American politicians

From the New York Times article on John P. Murtha (see here)

Even among donors, mainly defense interests, Mr. Murtha’s standing appears to be slumping. His first-quarter campaign contributions were down by half from the same period after his previous re-election — to about $225,000, he reported this month.

This means that his previous re-election had him with about $500,000 in campaign contributions per quarter, so about $2 million annually.

Frontline documentary “Black Money” on foreign bribery mentions that one Saudi Prince received close to $100 million from BAE.  (see videos here)

I’m always amazed at the leverage that lobbyists have over American politicians.  A couple of hundred thousand dollars can get you some of the most lucrative contracts in the world worth tens of billions of dollars.  Besides the simple truth that this type of situation is unethical it seems to me that it should be stopped more for being lame.  A system that drives politicians to such deptsh should be reformed just on principle.

Flip flopping

Is what I’m doing.  After taking a look at the economic data on banks balance sheets, and debt levels in different sectors of the economy, I take back what I said in my last post.

The market is being over-optimistic and will likely retrench in the third quarter of this year.  It will start rising again this time next year.

That’s my call.

Green Shoots and Glimmers

“I don’t want to go overboard here. Maybe the banks really have swung from deep losses to hefty profits in record time. But skepticism comes naturally in this age of Madoff.”

So says Krugman’s new op-ed, “Green Shoots and Glimmers,” which talks about how although there are signs that things seem to be getting better in the economy, we shouldn’t get too excited. All that is happening is that the rate of decline is slowing in some parts of the country. Krugman argues that although this is moderately encouraging, things can get much worse.
Now, I just have two quick things to say about this. The first is that although skepticism should always be used and the numbers that the street relies on to jump can clearly not be trusted on face value, there is something very important in a general sense of betterness that can mark the beginning of the end. I am not sure you can argue this economically, but psychologically it seems to me that positive signals encourage more positive signals. As Soros and others have said, the economy is not some objective thing that we observe and don’t influence; the economy is shaped by all of our actions and responds to how people think it is doing. This doesn’t mean that the banks numbers might not be cooked. All it means is that positive signs from the bank can eventually lead to good things just by the fact of being positive. People base their hiring and borrowing on future expectations and these are shaped by the very signs they see around them of things to come.

Finally, although we should be “more skeptical in times of Madoff,” it’s important to realize that he was just a criminal. From what I gather, people could have uncovered his schemes through due diligence. That’s not to say that people like Madoff don’t benefit from the lower diligence people have in good times. But it’s one thing to be skeptical in deciding where to invest your money and another in predicting where the economy is going.

The “Green shoots and glimmers” should be seen as a very positive indication of the beginning of the end. Other things can derail it. But all things being equal, I appreciate positive news.

Perfection? Aren’t we talking about government?

Tonight President Obama emphasize that the “Economic Recovery & Reinvestment Plan” isn’t perfect.  He stressed pragmatism over idealism and dilly-dallying.

This is a short post to just comment on how odd it is that the President had to defend the bill from opponents decrying the lack of perfection and its tough-headededness and get-the-job-done-at-whatever-cost-idness.  Aren’t we talking about government?  Since when was anything perfect?  Nobody knows what will and will not work.  Nobel prize-winning economists, geniuses the world over, laypeople and politicians all disagree with each other and between themselves over what will and will not work.  How could it possibly, ever be perfect?

Maybe it is because of the high expectations with which the Obama administration entered office; how can anything he does not be perfect?  How can he not just renounce the current establishment and just start anew?  Why won’t he set up camps to publicly condemn bankers?  Why won’t he just go ahead an prosecute the old administration?  Why doesn’t he go into Afghanistan himself and just fix the war?  The level of expectations that people have of Obama are ridiculous.

The economy is not controlled by the government.  Nobody knows exactly what will work; solving the current crisis – or rather, stemming the current bloodbath – will require multiple attempts and a lot of time.  There are no easy answers.

The information and communication revolution of the past twenty years has changed the fundamental ways in which we perceive our economic problem and made us, as a country, much less patient.  We demand easy answers, quick fixes, new answers each night on the news and talk shows.  What happened today?  What will happen tomorrow?  If only it were that simple; this is going to take a while.

The fact that we realize that there is a problem and that government intervention is the answer (or so we think) is at least a step forward from the first Great Depression.  President Hoover’s first steps in 1929 were, as Secretary of the Treasury Andrew Mellon said, to “purge the rottenness out of the system” – “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.”  (It’s amazing that he said that, isn’t it?) Hoover’s policy was to emphasize confidence in speeches without taking any corresponding actions to stem the crisis.  However, as historians Tindall & Shi write, “Hoover did more than try to reassure the American public.  He hurried the building of public works in order to provide jobs, but state and local cutbacks more than offset new federal spending.”   His actions were not commesurate with the needs of the country and speeches alone did not stem the tides.

