Too Bernanke To Fail?
There is no practical solution to "too big to fail," and no alternative to the Fed's ability to print money to ease potentially destabilizing financial panics.
Last week's show trial of Ben Bernanke, like all show trials, was less about convicting a man than about upholding a view of reality. An unspoken concordat authorized both parties to take refuge in their tropes. Republicans labored to portray Mr. Bernanke as a high-handed government bureaucrat, dictating terms to a private sector CEO.
Democrats wafted along on their preferred trope, the scheming businessman (Bank of America's Ken Lewis) extorting a bailout from the Federal Reserve.
Edolphus Towns, chairman of the House Oversight Committee, did his bit to frame the choice of bogus narratives, saying BofA's controversial Merrill Lynch acquisition was a shotgun wedding and all that remains is to find out who was "holding the shotgun."
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Getty Images Fed Chairman Ben Bernanke
The effort of congressmen to uphold the distinction between the public and private sectors is noble, and doomed to fail in this case. Last week's hearing reflected unmedicated unease over two facts legislators recognize but resist acknowledging: There is no practical solution to "too big to fail," and no alternative to the Fed's ability to print money to ease potentially destabilizing financial panics.
Governments long ago authorized banks to operate with capital and reserve requirements inadequate to cover serious panics, with the understanding that government would step in. "We have chosen capital standards that by any stretch of the imagination cannot protect against all potential adverse loss outcomes," Alan Greenspan explained in a talk at the American Enterprise Institute this month. "Implicit in this exercise" is the occasional bailout of the financial system.
Roll back the tape: Bank of America was "too big to fail." Merrill Lynch was "too big to fail." Together they were "too big to fail." There was no way, ipso facto, Mr. Lewis would have sought to put the two companies together last September without the Fed's OK, and no way he would have failed to go to the Fed in December when he decided belatedly that Merrill's soon-to-be-revealed losses might endanger market confidence in BofA.
One strand is the argument, tested by some on the Hill, that Mr. Lewis owed a "duty" to inform his shareholders of the pending Merrill losses so they could vote against the deal. The Fed allegedly stopped him. But shareholders in "too big to fail" institutions are partners with the government too -- a partnership in which inevitably government takes the senior role when its safety net is in play.
Nothing proposed by the Obama administration or likely to find a footing in Congress will dissuade the capital markets from creating companies that, in a panic, politicians will judge too dangerous or costly to let fold. There will be no repeal of deposit insurance. There will be no repeal of limited liability for financial institutions, which would radically alter the ownership incentive to take leveraged bets.
This isn't the end of the world. "Too big to fail" has been the de facto law of the land since at least the late 1970s, and didn't impede the longest run of prosperity in U.S. history. But let's not make matters worse.
The Fed already is the "system regulator," and too often already has allowed protecting the value of the dollar (its first duty) to become subordinated to trying to soften the blow for financial firms of episodes of failed risk taking. The Obama plan for a SuperFed would take us farther down the wrong road.
Likewise, formalizing the status of some institutions as "systemically important" would only create, as Peter Wallison of the American Enterprise Institute argues, Fannies and Freddies galore. A new "resolution regime" might be useful but not if it places more AIGs in government hands. Better would be a rule that automatically imposes stiff debt-for-equity haircuts on bondholders if a firm needs long-term government financing to survive.
And Mr. Bernanke? His moment of twisting in the wind has created, surprisingly, an opportunity for Mr. Obama, who, after a suitable pause, can now reappoint the Republican-appointed Fed chief and make him a bit more of an Obama man.
Larry Summers, who is believed to want the job, is problematic on two counts: The White House might be accused of trying to install a political operative to support Mr. Obama's re-election; yet the ambitious and unclubbable Mr. Summers might actually prove a headache for the White House if he decided he should run the economy single-handedly.
Better the devil you know (and like personally). There's even an opening for a steroid replay of the Clinton-Greenspan bargain of the early 1990s: Mr. Obama gets a grip on spending; Mr. Bernanke keeps interest rates low. Just maybe we get out of today's mess without wrecking the dollar or snuffing the economy with killer taxes.
The Wages of Chavismo
The Honduran coup is a reaction to Chávez's rule by the mob.
As military "coups" go, the one this weekend in Honduras was strangely, well, democratic. The military didn't oust President Manuel Zelaya on its own but instead followed an order of the Supreme Court. It also quickly turned power over to the president of the Honduran Congress, a man from the same party as Mr. Zelaya. The legislature and legal authorities all remain intact.
We mention these not so small details because they are being overlooked as the world, including the U.S. President, denounces tiny Honduras in a way that it never has, say, Iran. President Obama is joining the U.N., Fidel Castro, Hugo Chávez and other model democrats in demanding that Mr. Zelaya be allowed to return from exile and restored to power. Maybe it's time to sort the real from the phony Latin American democrats.
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Associated Press People against the return of ousted Honduras President Manuel Zelaya participate in a rally at the central park in Tegucigalpa, Tuesday, June 30, 2009.
The situation is messy, and we think the Hondurans would have been smarter -- and better off -- not sending Mr. Zelaya into exile at dawn. Mr. Zelaya was pressing ahead with a nonbinding referendum to demand a constitutional rewrite to let him seek a second four-year term. The attorney general and Honduran courts declared the vote illegal and warned he'd be prosecuted if he followed through. Mr. Zelaya persisted, even leading a violent mob last week to seize and distribute ballots imported from Venezuela. However, the proper constitutional route was to impeach Mr. Zelaya and then arrest him for violating the law.
Yet the events in Honduras also need to be understood in the context of Latin America's decade of chavismo. Venezuela's Hugo Chávez was democratically elected in 1998, but he has since used every lever of power, legal and extralegal, to subvert democracy. He first ordered a rewrite of the constitution that allowed his simple majority in the national assembly grant him the power to rule by decree for one year and to control the judiciary.
In 2004 he packed the Supreme Court with 32 justices from 20. Any judge who rules against his interests can be fired. He made the electoral tribunal that oversees elections his own political tool, denying opposition requests to inspect voter rolls and oversee vote counts. The once politically independent oil company now hires only Chávez allies, and independent television stations have had their licenses revoked.
