is now similarly intent on massive enlargement of government bureaucracies, expansion of labor unions and regulation of the health care, banking and finance as well as the utility and energy sectors.
If the missteps in trade, tax and regulatory policies were not enough, the killer bullet to the U.S. economy could be the shrinking of available credit to private business, which is the mother's milk of recovery.
In the last year, the federal budget deficit soared 207 percent to $1.42 trillion, all of which is financed with increased U.S. Treasury debt. Successive years of additional red ink will likewise require issuing more government debt at a time when our largest creditors, notably China and the OPEC countries, have signaled reluctance to increase their exposure. The most likely investors to pick up the slack in buying this debt will be domestic banks, which will crowd out lending to businesses that need capital for expansion and job creation.
If tempting fate with a second Depression is too abstract, what may prove to be the turning point on both sides of the political aisle is the harsh reality of hitting the federal government's $12.1 trillion debt ceiling by year end. A fitting New Year's resolution would then be to vote against anyone who favors continuing down failed paths and cannot commit to debt reduction.
Scott S. Powell is managing director of AlphaQuest LLC and a visiting fellow at the Hoover Institution. Ron Laurent is the managing partner and chief investment strategist of Veritas Partners LLC.

Obama's 2008 Campaign: A Job Creation Lesson

2009-12-11T01:38:00.000-03:00

By John Tamny

With the federal government's measure of unemployment in the double digits, President Obama has unsurprisingly moved job creation to the top of his list of initiatives. And while his priorities could surely be worse, his approach has been contradictory to that which might actually lead to the creation of new jobs.

Some will no doubt say Obama's propoals on job creation are evidence of his lack of private sector experience, but it could be argued that his success in raising money for and running a national presidential campaign speaks to intimate knowledge. There are some similarities to say the least.

Indeed, when Obama sought financial support for what was at the time a long shot bid for the Democratic presidential nomination, he surely didn't wax poetic to potential supporters about all the workers he was hiring and equipment he was purchasing in order to run the campaign. More realistically he pointed to a lean operation (including voluntary workers) and polls suggesting he had a chance to secure the nomination; those polls and subsequent primary wins the "profitable returns" that campaign donors were interested in given their desire to achieve a return on their investment in him.

As every politician knows, there are no donors without promising polls and victories. Sadly, those same politicians - including Obama - haven't seen how clearly this correlates with businesses and jobs.

To use but one example, last weekend Obama talked up a recovering economy while at the same time expressing concern that rising business profits were a function of layoffs and businesses generally doing more with less. But had he applied his significant campaign experience to what businesses are presently doing, his outlook might have been more sanguine.

Just as campaign funds dry up due to a lack of success at the ballot box, so do investors shun businesses that aren't profitable.

As opposed to altruistic public goods created to employ those looking for work, businesses exist thanks to the self-interest of investors seeking profits. In that sense company heads don't mesmerize investors with tales of all the jobs they're creating, instead they do their best to exhibit their ability to generate the greatest amount of profits with the least number of workers possible.

Paradoxically, their skill when it comes to running lean, profitable businesses is what ultimately leads to job creation. Just as Obama's rising success in the Democratic primaries emboldened him to ask donors for more money to expand his campaign, business profits embolden company CEOs to ask investors for more capital in order to expand their operations.

With businesses, the efficiencies and profits wrought by painful layoffs are the "seen", but the positive "unseen" is the investors those profits attract who will fund company expansion, and with expansion, job creation. There is no investment without profits, and there are no jobs without investment.

This is important when we consider looming healthcare legislation. President Obama has made plain that he would like all Americans to be insured. But whatever one's opinion of Obama's healthcare views, the simple truth is that healthcare is a cost, and a significant one at that.

Applied to his initially cash-strapped presidential campaign, imagine if in addition to all of his other expenses, Obama had to buy health insurance for his employees? If so, he would have had to divert significant funds from television ads and get-out-the-vote initiatives that would have made funding his nascent presidential bid more risky. When donors are considered, healthcare costs would undeniably have factored into their willingness to support Obama altogether.

Investors in businesses of all sizes must think the same way. Quality healthcare has myriad benefits, but looked at objectively, it is a cost that diverts what is limited capital from potentially profitable initiatives. Healthcare mandates placed on businesses will not only raise the cost of hiring workers, they will also weigh on future returns on capital so important to investors.

Some might reply that a "public" healthcare option would free businesses of those costs, but there it must be stressed that there's no such thing as public healthcare. With governments lacking any resources other than those they tax or borrow from the private sector, businesses will either pay for the public option through taxes, or through reduced investment thanks to the federal government vacuuming up capital to fund its initiatives. With regard to "stimulus", the same scenario applies.

Considering small businesses, President Obama has regularly said that they are the source of the majority of new job creation. And while there's some truth to his assertion, it's also true that by virtue of being small, the businesses founded in the nations' garages are the riskiest kinds of investments. Much the same, Obama's campaign was at least in the beginning the proverbial small, risky business.

This looms large when Obama's tax plans are considered. He's made it clear that he would like the richest Americans to pay a higher percentage of their incomes to the federal government in taxes. The problem there is that if higher taxes reduce the amount of disposable income among those who have it to dispose, small businesses and quixotic political campaigns will suffer the most.

Indeed, rare is the individual who will take a flyer with limited savings on unproven businesses or politicians. But when money is plentiful thanks to low levels of taxation, there's a greater willingness among those with means to speculate on business concepts and politicians possessing potential, but slim track records.

Long before President Obama came onto the scene, politicians have suffered the perception that their lack of real world experience makes them unsuited to pursue economic policy of any kind. No doubt there's some truth to the assertion, but it should also be said that their rise as politicians speaks to real knowledge of how businesses grow and create jobs. If they would take the time to analyze what drove their success in politics, they might become better at fashioning policies that lean toward economic freedom, and which foster a business climate characterized by growth and low unemployment.

John Tamny is editor of RealClearMarkets, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com). He can be reached at jtamny@realclearmarkets.com.

Bashing the rich is bad politics and rotten economics

2009-12-11T01:35:00.000-03:00

Class warrior

GORDON BROWN has been many things in his time: co-author of market-friendly New Labour, Prudence with his hand on the Treasury tiller, friend of Britain’s all-important City. Now, with a general election less than half a year away, a new prime minister is emerging. The well-off, already set to lose half of their earnings above £150,000 ($243,000) to the taxman, face a further cut to tax relief on their pension contributions; a promised increase in the inheritance-tax threshold has been shelved; those with offshore bank accounts will have their feet held to the fire, American-style. Mr Brown’s Conservative opponents, by contrast, have dreamed up their tax policies “on the playing fields of Eton”. Mr Brown’s inner class warrior has finally stepped forth (see article).
As one of the few set-piece occasions before the general election due by June for Mr Brown’s embattled government to make its case to voters, the pre-budget report (PBR) on December 9th (see article) was always likely to be more political than sensible. Even so it disappointed. Alleged dividing lines between Labour and its main opponents, the Conservatives, were dug deep into the sand: Labour, the party of the many, devoted to protecting public services and “going for growth”; the Tories, protectors of privilege and gleeful spending slashers.

Taxing bankers

Bankers’ bonuses are at the political centre of this issue. The banking system has received over £840 billion in state support one way and another, according to the National Audit Office. The money was intended to make banks safer (ie, to build up their capital) and more useful (eg, to encourage them to lend more) and has helped, in the event, to make them more profitable. Bankers in Britain were rumoured, until this week, to be in line for billions of pounds in bonuses for the year to April. Taxpayers are furious.
Hence the one-off 50% payroll tax at source on bank bonuses over £25,000 announced in the PBR. There are drawbacks—mostly practical—to this particular proposal. Banks will find ways around it; even the government thinks the tax might raise £550m at most. Moreover, banks argue that they need bonuses to lure and retain talent. This interference will irritate the City of London, generator in the good times of a quarter of Britain’s corporate-tax revenue, and could encourage people who are already being squeezed by a string of disobliging tax measures to pack their bags (see article).
This paper has argued that there are better ways to curb large bonus payments based on government-subsidised bank profits—namely, by charging a fee for the implicit guarantee that lowers banks’ borrowing costs. But such a big change ought to be co-ordinated internationally. In the meantime, this one-shot levy is a reasonable way of recouping some cash.
The bonus tax has garnered most attention; but other ways in which Mr Brown’s new theme has influenced the PBR are more worrying. A cut in pension relief risks turning off not just the prosperous but also those who aspire to be rich. The real problem, however, is that the government’s desire to portray itself as protector of the poor is getting in the way of the job it urgently needs to do—managing the public finances properly.
The big issue is how and how fast to replace fiscal stimulus with stringency. Too quickly, and economic recovery will recede; too slowly and creditors will start demanding higher interest rates. To err in either direction is to court disaster.

Balancing the books

Britain is the last of the big G20 countries still to be mired in recession. Its GDP has shrunk by 4.75% this year, far more than the 3.5% reckoned likely in April. Public-sector borrowing will be around 12.6% of GDP this year and not far off it next. The Bank of England, the OECD, the IMF and credit-rating agencies have all given warning that such deficits are unsustainable. It is time, in other words, for the government to come up with a credible plan for reining in the deficit.
Alistair Darling, the chancellor of the exchequer, has signally failed to do that in the PBR. The fiscal stance is broadly unchanged from that in April’s budget. Spending will expand next year by £31 billion, or 2.2% after inflation, before hitting a more modest stride thereafter. Government borrowing will be slightly higher than predicted this year and next.
Mr Darling is rightly wary of withdrawing fiscal stimulus before economic recovery is well under way. But he ought to have produced a convincing blueprint for deficit reduction after that. He expects the economy to grow next year, by 1-1.5%, and by a heroic 3.5% in 2011 and 2012. Economic growth, a cap on public-sector pay and pensions from 2011, an increase in the employment-insurance tax, plus the usual unspecified efficiency gains and programme postponements are to help Mr Darling shrink the deficit each year as a percentage of GDP. But even on these assumptions, it will take five years to cut borrowing to a still unacceptable 4.4% of GDP.
It is pretty clear why Mr Darling has failed to offer the country an honest account of the cuts in public spending that are needed to restore the public finances to health. Bashing the rich is only half of class politics. Protecting public services, such as the imperfectly reformed National Health Service (see article), is the other, for public services are disproportionately used by the poor, and their employees tend to vote Labour. By looking after the state, Mr Darling and his boss are looking after their core vote. Tony Blair was willing to use market mechanisms to improve the efficiency of the health service, and there is evidence that they were working. Under Mr Brown, however, those reforms have stalled. Market reforms are not what class warriors do. They prefer to protect budgets than to increase efficiency.
Britain has much experience of class politics, and none of it has been good. Class politics makes for bad economics: the state swells, public money gets wasted and entrepreneurs grow nervous. And it makes for a sad country, too: divisions deepen, suspicion flourishes and the social contract frays. When the time comes to judge the parties’ electoral strategies, voters should remember that.

Dems to lift debt ceiling by $1.8 trillion, fear 2010 backlash

2009-12-10T11:25:00.002-03:00

: A legislative aide changes signs at left, as Senate Budget Committee Chairman Sen. Kent Conrad (D-N.D.) at podium, speaks at a news conference announcing a proposed bi-partisan task force to solve the country's fiscal problems. Photo: AP

In a bold but risky year-end strategy, Democrats are preparing to raise the federal debt ceiling by as much as $1.8 trillion before New Year’s rather than have to face the issue again prior to the 2010 elections.

“We’ve incurred this debt. We have to pay our bills,” House Majority Leader Steny Hoyer told POLITICO Wednesday. And the Maryland Democrat confirmed that the anticipated increase could be as high as $1.8 trillion — nearly twice what had been assumed in last spring’s budget resolution for the 2010 fiscal year.

The leadership is betting that it’s better for the party to take its lumps now rather than risk further votes over the coming year. But the enormity of the number could create its own dynamic, much as another debt ceiling fight in 1985 gave rise to the Gramm-Rudman deficit reduction act mandating across-the-board spending cuts nearly 25 years ago.

Already in the Senate, there is growing pressure in both parties for the creation of a novel bipartisan task force empowered to force expedited votes in the next Congress on deficit reduction steps now shunned by lawmakers.

As introduced Wednesday, the legislation sets no specific targets for deficit reduction, but its 18-member task force — 16 of whom would come from Congress — is promised immense leverage to force change if they can first come together behind a plan.

“This is a defining moment,” said Senate Budget Committee Chairman Kent Conrad (D-N.D.), one of the lead sponsors, and New Hampshire Sen. Judd Gregg, the panel’s ranking Republican, is already maneuvering to try to add the legislation as an amendment to any bill tapped to carry the debt increase.

As explained by Hoyer and other Democrats, that will almost certainly be a pending $636.4 billion Pentagon appropriations bill that includes $128.3 in contingency funds for military operations in Iraq and Afghanistan.

The House leadership has held back the bill for weeks, saving it for this moment, but now appropriations clerks have been instructed to have a final package ready to go by Monday.

Leadership staff stressed that nothing was yet final in what has become a year-end negotiation between top Democrats in the House and Senate. But the Senate appears to have been the first to put the $1.8 trillion number on the table. And Hoyer’s comments are the clearest yet on the scale of the increase and the expectation that it will be part of a larger year-end legislative train pulled along by the must-pass military bill.

House Appropriations Committee Chairman Dave Obey, who is pursuing job-related measures he would also like to add, insisted that the debt issue is a “leadership call” alone. But the Wisconsin Democrat showed no sign of opposition to the strategy outlined by Hoyer.

“It is December. We don’t really have a choice,” Obey told POLITICO. “The bill’s already been run up; the credit card has already been used. When you get the bill in the mail you need to pay it.”

Though Treasury can buy itself time by moving assets around, it is already coming close to the current debt ceiling of $12.1 trillion. Last spring, the Democratic-backed budget proposed to raise this to about $13 trillion, but given the current pace of borrowing, no one now expects that will be sufficient to get through 2010.
In fact, fiscal year 2009 ended Sept. 30 with a $1.4 trillion deficit, which demanded higher-than-expected Treasury borrowing. Most of that was due to the downturn in the economy and spending commitments in place before Barack Obama took office. And as much as Republicans point to the president’s economic recovery bill last February as the culprit, only a small share of that $787 billion package was spent by Sept. 30.

The picture in 2010 is different. The administration is predicting the stimulus will hit its stride with much more spending. And there will be a steady escalation of outlays driven by back-to-back increases in 2009 and 2010 appropriations for domestic agencies.

The White House has vowed to be more deficit conscious in its forthcoming 2011 budget due out in February. But the House could vote as early as Thursday on a $446.8 billion year-end package covering more than a dozen Cabinet departments and agencies and representing a healthy 9 percent to 10 percent increase over current spending for the same accounts.

For example, transportation and housing resources would grow by 12 percent, including $2.5 billion for high-speed-rail investments on top of the $8 billion already added by the White House to the giant stimulus bill in February. A $163.5 budget for the Departments of Labor, Health and Human Services, and Education would add an additional $8.6 billion to annual spending, and Veterans Health Administration spending would grow to $45.1 billion, a $4.1 billion increase.

Former BOE Official Buiter Says Greece May Be First EU Default

2009-12-10T01:37:00.002-03:00

By Svenja O’Donnell and Elliott Gotkine

Dec. 9 (Bloomberg) -- Former Bank of England policy maker Willem Buiter said Greece may be the first major country in the European Union to default on its debts since the aftermath of World War II.

“It’s five minutes to midnight for Greece,” Buiter, who will join Citigroup Inc. as its chief economist next month, said in a Bloomberg Television interview today. “We could see our first EU 15 sovereign default since Germany had it in 1948.”

The EU’s economic affairs commissioner said late yesterday that officials are ready to help Greece with its budget deficit after concerns about its public finances sparked a rout in Greek government bonds. Fitch Ratings cut its rating on the nation’s debt yesterday to BBB+ and two other major ratings companies are threatening to follow.

“Default is not unavoidable,” Buiter said. “But unless there are radical fiscal actions, lasting cuts in spending and tax increases of at least 7 percent of GDP, the writing is on the wall” for Greece.

There’s “absolutely” no risk Greece will default, Finance Minister George Papaconstantinou said in an interview today with Bloomberg Television. Greek banks are “fundamentally sound” and Greece will not seek an EU aid package, he said.

Greece, the lowest-rated country in the euro region, is struggling to cut a budget deficit of 12.7 percent of gross domestic product.

