Financial Reform: Will Congress Take The Side Of Corporations Or The Public?

The ability of congress to pass financial reform may be no match for the ability of large financial corporations to block it. Political writer Matt Taibbi describes the efforts of Goldman Sachs to shamelessly lobby congressmen to protect the interests of the financial giant. See the following from Economist's View to learn more.

I am not as negative toward naked short-selling as Matt Taibbi (feel free to convince me I'm wrong), but his insights into the lobbying effort against financial reform are useful, and I share his concerns about the distortions (e.g. regulatory capture) this brings to the reform process:

An Inside Look at How Goldman Sachs Lobbies the Senate, by Matt Taibbi: ...Later on this week I have a story coming out in Rolling Stone that looks at the history of the Bear Stearns and Lehman Brothers collapses. The story ends up being more about naked short-selling and the role it played in those incidents than I had originally planned..., but it turns out that there’s no way to talk about Bear and Lehman without going into the weeds of naked short-selling...

It’s the conspicuousness ... that is the issue here, and the degree to which the SEC and the other financial regulators have proven themselves completely incapable of addressing the issue seriously, constantly giving in to the demands of the major banks to pare back (or shelf altogether) planned regulatory actions. There probably isn’t a better example of “regulatory capture” ... than this issue.

In that vein, starting tomorrow, the SEC is holding a public “round table” on the naked short-selling issue. What’s interesting about this round table is that virtually none of the invited speakers represent shareholders or companies that might be targets of naked short-selling, or indeed any activists of any kind in favor of tougher rules against the practice. Instead, all of the invitees are either banks, financial firms, or companies that sell stuff to the first two groups.

In particular, there are very few panelists — in fact only one, from what I understand — who are in favor of a simple reform called “pre-borrowing.” Pre-borrowing is what it sounds like; it forces short-sellers to actually possess shares before they sell them.

It’s been proven to work, as last summer the SEC, concerned about predatory naked short-selling of big companies in the wake of the Bear Stearns wipeout, instituted a temporary pre-borrow requirement...

The lack of pre-borrow voices invited to this panel is analogous to the Max Baucus health care round table last spring, when no single-payer advocates were invited. So who will get to speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a hedge fund that has done the occasional short sale, to put it gently), Credit Suisse, NYSE Euronext, and so on.

In advance of this panel and in advance of proposed changes to the financial regulatory system, these players have been stepping up their lobbying efforts... Goldman Sachs in particular has been making its presence felt.

Last Friday I got a call from a Senate staffer who said that Goldman had just been in his boss’s office, lobbying against restrictions on naked short-selling. The aide said Goldman had passed out a fact sheet about the issue that was so ridiculous that one of the other staffers immediately thought to send it to me. When I went to actually get the document, though, the aide had had a change of heart.

Which was weird, and I thought the matter had ended there. But the exact same situation then repeated itself with another congressional staffer, who then actually passed me Goldman’s fact sheet.

Now, the mere fact that two different congressional aides were so disgusted by Goldman’s performance that they both called me on the same day — and I don’t have a relationship with either of these people — tells you how nauseated they were.

I would later hear that Senate aides between themselves had discussed Goldman’s lobbying efforts and concluded that it was one of the most shameless performances they’d ever seen from any group of lobbyists, and that the “fact sheet” ... was, to quote one person familiar with the situation, “disgraceful” and “hilarious.” ...

This post has been republished from Mark Thoma's blog, Economist's View.

Why Farmland Is A Better Hedge Than Gold

A lot of investors are worried about inflation in the future, which helped Gold prices rally recently as investors sought a hedge against the dollar. However, consider farmland values which outpaced inflation by 2% from 1941 to 2002 and unlike gold has intrinsic value in its ability to produce food. See the following from Daily Wealth to learn more about investing in farmland.

In the past few years, there's been an explosion of investor interest in "hedges."

Investors want to own foreign real estate for a hedge against a big depression in the United States. They want to own gold for a hedge against a dollar crisis. They want to own oil for a hedge against inflation.

But consider this "hedge factor"...

Between 1941 and 2002, average farmland values outpaced the growth of inflation by 2%.

In fact, some call farmland as good as gold with yield – because you clock in steady income from rents while you wait for the value to grow. I can think of no better asset to own during any kind of financial crisis.