Mr. Chávez has also exported this brand of one-man-one-vote-once democracy throughout the region. He's succeeded to varying degrees in Ecuador, Bolivia, Argentina and Nicaragua, where his allies have stretched the law and tried to dominate the media and the courts. Mexico escaped in 2006 when Felipe Calderón linked his leftwing opponent to chavismo and barely won the presidency.
In Honduras Mr. Chávez funneled Veneuzelan oil money to help Mr. Zelaya win in 2005, and Mr. Zelaya has veered increasingly left in his four-year term. The Honduran constitution limits presidents to a single term, which is scheduled to end in January. Mr. Zelaya was using the extralegal referendum as an act of political intimidation to force the Congress to allow a rewrite of the constitution so he could retain power. The opposition had pledged to boycott the vote, which meant that Mr. Zelaya would have won by a landslide.
Such populist intimidation has worked elsewhere in the region, and Hondurans are understandably afraid that, backed by Chávez agents and money, it could lead to similar antidemocratic subversion there. In Tegucigalpa yesterday, thousands demonstrated against Mr. Zelaya, and new deputy foreign minister Marta Lorena Casco told the crowd that "Chávez consumed Venezuela, then Bolivia, after that Ecuador and Nicaragua, but in Honduras that didn't happen."
It's no accident that Mr. Chávez is now leading the charge to have Mr. Zelaya reinstated, and on Monday the Honduran traveled to a leftwing summit in Managua in one of Mr. Chávez's planes. The U.N. and Organization of American States are also threatening the tiny nation with ostracism and other punishment if it doesn't readmit him. Meanwhile, the new Honduran government is saying it will arrest Mr. Zelaya if he returns. This may be the best legal outcome, but it also runs the risk of destabilizing the country. We recall when the Clinton Administration restored Bertrand Aristide to Haiti, only to have the country descend into anarchy.
As for the Obama Administration, it seems eager to "meddle" in Honduras in a way Mr. Obama claimed was counterproductive in Iran. Yet the stolen election in Iran was a far clearer subversion of democracy than the coup in Honduras. As a candidate, Mr. Obama often scored George W. Bush's foreign policy by saying democracy requires more than an election -- a free press, for example, civil society and the rule of law rather than rule by the mob. It's a point worth recalling before Mr. Obama hands a political victory to the forces of chavismo in Latin America.
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Yellen Takes a Big Swing at Inflation Hawks
Posted by Jon HilsenrathJanet Yellen, President of the Federal Reserve Bank of San Francisco, took a shot at inflation hawks who worry that the Fed’s easy money policies are going to send consumer prices soaring.
The hawks, she notes, worry that the Fed has pumped too much money into the economy and won’t be able to withdraw it in time to forestall inflation. She says the Fed has the tools it needs to withdraw the money when needed – it can sell the mortgage and Treasury bonds it has accumulated if needed and some of its emergency programs are already tapering off.
Trickle-Down Economics Fails to Deliver as Promised
Posted by Michael S. DerbyTrickle-down economics, a centerpiece of conservative economic thinking for many decades, failed to deliver its promise of distributing wealth across the economy, a new paper from Harvard University’s Kennedy School of Government says.
According to this theory, when government policies favor the wealthy — for example, via tax cuts for upper-income classes — the increase in wealth flows down to those with lower incomes. That’s because the rich are more likely to spend the additional income, creating more economic activity, which in turn generates jobs and eventually, better paychecks for the less well-off.
It’s a school of thought that is closely linked to former President Ronald Reagan, and is frequently referred to as “Reaganomics.”
The idea has had enough power to be used as part of a long process to lower tax rates on the wealthiest Americans. According to the Tax Policy Center, the top marginal tax rate in the U.S. stood at 70% when Reagan was elected in 1980, falling steadily to 28% by 1989, before it began to rise modestly. The top marginal rate now stands at 35% against a peak of 94% in 1945.
Trickle-down economics prevailed in a period in which a smaller portion of the U.S. gained an increasing share of the most important measures of economic vigor. Be it total wealth or net income, the top gained a greater share of the pie at the expense of the less-well-off.
The paper does not argue that trickle-down economics is without merit. It’s just that it doesn’t appear to generate enough bang for the buck. It was written by Harvard’s Dan Andrews and Christopher Jencks, and Australia National University’s Andrew Leigh.
“Increases in inequality lead to more growth,” the paper’s authors wrote. “There appears to be some trickle-down effect in the long run, but since the impact of a change in inequality on economic growth is quite small, it is difficult to be sure from our estimates whether the bottom 90% will really be better off or not.”
In an interview, Jencks said it’s a real challenge to gather the information needed to determine whether trickle-down economics works as its advocates believe.
But he concludes the evidence shows “it certainly didn’t deliver as much as many said” and to the degree it did work, “the effects are really small.”
The paper’s findings were based on data from 12 developed nations, observed over most of the last century into the current century.
Trickle-down economics’ day is probably done, for now at least. The financial crisis will bring not just stricter regulation and tighter oversight for many markets. The massive budget deficits that the U.S. will be left with as a consequence of the bailouts and economic stimulus spending will require tax hikes that are likely to reach beyond the rich.
Explaining the FOMC
Posted by Jon HilsenrathThe Federal Reserve’s June policy meeting is now a week in the past, and Fed officials are starting to emerge to explain the central bank’s decision-making in more detail.
James Bullard, president of the St. Louis Fed, was up today with a talk to Philadelphia’s Global Interdependence Center. Departing from the standard practice of Fed officials who like to read from prepared texts, Mr. Bullard gave a college-style lecture with a power point presentation. He also followed up with discussions with reporters. We’ll follow his lead and offer our take — in power point form — of three important messages:
- The Fed’s benchmark interest rate — the federal funds rate — is going to stay near zero for the “foreseeable future,” given the weak economy and low inflation. That ought to reinforce to investors who were expecting rate hikes by year end that it isn’t likely. Still, Mr. Bullard is wary of counting too much on the “slack” argument. This argument holds that high unemployment and excess manufacturing capacity push inflation rates down. While there is lots of slack in the economy, he says, inflation might not fall as much as some models suggest. Indeed, inflation expectations, what he considers a better inflation indicator, have bounced back from depressed levels earlier this year to modest levels around the Fed’s rough goal of 2%.