European Assistance

The European Commission “stands ready to assist the Greek government in setting out the comprehensive consolidation and reform program, in the framework of the treaty provisions for euro-area member states,” said Joaquin Almunia, who is in charge of EU economic and monetary policy. He didn’t say what form any assistance could take.

Greece can expect a bail out from the European Central Bank “only at a price,” Buiter said. “They’ll probably go to the IMF, have a credible standby program and then aid from Brussels and bilateral aid from selected sovereign governments in Europe and the U.S. will be available.”

The benchmark Athens Stock Exchange General Index has fallen more than 11 percent in the last three days. The spread between the Greek and German 10-year benchmark bonds widened to 221 basis points from 130 basis points on Oct.

Buiter, currently a professor of political economy at the London School of Economics, was one of the founding members of the U.K. central bank’s rate-setting panel when he joined in June 1997.

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net; Elliott Gotkine in London at egotkine@bloomberg.net

Coal company cuts 500 jobs, blames environmentalists

2009-12-10T01:35:00.003-03:00

Coal company cuts 500 jobs, blames environmentalists

Chalk up another 500 jobs to the list of jobs President Obama will need to create or save.
A Pittsburgh-based coal company, CONSOL Energy, will lay off nearly 500 of its West Virginia workers next year and its CEO blames environmentalists dead-set against mountaintop mining who have waged “nuisance” lawsuits for the job loss.
But CONSOL Energy’s political problems are not unique to the mining industry, which has suffered under the Obama Administration. The Environmental Protection Agency is already holding 79 surface mining permits in West Virginia, Kentucky, Ohio and Tennessee. The EPA says these permits could violate the Clean Water Act and warrant "enhanced" review. And, agency went even further in October, announcing plans to revoke a permit for the Spruce No. 1 Mine in West Virginia.
The latest setback for the coal industry was announced on Tuesday when CONSOL Energy said close to 500 workers would lose jobs at their Fola Operations location near Bickmore, West Virginia in February 2010.
CEO Nicholas J. DeIuliis said the poor economy compounded by legal challenges by environmental activists forced CONSOL to slash jobs.
"It is challenging enough to operate our coal and gas assets in the current economic downturn without having to contend with a constant stream of activism in rehashing and reinterpreting permit applications that have already been approved or in the inequitable oversight of our operations,” he said in a statement. “Customers will grow reluctant to deal with energy producers they perceive are unable to guarantee a reliable supply due to regulatory uncertainty. It inhibits the ability to remain competitive."
The Ohio Valley Environmental Coalition, the Sierra Club, the West Virginia Highlands Conservancy and the Coal River Mountain Watch were the various groups active on the legal challenge CONSOL Energy refers to.
OVEC’s Executive Director Janet Keating told the Washington Times she believes CONSOL Energy is using the lawsuit as an excuse to layoff workers, although she says "we don't hide the fact we don't like mountaintop mining."
“The price of coal has dropped in half and I think we are a convenient target, a convenient scapegoat,” she said.
“This ruling does not even go into effect for 60 more days so doesn’t that tell you something?” Ms. Keating added. “Suddenly, all the sudden they are issuing these layoff notices as if the world is ending.”
District Judge Robert C. Chambers handed down the ruling in question on Nov. 24. He said the Army Corps of Engineers violated the law by not giving the public enough information during the public comment period for permits issued by the government, although he wrote the error “did not stem from any wrong-doing on the part of the mining companies.”
Even though the court said not enough information was given to the public, the permit application process for the Fola mine consumed nearly a year and a half, according to court papers. But, environmentalists say they weren’t given the enough specific information during the 30-day public comment period. “How can we make substantial comment if they only give us general information?” Ms. Keating asked.
Judge Chambers said requiring the mining companies to go back through the public approval process would provide the public “meaningful opportunity” to weigh in on the permits as well as “force the Corps to reconsider these permits, possibly with new information.”
“To put it into human terms, we are talking about the jobs of nearly 500 of our employees at the Fola Operations, and the impact such legal interpretations will have on their quality of life and that of their families," CONSOL CEO Mr. DeIuliis said.
But OVEC maintains CONSOL Energy is putting blame in the wrong place.
“We’re in a recession right now and utilities are using less coal and using more natural gas,” Ms. Keating said. “The manufacturing sector isn’t using the same levels of coal so there are these stockpiles and they are going to wait until the price of coal goes up.”

Stimulus III

2009-12-09T15:16:00.002-03:00

Democrats want TARP to become a revolving line of political credit.

If at first fiscal stimulus doesn't succeed, spend, spend again. That's the motto President Obama embraced yesterday, even if he didn't use the word "stimulus," which has managed to set a political record in the speed with which it has become unpopular with voters. This time, the spending is being called "Proposals to Accelerate Job Growth and Lay the Foundation for Robust Economic Growth."
But wasn't that also supposed to be the point of last February's $787 billion stimulus, or for that matter of the Nancy Pelosi-George W. Bush $165 billion stimulus of February 2008?
Nearly two years after that first Keynesian stimulus that was supposed to prevent a recession, and nearly a year after the second that the White House said would keep the jobless rate below 8%, the President now feels obliged to propose a third. Like the joke about Paul Krugman having predicted seven of the last two recessions, sooner or later the White House is bound to get the political timing right.
This time around, the President is at least suggesting a couple of good ideas. One proposal would revive his 2008 campaign promise for a zero capital gains tax on new investments in small business stock. Mr. Obama dropped the idea from his first stimulus because liberals on Capitol Hill hate the words "capital gains," but yesterday he proposed a zero rate for one year.

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Associated Press

Eight of the 18 California Conservation Corps workers were hired by the U.S. Forest Service as part of the federal stimulus plan.

Another decent idea would extend enhanced expensing for small business that was otherwise set to expire at the end of this year. This will allow businesses to immediately expense up to $250,000 of certain investments, which should help with business cash flow.

Both ideas would reduce the cost of capital, and thus would partially counteract the many tax increases coming from the House and Senate that would raise the cost of capital and hiring. These tax reductions also recognize that the only source of real long-term job creation is private business.
Most of the rest of Mr. Obama's proposals are unfortunately a grab-bag of greatest Congressional mis-hits. They include a "new" tax credit for small business hiring that looks suspiciously like Jimmy Carter's jobs tax credit that led to few net new jobs and was abandoned after a year.
There's also a flood of new spending, with the amount presumably to come later from Congress (oh oh!), on highways and other public works. Perhaps you thought these "shovel-ready" projects had been included as part of Stimulus II. Alas, that was merely the sales pitch. In the event, the bulk of that money was shovel-readied to such transfer payments as Medicaid, welfare, community block grants, and cash for the clunkers who run failing public schools. This time, we're told, roads and bridges really will get the money—and you can bet they'll all be built with higher Davis-Bacon wage rates that will balloon their cost, too.
How will this all be paid for? Well, there are the huge tax increases to come in 2011, if not earlier, as well as more federal borrowing. This time, however, Mr. Obama is also proposing to use funds repaid by banks to the $700 billion Troubled Asset Relief Program. When Congress passed TARP a year ago, the Democrats who ran the joint vowed that the cash was intended to save the financial system and that any returns would promptly go to pay down the debt. As Candidate Obama put it, "every penny" would go "directly back to the American people." That was then.
Now, we're heading into a new election year and Treasury says it expects the bailout to cost $200 billion less than expected, and that it should be able to recover all but $42 billion of the $370 billion it has lent to financial firms. That ought to be cause for rejoicing—and for using the cash to reduce a federal deficit that reached $1.4 trillion in fiscal 2009 and after two months is on pace to be even higher in 2010.
Instead, TARP is now morphing into a revolving line of Democratic political credit. Barney Frank wants to divert at least $4 billion to bail out more home owners. Virginia Senator Mark Warner wants $50 billion for loans to small business. Mr. Obama proposed yesterday to use TARP to finance his own ideas as part of Stimulus III, and if he and fellow Democrats succeed the taxpayers will never see this cash again.
The President tried to recast his "every penny" promise yesterday by arguing that recycled TARP cash would create jobs and thus revenue to bring down the deficit. This is also Speaker Nancy Pelosi's new talking point. They're right that a strong economy is the best way to reduce deficits, but their spend and spend again policies only make closing those deficits more difficult.
One note of hope here is that the White House admits that the TARP statute restricts its use to the "stabilization" of the financial system. The law also specifies that repaid money must go to deficit reduction, a fact that allowed Mrs. Pelosi to gather enough votes to pass TARP last year. This means Democrats are going to have to rewrite the law to spend TARP on pork and green jobs, giving Senate Republicans some leverage and Blue Dog Democrats another chance to write the ad scripts for their 2010 opponents.
As the President gladly admitted yesterday, the economy is recovering and even the job market is healing. If Congress won't reduce taxes, the best stimulus now would be for Congress to stop scaring private job creators by promising to help them. Just do nothing at all.

New Obama Plans: Spend Our Way Out of a Downturn

2009-12-09T02:24:00.000-03:00

President Barack Obama speaks on the economy at the Brookings Institution...

WASHINGTON (AP) - President Barack Obama outlined new multibillion-dollar stimulus and jobs proposals Tuesday, saying the nation must continue to "spend our way out of this recession" until more Americans are back at work. Without giving a price tag, Obama proposed a package of new spending for highway, bridge and other infrastructure projects, deeper tax breaks for small businesses and tax incentives to encourage people to make their homes more energy efficient.

"We avoided the depression many feared," Obama said in a speech at the Brookings Institution, a Washington think tank. But, he added, "Our work is far from done."
For the third time in a week, Obama sought to focus on job creation, noting that the unemployment rate was still at 10 percent in November, though down slightly from its 10.2 percent peak. He said "a staggering" 7 million Americans have lost jobs since the recession began two years ago.
While his proposal did not include the kind of direct federal public works jobs that were created in the 1930s, he said government could set the stage for more job creation by private businesses.
A major part of his package is new incentives for small businesses, which account for two-thirds of the nation's work force. He proposed a new tax cut for small businesses that hire in 2010 and an elimination for one year of the capital gains tax on profits from small-business investments.
Obama also proposed an elimination of fees on loans to small businesses, coupled with federal guarantees of those loans through the end of next year.
He called for more government spending on infrastructure projects such as roads, bridges and water projects and for new tax breaks for consumers who invest in energy-efficient retrofits in their homes. This could be what some administration officials have called a "Cash for Caulkers" program modeled on the now-expired Cash for Clunkers program of tax rebates for people who turned in old cars for more fuel-efficient models.
The administration also is eyeing ways to get money still not spent in the $787 billion stimulus bill passed last winter into projects more quickly.
Obama did not characterize his new proposals as another stimulus program like that mammoth measure, but Republican critics have called it just that and have said it will increase a federal deficit that is already at a record level.
Obama included sharp criticism for Republicans in his speech, accusing them of opposing economic stimulus efforts and his health care overhaul while supporting tax cuts and spending that have ballooned the deficit.
He said that soon after taking office, he and congressional Democrats took "a series of difficult steps" to try to stabilize the financial system and pull the economy out of a deep recession.
"And we were forced to take those steps largely without the help of an opposition party which, unfortunately, after having presided over the decision-making that led to the crisis, decided to hand it to others to solve."
Obama did not say how much his proposals would cost, although congressional Democrats are eyeing a $70 billion package to help create jobs and to provide aid to hard-pressed state and local governments. Administration aides suggested that the part of the package dealing with roads, bridges and other infrastructure could total about $50 billion.
While acknowledging increasing concerns in Congress and among the public over the nation's growing debt, Obama said critics present a "false choice" between paying down deficits and investing in job creation and economic growth.
To pay for the new programs, the administration is citing the Treasury Department's report on Monday that it expects to get back $200 billion in taxpayer-approved bank bailout funds faster than expected.
Obama suggested this windfall would both help the government spend money on job creation while also paying down the nation's debt, which now totals $12 trillion.
Obama called the bank bailout, under the Troubled Asset Relief Program (TARP), "galling."
"There has rarely been a less loved—or more necessary—emergency program," Obama said. The program is expected to go out of business at the end of this year unless extended by Congress.
Since the program is costing taxpayers at least $200 billion less than expected, Obama said, "This gives us a chance to pay down the deficit faster than we thought possible and to shift funds that would have gone to help the banks on Wall Street to help create jobs on Main Street."
But Republicans continued to insist that the leftover and repaid TARP money must be used exclusively for deficit reduction and not for a new jobs program.
"The president's announcement is further proof that TARP has morphed from an emergency injection of liquidity to thaw frozen credit markets into a $700 billion revolving slush fund to promote the Democrats' political, social and economic agenda," said Rep. Jeb Hensarling, R-Texas.
Obama said he is backing the measures he outlined because they "will generate the greatest number of jobs while generating the greatest value for our economy."
"These targeted initiatives are right, and they are needed," he said.

Dubai World loses control of New York hotel

2009-12-09T02:15:00.005-03:00

NEW YORK (AP) - Dubai World's investment arm, Istithmar, lost ownership of the W Union Square New York hotel in a foreclosure auction Tuesday. One of the hotel's interim lenders, a private equity firm called LEM Mezzanine, acquired the 270-room hotel for $2 million, according to Dow Jones. The sale was another financial blow to Istithmar, which acquired the hotel in October 2006 for $285 million, according to Real Capital Analytics, a data tracking firm.
Calls to Dubai World and LEM Mezzanine were not immediately returned. LEM said in a statement it plans to continue to operate the hotel and hopes to "take full advantage of any market recovery."
New York hotels have struggled in the wake of the national recession and financial downturn that have curbed business and leisure travel. Many properties have slashed their rates to attract business.
At the beginning of December, owners of eight New York hotels worth a total of $985 million were in financial distress, including a Courtyard Marriott and The Time Hotel, according to Real Capital Analytics.
The W was not the only Dubai World hotel in trouble. The Fontainebleau in Miami Beach is also in financial straits. The property's $660 million loan was due in August. Contractors also claim the owner of the historic hotel owes them $60 million.
The New York auction comes almost two weeks after Dubai World revealed it was seeking at least a six-month delay on repaying $60 billion in debt. The news rattled world financial markets and credit agencies slashed the debt ratings on Dubai's state companies, saying they might consider the plan a default.

Greece downgraded over high debt

2009-12-09T02:15:00.002-03:00

By David Oakley in London and Kerin Hope in Athens
Published: December 8 2009 13:34 | Last updated: December 8 2009 18:22

Greece saw its credit ratings downgraded to the lowest level in the eurozone on Tuesday as fears mounted over its deteriorating public finances.
Heavy selling of Greek stocks and bonds came amid fears that the country was heading for financial disaster unless politicians tackled dangerously high debt levels. Shares on the Athens stock exchange fell more than 6 per cent.
Fitch cut ratings on Greek debt to BBB plus with a negative outlook. It is the first time in 10 years a leading ratings agency has given Greece a rating of below A grade.
George Papaconstantinou, Greek finance minister, said the country would do “whatever is required” to reduce a record budget deficit and achieve its medium-term fiscal targets.
He said the downgrade reflected Greece’s “mounting credibility gap in recent years and an exceptionally difficult fiscal situation” faced by the new Socialist government, which took over in October.
Fitch said the downgrade “reflects concerns over the medium-term outlook for public finances, given the weak credibility of fiscal institutions and the policy framework in Greece, exacerbated by uncertainty over the prospects for a balanced and sustained economic recovery”.
Moody’s and Standard & Poor’s, the other main ratings agencies, have also warned Greece it could be downgraded owing to its debt, which is forecast to rise to 125 per cent of gross domestic product next year.
Mr Papaconstantinou said both Fitch and Standard & Poor’s had failed to take into account recent government initiatives described as positive by the European Commission. “Many analysts express mistrust ... which has to do with the gap between words and actions in recent years.”
Mr Papaconstantinou was referring to Greece’s repeated failure since joining the euro in 2001 to carry out structural reforms and keep the deficit within the eurozone limit of 3 per cent of gross domestic product
Concern focuses on whether Greece will be able to implement new revenue-raising measures swiftly enough to cut the deficit from 12.7 per cent to 9.1 per cent of GDP next year in line with budget projections. Mr Papaconstantinou said Greece was prepared if necessary to produce a supplementary budget in 2010.
Anders Borg, finance minister of Sweden, which holds the EU presidency, said: “They [Greece] need to get serious about their fiscal situation. You can’t run a 10 or 12 per cent deficit.”
Analysts also warned that the downgrade could pose problems for Greece in raising money in the bond markets and through the European Central Bank’s liquidity operations.
Under pre-financial crisis rules, the downgrade would have disallowed Athens from exchanging sovereign bonds for ECB loans as their credit ratings would no longer be good enough.
Although the ECB will keep the emergency rules next year, Greece must reduce its deficit soon. The relaxed ECB rules allow for collateral of bonds with ratings of BBB minus.
Goldman Sachs said: “Unless the ECB fiddles with its rules before the end of next year, then from the beginning of 2011, Greek sovereign bonds will no longer be eligible for ECB collateral.”