In some ways, farmland is even better than gold or silver. At least farmland is an intrinsically useful thing. It provides a tangible yield in the form of good things from the earth. We all have to eat. As consumers trim their sails, they'll give up a lot before they give up their calorie intake.

Governments, particularly in times of crisis – like now – have a tendency to flood the system with money in an attempt to "goose" the economy. Mostly, such efforts have succeeded in destroying the value of the currency in question.

Anyway, if you believe that we will continue to feel the bane of inflation, then farmland's performance in the 1970s will give you some comfort... While you lost half of your money in the S&P 500, your farmland kept its value nicely. Again, I think that's rooted in the fact that farmland is intrinsically useful. It produces useful and needed things.

Now imagine what farmland might do in today's climate, in which you have not only the likely prospect of inflation, but also a tightening supply of farmland and rising demand for crops. You have biofuels eating up more of our grain supply. I imagine you'll do quite a bit better than in the 1970s.

Farmland treated British investors great just last year. As British housing prices collapsed in 2008, British farmland value rose by 21%. Over the last five years, Brit farmland rose a total 135%. Forget commercial property. That's not a bad ROI in my book.

And there's one more way to look at it: This hedge can outperform gold. In Britain, the farmer outpaced the gold owner. Expanding land values rode up 115% since 1983, versus gold at 81%. You can be sure institutional investors are already placing their long-term bets. Almost half the farmland bought there last year was snapped up by banks and funds.

The obvious investment conclusion: If you're worried about the dollar, the economy, or any other problem, buy farmland today. This is hard to do directly through the stock market... so I encourage you to consider a private deal. You can play agriculture through companies that manufacture irrigation equipment, produce fertilizer, or operate grain-handling facilities.

Check these investments out soon. I think we're in for broad farmland/agriculture rally that should be good for hundreds of percent returns. As you can see from farmland's past results, it's a great hedge in all kinds of environments.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

Learn How To Invest Like Warren Buffett With These 6 Essential Books

Reading the right books can help you become a better investor by learning from other's successes and failures. Don Dion from The Street has complied 6 essential books that will teach you how to think and invest like genius investor, Warren Buffett. See the following article to learn more.

Amazon.com recently listed more than 200,000 titles under the keyword "investing." Some of those books are useful. Others are a waste of time. And many, designed to exploit our ignorance and greed, are downright dangerous.

How do you approach this slew of investment information without getting overwhelmed? Every month, financial writers and journalists churn out hundreds of articles that aim to explain the financial world to ordinary investors. The financial media is full of investment picks, ideas, strategies and other advice.

Books still play an important role, however, in mastering the art of intelligent investing. Selecting the right tome can be a daunting proposition. The first place to start is with the basics. The best investment books avoid the sleazy manipulation of the get-rich-quick schemes you'll find in many books, magazines and, newsletters. Instead, they seek to impart the hard-won wisdom of the great investors to readers like us.

Which books should you read?

Books can serve to strengthen your fundamental investing knowledge while providing you with an important historical prospective.

In addition to several guides and anthologies that offer timeless advice, a number of books about Warren Buffett's philosophy provide a valuable foundation for any long-term investor.

While Warren Buffett has never penned his own book of investing advice, several stand-out books have been written about his investing style.

Even if you stick to mutual funds, rather than picking individual stocks, Warren Buffett's method of stock selection can help you evaluate the skills and strategy of a mutual fund manager.

Here are some picks. The best investors, like Warren Buffett, use a strong understanding of the fundamentals to inform their personal investment philosophies. One good place to begin developing your own foundation is an anthology.

Charles Ellis, a money manager himself, compiled Classics: An Investor's Anthology for an audience of students and professional money managers. It includes many short pieces by respected investment thinkers -- the kind of material that has appeared in professional journals over the years.

When it comes to economic trends, history often repeats itself. Familiarizing yourself with the history of investment ideas is one of the most effective ways to prepare for the future.

The Only Investment Guide You'll Ever Need isn't quite what its title claims, but it's one of the books every investor should read. The book was written by Andrew Tobias and first published back in 1978, when very few readers sought out books about personal finance. It became a national best seller for two reasons: the book is funny and creative.