- The Fed’s ‘liquidity programs,” such as efforts to support the commercial paper market or money market mutual funds, are on track to end next year “if financial conditions continue to improve.” The Fed signaled this on Thursday when it said the liquidity programs would run out on Feb. 1, 2010.
- The central bank effectively punted on the third prong of its efforts to revive the economy — its purchases of mortgage backed securities, Fannie Mae and Freddie Mac debt and U.S. Treasury bonds. Some investors expected the Fed to make changes in the program to buy $1.75 trillion worth of this debt when it met last week. The Fed took no action. But that doesn’t mean it won’t decide to take new steps with the programs when officials meet again in August. “Let’s see how the data come in over the summer and then we’ll evaluate,” Mr. Bullard said in response to a reporter’s question. Treasury purchases are on track to run their course by late August. Mortgage-debt purchases are set to run their course by year-end. Fed officials could let these purchases run out, decide to stretch them out over a longer period of time, or even increase them, depending on how the economy looks.
Mr. Bullard is not a voting member of the Fed’s policy-making Federal Open Market Committee.
ys Fed Can’t Be Seen as Losing Independence
Posted by Romy VargheseA Federal Reserve official warned Tuesday that that the rising level of “populism” seen in Congress and in the public may become “counterproductive” if the Fed is seen as losing its independence.
“Anything that erodes the independence of the Fed is going to feed that kind of expectation and will drive yields higher,” said James Bullard, president of the Federal Reserve Bank of St. Louis at a presentation in Philadelphia. “So I think we’re really in a delicate situation with regards to the independence of the Fed and that is an important consideration going forward.”
Bullard was answering audience questions after discussing quantitative easing exit strategies for the Federal Reserve at a presentation held by the Global Interdependence Center at the Federal Reserve Bank of Philadelphia.
While he doesn’t think anyone wants to strip the Fed of its independence, that impression may be raised and affect investors, particularly foreign investors, who may not “understand the subtleties” of American politics, Bullard later said to reporters.
What Would Obama’s Planned Consumer Financial Protection Agency Do?
Posted by Damian PalettaThe Treasury Department sent 152 pages of legislation to Capitol Hill on Tuesday that spells out in detail its plan for the creation of a new Consumer Financial Protection Agency. The banking industry is already mobilizing to fight the proposal but Democrats are pushing for it aggressively.
According to the draft legislation, Treasury’s plan would:
- 1) Give the agency broad authority to write rules about services or products including:
- a. Deposit-taking activities
b. Extending credit and servicing loans (this could include mortgages, credit cards, etc.)
c. Check-guaranty services
d. Collecting, providing, or analyzing consumer report information
e. Providing real estate settlement services, including title insurance
f. Leasing personal or real property
g. Investment advisers that aren’t already regulated by the CFTC or SEC
h. Processing financial data
i. Sale or issuance of stored value cards
j. Acting as a money service business
k. And any other activity the agency defines as a rule, except for most types of insurance, which are exempt. - 2) Give the agency five board members, four of whom would be appointed by the President and confirmed by the Senate and the fifth would be the head of the regulator overseeing national banks.
- 3) Appropriate money to run the agency while also allowing the agency to collect annual fees or assessments from companies it supervises. The bill would also establish a victim’s relief fund for penalties collected by the agency.
- 4) The agency’s objectives would be to make sure consumers can make informed decisions about financial products and services, protect them from abuse, make sure markets operate fairly and efficiently, and ensure that all consumers have access to financial services.
- 5) Permit the new agency to prohibit or place conditions on mandatory pre-dispute arbitration agreements between consumers and firms such as credit card companies “if doing so is in the public interest and for the protection of consumers.”
- 6) Ensure that any rule adopted by the new agency would new preempt state law “if State law provides greater protection for consumers.”
- 7) Allow state attorneys general would be allowed to bring law suits for violations of new federal rules.
- 8) Allow the new agency to file subpoenas to collect information for the companies they oversee.
Unemployment Rates, by Metro Area
Posted by Phil IzzoUnemployment rates in every metropolitan are were higher in May from a year earlier, the fifth consecutive time that has happened, the Labor Department reported.
Almost a third of the metropolitan areas have a jobless rate over 10%, up from just six regions in May 2008. 15 cities have rates over 15%.
Of the 49 metropolitan areas with a 2000 census population of one million or more, Detroit-Warren-Livonia, Mich., reported the highest unemployment rate in May, 14.9%. That area has been hit hard by automobile industry troubles. Riverside-San Bernardino-Ontario, Calif., struggling amid the housing bust, was second worst with a 13% rate. On the East Coast, the Providence, R.I. and Charlotte, N.C. regions were the hardest hit large areas, each with a 12% unemployment rate.
The large areas with the lowest jobless rates in May were Oklahoma City, Okla., and San Antonio, Texas, with rates of 5.7% and 5.8%, respectively.
Click Continue Reading for a chart sortable by metro area, state, May 2009 unemployment rate and the change from a year earlier.
A Look at Case-Shiller Numbers, by Metro Area (June 2009 update)
Posted by Phil IzzoThe S&P/Case-Shiller home-price index, a closely watched gauge of U.S. home prices, continued to post declines in April.
Click the image for an interactive map of home-price declines. In the 20-city index, no area experienced year-over-year price gains, the thirteenth straight month that has happened. However, nine cities managed to avoid month-to-month declines, up from just three last month. Dallas, Denver and Cleveland posted increases greater than 1%, while Washington, San Francisco, Boston, Atlanta and Seattle posted moderate rises. Prices in Chicago were flat.
Las Vegas and Phoenix posted the largest monthly and annual declines. Phoenix is down 54% from its peak in June 2006. Charlotte, Chicago, Cleveland, New York, Portland and Seattle posted record annual declines in April.
“It is important to understand that these indices are constructed using non-seasonally adjusted sales prices, and therefore when housing activity perks up seasonally in the spring and summer months, any effect on selling prices would not be adjusted out of these data,” said economist Joshua Shapiro at MFR, Inc. “In fact, in 2008, after dropping by an average of 2.4% per month in the first quarter, the composite 20 city index than registered average month-to-month declines of 0.9% during the prime spring and summer selling season before reaccelerating to post an average 2.2% monthly decline in the final four months of the year. We continue to believe that it is unlikely that we are near a bottom in nationwide home prices.”- 1) Give the agency broad authority to write rules about services or products including:
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Secondary Sources: Toxic Assets, Bubble Benefits, Dueling Economists
Posted by Phil IzzoA roundup of economic news from around the Web.