U.S. already $292 bln in the red this year - CBO

2009-12-08T16:38:00.002-03:00

WASHINGTON, Dec 4 (Reuters) - The U.S. government racked up a gaping shortfall in the first two months of this fiscal year after posting a record budget deficit last year, congressional analysts said on Friday.

Bonds

In October and November, the government spent $292 billion more than it took in, the nonpartisan Congressional Budget Office said.
That was even worse than the same period last year, when the government was on its way to posting a record $1.4 trillion deficit for the fiscal year that ended Sept. 30.
The federal budget has been battered by the worst economic downturn since the Great Depression of the 1930s, as tax revenues have plunged and spending on safety-net programs like unemployment insurance have skyrocketed.
The budget deficit was $176.4 billion in October, according to Treasury Department records, and the CBO estimated the deficit for November will have come in at $115 billion.
The CBO gave its figures in billions of dollars and said numbers may not add up to the totals because of rounding.
Receipts totaled $132 billion in November, the CBO estimated, down 9 percent from the same month last year. That was partly due to new legislation that gives increased tax write-offs to corporations.
Outlays were down $23 billion from a year earlier, the CBO estimated, as the government spent less on federal programs to stem the financial crisis. (Reporting by Andy Sullivan; Editing by John O'Callaghan) ((andy.sullivan@thomsonreuters.com; +1 202 898 8391; Reuters Messaging: andy.sullivan.reuters.com@reuters.net))

Moody’s Says U.K., U.S. AAA Ratings Relatively Weaker

2009-12-08T12:43:00.003-03:00

By Matthew Brown and Rocky Swift

Dec. 8 (Bloomberg) -- Moody’s Investors Service said its top debt ratings on the U.S. and the U.K. may “test the Aaa boundaries” because their public finances are worsening in the wake of the global financial crisis.
The U.S. and U.K. have “resilient” Aaa ratings, as opposed to the “resistant” top ratings of Canada, Germany and France, analysts led by Pierre Cailleteau in London said in a report. None of the top-rated countries is “vulnerable,” or have public finances that are “stretched beyond the point of ‘no return’ to the Aaa category,” New York-based Moody’s said.
The dollar weakened to 88.60 yen, from 89.51 yen, and strengthened to $1.4795 per euro from $1.4827. The pound fell against all 16 most-traded counterparts, dropping to $1.6289, from $1.6446. It weakened to 90.83 pence per euro, from 90.16. U.K. bonds rose, pushing the yield down 8 basis points to 1.08 percent, the biggest drop since Nov. 9.
“There has been a huge increase in debt-to-gross-domestic- product ratios as a result of the crisis,” said David Keeble, head of fixed-income strategy in London at Calyon, the investment-banking unit of Credit Agricole SA. “It’s right that there should be a lot of attention and pressure on these numbers.”
The U.S.’s debt burden will climb to 97.5 percent of gross domestic product next year from 87.4 percent, the Organization for Economic Cooperation and Development forecast in June. National debt in the U.S. climbed to $7.17 trillion in November. The U.K.’s public debt will swell to 89.3 percent of the economy in 2010 from 75.3 percent this year, according to the OECD.
‘Resistant’ Countries
All Aaa rated governments are affected by the global financial crisis, with differences in their impact and ability to respond, Moody’s said. “Resistant” countries, which also include New Zealand and Switzerland, started from a more robust position and won’t see debt exceeding levels consistent with their Aaa status, Moody’s said.
Moody’s defines “resilient” countries as “Aaa countries whose public finances are deteriorating considerably and may therefore test the Aaa boundaries, but which display, in our opinion, an adequate reaction capacity to rise to the challenging and rebound.”
The cost of protecting U.S. debt from default was unchanged at 32 basis points, or $32,000 a year to protect $10 million of the nation’s bonds from default for five years, according to CMA DataVision prices. That compares with a peak of 100 basis points in February and 20 basis points in October.
Credit-Default Swaps
The cost of protecting U.K. debt from default was equivalent to that of Portugal, which is rated Aa2 by Moody’s, its third-highest grade.
Credit-default swaps on U.K. government debt cost 74 basis points, up from 72.5 yesterday, according to CMA prices. The U.K. contracts, which peaked at 175 basis points in February, rose from 44 basis points on Sept. 30, CMA prices show.
“The U.K.’s fundamentals are dismal and don’t support the ratings,” said Mark Schofield, head of interest-rate strategy in London at Citigroup Inc. “Only if some pretty draconian fiscal measures are in place will the U.K. keep hold of its Aaa rating.”
British Chancellor of the Exchequer Alistair Darling said yesterday that he would rather suffer criticism for removing support for the economy too late than too early, signaling he will put off measures to reduce Britain’s biggest budget deficit since World War II.
‘Determined Effort’
“I do think we need to make a determined effort to get our debt down,” Darling said. “I would rather be found guilty of removing the support slightly too late than slightly too early.”
The opposition Conservative Party has pledged to make reducing the budget deficit a priority if it is elected next year. The government must call an election next year.
“We can’t solve the problem of the deficit straight away, but what there’s an absence of is a credible plan,” Conservative leader David Cameron said at an event in southeast England. “If you have a government that doesn’t have the courage to tackle the deficit, that’s the risk of the double dip,” he said, referring to the possibility of a second downturn in the economy once it has exited recession.
The U.K. entered the crisis in a vulnerable position and is now facing an “inexorable deterioration of debt affordability,” Moody’s said. The government’s ability to borrow large amounts of money at favorable terms supports its ratings, according to the report.
‘Political Willpower’
The expansion of the U.S. economy won’t be enough for it to make “major progress” in reducing its budget deficit, the ratings company said.
“It’s difficult to drive a big wedge between the U.S. and U.K. in terms of their fiscal outlook,” said Calyon’s Keeble. “The flexibility that Moody’s spoke about isn’t obvious. It’s all a matter of political willpower.”
Countries with Aaa ratings aren’t likely to be downgraded anytime soon even after being “severely hit” by the global economic crisis, Moody’s said on Sept. 9. The U.K. and the U.S. have “lost altitude” in their ratings even as they remain resilient, Moody’s said in the report.
To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net

Liberal Group Puts Bounty on Head of Chamber of Commerce CEO

2009-12-08T02:05:00.002-03:00

By Judson Berger

- FOXNews.com

Chamber of Commerce CEO Tom Donohue is a wanted man -- at least according to the liberal activist group that's put a de facto bounty on his head.

Shown here is the ad asking for damaging information about Chamber of Commerce CEO Tom Donohue. (Velvet Revolution)

Chamber of Commerce CEO Tom Donohue is a wanted man -- at least according to the liberal activist group that's put a de facto bounty on his head.
A network of liberal groups known as Velvet Revolution started an ad campaign offering $200,000 for information leading to the arrest and conviction of the man whose trade organization has become a thorn in the side of the Obama administration and congressional Democrats.
The group is not leveling any specific charges of criminal behavior. Rather, it is casting a wide net, fishing for any whistleblowers from Donohue's past who might come forward with allegations of wrongdoing. The campaign against the Chamber was launched in response to the group's opposition to climate change legislation and health care reform, and its plan to spend $100 million lobbying against these and other initiatives.
"On every issue, the Chamber is kind of the lead corporate advocate for the status quo," said Kevin Zeese, a lawyer who sits on the board for Velvet Revolution, calling Donohue a "knee-jerk reactionary" and the Chamber a "right-wing extremist group."
The Chamber of Commerce, meanwhile, decried the ad campaign and threatened possible legal action.
"The media should be following the money trail behind this scurrilous group instead of giving credence to its outrageous tactics -- and we are considering legal options with the ad," spokesman Eric Wohlschlegel said.
The Chamber has already taken a lot of heat from the White House. Top aides tried to neutralize the group earlier in the year by doing an end-run around the organization and dealing directly with members, as some big companies, like Apple, peeled off from the Chamber due to disagreements over issues like climate change.
The organization was also not invited to Obama's jobs forum in Washington last week.
But Zeese said the White House has nothing to do with the bounty on Donohue.
"It's individual donors. We have no connection to the White House or unions or anything like that," he said.
Velvet Revolution launched the StoptheChamber campaign in October and started offering a bounty for information on Donohue a month later. A $100,000 reward was increased to $200,000 early this month, thanks to what Zeese called a "handful of larger donors" whom he would not identify.
A full-page print ad that looks like a "wanted" poster out of the wild West began to run in the Washington City Paper this week. It features a head shot of Donohue and offers a tip line for "insiders and whistleblowers possessing information not already in the public domain."
The tip line is live. When FoxNews.com called, the operator asked for "criminal" information about Donohue.
Zeese said that a handful of tips have come in which the group is "pursuing."
He said the hope is to forward any damaging information onto the Justice Department or Congress for further investigation.

Absolute Return: Preparing for an Uncertain 2010

2009-12-08T01:54:00.002-03:00

Worries about the direction of all asset classes may make an absolute return strategy a smart 2010 portfolio bet. Here's the long and the short of it

By David Bogoslaw

It's a sign of the times that even after a 65% runup in the Standard & Poor's 500-stock index over the past nine months, investors still feel nervous about what 2010 may have in store for them. The official end of the recession in the third quarter has all but quelled speculation about a double-dip economic downturn. Still, plenty of doubts remain as to how the economy will respond to the withdrawal of the government's massive fiscal stimulus and the open-ended questions around unemployment and mortgage foreclosures rates.
The sting from the wide-scale wealth destruction of last year and early 2009 was enough to scare all but the most risk-averse investors into the arms of money managers whose primary goal is to reduce volatility and downside risk in their clients' portfolios. That's the bedrock of the absolute return approach. Think of it as the market equivalent of the medical profession's credo "First do no harm," which in this case applies to a client's principal.
Absolute return strategies have been common in hedge funds, but are now filtering into the broader investment world in the form of mutual funds, says Jeremy T. Welther, a principal at Brinton Eaton Wealth Advisors in Madison, N.J. The 1940 Investment Act regulations that govern mutual funds require that all assets be kept in custody at a bank, that the net asset value of all assets be calculated daily, and that all assets be liquid. (Hedge funds are exempt from having to pursue these safety features.)
It's important to distinguish between two major tracks within absolute return: long/short and market-neutral. With a long/short equity bet, for instance, you're relying purely on a manager's skill at identifying stocks that will keep appreciating in value (the "long" part of the strategy) and those headed for losses (the "short"). A market-neutral strategy is a bet on the fund's ability to eliminate the variability of the market from the returns, says Jerry Miccolis, a principal at Brinton Eaton.

using a long/short portfolio anchor

Tom Samuels, portfolio manager of the Palantir Fund (PALIX), a no-load mutual fund with a global long/short strategy in all market cap segments, thinks the lower-volatility features of an absolute return strategy can be a key tool for minimizing a portfolio's downside risk in the uncertain year ahead.
"If you anchor your portfolio with a long/short approach, it allows you to be more market sensitive in other parts of your portfolio because you know you have that anchor," he says.
Samuels has been using pair trades a lot, especially in the second half of 2009. This consists of getting exposure to any given sector by matching up a stock whose fundamentals point to continued upside with one that you believe will sell off under tougher market scrutiny.
For example, within the retail sector, he's been long Timberland (TBL) for a while, citing its low debt level and proven ability to expand its business into foreign markets and via the Internet. He counters this with a short position on Tiffany & Co. (TIF), which he sees as overpriced at nearly 22 times estimated earnings for fiscal 2010. If consumers continue to pull back on the margin, luxury retailers such as Tiffany will likely disappoint on quarterly earnings reports, he says.
Here's how it can work: Say the retail sector as a whole declined 10%, but Timberland only dropped 5%, while Tiffany shares fell 12%. You would lose 5% of your portfolio's exposure in that sector on the drop in your long position but gain 12% on your short bet, for a net gain of 7%, vs. the sector's 10% decline. The Palantir Fund was up 12.6% year-to-date as of Dec. 3 and up 20% for the year ended Dec. 3.

absolute return for fixed-income, too

"When we think market risk is elevated, we'll put more and more of the portfolio into pair trades," says Samuels. "[That] protects us from a sudden drop in the market and allows us to hold more of a particular name we feel good about, even if it declines some, and maybe even add some more [to it while it declines] and have our risk ameliorated with the short."
For investors who prefer fixed-income assets over equities, there's the Aston Lake Partners LASSO Alternatives Fund (ALSOX), which is up 14.2% since its launch on Apr. 1, 2009. While it doesn't offer much of a track record, the fund uses the same strategies that Lake Partners, the hedge fund consulting firm that manages it, has run as separately managed accounts for 11 years, using assorted fixed-income instruments to reduce volatility. Since its inception in 1998, the LASSO portfolio is up 67.8%, vs. a 1.8% gain for the S&P 500, with one-third the daily volatility of the S&P 500.
The fund includes long/short credit strategies such as the JPMorgan Strategic Income Opportunity Fund (JSOSX), which might go long certain mortgage-backed securities whose underlying homes hold substantial equity and are in well-established neighborhoods, while shorting lower-quality commercial MBS whose pools include office buildings that have dropped in value.
The LASSO fund also makes capital-structure arbitrage funds such as the Driehaus Active Income Fund (LCMAX) available to retail investors. These funds look for market anomalies company by company, typically buying a debt instrument they see as undervalued and shorting another kind of debt of the same company that they think is overvalued.

Earnings surprises unwelcome to some

Another component of the LASSO fund is global bond exposure through vehicles such as the Eaton Vance Global Macro Absolute Return Fund (EAGMX), which might be long high-quality U.S. agency bonds and short the sovereign bonds of a country believed to have challenging fiscal issues, such as Greece.
Like most philosophies, financial and otherwise, there's a sense of orthodoxy in the world of absolute returns that some advisors insist be followed. Money managers in this area don't have the same discretion as hedge funds to invest in anything they deem appropriate because they must adhere to certain strategies laid out in a fund's prospectus, says Welther at Brinton Eaton.
"We're not looking for surprises, upside or downside. When you see them [diverging from their stated target return], it shows the manager's going away from the core strategy," he says. "If you had an absolute return strategy and you were looking to earn 10% and it earns 20%, something doesn't smell right there."
Michael Aronstein, chief executive of Marketfield Asset Management, takes a more flexible view of how the strategy works. He dislikes the pervasive portfolio model, which provides a big menu of choices and transfers the burden of asset allocation back to the client.
"If you have a good money manager, you should afford them as much latitude to do what they want as possible," he says. "We tell customers: 'If things don't work out, you can blame us entirely.' There are risks to that. We are making broad allocation decisions that in most cases the customer wouldn't agree with."

U.S. intervention hurt 2008 shorts

He's referring to what every investor knows in his head but can't embrace emotionally at the crucial moment—the directive to buy low and sell high. Around Thanksgiving of 2008, at the height of the forced selling across all asset classes, the Marketfield Fund (MFLDX) began to take advantage of the bargains. By early March, with the market nearing its low, the fund "had a very aggressive, pro-cyclical posture," he says. The fund was up 28% year-to-date as of Dec. 3 and up 33% for the year ended Dec. 3.
Investors need to be aware that absolute return strategies can pose risks even if asset managers are right and the market takes another nosedive. That may seem mystifying because that's precisely what these strategies were designed for, but consider this: In 2008, the long/short equity strategy didn't perform as well as it could have because the U.S. government became "more aggressive about intervention [to prevent some companies from failing] and not being bound by precedent regarding how it will intervene and how it changes the rules along the way," says Samuels at the Palantir Fund.
This makes it hard to analyze which stocks are safe to short, he says. Take Washington Mutual, whose overleveraged balance sheet and huge exposure to the subprime market made it an ideal candidate to short until Uncle Sam altered mortgage rules in 2007, watered down mark-to-market accounting rules in 2008, and engineered the troubled thrift's takeover by JPMorgan Chase (JPM) in September 2008.
"You don't get to give the full benefit [of shorting a stock] to your shareholders," says Samuels. "It can get tricky even if you're right because the rules can be malleable in a crisis situation."
Still, amid such uncertainty, the appeal of a disciplined approach like absolute return is undeniable.