The revised version is worth reading whether you are a novice or an expert. Tobias' ideas about taxes, commodities, stocks, insurance and other financial matters will help you rethink some of the conventional wisdom that gets many investors in trouble.

Want a good story? Have a look at Buffett: The Making of an American Capitalist. This lively, well-researched biography is a great book about his life and his investment methods.

It's also great background for readers who want to dip into The Essays of Warren Buffett: Lessons for Corporate America that is edited by Lawrence A. Cunningham. Buffett has never written a book, but his annual letters to shareholders are famous for their wit and intelligence. Cunningham has compiled some of the best material in this slim book. This book serves as a window onto his methods and his beliefs.

Here's a brief sample: "I've said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. I just wish I hadn't been so energetic in creating examples. My behavior has matched that admitted by Mae West: 'I was Snow White, but I drifted.'"

The Snowball: Warren Buffett and the Business of Life is unique among other Buffett pieces. The author, Alice Schroeder, sits down with the legendary investor to discuss everything from Berkshire Hathaway(BRK.A Quote) to his family life. This book is the closest thing to a Buffett autobiography on shelves today.

To truly understand Buffett, the best place to start is with his inspiration. Buffett got his start as a student of Benjamin Graham, the father of securities analysis. Graham's 1934 classic, The Intelligent Investor, is a wonderful introduction to the master's methods. The book has sold more than a million copies in hardcover; more importantly, it offers insight into how Graham thought about investing -- in particular his notion of a margin of safety. Graham advocated buying cheap stocks of companies with sound financials, establishing a "margin of safety" by purchasing the stock below its intrinsic value.

The Intelligent Investor suggests that stocks can be prudent investments, given the right approach. That idea shocked people who had endured the stock market crash of 1929 and the ensuing Depression. Jason Zweig, a senior writer for Money magazine, has done an excellent job in the latest issue of the magazine of updating the book without undermining its essential wisdom.

It was Graham's lessons that helped Buffett find winning companies such as Coca-Cola(KO Quote), Burlington Northern Santa Fe(BNI Quote), Goldman Sachs(GS Quote) and Nalco(NLC Quote).

For a little hint to readers who may find the 368-page book daunting, Buffett has gone on the record saying that the most crucial chapters in "The Intelligent Investor" are 8 and 20.

Navigating through the sea of investment advice books can be a daunting task. The Buffett basics are a good place to start, and the wisest investors will stay on top of new investing trends while keeping in mind the fundamentals.

Please leave your picks for the best investing books in the comments below.

This post has been republished from The Street, an investment news and analysis site.
Image from Wikipedia Commons.

Time Running Out On Financial Reform

Both Obama and Barney Frank want to see financial regulation passed by the end of the year, but the progress so far is not encouraging. Each day that meaningful reform is delayed makes success tougher, as public interest of the issue continues to fade. See the following discussion from Mark Thoma's blog.

Simon Johnson and James Qwak wonder how much political capital the administration is willing to use to meaningfully reform the financial system:

It's Crunch Time: The Fight to Fix the Financial System Comes Down to This, by Simon Johnson and James Kwak, Commentary, Washington Post: The next couple of months will be crucial in determining the shape of the financial system for decades to come. And so far, the signs are not encouraging.

The Obama administration is trying to refocus our attention on regulation, beginning with the president's speech in New York two weeks ago. ... Barney Frank, chairman of the House Financial Services Committee, says that he still plans to pass a regulatory reform bill before the end of the year.

But in a clear indication of trouble ahead, Frank signaled his intention last week to scale back the proposed Consumer Financial Protection Agency, one of the pillars of the administration's reform proposals. ...

We have criticized the administration's reform proposals, in particular for not going far enough to address the problem of financial institutions that are "too big to fail." But we support much of what was in the original package... The question now is how hard Obama and Geithner will fight for it.

Financial regulation, like health care reform, has entered the phase where speeches and proposals matter less than arm-twisting and horse-trading on Capitol Hill. With health care, President Obama attempted to go over the heads of Congress, directly to the American people. With financial regulation, that is no longer an option, given the extent to which it has faded from public consciousness. Instead, the administration is playing on the home turf of the banking industry and its lobbyists. ... Is Obama up for this fight? ...