- Toxic Assets: On the Stash Noam Scheiber speaks to Treasury officials about the importance, or lack thereof, of getting toxic assets off banks’ balance sheets. One unidentified official states: “If you had asked–I don’t want to speak for the secretary–what’s problem number one? I think he’d say capital. Problem two? Capital. Problem three? Capital. Everything was in the service of that view. The legacy loans program was meant to help clean balance sheets. It was not an independent good in itself. It was seen as friendly to equity raising. Now people say the legacy loans thing is not gaining as much traction, so is that a failure? But because we had a good outcome in terms of raising equity, they [the banks] were able to raise equity without shedding assets … you should be okay with that.”
- Bubbles: Writing for voxeu, Guillermo Calvo and Rudy Loo-Kung say that there are upsides to bubbles. “Our analysis in this column may help explain why policymakers are hesitant to prick the bubble when it starts – they may simply be trying to maximise social welfare and realise that a potential crisis is not strong enough reason to prevent the bubble from developing (Tennyson’s verses ringing in their ears?). Of course, no policymaker likes crises. When crises strike, much of the discussion focuses on how to avoid them or lessen their impact in the future. This is quite understandable. However, this does not insure that “they are not going to fall in love again.” Therefore, the policy debate should give equal time to discussing what to do when crises happen and to developing institutions that help to assuage their blow.”
- Krugman vs. Mankiw vs. DeLong on Health Care: The blogosphere back and forth has gotten a little heated, as Democrats Paul Krugman and Brad DeLong tag team Republican Greg Mankiw on a public plan for health care. “The exammple Mankiw uses to back up his argument seems to me to be very strange. It is: ‘Fannie Mae and Freddie Mac, the mortgage giants created by federal law, were once private companies. Yet many investors believed–correctly, as it turned out–that the federal government would stand behind Fannie’s and Freddie’s debts…’ and thus provide them with a subsidy. There is a problem with this argument. The problem is that in the past year and a half the Federal government has stood behind the debts of not just Fannie and Freddie, but AIG, Bear Stearns, Merrill Lynch, Bank of America, Morgan Stanley, and Goldman Sachs–none of which bear any resemblance whatsoever to a “public plan.” The government has stood behind Fannie and Freddie not because they were, before 1968, public enterprises but because they were–like AIG, Bear Stearns, Merrill Lynch, Bank of America, Morgan Stanley, and Goldman Sachs–too big to fail. The Treasury staff would have loved to have let Fannie and Freddie default on their bonds had they not feared the systemic consequences.
The Growing Generation Gap (Which Has Little to Do With Technology)
Posted by Conor DoughertyThe Pew Research Center released a report on aging.
The survey shows, perhaps not surprisingly, that many people feel younger than their age. Meanwhile, medication and prayer increase with age while driving and exercise decrease. The benefits of old age include more family time and less work. For the record, old age begins at 68, according to the average of 2,969 survey respondents.
One of the more surprising finds was the generation gap — which is generally defined as a difference in point of view between young folks and older folks — is larger than at time since the 60s. But it has little to do with texts or tweets. Certainly older folks are less engaged with technology: According to the survey, only four in 10 of respondents between 65 and 74 used the Internet daily, versus three quarters of those between 18 to 30. But only 6% of respondents said that the gap had to do with technology, about the same amount that said views on financial matters separated the generations.
Among the larger issues separating the generations were values, including morals (12% of respondents) and work ethic (10%). Experience and political views also ranked higher than technological differences. The more things change…
Fireworks: Bad for Budgets, Good for the Economy
Posted by Conor DoughertyHeading into Fourth of July weekend, cities and towns across the country are rethinking their fireworks displays as they grapple with the worst budget deficit in a generation.
Displays such as this may be rare this year. (Getty Images) In Connecticut several towns are debating the merits of fireworks in this recessionary time while many other cities have gone ahead and cancelled this year’s fireworks display.
This article notes several Ohio towns and cities have scaled back or cancelled or their fireworks displays.
Yet there is evidence that consumers aren’t as eager to scale back their celebrations. Be it tradition, a comforting indulgence in a time of cutbacks, or a way to support local charities, sales of fireworks appear to be … rising (we refuse to say booming).
The Perils of a Smaller Wall Street
Reforms Seek Smaller Pockets of Risk, but Globally, Big Firms Still Dominate
Little is the new big. Major financial institutions are shedding assets. Consumers are cutting back. Even "Jon & Kate Plus 8" are shrinking the franchise.
In the smaller-is-better Wall Street envisioned by the Obama administration, financial firms go about their business with nary a peep. They take small risks, record modest profits and, should they grow too large, they are slapped with onerous restrictions. If the government deems them troubled, they are ripped apart or unwound by an all-powerful panel charged with identifying institutions too-big-to-fail.
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Getty Images Global banking giants are no longer the exception – they're the rule.
The Treasury Department's plan feels like a natural and attractive fix, but the notion that smaller firms are better ignores the reality of a global marketplace where big firms rule. In it, the U.S. will be at a significant disadvantage against a bulge bracket of global banks that already have the heft to push weakened U.S. institutions around -- or at least beat them to the punch when it comes to landing a deal with a multinational corporation.
In the same way steroids have reshaped the game of baseball, deregulation of the financial-services industry has created freakishly big institutions around the globe.
It started here. In 1995, the top five U.S. banks held 11% of the nation's deposits. Today, they have 40%, according to the bank consulting firm Oliver Wyman.
Our hulking Barry Bonds, Citigroup Inc., became a model for banks from Zurich to Beijing. Now that Citi has been sidelined and faces breakup, its imitators remain on the global scene, poised to fill the gap left open by a smaller, reformed Wall Street.
In other words, much of the world remains on the juice while the U.S. is going cold turkey.
New World Order
This new power structure isn't a threat, it's reality. There is no longer a U.S. bank among the top five in the world as ranked by assets, according to Thomson Reuters. Only one of the two domestic banks that rank in the top 10, J.P. Morgan Chase & Co. at No. 7, is looking to build, not break up. The other, Citi, is struggling to shed the assets it doesn't want and keep those it does.