Scarier still is that in the first half of 1931 all the indicators seemed to indicate a recovery was starting.  However, a world away, an Austrian bank’s failure in May 1931 created to a domino effect that led further into the depression.  Crises this big don’t go away without their share of success, failures and luck.

President Obama was correct: stop the bloodbath and then let’s talk about the future.  Two things seem certain:  delays are bad, action is good and no one congressional bill will solve the problem alone.  Get the credit markets back on track, stop the unemployment spiral before both make the crisis much more severe.  If the Obama team’s Keynesian policies succeed and if what we think we learned from the Great Depression actually works, then we are in for better times at some point within this administration.  Let’s just hope for competence, patience and luck.

Autos, steel and the Iraqi army

Great article from The New York Times last week comparing steel to the auto industry.

Is Steel’s Revival a Model for Detroit?

Here are some good quotes from it (emphasis added):

Over the decades the [steel] companies had shed employees to stay afloat. Soon retirees greatly outnumbered the actual workers. At Bethlehem, the ratio was six retirees for every worker. All these retirees had good pensions and good health care plans, which they thought wereguaranteed. But these costs were a tremendous weight on the companies.

Bankruptcy changed the rules, allowing the steel makers to unload billions of dollars in pension obligations onto the government’s Pension Benefit Guaranty Corporation and to cut more than 200,000 workers from their supposedly guaranteed medical care.

The failures also allowed for the renegotiation of labor contracts, something Wilbur L. Ross Jr., a specialist in distressed assets, realized when he began looking at the moribund industry. The only bidder for the bankrupt LTV Steel, he proceeded to buy Bethlehem and other old-line companies, putting them together as International Steel Group. He cut more employees and revamped work rules, taking Bethlehem, for example, from eight layers of management to three.

Steel’s turn-around was dramatic. The 17 leading companies went from a combined loss of $1.1 billion in 2003 to an after-tax profit of $6.6 billion in 2004, according to an analysis done for an industry trade group. Ross sold International Steel to the Indian entrepreneur Lakshmi Mittal for $4.5 billion in 2005, earning a tremendous return.

Note: They cut 200,000 workers and offloaded retirees onto the PBGC.  Assuming a salary of $25,000 per worker, that means that the 17 leading companies cut five billion dollars in salaries. If you consider this a lower bound because of benefits and other employee-related expenses, this in itself explains most of the rebound in profits.  It’s not that they became exceedingly productive but rather that they redistributed revenues from employees to shareholders via bankruptcy proceedings.  Additionally,

Thanks to all of steel’s tribulations and consolidations — and, no doubt, a world economy that was booming until recently — the industry is relatively healthy.

Furthermore, it’s a tremendously problematic time. The final collapse of the steel industry came when the economy was relatively healthy and could absorb the blow. The current economy is the weakest in decades.

“Bankruptcy [of the auto industry] will be a total mess, and may not produce anything of value at the end of it,” Mr. Ross said. Instead, he would like to see a 90-day government loan to keep G.M. afloat on the condition that all the stakeholders — including employees, management, bond-holders — agree on a restructuring. The government would be there essentially to crack heads and make sure everyone made concessions.

I’ve no idea what the government should do about the auto industry but I do know that letting the auto companies go bankrupt is a terrible idea at this moment in time.  I’m reminded of the mistake that the Coalition Provisional Authority did in the first year in Iraq by disbanding the Iraqi Army (one of the many bad disbanding decisions in the post-Cold War): destroying organizations and institutions with a willful blindness to the consequences under the mantra of creative destruction seldom leads to good outcomes.  Organizations are useful; work within the structures that already exist.

A plea for managers – why Hillary should not be Secretary

Hearing most people argue why Obama should make Hillary Clinton a member of his cabinet usually sounds like the list of reasons you’d invite someone to a party.

Common reasons for including her are that Obama owes it to her for her help in the campaign; that it would help the “team of rivals” ideal that Lincoln espoused – keep your friends close and enemies closer; that it would give him leverage in the Senate; that it would solidify party dynamics; that it would make her fans happy; that she’s a good person; that she is dynamic and a social person; that she has a lot of international experience (and by experience we mean she’s visited a lot of countries); and that she would help Joe Biden not take too strong a lead in foreign policy (an anti-Cheney effect – unclear why anyone is afraid of Biden becoming Cheney since Obama is no Bush).