The Supreme Case Against Sarbanes-Oxley

2009-12-07T01:24:00.000-03:00

As the Justices consider its constitutionality, new evidence shows that the law's costs far outweigh its benefits.

By JAMES FREEMAN

The most powerful czar in Washington will receive some long-overdue scrutiny today when the Supreme Court hears a challenge to the constitutionality of the Public Company Accounting Oversight Board (PCAOB).
This board, created by the Sarbanes-Oxley Act of 2002, regulates the auditors of publicly-traded firms. The members are hired by the Securities and Exchange Commission (SEC) and, say the plaintiffs in Free Enterprise Fund v. PCAOB, do not answer to the president. This violates the Constitution's "appointments clause," according to which senior executive-branch officials should be appointed by the president and confirmed by the Senate.
Yet Sarbanes-Oxley, or Sarbox, itself should be subject to scrutiny. New research suggests that the costs of this legislation far outweigh its benefits to the investing public.

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Getty Images

If you're wondering whether the members of PCAOB qualify as senior officials, consider that they have regulatory power over every public company in America. Board members fund their activities by collecting taxes, i.e., fees, from public companies based on the size of their assets.

But those fees are just the tip of the iceberg of costs imposed by PCAOB. The board is charged with making sure that Sarbox's Section 404 rules on "internal controls" over bookkeeping are implemented. These rules are so onerous that companies have had to undertake exhaustive investigations of such minor issues as how many people should be required to authorize small customer refunds at a retail location.
In 2003 the SEC estimated that the average company could do much of its internal controls work for $91,000 per year. In 2007, the commission acknowledged costs had gotten out of hand, particularly for smaller companies, and told the PCAOB to make the internal controls audits more cost-effective.
In 2008, the SEC's Office of Economic Analysis launched a survey of public companies to judge the results, and it recently posted the findings on the SEC Web site, after collecting data from thousands of corporations.
Section 404 is still consuming more than $2.3 million each year in direct compliance costs at the average company. The SEC's survey shows the long-term burden on small companies is more than seven times that imposed on large firms relative to their assets. Are the internal controls audits helpful? Among companies of all sizes, only 19% say that the benefits of Section 404 outweigh the costs. More respondents say that it has reduced the efficiency of their operations than say it has improved them. More say that Section 404 has negatively affected the timeliness of their financial reporting than say it has enhanced it.
In the years since its passage, the country has experienced an historic drought of initial public offerings. Is Sarbox to blame? Many financial pundits say no, but the SEC survey results point in the other direction. When public companies are asked whether Section 404 has motivated them to consider going private, a full 70% of smaller firms say yes, and 44% of all public companies also say yes.
Has Sarbox driven businesses out of the country? Among foreign companies, a majority in the survey say that Section 404 has motivated them to consider de-listing from U.S. exchanges, and a staggering 77% of smaller foreign firms say that the law has motivated them to consider abandoning their American listings.
In a separate survey of securities analysts, credit raters and other financial-information consumers, the SEC staff found a more favorable view of section 404, but these consumers admitted they found the "benefits . . . are inherently hard to quantify."
In fact, consumers have already participated in a much more robust and meaningful survey. University of Minnesota economist Ivy Zhang has tracked stock trading during the consideration of Sarbox in 2002 and then during periods when the SEC has considered exempting small companies from the most onerous audits. Comparing U.S.-listed companies to foreign companies free from Sarbox, she finds an increased likelihood of heavier Sarbox regulation is followed immediately by "negative abnormal returns" for U.S. stocks. On the other hand, news of potential relief from the law pushes up American stock prices.
That's not a vote of confidence from the people supposed to benefit from the law. Investors have been skeptical about this political exercise from the beginning. Little surprise that 74% of SEC survey respondents say that Section 404 has had little or no impact on investor confidence in their companies.
More troubling, a new paper in the Journal of Accounting and Economics finds that since the passage of Sarbox, U.S. firms reduced their investments in capital expenditures and research and development compared to firms in the U.K. and Canada. Authors Leonce Bargeron, Kenneth Lehn and Chad Zutter of the University of Pittsburgh count the ways the law discourages innovation: "First, by increasing the role of independent directors in corporate governance and expanding/criminalizing their liability for corporate misdeeds, [Sarbox] discourages directors from approving risky investments that are costly to monitor." The same goes for senior managers.
The authors also note that the SEC "acknowledges that the risk of financial misstatements is directly related to the complexity of a firm's operations, the extent to which it relies on specialized knowledge, and the degree to which its organizational structure is decentralized."
Where these factors are more prevalent, compliance costs will increase. In short, national policy imposes a disproportionate burden on innovative companies that delegate responsibility to highly-trained scientists. Could one devise a more destructive policy for the U.S. economy?
A glimmer of hope lies in the fact that Sarbox, drafted in the political panic following the Enron and Worldcom accounting scandals, failed to include a "severability clause." Thus if PCAOB is struck down as unconstitutional, all of Sarbanes-Oxley could come crashing down with it.

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Associated Press

Sen. Paul Sarbanes

Is all this fuss about board appointments just legal hairsplitting? Sam Kazman, general counsel of the Competitive Enterprise Institute, one of the plaintiffs suing the PCAOB, doesn't think so. He notes that "responsibility for bureaucrats was a fundamental issue for the Framers," and that the appointments clause was created "as an essential check on overweening bureaucracy. As colonists of England, they had seen offices created by both the king and Parliament spawn more offices with no accountability, creating what the Declaration of Independence refers to as a 'multitude of new offices' and 'swarms of officers to harass our people and eat out their substance.'"

Today, people who work at public companies—and their investors—understand this problem perfectly.
Mr. Freeman is assistant editor of the Journal's editorial page.

79% Now Favor Auditing the Fed

2009-12-07T01:12:00.002-03:00

Federal Reserve Board Chairman Ben Bernanke on Thursday voiced his opposition to legislation calling for regular audits of the Fed’s monetary policies, but 79% of Americans think auditing the Fed is a good idea.
A new Rasmussen Reports national telephone survey shows that just seven percent (7%) of adults oppose auditing the Federal Reserve and making those results available to the public. Fourteen percent (14%) are not sure.
The new findings mark a four-point increase in support for auditing the Fed from July. The audit - to be conducted by the General Accounting Office, Congress’ investigative agency - was first proposed by Republican Congressman Ron Paul and is now part of the House’s version of a bill putting more regulatory controls on the financial sector. The Senate is more skeptical of the audit proposal.
But Bernanke himself is under the gun this week as Senate confirmation hearings began on his nomination by the president to serve a second four-year term as Fed chairman. Just 21% of Americans favor Bernanke’s reappointment, while 41% are opposed.
(Want a free daily e-mail update? If it's in the news, it's in our polls). Rasmussen Reports updates are also available on Twitter or Facebook.
Unlike many issues tracked by Rasmussen Reports, there is virtually no partisan disagreement on the issue of auditing the Fed.
Similarly, investors and non-investors are equally supportive of the idea. Generally speaking, there is overwhelming support for such auditing across all demographic categories.
Congressional supporters of the audit see it in part as a way to check how much the Fed’s actions are influenced by political pressure. Sixty percent (60%) of Americans believe the Fed chairman is influenced by the president in his decision-marking. Just 20% say the chairman acts independently.
Bernanke and the Fed also have been key players in the Obama administration’s unpopular stimulus and bailout plans.
President George W. Bush originally named Bernanke to be Fed chairman, and 50% of voters blame the bad economy on the recession which began under the Bush administration. Forty-two percent (42%) blame President Obama’s policies.
Americans worry about the Fed’s ability to keep inflation under control and interest rates down. While Obama and senior congressional Democrats favor putting more regulatory controls on the U.S. financial system, which includes expanded powers for the Fed, 53% of Americans oppose more government regulation in this area.
Most voters continue to worry that the federal government will do too much when it comes to reacting to the nation’s financial problems.

Near-Zero Rates Are Hurting the Economy

2009-12-04T02:24:00.002-03:00

Low rate expectations are pushing dollars abroad. That capital needs to stay here to grow businesses and create jobs.

By DAVID MALPASS

The Federal Reserve implemented an emergency monetary policy after the 2008 Lehman bankruptcy to salvage the world financial system. In his testimony yesterday before the Senate Banking Committee, Fed Chairman Ben Bernanke said, "We must be prepared to withdraw the extraordinary policy support in a smooth and timely way as markets and the economy recover."
This leaves all-out emergency monetary stimulus in place, but with a different, much weaker justification. With the system stabilized, the Fed hopes that artificially low interest rates and its purchases of mortgage-backed securities will spur growth. Instead they are pushing dollars abroad and wasting precious growth capital in asset and commodity bubbles.

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Martin Kozlowski

Since the show of global cooperation at the Nov. 6 G-20 meeting, the rest of the world has challenged the Fed's emergency policy. Asia warned President Barack Obama on his recent trip that the zero-percent fed-funds rate was flooding Asia with excess dollars, causing asset bubbles there and undercutting global growth.

Europe quickly joined Asia's criticism. On Nov. 20, German Finance Minister Wolfgang Schäuble said that the U.S. policy threatened "enormous turbulence." European Central Bank President Jean-Claude Trichet has repeatedly tried to bolster the U.S. commitment to a strong dollar, most recently with yesterday's comment that "I trust the sincerity of the U.S. authorities."
Nevertheless, more than a year after the heart of the panic, the Fed is still promising near-zero interest rates for an extended period and buying over $3 billion per day of expensive mortgage securities as part of a $1.25 trillion purchase plan. Capital is being rationed not on price but on availability and connections. The government gets the most, foreigners second, Wall Street and big companies third, with not much left over.
The irony of the zero-rate policy, coupled with Washington's preference for a weak dollar, is a glut of American capital in Asia (as corporations and investors shun the weakening U.S. currency) and a shortage at home. For gold and oil, the low-rate policy works, weakening the dollar so commodity prices go up and providing traders with ample funds to buy into the expanding bubble. Those markets are almost daring the Fed to try to break out of its zero-rate box.
But for small businesses and new workers, capital rationing is devastating, spelling business failures and painful layoffs. Thousands of start-ups won't launch due to credit shortages, in part because the government and corporations took more credit than they needed (because it was so cheap).
Already countries with higher interest rates, Australia for one, are viewed as less risky because they have room to cut rates if there's another emergency. This wins them capital and jobs that might otherwise be ours.
According to International Monetary Fund data, U.S. GDP has fallen to 24% of world GDP from 32% in 2001. And as U.S. capital escapes the weak dollar and high tax rates, the U.S. share of world equity market capitalization has fallen to 30% from 45%. This leaves the U.S. alone with Japan at the bottom of the monetary heap, with rate expectations so low they repel investment.
Yet the Fed's not nearly as trapped as it seems. Much of its current stimulus is being diverted to commodities and foreign economies—hence Asia's complaint about bubbles. Under emergency stimulus, corporations are borrowing dollars hand-over-fist, pleasing Wall Street while using the proceeds to expand their foreign businesses. If that stimulus could be retained here, the Fed could stand down gradually from the emergency yet still assure appropriate policy accommodation.
The simple goal is to convince the capital now funding gold mines and foreign asset bubbles to instead fund small businesses and the guaranteed mortgages the Fed's been buying. This means stopping the dollar's collapse, since it is fueling the outflow.
Since U.S. inflation is relatively low, even a Fed nod toward normalcy on monetary policy (not evident in Mr. Bernanke's testimony yesterday) should cause a dramatic improvement in the dollar and the magnitude of capital flows.
The fed-funds rate can stay near zero for a while longer, but the Fed can't keep promising "exceptionally low rates for an extended period," as it did last month. The sooner the Fed moves off its policy extreme, the sooner markets can resume their job of allocating capital and assessing relative value. In a more market-oriented allocation of global capital, the U.S. will be a big winner, especially for jobs and small businesses.
If the Fed wants to speed the capital reflow, it could mention the importance of the dollar in its Dec. 16 committee statement on interest-rate policy and inflation risks. In his Nov. 16 address to the Economic Club of New York, Mr. Bernanke said policies should "help ensure that the dollar is strong and a source of global financial stability." Putting that in the Fed's policy statement—with none of the normal winks to those who favor devaluation—would cause capital to flood back into the U.S., loosening small-business credit and adding jobs even when the Fed eventually contemplates rate hikes.
If the Fed announces that an end is in sight to its all-out emergency policies, two other benefits may accrue. China should be more willing to allow yuan appreciation if it thinks there's a net under the dollar. With no net, China fears that yuan appreciation would accelerate dollar flight, driving commodities even higher. And the Fed should be able to maintain its independence, which is at risk from congressional audits as long as the deeply unsettling emergency policies persist.
Wall Street will threaten a tantrum if the Fed even thinks about damping the air-raid sirens. The Street utterly loves the Fed's largess, earning massive profits from trading unstable currencies, the carry trade (borrow short-term dollars near zero, buy longer-term assets abroad), and the high-margin process of transferring America's capital abroad.
The hitch is that there isn't much trickle-down to normal jobs and small businesses from the sophisticated, zero-rate arbitrage that is propelling asset prices ever higher. It would be better to stand down from emergency stimulus and instead help markets direct the capital that is now going into bubbles into the economy and jobs.
Mr. Malpass is president of Encima Global LLC.

The Bernanke Record

2009-12-04T02:23:00.002-03:00

Will he repeat the mistakes of his four years?

Federal Reserve Chairman Ben Bernanke faces his Senate renomination hearing today, amid signs that the confirmation skids are greased. We nonetheless think someone should say that, as a matter of accountability for the financial crisis and looking at the hard monetary choices to come, the country needs a new Fed chief.
We say this not because of Mr. Bernanke's performance during the financial panic of 2008, for which he has been widely and often deservedly praised. Like others in the regulatory cockpit at the time, he had to make difficult choices with imperfect information and when the markets were shooting with real bullets.
He supplied ample liquidity when it was most needed last autumn, and he has certainly been willing to pull out every last page of the central banker playbook. If some of those decisions were mistakes, the conditions the Fed faced were extraordinary. Anyone at the helm would have made calls that in hindsight he'd regret.
The real problem is Mr. Bernanke's record before the panic, with its troubling implications for a second four years. When George W. Bush nominated the Princeton economist four years ago, we offered the backhanded compliment that at least he'd have to clean up the mess that the Alan Greenspan Fed had made. That mess turned out to be bigger than even we thought, but we also didn't know then how complicit Mr. Bernanke was in Mr. Greenspan's monetary decisions.

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Bloomberg

Chairman of the U.S. Federal Reserve Ben S. Bernanke

Now we do, thanks to the release of the Federal Open Market Committee transcripts from 2003. They show (see "Bernanke at the Creation," June 23, 2009) that Mr. Bernanke was the intellectual architect of the decision to keep monetary policy exceptionally easy for far too long as the economy grew rapidly from 2003-2005. He imagined a "deflation" that never occurred, ignored the asset bubbles in commodities and housing, dismissed concerns about dollar weakness, and in the process stoked the credit mania that led to the financial panic.

This, too, might be forgivable if Mr. Bernanke had made any attempt in recent months to acknowledge the Fed's role in the mania. Treasury Secretary Tim Geithner, Dallas Fed President Richard Fisher and others have conceded that monetary policy was too loose. How central banks can minimize, if not prevent, asset bubbles without inducing recessions would seem to be a subject for candid Fed debate.
But Mr. Bernanke and Vice Chairman Don Kohn have formed an intellectual moat around the Fed, blaming the credit bubble on the "global savings glut" that they themselves helped to create. They are the Edith Piafs of central banking, regretting nothing.
All of this bears directly on how the Fed will operate over the next four years. We are now in another period of extraordinary monetary ease. Mr. Bernanke is assuring the world that, this time, he knows how and when to start removing this stimulus, even as he also promises that the Fed will remain easy for months to come. The guideposts the Fed claims to follow on policy—the jobless rate, "resource utilization"—also remain the same. Price signals, especially the value of the dollar, count for much less in this Fed's decision-making.
Earlier this decade, the Fed had 20 years of sound-money history as a source of credibility. The world's investors were willing to give the Greenspan Fed the benefit of the doubt—too much doubt as it turned out. But now, after the mania and panic, investors are unlikely to show such forbearance. That's already clear in Asia, where the falling dollar is creating monetary distortions, and investors are bidding up assets and currencies on a bet that the dollar is in for further declines. Sooner rather than later, Mr. Bernanke will have to tighten money even if the U.S. jobless rate remains higher than everyone would like.
The Fed chairman has shown he knows how to ease money, and creatively so. But that is the easy part of his job. The hard part, the time when central bankers earn their fame, is when they have to take the money away. We see little in the chairman's policy history or guideposts to suggest he will be willing to endure the criticism that will come with tightening money amid a lackluster recovery, if that is what is required to protect the dollar or prevent an inflation outbreak.
The political irony today is that even as Mr. Bernanke is cruising toward confirmation, the Fed as an institution is under its most sustained political attack in two generations. The political class is especially riled about the Fed's forays into fiscal policy. While that is understandable given the last year, the response to this action should not be to put the Fed under even greater political control from Congress. That is the Argentinian solution.
The better response is to hold policy makers accountable for their actions, including chairmen of the Federal Reserve. At this monetary moment more than any since the late 1970s, the Fed needs a hard-money chairman with the courage and credibility to resist the temptation to escape from the consequences of the last bubble by floating another one.