"Even after massive consolidation, the United States remains one of the least concentrated banking markets in the developed world," Oliver Wyman concluded in a report released Wednesday.
Deutsche Bank AG, Barclays, BNP Paribas and HSBC Holdings PLC, each with more than $2 trillion in assets, are now in the driver's seat when it comes to global finance. Only three U.S. banks rank in the top 25 globally in terms of market value, according to Thomson Reuters.
As our competitors get bigger, U.S. institutions are under pressure to hold themselves together.
Pay limits, the strings attached to U.S. bailout packages, have created havoc on Wall Street. It may be true that there isn't much of a market for financial professionals right now, but those with proven track records are in demand not only by small U.S. firms but by overseas competitors, many unencumbered by pay limits.
Bigger Is Better
The world's biggest banks by assets
| Bank | Total Assets (Dollars in thousands) |
| Royal Bank of Scotland | $3,495,713,000 |
| Deutsche Bank | 3,055,650,000 |
| Barclays | 2,993,148,000 |
| BNP Paribas | 2,885,147,000 |
| HSBC Holdings | 2,520,455,000 |
| Credit Agricole | 2,296,720,000 |
| J.P. Morgan Chase | 2,175,052,000 |
| Citigroup | 1,938,470,000 |
| Mitsubishi UFJ Financial Group | 1,926,039,000 |
| UBS | 1,880,248,000 |
Source: Thomson Reuters
Disenchanted bankers are also taking flight to start their own smaller, autonomous and higher-paying shops. The Wall Street Journal on Tuesday reported that StormHarbour Partners LP, founded by former Citigroup bond-trading executives Antonio Cacorino and Fredrick Chapey, has hired 50 people in the last few months, including about 20 from Citigroup.
The pressure of defections has left the big banks scrambling to spend more to retain bankers. Goldman Sachs Group Inc. reportedly is putting aside a record bonus pool to keep some of its top performers. Bank of America Corp., Citi and Morgan Stanley have raised salaries in order to subdue the public's angst over bonuses and keep talent from the clutches of rivals, including smaller firms operating free of government intervention.
A Reduced Role
Our nation's new emphasis on smaller institutions and greater regulation will give the companies and consumers of capital across the globe a choice. They can do business with foreign megabanks that can offer discounts and services smaller U.S. players can't. In this scenario, Deutsche Bank or the Industrial & Commercial Bank of China may be the new Citigroup. Or, customers can opt for a safer system, one that in time may regain its reputation for reliability.
Time will tell if Americans are willing to accept the likely consequences of the former option: relinquishing global dominance in finance. Clearly it's a price the administration appears ready to pay if it diminishes the threat of crisis of the kind we've endured. After all, the phrase "systemic risk" is mentioned 22 times in the administration's 89-page white paper on financial-services reform.
A smaller influence in the world's flow of capital may be on the way anyway. More investors have been turning away from the dollar as a reserve currency. The greenback made up more than 70% of sovereign reserves as recently as 2001, but represented less than 65% at the end of October 2008, according to the International Monetary Fund. That figure is expected to dwindle further.
As former Evercore Partners chief and U.S. Deputy Treasury Secretary Robert Altman put it recently, you can include the U.S. among the nations where recovery is going to be "a long, painful slog."
"China is the one winner in this crisis," he added.
It may be one of the few places where size not only still matters, but still exists.
Dow Rises 838.08 for Quarter
Blue Chips Gain 11% as Risk Aversion Wanes and Credit Markets Thaw
Stocks have just posted their best quarter since 2003, but many investors remain wary.
The broad stock market goes into midyear holding onto the bulk of a powerful rally that left the Dow Jones Industrial Average up 29% from the 12-year low hit on March 9 and gave the index its first quarterly gain in over a year and a half. Yet it spent only one day during the quarter in positive territory for the year.
The Dow closed the second quarter at 8447, up 11%, or 838.08 points, for the last three months but down 3.8% for the year. ...
Commentary by Alexandre Marinis
June 30 (Bloomberg) -- For the past 50 years, Latin Americans had a love-hate relationship with the U.S. They loved American entertainment and hated U.S. foreign policies. They had particular disdain for Washington’s support for Latin dictators in the 1960s and 1970s, its campaign against Cuba and, more recently, just about everything associated with George W. Bush.
Fortunately, anti-U.S. feelings in the region are about to subside due to momentous changes now occurring. Think of them as C-3PO. I’m not referring to the android from “Star Wars.” This is an acronym for crisis, Cuba, China, protectionism, and Obama. Let’s take them in order.
-- The global economic crisis, born on Wall Street and exported to the rest of the world, has taught everyone a few things about the U.S. Namely, American economic policies and financial products aren’t risk-free and shouldn’t blindly be embraced by other nations.
Paradoxically, the worldwide recession will help improve relations between the U.S. and Latin America. Chastened by the economic crisis and Iraq War, the U.S. now is less arrogant. This resonates with Latin Americans in particular, following decades of being bullied by the superpower.
The world’s economic woes have made Latin Americans feel more pride and confidence in their ability to solve domestic problems. After all, for the first time in many years, a global monetary crisis wasn’t caused by the region’s debt default, currency devaluation or hyperinflation.
Rethinking Cuba
-- Though irrelevant in terms of the global economy, Cuba has been a powerful political symbol. Consider how much has changed. Fidel Castro retired. The Organization of American States agreed to readmit the communist nation after 47 years of banishment.
Also, the U.S. is likely to lift its trade embargo against Cuba in the near future. Once that happens Cuba won’t be able to blame the U.S. for its economic backwardness.
Over time, these developments will bring closure and psychological comfort to leftist Latin leaders who built their political careers in the 1960s and 1970s believing that communism represented a viable alternative to the U.S.
It’s getting more difficult for Latin leaders to blame U.S.-backed policies for their own misfortunes. Case in point: The demise of the so-called Washington Consensus, a package of economic policies the U.S. foisted on developing nations starting in late 1980s. American politicians argued the measures promoted the benefits of the free market. Their Latin counterparts said the measures worsened economic instability.
Here Comes China
-- Latin Americans share this deep-seated belief: their region’s social inequality and economic underdevelopment have been largely due to the exploitation of its vast natural resources by the developed world, first Europe and then, after World War II, the U.S.