Most often left out, or assumed in people’s analysis, is that she will do a good job at being Secretary.

Obviously what she will do a good job at, depends on the Department that she heads. However, as far as I can see, there is no reason to think that she will do a good job as Secretary of anything. Secretary’s are not advisors to the President – they are actually supposed to do things, and not just provide advice, give speeches and be sociable. In my opinion, we need Secretaries that are good managers. And although Hillary is many things, she is not a good manager.

My evidence is her mismanagement of her campaign. As most people that worked on her campaign will tell you without hesitation, she is not a good manager. She might be an inspirational leader, but she drove her campaign into the ground (or allowed others to drive it there for her).

In my opinion, one of, if not the most powerful characteristic that Obama possesses is his ability to manage. Many people have his rhetorical abilities, his drive, his intelligence. But without his ability to manage, I don’t think that Obama would be the President Elect.

Maybe the problem is that I have read the newspaper these past 8 years. The country is awash in incompetent leaders and managers at all levels of Government and the private sector. Most problems that this administration has had, have not been purely ideological – say what you will about NSA wiretapping, Supreme Court nominations and the like, these have not been the major problems of this administration (which is not to say they are not problems). The major problems have been ones of mismanagement – Katrina, Iraq, Afghanistan, the economy, the environment. The bad news that we read about every day in the paper are not acts of God but rather they are the results of years and decades of mismanagement and short-sightedness (GM anyone?).

If Obama picks Hillary as Secretary of State, I’m sure he has his reasons. Even good managers have to make compromises and for all I know, he knows that she would be a great Secretary. But based on what I have seen of Hillary, my only wish is that she will let somebody else manage the Department for her while she plays PR.

How bad can it get?

Dow went down another 700 points.  How long can this last?  There are only so many more times this can happen before it become cheaper for me to buy a share of Starbucks than the actual cup of coffee.

I thought I’d bring back a post from what now seem like golden days – June, 2008.

“Dow is down to 11300’s.  Has it hit bottom?

Here is my favorite Bear quote of the day, from the WSJ,

“The market will make a bottom when the world seems like it’s coming to an end and sentiment is at rock bottom,” said David Kotok, president of money-management firm Cumberland Advisors in Vineland, N.J. “It’s always hard to tell when that point we’ll be, but for the moment, it doesn’t seem like we have that sort of real panic.”"

The past is no guide, the future is uncertain, pundits are panderers and assurances ring hollow.  Whatever happened to the end of the business cycle?

Oops

Just when it seemed like everything was rosier, just when bear bashing had taken on increased gusto, we were slammed with the nationalization of Freddie and Fannie, most of AIG, the bankruptcy of Lehman Brothers, the bankification and near-extinction of Goldman Sachs and Morgan Stanley (and the sweet deal Buffet obtained with Goldman), the seizure and resale of WaMu to JPMorgan, a potential $700 billion bailout to rescue the entire world from doom and the complete remaking of the financial world as we knew it.

Wow.

Quick lessons learned:

1) Don’t believe what anybody says.  It will only lose you money.

2) Nobody knows the future.  I’ve yet to see anyone who predicted this exact scenario or even anything similar.  Read “Fooled by Randomness”.

3) Nothing lasts forever.

4) Learn from your mistakes.  I remember being amazed at the lies told by Angelo Mozillo previous to the collapse of Countrywide (one of the first warnings signs of this crisis); a couple of days before the stock plummeted, he went on television and swore that everything was fine and would only be getting better.  The same lies as those told by Enron and infinite dot-coms.  The same words spoken days before the current round of oblivion.  Rules 1-3 are good rules.

Where does that leave us?  A little less humble.

And with this article on something completely out of left field but a reminder that there are large problems other places too.

Somalian Pirates Seized a Ukranian ship full of tanks. Here’s a quick highlight (emphasis added):

“Somalia’s 1,880-mile coastline is infested with pirates, who strike with seeming impunity and then demand millions of dollars in ransom for the ships and their crews. This year is one of the worst on record, with more than 50 ships attacked, 25 hijacked and 14 currently being held by pirates.

The pirates are often former fishermen who have turned to the more lucrative work of plying the seas with binoculars and rocket-propelled grenades. [Plying!] They travel in light speedboats, deployed from a mother ship far out at sea. They have attacked everything from sailing yachts to oil tankers, sometimes as far out as 300 miles from shore. Pirates even tried to attack an American naval supply ship earlier this week. The navy ship fired warning shots and the pirates fled.”

Two best articles on Georgia-Russia conflict

Here are the two best articles I’ve found on the Georgia-Russia conflict currently underway.