How Not To Increase Employment

2009-12-04T02:20:00.001-03:00

David Malpass, 12.02.09, 01:59 PM EST

Obama's advisers have the wrong idea on job creation.

The president will hold a summit on Thursday to discuss job creation. Great.
The U.S. knows more than any country about how to create millions of jobs, having done it in the 1960s and again in the 1980s and 1990s.
The answer lies in small businesses that take advantage of freedom, a sound currency and low tax rates. Anytime those three things are available, they hire like crazy.
We also know how to stop job creation, as we learned the hard way in the 1970s and the last three years. A weakening dollar and the threat of high tax rates cause small businesses to freeze.
In the 1970s, tax rates rose because inflation pushed the country's best producers into higher tax brackets. The tax code wasn't indexed for inflation, so it was an automatic tax hike.
Amazingly, we're living in the 1970s again. Tax rates are scheduled to rise automatically at the end of next year, with a flood of proposals to accelerate and even increase those tax hikes. No wonder small businesses aren't hiring.
Which brings me to two disappointing articles from prominent Democrats as the president's summit approaches.
In Wednesday's Wall Street Journal, Christina Romer, chair of the President's Council of Economic Advisers, laid out her thinking on job creation. While the article is well-intentioned, her thrust is clear--to create jobs through government programs and public-private partnerships. Despite the massive 2009 stimulus and the Cash for Clunkers program, she correctly notes: "American businesses appear hesitant to hire and are producing more with fewer workers."
Rather than propose a stronger dollar to bring in capital, and lower top marginal tax rates to encourage private sector investment and hiring, she proposes "partnerships with the private sector," "harnessing the private sector" and techniques to "leverage scarce public funds." But no small business will increase hiring when harnessed more tightly to the government tax collector.
Deep in the article, there is a mention of small businesses, but no plan to offer them relief from their already-exorbitant tax "partnership" with Washington. Instead, Romer offers targeted Washington aid: "Others have suggested incentives to help small businesses invest, grow and create jobs. This could include measures to restore the flow of credit for small businesses and targeted tax cuts. In these types of ways, a moderate and targeted investment by the government might be leveraged into significant employment gains and purchasing power by small businesses."
Romer is one of the president's most respected policymakers. If her government-centered approach to job creation--"targeted, leveraged government investments"--is the outcome of the president's summit, it will be a big disappointment.
Paul Krugman's Nov. 30 column in the New York Times was even more direct. "It's time for at least a small-scale version of the New Deal's Works Progress Administration, one that would offer relatively low-paying (but much better than nothing) public-service employment. There would be accusations that the government was creating make-work jobs, but the W.P.A. left many solid achievements in its wake."
Their voices are clear. Romer and Krugman are advocating public-private partnerships and government jobs as America's path to lower unemployment. That's not the way America is used to doing it. The president may end up using their ideas to fill the policy vacuum, but he would be more effective (and popular) if he rethought the problem. The great American jobs machine depends on small businesses, relatively free of government, yearning for after-tax profitability, earned in dollars that hold their value over the decades. The president could deliver this, but not based using the current economic program.
David Malpass is an economist and president of Encima Global LLC. He writes a column for Forbes.

Mr. President, here's how to lift our economy

2009-12-04T01:56:00.000-03:00

By Mitt Romney
Today's White House jobs summit comes too late for millions of Americans who through no fault of their own have lost their jobs, their homes, their savings and, in many cases, the self-esteem and self-respect that come from work. Like other presidents before him, Barack Obama inherited a recession. But unlike them, he has made it worse, not better.

His failure to stem the unemployment tide should not have been a surprise. With no experience whatsoever in the world of employment and business formation, he had no compass to guide his path. Instead, he turned over much of his economic recovery agenda to House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, themselves nearly as inexperienced in the private sector as he. Congress gave him and them everything they asked for, including a history-making three-quarters of a trillion dollar stimulus.
But it did little to stimulate the real economy — where jobs are created. Studies, initiatives and programs that liberal think tanks had long pined for were given life even as the private economy was on life support. The president's team assured us that their massive stimulus would hold unemployment below 8%. So with unemployment now at 10.2%, it is clear that their stimulus was a miscalculated failure.
In an attempt to disguise the truth, the administration has touted inflated figures of jobs "created." But every month, in good times and bad, jobs are created and jobs are lost. What matters is the net difference between the two numbers. Focusing solely on jobs created while ignoring the far greater numbers of jobs lost is Harry Houdini economics.
Growing government, as was done with the stimulus, inevitably depresses the private sector and job creation. Shrinking government and reducing government jobs is healthier for the economy, but this option was never seriously considered. That's no wonder: As White House guest logs for the first half of the year reveal, the most frequent visitor to the executive mansion was Andy Stern, the head of the Service Employees International Union, which represents government workers.
My 10-point plan
The president's economists insist that technically, the recession is over. But double-digit unemployment was neither prevented nor has it ended. To get people back to work as rapidly as possible and to restore America's economic vitality, the nation must change course. Here's the advice I would give:
• Repair the stimulus. Freeze the funds that haven't yet been spent and redirect them to immediate, private sector job-creation priorities.
• Create tax incentives that promote business expansion and hiring. For example, install a robust investment tax credit, permit businesses to expense capital purchases made in 2010, and reduce payroll taxes. These will reignite construction, technology and a wide array of capital goods industries, and lead to expanded employment.
• Prove to the global investors that finance America's debt that we are serious about reining in spending and becoming fiscally prudent by adopting limits on non-military discretionary spending and reforming our unsustainable, unfunded entitlements. These are key to strengthening the dollar, reducing the threat of rampant inflation and holding down interest rates.
• Close down any talk of carbon cap-and-trade. It will burden consumers and employers with billions in new costs. Instead, greatly expand our commitment to natural gas and nuclear, boosting jobs now and reducing the export of energy jobs and dollars later.
• Tell the unions that job-stifling "card check" legislation is off the table. Laying new burdens on small business will kill entrepreneurship and job creation.
• Don't allow a massive tax increase to go into effect in 2011 with the expiration of the 2001 and 2003 tax cuts. The specter of more tax-fueled government spending and the reduction of capital available for small business will hinder investment and business expansion.
• New spending should be strictly limited to items that are critically needed and that we would have acquired in the future, such as new military equipment to support our troops abroad and essential infrastructure at home.
• Install dynamic regulations for the financial sector — rules that are up to date, efficient and not excessively burdensome. But do not so tie up the financial sector with red tape that we lose a vital component of our economic system.
• Open the doors to trade. Give important friends like Colombia favored trade status rather than bow to protectionist demands. Now is the time for aggressive pursuit of opportunities for new markets for American goods, not insular retrenchment.
• Stop frightening the private sector by continuing to hold GM stock, by imposing tighter and tighter controls on compensation, and by pursuing a public insurance plan to compete with private insurers. Government encroachment on free enterprise is depressing investment and job creation.
The 10% unemployment crisis hangs like an albatross around President Obama's neck. Eventually, as with every recession and recovery, the economy will improve and jobs will be created, but those who were unnecessarily unemployed due to the president's faulty economic program will not forget. In order to most rapidly re-employ all Americans and to speed a strong recovery, the president must change course. If he does not, Republicans will bring a change of their own to Washington in the 2010 elections.
Mitt Romney, former governor of Massachusetts, was a Republican presidential candidate last year.

Gold hits record above $1,217 an ounce on strong demand

2009-12-03T01:57:00.002-03:00

By Moming Zhou & Polya Lesova, MarketWatch

NEW YORK (MarketWatch) -- Gold futures rose Wednesday to close at a fresh high for the 19th session since the beginning of November, briefly topping $1,217 an ounce as demand for the metal as a hedge against a weaker currency remained strong with the dollar staying around 15-month lows.

Gold futures have soared 37% this year, and have made gains in 17 out of the past 20 weeks. They advanced in all but two trading sessions in November, and started December with two days of gains.
The rally came as speculative buying positions on the Comex futures exchange stayed at record highs, and holdings for gold exchange-traded funds hit another record.
In Wednesday trading, December gold rose as high as $1,217.30 an ounce in overnight electronic trading, surpassing the record set in the previous session. It ended up $12.90, or 1.1%, at $1,212 an ounce on the Comex division of the New York Mercantile Exchange.
The London afternoon gold fixing, a global benchmark for gold trading, stood at a record high of $1,212.50 an ounce Wednesday, up nearly 40% this year.
"While there is certainly an end to the party, we remain of the belief that the end of the secular bull market in gold will not be occurring any time soon," said Dan Greenhaus, chief economic strategist at Miller Tabak Co.

Just 21% Favor Bernanke’s Reappointment As Fed Chairman

2009-12-03T01:53:00.002-03:00

Ben Bernanke begins the formal process tomorrow for confirmation to a second term as chairman of the Federal Reserve Board, but 41% of Americans think President Obama should name someone new to the post.
A new Rasmussen Reports national telephone survey finds that only 21% of adults believe the president should reappoint Bernanke to another four-year term. But a sizable 39% aren’t sure what the president should do.
In July, Americans were more closely divided over Bernanke’s reappointment: 26% thought it was a good idea, while 33% felt the president should name someone new. Even then, however, 41% were undecided.
Republicans are more strongly opposed to Bernanke’s reappointment than Democrats and adults not affiliated with either of the major parties. However, investors support a second term for Bernanke by more than two-to-one over non-investors.
These findings come as a number of Rasmussen Reports’ regular economic indexes show downturns in confidence.
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Bernanke’s favorables continue to fall. Only 21% have at least a somewhat favorable view of the Fed chairman now, while 38% regard him unfavorably. His critics feel more strongly since 15% have a very unfavorable opinion of Bernanke, compared to three percent (3%) with a very favorable view. Forty percent (40%) don’t know enough about him to even venture a soft opinion, though.
Thirty-two percent (32%) still had a favorable view of Bernanke in June, a number that had held roughly steady since the Wall Street meltdown last fall. But his favorables fell six points to 26% in July.
Largely unchanged from the previous survey is the view Americans have of Bernanke in comparison to his predecessor as Fed chairman, Alan Greenspan. Seventeen percent (17%) say Bernanke has done a better job, but 44% think Greenspan was the better chairman. Thirty-nine percent (39%) are not sure.
Forty-one percent (41%) say the chairman of the Federal Reserve Board has too much power over the economy, but that’s down five points from 46% in June. Only seven percent (7%) say the Fed chairman doesn’t have enough power, while 29% say his level of power over the economy is about right. Twenty-two percent (22%) aren’t sure.
Whether the Fed chairman is too powerful or not, Americans remain skeptical about the Fed’s ability to keep inflation under control and interest rates down. Only 35% are at least somewhat confident in the Fed’s ability to maintain this kind of economic control, with eight percent (8%) who are very confident.
Fifty-six percent (56%) lack that confidence, with 35% who are not very confident and 21% who are not at all confident. These views have shifted little since mid-October.
Americans continue to be critical of another key player on the economic front, Treasury Secretary Timothy Geithner. Forty-two percent (42%) of Americans say Geithner has done a poor job handling the credit crisis and federal bailout programs. Twenty percent (20%) rate Geithner’s performance in these areas as good or excellent.
Consumer confidence as measured by the Rasmussen Consumer Index has fallen to a four-month low.
After three months of gains, the Rasmussen Employment Index dropped more than four points in November to its lowest level since July. Just 14% of workers now say their employers are hiring, the lowest total since February.
Economic confidence among America's small business owners in the Discover (R) Small Business Watch(SM) index plummeted in November, as more owners cited serious concerns about cash flow and saw economic conditions for their own businesses getting worse.
October’s exuberance over the short-term housing market appears to have fallen back to the levels seen for much of this year, while long-term confidence appears to be trending down.
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The Mess the Government Is Making

2009-12-02T02:06:00.000-03:00

For Democrats, the chickens are coming home to roost. Badly conceived efforts to rescue homeowners facing foreclosure, regional banks and the unemployed are failing.
Bureaucracy and corruption are to blame.
President Obama's program to restructure mortgages for homeowners who are facing payments too large for their incomes or who owe more money than their houses are worth has only helped several thousand, not millions as expected.
The Treasury now proposes to shame some banks and invasively monitor, nag and cajole mortgage-servicing companies -- much like autocratic Beijing abuses Chinese financial institutions.
With mortgage rates at 30-year lows, homeowners with enough equity in their homes and solid incomes can more easily restructure loans privately. As for those underwater, the president's program pays service companies too little -- one to two thousand dollars per loan -- to negotiate write downs.
Loan modifications generally require breaking covenants with bondholders, not reworking loan balances with banks, because many mortgages were bundled into bonds and sold to insurance companies and other fixed-income investors. Lacking sovereign immunity, service companies can't simply break contracts without consent. The whole process is too complex to succeed without strong-arm government confiscation of private property.
Had President Obama used TARP funds to create a bad bank, akin to the Resolution Trust Corp. that worked so well during the Savings and Loan Crisis, those bonds would now be in the hands of a federal agency, where loans could be worked out. However, the big Wall Street banks preferred easy credit from the Federal Reserve to borrow at near-zero interest rates to work off their losses, leaving fixed-income investors and regional banks to suffer.
Now 124 regional banks have failed, and the FDIC, which insures their deposits is insolvent and can't find buyers for many other banks it would like to shutter quickly. Meanwhile, the Wall Street bankers, who contributed generously to the President's campaign coffers, Chuck Schumer's campaign fund for Democratic senators and presidential economic adviser Larry Summer's multimillion dollar dowry in 2008, are "earning" record bonuses totaling $140 billion, or 1% of GDP.
Meanwhile, the president slipped the United Autoworkers billions in severance benefits and equity from TARP money through quick-rinse bankruptcies of General Motors and Chrysler.
You have to admit Obama takes care of his benefactors.
Meanwhile, Obama's stimulus package, the mythical calculations of White House economists notwithstanding, has failed to create the millions of private-sector jobs promised.
Simply, the $789 billion has mostly been spent on temporary tax credits that failed to generate much additional spending, on shortening furloughs for state and local government workers, and on financial rewards for other campaign constituents.
My Democrat-leaning colleagues at universities from Maryland to Minnesota are ecstatic about receiving summer research money that won't create new jobs.
Had $400 billion been properly spent on infrastructure projects, two million construction- related jobs would have been created. The stimulus program is slated to spend a paltry $100 billion, and those monies are being badly managed and will generate few jobs.
Now President Obama is convening a jobs summit. Attendees will include business leaders who have contributed to his campaign and labor-leaning economists.
No doubt, those constituents will advocate more tax cuts -- specifically focused at their businesses -- and industrial policies that boost unionized employment. Those will create some temporary jobs but at very high cost.
Increasingly, fiscal policy in Washington looks more and more like the finances of a 1970s Latin American republic that subsequently failed in the sovereign debt crisis of the 1980s.
Washington, even with its power to print dollars, cannot escape one iron law of economics: Corrupt governments ultimately fail.

Obama's 'predictably irrational' economic policies: 14 reasons Obama's love of Wall Street will trigger the Great Depression 2.0

2009-12-02T02:04:00.001-03:00

By Paul B. Farrell, MarketWatch

ARROYO GRANDE, Calif. (MarketWatch) -- First: Kiss the rally good-bye, says Jeremy Grantham, legendary CEO of the $101 billion GMO money-management firm.

Why? The market is overvalued 25%. A minimum 15% correction is coming in 2010, putting the Dow in the 8,000-9,000 range. The S&P 500? Not at 666 like last spring; maybe 800. Why a top? Black Friday? Dubai? Tiger Woods? All the dark films? The "2012" end of civilization? The post-apocalyptic "The Road?" Stop guessing, timing market turns is irrational.