This explains why Venezuela’s President Hugo Chavez gave Barack Obama a copy of Eduardo Galeano’s “Open Veins of Latin America: Five Centuries of the Pillage of a Continent” during the annual Summit of the Americas in April. The well-publicized gesture boosted the 1971 classic to No. 2 on Amazon.com’s bestseller list, up from No. 54,295.
Too bad Chavez presented it to the wrong president. China, not the U.S., looms as the region’s largest and most feared investor and trade partner.
China has already surpassed the U.S. as the largest buyer of Brazilian exports. It’s taking advantage of the world credit crunch to buy Latin American companies and provide loans to the continent’s nations in exchange for the guaranteed supply of raw materials -- oil, iron ore, soy beans -- the Chinese need to sustain economic growth.
Protectionism Increases
-- Latin Americans are already wondering when China will replace the U.S. as the latest economic powerhouse to plunder the region’s natural resources. Brazil’s Vale SA, the world’s largest iron-ore exporter, already sells 70 percent of its production to China and was pressured by Chinese clients to lower prices.
While China becomes the largest buyer of raw materials and commodities produced in Latin America, low-priced Chinese goods flood the region. Local makers of shoes, textiles and toys have been forced out of the market by Chinese competitors and are pressuring government officials to file antidumping cases against China.
Although only 13 percent of Brazil’s imports come from China, the Asian country is the target of 35 percent of the 123 antidumping investigations opened by the Brazilian government as of late March, according to the National Confederation of Industry.
The Obama Effect
-- Don’t be surprised if some Latin leaders who now oppose the U.S. -- including Venezuela’s Chavez, Evo Morales in Bolivia, Rafael Correa in Ecuador and even Cristina Fernandez Kirchner in Argentina -- suddenly soften their stance. You may even hear them parrot Obama’s rhetoric encouraging developing nations to adopt better environmental and labor practices.
Obama already appeals to many Latin American presidents as a completely different kind of U.S. leader. “Obama is the first U.S. president in many decades who looks like us,” said Brazilian President Luiz Inacio Lula da Silva.
The sooner Obama lifts the U.S. embargo on Cuba and reinforces trade ties with Latin America to prevent China from becoming the region’s new looter, the sooner leftist Latin leaders will see him as an ally rather than an enemyCommentary by Kevin Hassett
June 29 (Bloomberg) -- Federal Reserve Chairman Ben Bernanke broke out into a visible sweat last week for what must have been the first time in his public life. Summoned before a House panel to defend the Fed’s handling of the Bank of America Corp. merger with Merrill Lynch & Co. last fall, he faced tough and persistent questioning for more than three hours.
At issue was whether the Fed and the Treasury Department coerced Bank of America into buying Merrill Lynch at a time when Merrill was the financial equivalent of Pandora’s box with a faulty lid. Congressional staffers found enough smoke in subpoenaed Fed e-mails to give members of both parties concerns that the strong arm of the government may have gone too far.
It’s a useful rule of thumb to try to avoid situations where Congress is digging through your e-mails, and the heated hearing set off a flurry of speculation that Bernanke’s reappointment -- his four-year term ends Jan. 31 -- would be upended by the controversy.
Nothing could be further from the truth. Last week’s events practically guaranteed that Bernanke will be sitting in the chairman’s office for many years to come.
Each of the last four presidents, during his first term, has reappointed the sitting Federal Reserve chairman. Obama will probably do the same.
Ronald Reagan reappointed Paul Volcker. George H.W. Bush, Bill Clinton and George W. Bush all reappointed Alan Greenspan. In fact, of the chairmen since 1951, only one, G. William Miller, served less than two terms, and he did so because he left the Fed in the midst of stagflation to become secretary of the Treasury.
Soap Opera Plot
Bernanke’s reappointment is a Washington soap opera right now, and last week’s drama helped clear up the plot. To see why, you need to understand the motivations of each political party.
First, the Republicans. Since Bernanke was appointed by Bush and confirmed by a Republican Congress, he is their man. Accordingly, it might seem odd that so many of them were firing at him last week.
They pursued him for two reasons. First, the overreach of the Democrats during the bailouts is going to be a key focus of the midterm election in 2010, so introducing the theme to public scrutiny is a winning strategy right now.
Also, Republicans are wary of granting the Fed expanded authority to regulate “systemic” risk, and last week’s firestorm probably killed any momentum for such efforts. In the end, Republicans will support Bernanke’s reappointment, perhaps unanimously.
Three Options
Now, the Democrats. They have three top candidates for the position: Bernanke, Janet Yellen and Larry Summers. The difference in policy among the three is probably inconsequential and almost completely unidentifiable. That makes the appointment a political decision.
Viewed in the abstract, it would be a political advantage for the Democrats to seat a Fed chairman who is more sympathetic to their policies than is Bernanke, a Republican. Federal Reserve chairmen of the opposite party have the annoying habit of speaking up publicly when they see policies they don’t like.
But if Democrats replace Bernanke with one of their own, they acquire ownership of Federal Reserve policy. If the recession lasts longer than you like, it’s convenient to have a Fed chairman appointed by your predecessor to blame. For Democrats, the political calculation involves weighing the benefits against the costs.
The two candidates more closely associated with the Democratic Party have fundamental political flaws.
Not Political Enough
Yellen, president of the Federal Reserve Bank of San Francisco, is (like Bernanke) a highly regarded academic. She is a pragmatist whose career trajectory has been so stratospheric that she has nothing to gain from being political. She understands the value of an independent Fed and would be extraordinarily unlikely to play political games of any kind.
So if you appoint her to replace Bernanke, you get someone who is very similar to Bernanke -- but she is your responsibility. The Democrats would pay for Yellen with ownership of an economy that may well be a political liability by the next election. And they’d get little in return.
Summers is clearly the key economic figure in the Obama administration and might expect a Fed appointment as a reward for his service. However, his actions have increasingly been criticized as excessively political. A recent New York Times story, for example, implied that a minor mutiny among the less- politicized economists in the Obama administration was underway. Bernanke, in contrast, was careful to stay above the fray while he was Bush’s top economic adviser.