First is from the Atlantic Monthly: Excellent background and good analysis. “At Putin’s Mercy” by Jeffrey Tayler

Second article is from the New Yorker: Good high-level view of the conflict. “Boundary Issues” by David Remnick

Enjoy.

How would the covered bond market work?

What is this announcement about the emergence of an American covered bond market? Is it an answer to the housing market’s ills? What is a covered bond in the first place?

First, the announcement as reported in The Wall Street Journal (see here; rearranged for ease of use):

Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co. and Wells Fargo & Co. Monday unveiled plans to launch covered-bond programs and become leading issuers of the financial instruments, which date back to 18th-century Europe.

Treasury Secretary Henry Paulson speaks [sic] during a news conference on mortgage finance. “We are at the early stages of what should be a promising path, where the nascent U.S. covered bond market can grow and provide a new source of mortgage financing,” he said.
“We believe a robust U.S. covered-bond market would provide an additional stable and cost effective funding source for banks to originate and hold mortgages on their balance sheet,” the four banks said in a joint statement.
U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke have in recent months been touting the bonds as a way to help revive the nation’s struggling housing market.

OK. So, the four largest banks in the country, at the Fed and Treasury’s prodding, are all agreeing to start a covered bond market to try and revive the housing sector. So what are covered bonds? From Wikipedia (see here):

Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. They are similar in many ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet.

[i.e., They are very similar to the securities that have been problematic in the past year but are less risky since the issuer is liable for handing out bad mortgages and they remain of the issuer's balance sheet]

Essentially, a covered bond is a corporate bond with one important enhancement: recourse to a pool of assets that secures or “covers” the bond if the originator (usually a financial institution) becomes insolvent. [Again, much safer that securitization] This enhancement typically (although not always) results in the bonds’ being assigned AAA credit ratings. [I am not sure how this works - anyone? Is it because they have the properties as collateral? Why wouldn't the bonds be assigned ratings the same way as other corporate bonds?]

From the New York Times (see here) and the Wall Street Journal [rearranged]:

Covered bonds, issued by banks and secured by pools of assets like home loans, are widely used in Europe but have only become attractive in the United States since the segment of the mortgage securitization market driven by investment banks dried up last year amid a wave of home foreclosures.
Unlike mortgage securities, which pass all the risk to investors, covered bonds collateralized with mortgages would continue to perform even if the mortgages backing them default — as long as the bank remains solvent. [And what happens if they don't remain solvent? The bond holders get the assets.]

Are covered bonds the answer to the housing crisis?

In one way, covered bonds seem to spread risk more evenly since issuers would continue to be responsible for the losses even if the underlying mortgages default. However, didn’t banks get burned by mortgage securities as well? Didn’t banks loose money by holding the securities they issued? The key difference between covered bonds and the previous batch of mortgage securities seems to be that covered securities have stricter guidelines for what can be included in the portfolio.

Additionally, there is the fact that by making them bank debt, they are somewhat insulated from the underlying housing assets – arguably, making this more attractive. As Felix Salmon wrote in “What is a covered bond” (see here),

Now it’s true that covered bonds are, technically, mortgage-backed. But all the mortgages could default and go into foreclosure tomorrow, and so long as the bank remains in operation, the covered bond will pay out as normal. Similarly, if the bank blows up for some non-mortgage-related reason, investors in the bond will still get paid back in full. Their main risk is that the bank blows up because the mortgages blow up, and they’ll be left holding a bag of damaged loans – but because two things have to happen rather than just one, that risk is relatively low

The WSJ article mentions that previous attempts at creating a covered bond market in the US failed. However, this time the FDIC and the Fed are greasing the wheels. From the WSJ:

The Federal Reserve governor Kevin M. Warsh told the news conference the Fed was willing to consider highly rated, high-quality covered bonds as collateral for banks seeking emergency funds from the Fed.

Nothing like having the Fed help you start a business…

One question is who is going to rate their bonds? Moody’s? What will make this time different from the previous fiascos?

Speaking with very little experience, here is my take. As long as the regulations and guidelines for building covered bonds are conservative enough, I can see this market providing a boost to the housing market. The covered bond market will help by providing more liquidity now that Government Sponsored Enterprises account for over 60% of all mortgages. The private sector might just start getting back in the game. However, housing prices have still not corrected. Even if the covered bond market takes off, it still is unlikely to do much good until the market bottoms out and the economy starts to improve in 2009 or 2010. It is more likely a boon for the banks themselves since they now will have another way of making and borrowing money.

[Here is another article on this subject: Floyd Norris from the New York Times, “A New Way to Generate Mortgages”]