Deficit headwinds

Stacey Delo talks with Russ Koesterich of Barclays Global about the effect of the deficit on the equity market.

Grantham's shift from bull to bear appears rational. Remember, earlier this year the Dow was near 6,000, banks near bankrupt, and we were praying for the new untested president to change America. In his latest editorial Grantham reminds us why his prediction made sense in the spring: "Regardless of the fundamentals, there would be a sharp rally. After a very large decline and a period of somewhat blind panic, it is simply the nature of the beast." Get it? A rally was predictable, based on the history of cycles.
Trust Grantham? 100%. Back in early 2007, he warned: "The First Truly Global Bubble: From Indian antiquities to modern Chinese art; from land in Panama to Mayfair; from forestry, infrastructure, and the junkiest bonds to mundane blue chips; it's bubble time. ... Everyone, everywhere is reinforcing one another. ... The bursting of the bubble will be across all countries and all assets ... no similar global event has occurred before."
Grantham was one of a small group of industry leaders who saw a crash coming as early as 2000. But political leaders were ideologically blind: Fed Czar Ben Bernanke said the collapsing markets were "contained." Our devious Treasury Czar Henry Paulson was misleading Fortune and all America: "This is far and away the strongest global economy I've seen in my business lifetime." Worse, former Fed Czar Alan Greenspan was busy writing his memoirs bragging about how he invented a "New World" out of Reaganomics, Ayn Rand's New Age wishful-thinking and an unregulated $670 trillion derivatives market.
Three clueless leaders.

Grantham bearish, short-term correction, long-term disaster

Now Grantham's warning us again: America's irrational nightmare will repeat. First, the short-term correction, 15% to 25%. But then long-term, a deadly warning: Disaster ahead. Why? Because America has "learned nothing," we are "condemning ourselves to another serious financial crisis in the not too-distant future."
Yes, Americans are predictably irrational, doomed to repeat history: Grantham points us to a key chart, his "favorite example of a last hurrah after the first leg of the 1929 crash." The similarity between 1929-30 and today are obvious: "After the sharp decline in the fall of 1929, the S&P 500 rallied 46% from its low in November to the rally high of April 12, 1930, then, of course, fell by over 80%."
Familiar? You bet. We've had our rally. Next, the plunge. Our irrationality plus history guarantees another ... only bigger.
A year ago America came dangerously close to the Great Depression 2. We "learned nothing." When psychologist Daniel Kahneman won the 2002 Nobel Prize in Economic Science for his work on irrationality in 2002, the sense was that behavioral economics would help Main Street become "less irrational," that behavioral sciences would make us all better investors, better consumers, better citizens.
Obama even made a big issue of working with behavioral scientists to minimize irrational behavior in America.

Obama gets failing grade in behavioral economics

But they turned against us. Behavioral scientists, behavioral economists and behavioral-finance experts have become the mortal enemies of Main Street America. Two ways: First, behaviorists consistently put us down by reminding us how irrational (stupid) we are. Second: They're using their minds, tools and technologies against us, helping Wall Street profile us as targets for investing products, bank customer fees, tax propaganda, etc.
They are paid mercenaries helping Wall Street scam Americans out of billions. They cannot be trusted, they have lost their independence and professional integrity. They are failing to expose the most toxic sources of irrationality: Wall Street, Congress, the White House.
And that's why when a guy like Jeremy Grantham comes along focusing us on the toxic irrationality at the top of America's leadership he deserves to be seen as one of America's best behavioral economists. He's one of the few honest behaviorists, exposing the irrationality of America's leaders.
So please listen closely to his 14-point analysis of the rampant irrationality at the highest level of American government today, because what he is also predicting is another catastrophic meltdown dead ahead.

1. Obama's shift into 'predictably irrational' economics

If Grantham ever was a fan, he's clearly disillusioned with the president. His 14 points expose the extremely irrational behavior of Obama breaking promises by turning Washington over to Wall Street, a blunder that will trigger the Great Depression 2. Grantham is cynical but subtle. If you want a more brutal attack, read Matt Taibbi's latest Rolling Stone feature: "Obama's Big Sellout," detailing how Obama, same as Bush, turned government over to Wall Street, to the same crooks who created the mess.

2. Bernanke's reappointment, a totally irrational blunder

"The most passionate cheerleader of Greenspan's follies ... completely clueless." A blunder "like reappointing the Titanic's captain" and "a wasted opportunity."

3. Summers, Geithner: Wall Street's newest Trojan Horses

Larry Summers blew "no warning whistles of impending doom back in 2006 and 2007." Earlier as Treasury Secretary he "beat back attempts to regulate" derivatives. Tim Geithner "sat in the very engine room of the USS Disaster and helped steer her onto the rocks" as New York Fed Czar. Still an irrational Obama appointed him, as Wall Street cheered.

4. Idiotic, irrational, greedy mortgage borrowers

"The more misguided or reckless the borrowers, the more determined the efforts to help them out," although "these efforts had limited effect." Short-term politics, bad economics.

5. Reckless, irrational and stupid home builders

They "magnificently overbuilt" for years." Still our irrational president stimulated "even more home building by giving new house buyers $8,000 each."

6. Nation of irrational overspenders and undersavers

Americans have been "dangerously overconsuming for the last 15 years." Still, our irrational politicians "encourage consumption and penalize savers by maintaining artificially low rates" fueling the same irrational speculation that created the meltdown.

7. America's too-Irrational-to-fail' banking system

Our banking "system shows every sign of being out of control." Make it simpler, smaller, "so they can be allowed to fail." Separate the "dangerously risk-seeking hedge fund heart from the banking system." Instead Obama set up a bizarre, irrational policy ... force them to be bigger." Now they're "at extreme tilt to risk-taking: it's practically a cliff!"

8. Wall Street's unconscionable crooked mega-bonuses

"Two-thirds of Goldman's huge profits went for bonuses ... largest ever." Last year the "same guys were on the edge of a run on the bank ... saved only by government." Our irrational president upset "the formerly infallible workings of capitalism."

9. Corporate America's grossly overpaid CEOs

"Galling," says Grantham: When he came to America in 1964 "the ratio of CEO pay to the average worker was ... between 20/1 and 40/1." That had "held for the previous 30 years. By 2006, this ratio had exploded to between 400/1 and 600/1 ... obscene."

10. Our irrationally overleveraged, zombie companies

Wall Street has "so overstimulated the risk-taking environment that junky, weak, marginal companies and zombie banks" outperform, with "junk over the great blue chips." We let losers "live to compete against the companies that actually deserve to be survivors." That's "not healthy for the long-term well-being of the economy."

11. Our irrationally managed U.S. auto industry

"Most short-sighted industry of the last 20 (40?) years, and one of the worst managed."

12. A nation addicted to automobiles, dying for more oil

"We chew up a dangerously large amount of Middle Eastern oil ... ruinous for our global political well-being (and ability to avoid war)" and bad for "an overheating world." Still, our irrational politicians are subsidizing more car purchases.

13. Stock options give CEOs a legal right to steal from shareholders

They're robbing us: Corporate CEOs have a "legalized way to abscond with the stockholders' equity." If management messes up and the stock crashes, they just "rewrite the options at new low prices ... no serious attempt to match stock option ... to the building of long-term franchise value. Instead, the motto is: grab it now and run!"

14. Finally, Grantham's irrational 'old nemesis, Greenspan'

He gets "the title of Maestro in the U.S. and is knighted by the Queen ... for thoroughly demolishing the integrity of the U.S. financial system. He overtly ignored the great threat of bubbles in asset classes and, in fact, encouraged them. He Ayn Rand-ishly facilitated the progressive dismantling of governmental restrictions on financial behavior, he deliberately kept real interest rates at zero for years, etc., etc., etc. You have heard it before. ... In the good old days, he would have been set in the village stocks, and not the kind you buy and sell. And I would have been right there, Alan, with very ripe tomatoes."
In the end Grantham encourages everyone to read a John Kay article in the Financial Times. Kay's title says it all: "Our banks are beyond the control of mere mortals." He advises investors to "follow an aphorism of Warren Buffett's: 'Invest only in businesses that an idiot can run, because sooner or later an idiot will.'"
Rereading Buffett's wisdom I wonder: Perhaps America really is a "business" that nobody can run? Not the best and brightest. Nor an idiot. And certainly not our too-clever behavioral scientists.
Moreover, "people" are not the problem. The 1982 classic "In Search of Excellence" tells us that 85% of organizational failures were systemic, not people caused. "It's the system stupid." That means America, our economy, our markets, our capitalist system have become too big, too complex, too out-of-control, too unmanageable.
Our wealthy elite already know that and are grabbing what's left. The "idiot" masses could regain control, but only in a 1776-style revolution, except they're too docile, too irrational to revolt.

Systemic Risk and Fannie Mae

2009-12-01T13:43:00.000-03:00

The education of Joe Stiglitz and Peter Orszag.

As Congress lumbers toward creating a systemic-risk regulator, it's worth a look back—to 2002, when an economist named Stiglitz and a duo named Orszag wrote a paper with the droll title, "Implications of the New Fannie Mae and Freddie Mac Risk-Based Capital Standard."
We won't keep you in suspense. The paper, written the year after Joseph Stiglitz won the Nobel Prize for economics, concludes that "on the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero." Their analysis has recently been making the rounds on the Web to a chorus of chortles.
But the real lesson of the paper is not that Mr. Stiglitz, or Peter Orszag, the current White House budget director, and his brother Jonathan are dupes or rubes. The paper is notable because it represents the almost universally held view of the two government-sponsored mortgage giants at the time and for years afterward.
These pages began writing about the systemic risk posed by Fannie and Freddie at around the same time, but until the very end we were in the distinct minority. Fan and Fred's own regulator assured the world that they were well-capitalized almost until they were put into conservatorship in September 2008.

Bloomberg News

Peter Orszag

The Stiglitz-Orszag paper's method was to put the companies through "millions of potential future scenarios," and then to judge the likelihood of default. The assumptions in the test were said to be "severe." Even so, the probability of a default was found to be "so small that it is difficult to detect." Some $111 billion in taxpayer-funded bailouts later, with perhaps hundreds of billions to go, the risks have been detected.
To be fair, the Orszags and Mr. Stiglitz acknowledged that "the extremely rare events located in the tail of a distribution are often quite difficult to analyze accurately." Even so, they noted that White House budget gnomes had tested Fan and Fred's capital against "the financial and economic conditions of the Great Depression." The result: "[G]iven 1990 levels of capital, both Fannie Mae and Freddie Mac had sufficient capital to survive."
In reality, it took barely a year of financial distress for Fan and Fred to burn through their capital and wind up in taxpayer laps. Professor Stiglitz says of his paper today, "I'd like to think that if we'd done the same stress test in 2007 . . . we would have said, 'You ought to be worried.'" Taxpayers would like to think so too.
The crucial point is that assessing systemic risk is difficult to impossible—and the likelihood of coming to a reliable consensus about it is even lower. Both Orszags and Mr. Stiglitz were officials in the Clinton Administration and saw the debates about Fan and Fred that the Clinton Treasury began in the late 1990s, only to get clobbered by the companies' lobbying machine. Yet the three amigos still saw fit to put their names to a paper dismissing any risk of failure.
Why should anyone think that regulators—or economists—will predict the next systemic debacle any better? We only know better about the past. When the next problem erupts, as in 2002, smart people will be on both sides of the argument. And when large, systemically important companies are threatened with curbs on their business, they will pay Nobel laureates to write studies that explain away the dangers, and hire lobbyists to block any reform. A future Treasury secretary may also dismiss critics of a future Fannie Mae, or Goldman Sachs, as "ideologues," as Hank Paulson did in 2007-2008.
The very existence of a systemic risk regulator, or council of regulators, will assist the largest and riskiest firms by creating an illusion of stability in a world made less stable by the implicit guarantee that this regulator would convey. It would be an accident waiting to happen, and one made inevitable by the institution created to prevent it.
Look no further than the eminent Mr. Stiglitz or the brilliant Orszag brothers for how hard it is to detect systemic risk, much less to do anything about it.

Gold run a reason to be wary of the stock market

2009-12-01T02:03:00.000-03:00

Commentary: 10 years ago, everyone had lost interest in yellow metal

By Brett Arends, WSJ.com

BOSTON (MarketWatch) -- The booming gold price is making me very nervous. About Wall Street.

Why? Because gold's rocketing boom -- it's risen from around $260 an ounce about a decade ago to just under $1,200 now -- is a vivid daily example of what a real bull market looks like.

SPECIAL REPORT: THE NEW GOLD BUGS
Gold has long been favored by a fringe of the investment world, but this year some of the world’s leading hedge fund managers have loaded up on the precious metal. Why gold and why now?

History says that such massive bull markets -- like equities from 1982 to 1999, or commodities in the '70s or real estate from the mid-'90s to 2005 -- usually start only after a big bear market ends.
Sounds like common sense, yes? Maybe even a banality.
But here's the problem: Those holding a lot of stocks right now are taking a gamble that the big bear market on Wall Street, which began in 2000, ended earlier this year. They're betting that the Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed (INDU 10,345, +35.30, +0.34%) , now 10,309, won't tumble again toward, or even below, the intraday low of 6,440 seen on March 9.
Are they right?
No one yet knows for certain. Looking back to early March, there certainly was a lot of panic and capitulation, which you usually see at a market bottom. People talked of a new "Great Depression." One thing I noted at the time was that investors were shying away even from rock-solid defensive stocks with big, well-protected dividend yields. People weren't just scared; they were petrified.
Is that really how a massive bear market usually ends?
The last example before our eyes was gold, whose big bear market ended a decade ago. It looked very different.
Like shares in the 1930s and the early 1980s, gold ended its secular bear market in 1999-2001 with a whimper, not a bang. People didn't panic; they simply lost interest.
I remember calling around gold analysts in London in 2000, when gold was near its lows. There weren't many left; most of them had been laid off years earlier, as investor demand had dried up. The few who remained generally earned their keep by advising gold-mining companies on how to use the futures market to sell their output. It was dull work in a dull market.
Key fact: Almost none of the analysts was bullish on gold! A number of them gave me reason upon reason why gold was going to fall even lower.
Everyone now pretends they were buying gold back then. But of course if they had been, gold wouldn't have fallen as low as it did.
I actually know two investors who really were buying. Everybody else rolled their eyes or laughed at them.
Gordon Brown, Britain's hapless and accident-prone prime minister, was the chancellor of the exchequer, or Treasury secretary, at the time. He chose to sell more than half of Britain's entire gold reserves near the lows. According to Her Majesty's Treasury, the government sold about 395 tonnes in 17 auctions between 1999 and 2001, raising around $3.5 billion.
The average sale price worked out at around $275 per troy ounce. At today's price of $1,178, those same 395 tonnes would sell for $15 billion. Put it another way, the move cost Her Majesty's government, or the British taxpayer, a stunning $11.5 billion in lost profits.

Britain sold about 395 tonnes of gold in 17 auctions between 1999 and 2001, raising around $3.5 billion. At today's price of $1,178, those same 395 tonnes would sell for $15 billion.

Hindsight is 20-20. (The Treasury also made back a small amount of those losses by moving some of the money in currencies like the euro, which have risen.) What is important here is that Brown's move was not especially controversial at the time.
Yes, some people warned it was a bad move, but they were a small minority. Some in the City of London criticized the way the government handled the sale. Yet the overall direction of the move -- cutting Britain's holdings of the "barbarous relic" of gold for more "productive" assets -- enjoyed broad support among the financial community.
Indeed, around the same time other European central banks (notably the Swiss, Dutch and Belgian governments) quietly sold even more gold than Britain did -- more than 2,000 tonnes in all.
(An aside: The U.S. Treasury kept its 8,134 tonnes. These show up in the national accounts as an asset of just $11 billion, because for historic reasons the gold is booked at just $42 an ounce. But at today's prices, the gold is really worth $308 billion, and account for the bulk of the U.S. government's entire foreign-currency reserves.)
Ten years ago, pension funds and institutional investors around the world held little gold, if any. Merrill Lynch's monthly survey of institutional fund managers, probably the best barometer of their collective sentiment, didn't even include a question about gold until I (as it happens) asked them to start about five or six years ago.
Gold was such a nonissue that neither Merrill Lynch nor the fund managers had noted the absence.
This is how, on the financial markets, a big bear market tends to die. Not in a dramatic hail of gunfire, like Wall Street last March, but quietly, unnoticed, in the night of old age.
No, this doesn't mean we necessarily have to see new lows in stocks. Financial markets don't function like clockwork. It is notable that even fund legend Jeremy Grantham, a long-standing bear, thinks we probably did see the lows last March. (My own preference, as an investor, is to buy good-quality companies when they look cheap, regardless of what I think of the market or the economy.)
But history says a generational bull market, like Wall Street from 1982 to 1999, is usually followed by a generational bear market. I'd feel a lot more comfortable about stocks if everyone had lost interest completely, like they did in gold 10 years ago.