Prone to Controversy
Summers’ partisanship will give his opponents plenty of ammunition. If you add to that the concern that Summers has been almost pathologically unable to speak publicly without arousing controversy throughout his career, it seems unlikely that Democrats would be pleased by his elevation to the most visible of economic-policy positions.
In short, Yellen would not be political enough, and Summers might be too controversial a character to make it worth the bother to appoint him.
All of these forces are impossible to quantify, and it was anyone’s guess how things would break. Until last week.
If Democrats had decided they would support Summers or Yellen, they would have hung Bernanke out to dry at the hearing. After all, if you break tradition and refuse to reappoint a sitting Fed chair, you need to have a good reason.
Instead, they focused their criticisms on the Fed, and the actions of Fed staffers. They never took any potshots at Bernanke himself. They will never have a better chance to go after him, and they declined.
Which means that Bernanke’s the man.
June 30 (Bloomberg) -- U.S. stocks fell, limiting the biggest quarterly advance for the Standard & Poor’s 500 Index since 2003, after consumer confidence unexpectedly slid and delinquencies on the least-risky mortgages more than doubled.
Caterpillar Inc., Expedia Inc. and Starbucks Corp. lost more than 4.4 percent after the Conference Board’s sentiment index slumped to 49.3, six points below the average economist forecast. Citigroup Inc. and JPMorgan Chase & Co. dropped as government data showed prime mortgages 60 days or more past due climbed to 2.9 percent in the first quarter from 1.1 percent at the same time last year.
The S&P 500 lost 1.4 percent to 914.16 at 1:58 p.m. in New York, putting the index on track for the first monthly drop since February. The Dow Jones Industrial Average slid 121.98 points, or 1.4 percent, to 8,407.4. Stocks in Europe retreated, while Asian shares rallied.
“You had a great market run-up this quarter and people are starting to wonder what’s going to happen next,” said Jonathan Vyorst, senior vice president at New York-based Paradigm Capital Management Inc., which oversees about $1.5 billion. “The fundamentals of the economy aren’t really that strong.”
Even though the S&P 500 has gained almost 15 percent this quarter, the rally stalled in June amid concern share prices already reflect a economic recovery, leaving the index down 0.6 percent for the month. Investors are paying 14.5 times trailing 12-month profit for companies in the S&P 500, near the most- expensive level in seven months.
‘Wall of Worry’
The Chicago Board Options Exchange Volatility Index, or VIX, rose for the first time in six days, adding 6.9 percent to 27.09. The VIX yesterday dropped below its level when Lehman Brothers Holdings Inc. collapsed in September, yet was still 26 percent above its average.
Above-average volatility shows traders are still paying up for insurance to protect against losses in the S&P 500. Bigger equity gains depend on investors overcoming the remaining skepticism, sometimes called the “wall of worry,” spurred by last year’s 38 percent slump in the equity index, the steepest slide since 1937.
Caterpillar, the biggest maker of earth-moving equipment, dropped 4.8 percent to $33.06. Expedia, the Internet travel agency, tumbled 6.4 percent to $14.90. Starbucks slumped 4.4 percent to $13.99. Consumer confidence weakened as U.S. firms were slow to start hiring again and the wealth destruction caused by the housing slump forced Americans to rebuild savings.
Banks Slump
Citigroup fell 1.7 percent to $2.97. JPMorgan lost 1.9 percent to $33.93. Overall, mortgages 60 days or more past due rose 88 percent from last year, according to data from the Office of the Comptroller of the Currency and the Office of Thrift Supervision. First-time foreclosure filings on the loans rose 22 percent from the fourth quarter, the report said.
Southern Co. sank 3 percent, the most in two months, to $30.90. The largest U.S. power producer was cut to “hold” from “buy” by Citigroup Inc. analysts.
“We’ve had a rally that lifted most boats, but I think the advance from here is going to be more selective,” said Alan Gayle, the Richmond, Virginia-based director of asset allocation at Ridgeworth Investments, which manages $60 billion. “As we get closer to the earnings season, investors are going to be looking carefully for companies with signs of sustainable growth.”
AIG Tumbles
American International Group Inc. posted the S&P 500’s steepest loss, plunging 13 percent to $1.16. The insurer bailed out by the U.S. said valuation declines on credit-default swaps sold to European banks could have a “material adverse effect” on the company’s results. The risk of losses on the derivatives may last “longer than anticipated,” AIG said yesterday in a regulatory filing.
Energy stocks lost 1.3 percent as a group as oil dropped below $70 a barrel on evidence the recession may be worsening around the world. Schlumberger Ltd., Tesoro Corp. and Hess Corp. retreated more than 2.2 percent.
The U.K. economy shrank the most since 1958, contracting 2.4 percent from the final three months of 2008, the Office for National Statistics said. Gross domestic product in Canada contracted for a ninth month, declining 0.1 percent in April, because of falling output in the retail, manufacturing and energy industries, according to data from Statistics Canada.
Benchmark indexes rose at the open following better-than- estimated results at Apollo Group Inc. and H&R Block Inc. and reports showing home prices fell less than forecast and two purchasing managers’ gauges topped economists’ estimates.
“My guess would be that home prices are going to level off -- they’re not going to keep falling,” Robert Shiller, an economist at Yale University and co-founder of the home price index that bears his name, told Bloomberg Television. Still, it’s “hard to predict” a speculative market, and “I am not optimistic that we’re going to see any sharp rebound.”
Inflation: What You See and What You Don't See
In an attempt to fight the international credit market turmoil and its effects on economic activity and overall prices, the US Federal Reserve (Fed) keeps increasing the supply of base money — which is cash in circulation and commercial banks' money balances held with the Fed.
From August 2008 to May 2009, the monetary base in the United States more than doubled. The bulk of the expansion reflects an unprecedented rise in banks' excess reserves — that is, banks' base money which is available for additional credit and money creation.[1]
People are being told by governments, central bankers, and leading mainstream economists that such a policy wouldn't be inflationary — because the money would remain in the portfolios of banks and would not spill over into the hands of firms and private households.
This is, to put it mildly, an uninformed view. To show that a rise in base money is inflationary — that it either lowers the purchasing power of money or, what basically amounts to the same, prevents money's exchange value from rising — let us start right from the beginning.
How Mainstream Economists Define Inflation
If you ask mainstream economists what inflation is, they typically respond that inflation is an ongoing rise in the consumer price index of more than 2 or 3 percent per annum; if the increase remains between zero and 2 to 3 per annum, these economists would speak of price (or price-level) stability.