Much Ado About Dubai

2009-11-30T14:23:00.000-03:00

The panic over its debt problem tells us more about investors than it does about the emirate.

By ZACHARY KARABELL

Global markets sank sharply at the end of last week on fears that Dubai World, a subsidiary of the government of Dubai, was on the verge of defaulting on approximately $60 billion of the emirate's $80 billion in total debt held by creditors world-wide. The rush of news stories added to the wildfire of panicky speculation, with headlines ranging from "Dubai Default Risk May be Big US Bank Problem," to "Dubai Shows Limits of Government Rescues."
The mini-panic, however, has little to do with Dubai and everything to do with the tenuous psychology of global investors still skittish after the financial crisis that hit in the fall of 2008.
The challenges that Dubai faces are both well-known and at least a year old. In the wake of the global financial crisis, Dubai's debt was seen as one of many international soft spots, especially since most of the debt was tied to the assumptions that oil would stay above $145 a barrel, and that Dubai would continue to make the fantastic real-estate gains that had characterized the previous years.
The much-lauded and debated Dubai development model depended in part on a well of capital secured by oil and buoyed by the confidence of the emerging world. That confidence led to the creation of man-made islands, ski slopes in the desert, and some of the world's tallest buildings. It also led to aggressive foreign investments in a portfolio that included luxury stores such as Barney's and frivolities such as Madame Tussaud's wax museums.
What led to Dubai's rise was a vision of Arab entrepreneurialism, easy credit, and anything-is-possible attitude that epitomized the "if you build it they will come" philosophy. It was and is a dynamic materialistic outpost in a corner of the world more identified with religious and ethnic strife, and for a time it seemed to break free of the mooring of history. If nothing else, Dubai is the shopping mall and nightclub for much of the region.
Its obituary was written in the aftermath of the financial crisis as yet another icon of hubris. But Dubai is part of a United Arab Emirates confederation that includes Abu Dhabi and Sharjah, which have oil wealth that Dubai lacks.
As Dubai's ruling family preened, the neighboring emirs sulked, and when Dubai's debts came due prematurely, they swooped in, replete with the scolding I-told-you-so's and armed with billions in oil dollars. Unique model aside, Dubai was always a story of wealth expatriated from Abu Dhabi, Saudi Arabia, Kuwait, and, more opaquely, Iran. If there was ever an example of too big to fail, Dubai was it.
Dubai will not default on its debts—its neighbors simply will not allow it and as of yesterday they have pledged not to. They can well afford to bail out their cousin, though not without extracting a price for the infusion of funds. At one point early this year, with oil heading to $30 a barrel, it was possible the money wouldn't be there. But with oil near $80, the sovereign wealth funds of Abu Dhabi that have been conspicuously silent of late have their hundreds of billions.
Dubai is central to the fate of those who will bail it out. Rich-as-Croesus neighbors, whose conservative culture precludes the carefree amoral opportunities offered by Dubai, use the country as an escape valve. More important, Dubai remains a vital hub of banking, financial markets, deal-making and real estate development that is not about to pass quietly into that good night.
The panic in global markets, as absurd as it was, indicates a fragile state of mind that can do damage. If Dubai had defaulted, it's not as if all $80 billion owed would be written-off like some foreclosed subdivision in central Florida. There is still cash-flow, and no sane bank would willingly forgo that and refuse to renegotiate the loans.
Even a doomsday scenario for Dubai—complete default—wouldn't be a global disaster. While $80 billion is a lot of money, it is still $100 billion shy of what the U.S. government paid to keep American International Group afloat, and it is a pittance in the pool of tens of trillions in bonds world-wide.
So why did markets react as they did? Panic is the easy answer, and global investors do at regular intervals overreact. More disturbing is the possibility that investors in the traditional financial capitals of Europe, the United States and Asia have no better understanding of the world now than they did before last year's crisis.
The old centers—New York, London, Frankfurt, Tokyo—fear risk in parts of the world they deem emerging and underplay the risks in the offices next to them. They view the Dubais, the Shanghais and the Rios with suspicion and with errant conviction that their models are built on foundations of sand, ready to collapse, when it was their own foundations that have proved to be weak. Judging from the misguided reaction to Dubai's challenges, the past year hasn't changed those attitudes. That should make us worried, very worried, but not about Dubai.
Mr. Karabell is president of River Twice and author most recently of "Superfusion: How China and America Became One Economy" (Simon & Schuster, 2009).

Bernanke Says Limiting Fed Independence Would ‘Impair’ Economy

2009-11-30T11:41:00.002-03:00

Nov. 29 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said curbing the central bank’s authority to supervise the banking system and tampering with its independence would “seriously impair” economic stability in the U.S.
“A number of the legislative proposals being circulated would significantly reduce the capacity of the Federal Reserve to perform its core functions,” the Fed chairman said in a commentary in today’s Washington Post. The measures “would seriously impair the prospects for economic and financial stability in the U.S.”
Bernanke has presided over the most expansive use of Fed powers since the Great Depression. While the 55-year-old Fed chairman has said he averted a financial meltdown, lawmakers have voiced concern about taxpayer-sponsored bailouts and proposed the most sweeping dismantling of Fed authority since the creation of the institution in 1913.
Bernanke’s commentary is his first comprehensive answer to proposals in the House and Senate that would limit the Fed’s supervisory powers and exert more political oversight in the setting of interest rates. The issues are likely to be discussed when he faces the Senate Banking Committee on Dec. 3 for a hearing on his nomination to a second term as chairman.
“In the current environment with so much borrowing by the government, the political pressure on the Fed is out there,” said James Glassman, senior economist at JPMorgan Chase & Co. “I don’t think you can totally dismiss it.”
Lax Supervision
Senate Banking Committee Christopher Dodd, a Democrat from Connecticut, has criticized the central bank for lax supervision and introduced legislation this month that would strip bank oversight from the Fed and create a single bank regulator. Dodd would also limit the central bank’s ability to loan to individual companies.
“There is a strong case for a continued role for the Federal Reserve in bank supervision,” Bernanke said. “Because of our role in making monetary policy, the Fed brings unparalleled economic and financial expertise to its oversight of banks.”
The Fed chairman pointed to capital adequacy tests the Fed performed in May which helped restore confidence in the banking system. The Standard and Poor’s 500 Financials Index has increased 34 percent since May 1, outperforming the S&P 500 by about 10 percentage points.
Market Recovery
“The Fed has done a very remarkable job managing the financial crisis and the recovery of the financial markets is a testimony to that,” Glassman said. “Of all the things to ‘fix,’ why would we tamper with the one that actually has worked well?”
Dodd and Representative Barney Frank, chairman of the House Financial Services Committee, want to take away the Fed’s rule- writing power on consumer financial products and give it to a new Consumer Financial Protection Agency.
“The Federal Reserve, like other regulators around the world, did not do all that it could have to constrain excessive risk-taking in the financial sector in the period leading up to the crisis,” Bernanke said. The Fed has reviewed its performance and “moved aggressively to fix the problems,” he added.
As the subprime mortgage crisis began to trigger losses in bank portfolios, Bernanke used emergency authority last year to purchase securities from Bear Stearns Cos. and facilitate its merger with JPMorgan Chase & Co.
Necessary Actions
The Fed chairman said that the government’s actions, while in some instances “distasteful and unfair,” were necessary to prevent “a global economic catastrophe that could have rivaled the Great Depression in length and severity.”
Bernanke pushed the Fed’s backstop lending beyond banks, setting up programs to support the commercial paper and asset- backed securities markets. The Fed Board approved the bank- holding-company applications of Goldman Sachs Group Inc. and Morgan Stanley, giving them access to the Fed’s loan window.
The former Princeton University economist and Great Depression scholar has more than doubled the Fed’s assets to $2.21 trillion and become the lender of last resort to government bond dealers, banks, Wall Street firms and U.S. corporations. The central bank has also propped up markets for mortgage-backed and asset-backed securities that support credit to consumers, small businesses and commercial real estate.
Support for Attack
“Congress has a lot of public support for an attack on the Fed,” Allan Meltzer, a Fed historian and professor at Carnegie Mellon University in Pittsburgh, said in an interview Nov. 23. “They bailed out everybody in sight.”
A financial regulatory reform bill proposed by Frank, a Democrat from Massachusetts, would limit Fed emergency lending to broadly available credit programs.
The Frank bill preserves the Obama administration’s proposal to make the Fed the lead regulator of risk across the financial system.
The central bank’s independence is also under fire from both chambers of Congress. Frank’s committee advanced a proposal this month to remove a three-decade ban on congressional audits of Fed interest-rate decisions. The proposal was offered by Representative Ron Paul, a Republican from Texas, and based on a bill with more than 300 co-sponsors.
Less Independent
Bernanke said studies show that central banks independent of political influence tend to keep inflation and interest rates lower than their less independent counterparts.
“The general repeal of that exemption would serve only to increase the perceived influence of Congress on monetary policy decisions, which would undermine the confidence the public and the markets have in the Fed to act in the long-term economic interest of the nation,” Bernanke said.
Under the proposal by Dodd, commercial banks would lose their power to appoint directors of the 12 regional Fed banks. Instead, directors would be chosen by the Fed’s Senate-confirmed governors, and each board chairman would be appointed by the president of the United States and subject to Senate approval.
The proposal would increase political oversight of the Fed bank presidents, who are among the most vocal proponents on the Federal Open Market Committee for keeping inflation low.
“Now more than ever, America needs a strong, nonpolitical and independent central bank with the tools to promote financial stability and to help steer our economy to recovery without inflation,” Bernanke said.
Policy makers cut the benchmark lending rate to a range of zero to 0.25 percent almost a year ago and this month reiterated a pledge to keep the policy rate low for “an extended period.”
While the economy expanded at a 2.8 percent annual pace in the third quarter, unemployment jumped to 10.2 percent in October. The Fed’s challenge is to support growth without unleashing expectations of higher inflation prompted by aggressive monetary stimulus.
“The ultimate goal of all our efforts is to restore and sustain economic prosperity,” Bernanke said. “Our ability to take such actions without engendering sharp increases in inflation depends heavily on our credibility and independence from short-term political pressures.”
To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net.

Dubai in deep water as ripples from debt crisis spread

2009-11-27T03:00:00.002-03:00

Work has been halted on the artificial islands

Fears of a dangerous new phase in the economic crisis swept around the globe yesterday as traders responded to the shock announcement that a debt-laden Dubai state corporation was unable to meet its interest bill.
Shares plunged, weak currencies were battered and more than £14 billion was wiped from the value of British banks on fears that they would be left nursing new losses.
Nervous traders transferred the focus of their anxieties from the risk of companies failing to the risk of nation states defaulting. Investors owed money by Mexico, Russia and Greece saw the price of insuring themselves against default rocket.
Although the scale of Dubai’s debts is comparatively modest at $80 billion (£48 billion), the uncertainty spooked the markets, with no one sure who its creditors are. Several banks rushed out statements to reassure investors that their exposure was small.
The FTSE 100 plunged by 171 points to 5,194 — its biggest one-day fall in eight months in one of the most jittery days in the financial markets since the depths of the banking crisis.
The Treasury, the Bank of England and the Financial Services Authority were monitoring events closely and are demanding figures from UK banks on their loan exposures to Dubai.
According to a senior government official, Dubai’s crisis is regarded as modest and manageable for Britain, but there were growing fears that Abu Dhabi, the oil-rich neighbouring emirate that has in the past given rescue loans, would leave Dubai to its fate.
Dubai World, the state-owned corporation that began the panic on Wednesday by demanding a standstill on its interest payments, worsened the mood when it postponed a teleconference for its bond holders, saying the phone lines were overwhelmed.
Gerard Lyons, chief economist with Standard Chartered, said: “The market reaction shows how vulnerable some economies are to the aftermath of the debt binge. This highlights how fragile confidence is.”
The Eid al-Adha religious holiday in the Middle East, and the closure of financial markets in the United States for Thanksgiving, exacerbated the sense of uncertainty in markets that were open for business.
A computer crash at the London Stock Exchange, which by coincidence is 21 per cent owned by the Dubai Government, left dealers unable to trade for three and a half hours.
Shares in HSBC slumped by 5 per cent, wiping £6.2 billion from its value. According to the United Arab Emirates Banks Association, HSBC has £11 billion of loans outstanding to the UAE, of which Dubai is one of seven emirates. HSBC declined to comment.
More than £2.6 billion was slashed from the value of Barclays, while Lloyds and Royal Bank of Scotland, both partly owned by the taxpayer, saw their values fall by £1.7 billion and £1.5 billion respectively.
One analyst said that the fears were overdone because Abu Dhabi would eventually come to the rescue to save the UAE from embarrassment. Dubai World has liabilities of £36 billion, about three quarters of Dubai’s total state debt. Its subsidiary Nakheel built The Palm Islands development, but the property bubble in the emirate burst a year ago, leaving buildings unfinished, debts unpaid and paper fortunes erased.

Will The World Go Shopping?

2009-11-27T02:52:00.000-03:00

Nouriel Roubini, 11.26.09, 12:01 AM EST

The wobbly holiday retail outlook in North America and Europe.

Roughly one year ago, around the Thanksgiving festivities, the National Bureau of Economic Research announced that the U.S. recession started in December 2007. One year later, though the U.S. economy is in recovery mode, retailers are approaching the holiday season--which accounts for slightly less than one- fifth of yearly U.S. retail sales--with some concern.
A sharp collapse in U.S. consumer spending since mid-2008 led to a particularly dismal 2008 holiday retail season. As per U.S. Census Bureau estimates, core retail sales (which exclude autos, gasoline and building supplies) fell by 1.1% year on year during November and December 2008, compared to an average 4.6% year-on-year increase in holiday season sales over the past decade. Total retail sales suffered a larger collapse, falling 9.5% year on year. After collapsing in 2008, retail sales showed signs of stabilizing over the summer of 2009. While auto sales have fluctuated sharply during recent months due to the government's "cash for clunkers" initiative, core retail sales have risen for three consecutive months as of October 2009, creeping up at a pace of about 0.5% month on month. Entering the 2009 holiday season, the recent uptick in core sales offers hope for better than anticipated holiday retail sales.
Economic indicators, however, suggest a note of caution. The renewal in U.S. consumer confidence over the first half of 2009 faded. Successive grim reports on the employment situation revealed no quick end to labor market woes, lowering consumers' income expectations. According to the October Reuters/University of Michigan Survey of Consumer Sentiment, in October 2009, consumers reported worsening personal finances for the 13th consecutive month, the "longest and deepest decline in the 60-year history of the surveys."
The poor state of personal finances has driven consumers to reduce debt at an accelerated pace. In September, consumer credit fell for the eighth consecutive month at an annualized pace of 7.2%. The poor health of personal finances, labor market uncertainty and the ongoing household balance- sheet repair will continue to promote frugal behavior by U.S. consumers. The Conference Board consumer confidence surveys tell a revealing story: Consumers' plans to purchase big-ticket appliances have declined in the run-up to the 2009 holiday season. This is a bit unusual as plans to buy big-ticket appliances usually display a sinusoidal pattern, with a trough in the month of October and a peak sometime the following spring.
A measure of weekly retail sales released by the International Council of Shopping Centers and Goldman Sachs ( GS - news - people ) indicates that same-store sales flattened over the first three weeks of November, though compared to 2008, sales are up by a promising average pace of 2.9%. The National Retail Federation projects retail sales will fall 1% during this holiday season, compared to an average 3.4% annual gain in holiday sales over the past decade. After the sharp slide in 2008, a decline of "only" 1% or even a small positive gain in 2009 holiday sales may seem like a welcome number; however, accounting for the base effects of a dismal 2008 season, the underlying reality for retailers remains grim for this holiday season. Here is our outlook for Canada and Europe.
Canada
North of the border, Canadian retail sales have recovered, consistent with a resilient domestic demand and the revived housing market. However, despite climbing for seven out of the last nine months, the improvement has not yet been robust and sales remain over 3% lower than in September 2008. Canadian domestic demand has been restrained by a still-weak labor market, where job gains have been mostly in part-time work, which along with a weak external sector have kept Canadian output roughly flat this quarter. As tax incentives on retrofitting houses have expired, some of the related purchases may soften in coming months. Moreover, consumer confidence has weakened going into the holiday season and consumer surveys suggest lower holiday spending than in 2008, when Canada was just entering recession.
United Kingdom
Uncertainty surrounds the U.K. retail sales outlook. With unemployment continuing to rise, credit conditions remaining tight and economic confidence subdued, the forecast for holiday sales is not overly optimistic. However, retail sales figures for October rose 0.4% while September's data enjoyed an upward revision of the same amount. Clothing and household goods proved to be the foundation for the increased retail activity amid hopes that the holiday sales period can continue to experience improvements in retail figures despite constrained domestic demand.
Spain
The Spanish retail outlook is extremely constrained. One in five workers could be unemployed by the end of the year and household consumption is severely dampened by depressed economic sentiment. Disposable income has fallen and will continue to fall while precautionary saving has risen significantly. Retail discounts are ongoing and are likely to continue as fierce price wars persist into the new year. Yet consumer confidence is likely to curtail any significant impact this could have on retail figures.
Greece
In Greece, the economy failed to escape the recession and is particularly affected by deteriorating labor figures. With the true extent of Greece's problem unknown until into the fourth quarter of 2009, unemployment had risen only mildly, but that is likely to accelerate as the holiday season approaches. With a 2% rise in unemployment likely to take the rate to 10% by year end, retail sales are likely to feel the pinch of dampened household expenditure. A yearly rise is still likely from 2008 figures, but a smaller increase than first hoped will probably be the outcome of a deteriorating economic picture in Greece.
Portugal
Portugal has not witnessed the same fall in private consumption as some of its counterparts. Its decline has been relatively contained to less than a 1% fall in 2009, and retail sales are likely to rise as the holiday period approaches. The relative insulation of the Portuguese consumer from the effects of the global depression can be traced to the constrained increase in unemployment and the rigidity of the labor market. Nominal wages have grown in 2009 and consumer confidence has not plummeted as heavily as for example in Spain or Ireland.
Ireland
The recession in Ireland has been exacerbated by a collapse in domestic demand with private consumption expected to fall by over 7.5%. Labor market conditions have deteriorated, as have retail sales figures, and little change in circumstance is expected before the holiday period. A yearly rise in retail figures is unlikely despite the poor performance in 2008 as Ireland struggles to contain its collapsing household consumption levels. Consumer confidence has fallen as jobs continue to be cut across the fragile economy.
Germany
During recent months, private consumption unexpectedly helped stabilize the German economy--a trend that is likely to continue during the 2009 holiday sales season which contributes almost 20% to annual retail sales. Despite the sharp contraction of the German economy, nominal retail sales only declined 2% year on year in the first nine months of 2009, and retailers still expect that "Christmas Business" in November and December will bring in an additional 73 billion euros. While workers expect to be affected adversely in the coming months due to rising unemployment and declining wages, consumer sentiment has recovered substantially from a year ago.
Unemployment has been kept in check so far with the help of government subsidized short-work schemes. Disposable income has been boosted by the German welfare state's extensive economic stabilizers as well as by the favorable inflationary environment. Still, Christmas retail sales are unlikely to exceed their 2008 levels since the expiration in September of the cash for clunkers program will act as a drag on sales in the coming months. Mark-ups will remain under pressure as retailers are trying to attract more business through discounting.
France
The French consumer has been remarkably resilient during the current economic downturn and French holiday sales in the November-December period might even exceed results from previous years. Despite a sizable increase in the unemployment rate, retail sales are unlikely to suffer significantly during the 2009 holiday sales period due to the supportive effect of France's extensive automatic stabilizers and low inflation. Consumer confidence staged a comeback in recent months and bounced back to its January 2008 level. Moreover, French retail sales will continue to benefit substantially from France's cash for clunkers program, which will only expire in 2010. While traditionally the French winter sales season kicks off in the second week of January, a new law now allows for more flexibility on the timing of sales. As a result, retailers are likely to offer steep discounts in an effort to attract additional business in the pre-Christmas period.
Italy
Holiday retail sales in Italy make such a substantial contribution to annual turnover that many retailers only manage to post profits due to sales made in the last two months of the year. Traditionally, Italian retail sales in the November-December period are more than 30% above the average of the ten preceding months, even though the official sales season does not start until after Jan. 6. The 2009 holiday retail sales are likely to disappoint compared to previous years due to the ongoing economic uncertainty. As a result, consumers are still too worried about rising unemployment and are saving a larger percentage of their incomes. Not even the favorable inflationary environment is expected to boost retail sales, which have been contracting for the past 30 months. Tax incentives for durable goods and subsidies, in particular the cash for clunkers program, are expected to have a positive impact on retail sales in the coming months. Italy registered the greatest deterioration in retail margins in the eurozone, indicating that only aggressive discounts prevented an even larger fall in sales.
Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes. (Read all of his columns here.) RGE analysts assisted in the writing of this column.

The Uncertainty Economy

2009-11-26T01:47:00.003-03:00

Tim Geithner is not the Democrats' biggest problem.

Preparing to write about yesterday's downward revision in third-quarter GDP, we were tempted to say the Obama Administration has hit a speed-bump on its promised exit out of the recession. But it is the American economy that has hit a speed bump, and on the evidence of the policy mix emerging now from Democratic Washington, the road ahead for the economy is bump, bump, bump, bump, bump. Other than a few lucky banks, few seem be enjoying the ride.

What last month had appeared to be third-quarter growth of 3.5% in gross domestic product turns out to have been a more modest 2.8%. Consumer spending was pared back to 2.9% from 3.4%. The cash-for-clunkers subsidy produced fewer new-vehicle purchases than first estimated. In short, we aren't getting much bang for our $787 billion stimulus bucks. But you already knew that.

The frustrated Congressional Democrats who designed and enacted the stimulus seem more surprised, and they are now circling the wagons and starting to look for someone else to blame.

The Democrat catching most of the bullets is Treasury Secretary Timothy Geithner. Democratic Congressman Peter DeFazio of Oregon last week called on Mr. Geithner to resign. No surprise there. More noteworthy was that not a peep of support emerged for Mr. Geithner from the Obama White House. We've had our differences with the Treasury secretary, but how throwing Mr. Geithner off the wagon train would turn around the unemployment rate is, to put it mildly, far from clear.

The panicked Democrats' biggest problem is that Congress and the President have erected the biggest overhang of economic policy uncertainty that anyone can remember.

One big difference between Washington and private markets is that politicians think everything they do is free-standing. Markets, however, combine all the potential costs of Washington's policies and then decide whether to invest, or not. Consider what private decision-makers see in their future:

A 2,074-page, trillion-dollar health-care bill to redesign 17% of the U.S. economy. A carbon tax—cap and trade—that remains an Obama priority ahead of the Copenhagen climate summit next month. A falling dollar and gyrating commodity prices, with no idea where those prices will go next.

Democratic liberals are talking about an income tax surcharge to pay for any commitment in Afghanistan. Card check, to expand unionization of the private economy, remains a priority. Domestic discretionary spending in fiscal 2010 is set to rise at 12.1%, with inflation near zero.

Nurturing a fragile economic recovery into a durable expansion requires policies that restore public confidence and reassure investors, risk-takers and employers. The Democratic agenda is doing precisely the opposite, which is how you get subpar growth and fewer new jobs.

Heed the danger of asset bubbles

2009-11-25T12:37:00.000-03:00

By Robert Zoellick
Published: November 24 2009 20:03 | Last updated: November 24 2009 20:03
As the world begins to recover from the worst downturn since the Great Depression, the conventional wisdom is that we have employed lessons of the past effectively: a flood of money; a dose of fiscal stimulus; and an avoidance of the worst trade protectionism. We even have Ben Bernanke, a scholar of the Depression, at the helm of the US Federal Reserve. So what could we be missing?
The old playbook may have new, unintended consequences. Last year, when governments faced financial markets paralysed by possible failure of counterparties, they used the tools they had, even if an imperfect fit. To keep credit flowing, central banks opened the money spigots. When traditional monetary tools were insufficient, they invented new ones to buy or lend against assets. And it worked.
Of course, governments knew these dramatic actions would have consequences. Central banks have been watching carefully for early signs of the traditional danger – inflation. Yet in a new era of global competition, companies are unlikely to have the pricing power that led to “demand pull” inflation in decades past; nor are unions likely to be able to make wage demands that contributed to “cost-push” stagflation. Walmart and the developing world’s labour force have changed the paradigm.
Yet the revival of John Maynard Keynes should not lead us to ignore Milton Friedman: where will all that money go? For a hint of the future, look to Asia, where a new risk is emerging: asset bubbles.
Asia is now leading the world economy with increases in industrial production and trade, partly reflecting the growth in China and India. This welcome economic upswing is accompanied by rising equity and property prices. House prices in China jumped in October by the biggest amount in 14 months, with a recent auction in Shanghai attracting record bids to a commercial property that drew none last year. Elsewhere in Asia, equity markets have surged and property prices are on the rise, notably in Hong Kong and Singapore. Gold is rising and the prices of other commodities are likely to rise too. The combination of loose money, volatile commodity markets and poor harvests – such as occurred recently in India – could make 2010 another dangerous year for food prices in poor countries. Asset bubbles could be the next fragility as the world recovers, threatening again to destroy livelihoods and trap millions more in poverty.
Unfortunately, the chapters in the history books about how to deal with asset bubbles usually precede tales of woe. Asset bubbles can be more insidious than traditional product inflation, because they seem to be a sign of health: higher values lift the real economy, which in turn can send the bubbles higher. Jaw-boning irrational exuberance has not worked well against asset or product price inflation. Waiting for bubbles to burst and then cleaning up the aftermath is now a new lesson of what not to do. But tightening interest rates too abruptly – especially where recoveries are weak, such as in the US and Europe – could trigger another downturn.
Australia, with its ties to the Asian economies, has already raised interest rates. Asian countries, which traditionally follow the US Fed’s monetary policy, will be under pressure to follow. But raising rates while the Fed keeps its rates close to zero would cause Asian currencies to appreciate. This would make their exports more expensive and decrease overseas sales, hurting recoveries based on exports. Moreover, there is competition from China. The renminbi is tied to a declining US dollar that makes Chinese goods cheaper to buy than those of Asian rivals.
Some policymakers in Asia are testing alternative approaches. In Singapore, the 16 per cent surge in property prices during the third quarter of this year led the authorities to release more land for development and to take steps to stop borrowers from deferring payments. Other more focused measures include setting targets for the overall rate of growth of bank credit, imposing caps on the share of bank lending for real estate and portfolio investments, or higher capital requirements for riskier lenders. In developed countries, where central banks want to keep rates low, regulators should be considering supplementary tools such as raising margin requirements on stock, bond and futures transactions, or raising down-payment requirements on commercial or speculative real estate deals.
It would also help if North America and Europe took a closer look at the agenda that Australia and many Asian countries are starting to pursue. To build confidence and opportunity for the private sector, the Asia-Pacific countries are advancing structural reforms – including in service sectors – to boost productivity and potential growth. These reforms will help them to compete even if their currencies appreciate.
Perhaps the primary lesson from history is for countries to co-operate in making assessments that distinguish their situations, avoiding one-size-fits-all “exit strategies”, and cautioning against currency or trade protectionism. Debates about new financial regulatory structures should not distract governments from using tools they have to counter these emerging risks. These will be the challenges for the Group of 20 nations in 2010. The G20 had better put asset price bubbles and new growth strategies on its agenda. Otherwise, the solutions of 2008-09 could plant the seeds of trouble in 2010 and beyond.

The writer is president of the World Bank Group

Economy's rebound not as strong as first thought

2009-11-25T01:32:00.001-03:00

By JEANNINE AVERSA

WASHINGTON (AP) - The economy grew at a 2.8 percent pace last quarter, as the recovery got off to a slower start than first thought.
The Commerce Department's new reading on gross domestic product wasn't as energetic as the 3.5 percent growth rate for the July-September period estimated just a month ago.
The main factors behind the downgrade: consumers didn't spend as much, commercial construction was weaker and the nation's trade deficit was more of a drag on growth. Businesses also trimmed more of their stockpiles, another restraining factor.
The new reading on GDP, which measures the value of all goods and services produced in the United States - from machinery to manicures - was a tad weaker than the 2.9 percent growth rate economists surveyed by Thomson Reuters had expected.
Still, the good news is that the economy finally started to grow again, after a record four straight losing quarters. The bad news is that the rebound, now and in the months ahead, probably will be lethargic.
The worst recession since the 1930s is very likely over, but the economy's return to good health will take time, Fed officials and economists say.
Growth probably won't be strong enough to quickly drive down the nation's unemployment rate, currently at 10.2 percent. It's only the second time in the post-World War II period that unemployment has topped 10 percent.
Some economists think economic growth will slow to around a 2.5 percent pace in the current quarter, although others say it could clock in at about 3 percent if holiday sales are better than expected.
Most say they think the economy will weaken again next year, with growth at a pace of around 1 percent as the impact of the $787 billion stimulus package fades and consumers keep tightening their belts under the strain of high unemployment and hard-to-get credit.
Much of the economy's return to growth last quarter reflected federal support for spending on homes and cars.
But Tuesday's report shows that some of that spending was a bit less robust than initially thought.
Spending on homes and other residential projects soared at an annualized pace of 19.5 percent last quarter, a little slower than the 23.4 percent rate first estimated. Spending on big-ticket "durable" goods - including cars - jumped at a pace of 20.1 percent, down from 22.3 percent.
Even with the downward revisions, it was notable that such spending grew, after falling in the previous quarter.
In the third quarter, the popular Cash for Clunkers rebates and an $8,000 tax credit for first-time homebuyers juiced up sales of cars and homes. The clunkers program ended in August, but the tax credit has been extended and expanded beyond first-time buyers.
What's not clear is whether the recovery can continue after government supports are gone.
If consumers clam up, the economy could tip back into recession. President Barack Obama recently cautioned that the economy could suffer a "double dip" downturn.
Fed Chairman Ben Bernanke, however, says he doesn't think that will happen. But last week the Fed chief did warn the recovery faces "important headwinds," such as tight credit and a weak job market that will make consumers cautious in their spending.
Those factors "likely will prevent the expansion from being as robust as we would hope," Bernanke said.
Tuesday's report showed that overall consumer spending - a major shaper of national economic activity - grew at a pace of 2.9 percent last quarter. That was down from a 3.4 percent growth rate first estimated, but still marked the best showing since early 2007.
On the business side, companies cut back spending on commercial construction - a weak spot in the economy - at 15.1 percent annualized pace. That was deeper than the 9 percent annualized cut back first estimated.
Businesses also trimmed stockpiles of goods by $133.4 billion last quarter, slightly more than initially estimated.
And the nation's trade deficit ended up shaving 0.83 percentage point off GDP last quarter, more than first thought.
Unlike past rebounds that were driven by the spending of everyday Americans, this one appears to hinge on spending by businesses, foreigners and - until it runs out - the government.
In an encouraging note on that front, businesses after-tax profits grew at a 13.4 percent pace last quarter, up from a 0.9 percent pace in the prior period, Tuesday's report showed.
In 1980, businesses led an economic recovery. It quickly fizzled, and the economy fell into a severe recession in 1981 and 1982. The unemployment rate climbed to 10.8 percent, the post-World War II high.
The government makes three estimates of economic activity for any given quarter. Each is based on more complete data. Tuesday's was the second reading of the third-quarter GDP data.
The return of economic growth puts the White House in a delicate position: Obama wants to take credit for ending the recession, but unemployment is still causing pain and anxiety nationwide.
Millions have yet to feel a benefit from the recovery in the form of a new job or even an easier time getting a simple loan. Even those with jobs are reluctant to go on a spending spree. The values of their homes and 401(k)s have not fully recovered.
Some economists think the jobless rate could climb as high as 11 percent by the middle of next year before making a slow descent. It could take at least four years for the unemployment rate to drop back down to more normal levels.
"The best thing we can say about the labor market right now is that it may be getting worse more slowly," Bernanke said last week.
Against that backdrop, Obama said he's weighing tax breaks that could encourage businesses to hire again.

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