Currently, annual changes in consumer price are running at around zero. So it comes as no surprise that mainstream economists do not see inflation whatsoever; in fact, they would warn against deflation — which they characterize as an ongoing decline in consumer prices.
The prices of assets such as stocks, bonds, real estate, and housing are typically considered different from consumer prices. Asset prices are seen as prices sui generis, especially as they are not included in the official definitions of price indices.
So-called asset price inflation — a term which mainstream economists use for characterizing the phenomena of extraordinarily strong and ongoing increases in the prices of, for instance, stocks and housing — is not seen for what it really is: a visible symptom of the erosion of the purchasing power of money.
What is more, mainstream economists wouldn't mind about the Fed increasing the monetary base, or commercial banks increasing money supply, per se. This is because they do not see a direct, let alone a logically necessary, link between changes in the money stock and the purchasing power of money.
Austrians' Definition of Inflation
In sharp contrast, Austrians hold that inflation is an increase in the money stock, and that the upward drift of money prices is a consequence of a rise in the money stock; from the Austrians' viewpoint, rising prices are a symptom of an increase in the money stock.
Mainstream economists may say that if a rise in the money stock is accompanied by a (sufficient) rise in the supply of goods and services, an increase in the money stock would not cause inflation, as it would not make prices go up.
From the Austrian viewpoint, such an argument does not hold water, though: had the money remained unchanged, money prices would have actually declined (other things being equal), thereby having increasing the purchasing power of money.
In other words, a rise in the money stock prevents the money stock from gaining in purchasing power (other things being equal). That said, there are two consequences that come with a rise in the money stock that need to be highlighted in this context.
First, the visible effect is a rise in money prices; it is the result of a rise in the money stock while the supply of goods and services remains unchanged.
Second, the invisible effect is brought about by a rise in the money stock, even if it is accompanied by a rising supply of goods and services: the rise in the money stock prevents money prices from declining.
Needless to say, to most people the first effect goes unnoticed — as a result of a misguided definition of inflation. That said, the only economically meaningful definition of inflation is a rise in the money stock.
An Invisible Effect of a Rising Monetary Base
As far as its impact on prices goes, the rise in the monetary base sponsored by the Fed has so far been restricted to an invisible effect.
First and foremost, the base money increase prevents banks' troubled asset prices from adjusting to lower levels. Buyers of these assets have to pay a higher price when compared to the scenario in which the Fed hadn't increased the money supply.
In addition, prohibiting the prices of banks' assets from adjusting downwards keeps markets from performing an essential function, namely, rewarding those players who serve the needs of their clients and pushing those players out of the market who do not.
Furthermore, as prices of banks' troubled assets are kept from declining, the need for revaluing other assets (such as book loans extended to firms, house builders, and governments; bonds; stocks, etc.) tends to decline or is prevented altogether.
If, however, asset prices are kept from falling by monetary policy expanding the money supply, the mechanism of relative prices cannot do its job properly. It actually paves the way for making other prices — such as wages, and producer and consumer prices — go up.
A Visible Effect of a Rise in the Money Stock
Let us take a look at the visible effect caused by a rise of money on consumer prices — an effect that is put into question by mainstream economists. The graph below plots annual changes in the stock of M2 against those of the consumer price index from 1960 to May 2009.
At first glance, there isn't much of a correlation between the series under review. However, if a closer look is taken at series' underlying trends, which strip out short-term fluctuations and "noise," two findings stand out.
First, trend money growth of M2 and trend changes in consumer prices are pretty much on the same wavelength, and they are positively and highly correlated. Second, trend changes in the money stock seem to affect trend changes in prices with a time lag, and trend money growth seems to lead trend changes in prices.
The (admittedly arbitrary) trend lines suggest that consumer prices will go up and that the latest drop in rising consumer prices should be interpreted as a temporary downward blip (driven by lower commodity prices).
Will It or Will It Not?
A key issue for many market observers is this: will the massive increase in base money really translate into a rise in the money stock in the hands of private households and firms, which would then lead to visible effects of a rise in the money stock?
The multipliers — which show the relationships between credit and commercial-bank money stocks relative to banks' holdings of base money — have collapsed since late summer 2008. Banks' willingness and ability to churn out credit and money have declined severely.
Commercial banks are in a process of deleveraging and derisking their balance sheets. Private owners of the banks are no longer willing to risk their capital in the credit business at currently prevailing return levels.
That said, one can say that markets have embarked on a process of correcting the effects of misguided policies — caused by a relentless expansion of circulation credit and money created out of thin air, encouraged by central banks' artificial lowering of interest rates.
Markets are about to cause a contraction of credit and money supply; if banks are no longer willing to extend additional credit and call in maturing loans, credit and money supply will decline, leading to recession and deflation.
Such a development would be highly undesirable from the viewpoint of governments and their beneficiaries in particular; in fact, it would threaten their very existence. And it is from here that the real danger for even higher inflation comes.
Why Inflation Will Become Worse, Not Better
The policy of expanding the money stock is the foremost tool of government aggrandizement. It allows financing the state's income, public deficits, and elections, and for expropriating and corrupting members of society in the most subtle way. As Ludwig von Mises noted,
A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, i.e. of anti-democratic, policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. It explains why inflation has always been an important resource of policies of war and revolution and why we also find it in the service of socialism. When governments do not think it necessary to accommodate their expenditure to their revenue and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism.
Those who hope that inflation will now come to an end — given that market is close to contracting circulation credit expansion and the money supply — implicitly express optimism that the government leviathan is on the retreat. Unfortunately, the latest developments — namely, increasing base money and the running up even bigger public deficits — don't support such a view.
Even though banks scale back on their lending activity, one should not forget that, under today's government-controlled fiat-money systems, the money stock can be increased at any time, in any amount deemed politically desirable. Tragically, deflation — the decline in the money stock, which is so widely feared these days — can be prevented if this is politically desired.
Inflation can be produced by central banks or commercial banks, simply by lending or purchasing assets from nonbanks, paying with newly issued money. As things stand, central banks' monetizing government debt is presumably the way forward for producing inflation — which is, and must be, defined as a rise in the money stock.
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