Elections have consequences, people used to say. This election brought in a popular Democratic president with reasonably large majorities in both houses of Congress. The financial crisis exposed the worst side of the financial services industry to the bright light of day. If we cannot get meaningful financial regulatory reform this year, we can't blame it all on the banking lobby.

The initial bill needs to be as strong as possible, and I agree that the administration needs to do what it can to prevent the bill from being scaled back. However, the initial legislation won't be as strong as I'd like even if the administration does prevail. But I hope we aren't thinking that we'll take one stab at financial reform and then we'll be done with it. Like climate change and health care, it will require a series of bills to achieve effective reform.

This post has been republished from Mark Thoma's blog, Economist's View.

The Impending Commercial Real Estate Crisis

Commercial real estate may be a ticking time bomb that could create a whole new set of problems for the struggling economy. The commercial real estate market, which is half the size of the residential real estate market, is nearing a breaking point as more tenants leave and refinancing becomes impossible for more landlords. See the following post from Tom Dyson from Daily Wealth for more on this.

This weekend, I had pizza and beer with an executive at a commercial real estate company...

My friend's company is one of the largest office landlords in America, with big investments up and down the East Coast. My friend manages the debt-finance division.

"So is there a commercial real estate crisis coming?" I asked.

"Yes. Absolutely," he said. "It's definitely coming."

"How do you know?"

"Nobody can refinance their loans. You have to be able to roll your debt. But if the property isn't worth as much as the debt, you can't roll it over. And there's a lot of debt coming due soon. We were fine... But we've slowly lost tenants. Now we've got a couple of buildings where rent doesn't cover the mortgage. We're giving these buildings up soon..."

He said his company is sending the keys back to the bank.

"It'll damage our reputation," he said. "We've never given up property before. But we don't have a choice."

Over the last decade, commercial real estate boomed. All over the country, players took on trillions of dollars in debt to buy malls, warehouses, office towers, and industrial parks, believing prices and rents would rise forever.

The recession caused consumers to stop shopping and retailers to stop hiring. Occupancy levels and rents started falling. Commercial real estate prices should have collapsed...

Here's the thing: So far, the commercial real estate market has held up better than the residential market. According to my friend, this is for two reasons. First, commercial real estate is mostly leased to tenants. In the residential market, you walk away as soon as you get underwater. But in the commercial market, you don't mail the keys back to the bank until your tenant leaves. Because occupancy erodes slowly, there's a delay in defaults.

Secondly, the new mark-to-market accounting rules kept the game going. These rules free banks from reporting loan losses until their loans mature. And they free commercial real estate owners from reporting investment losses until they sell the property. In other words, they give banks a huge incentive to extend bad loans and companies a huge incentive to keep holding properties.

Investors and banks hoped if they could hold on for long enough, the turnaround in the economy would rescue them. But it hasn't happened. Now, according to my friend, the reckoning is here for commercial real estate.

One way to play the coming crisis is to short the stock prices of commercial property REITs, like Boston Properties, Simon Properties, Prologis, and Vornado. These companies hold billions of dollars in investment property that needs marking down, and their stock prices have soared in the last six months.

Shorting regional banks is another way. Many regional banks have huge exposure to commercial property.

Finally, you could just short the stock market. When the residential real estate market collapsed, it brought America's financial system to its knees. The commercial real estate market is half the size of the residential market. Its collapse may not cause another credit crunch, but it'll definitely knock a few points off the S&P...

One word of warning: Standing in front of a freight train is never a good idea. These investment ideas are all rising in a powerful uptrend right now. I’d wait for a 10% decline in the S&P before you start placing these short trades.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

Why Financial Innovation Is A Very Good Thing

Destructive financial innovations like derivatives have eroded the public's trust and made financial innovation a bad word. However, there are still financial innovations that can help the average American, and Robert Shiller argues why financial innovation is still needed. See the following post from Economist's View for more.

Robert Shiller defends financial innovation:

In defense of financial innovation, by Robert Shiller, Commentary, Financial Times: Many appear to think that the increasing complexity of financial products is the source of the world financial crisis. In response to it, many argue that regulators should actively discourage complexity. ... They do have a point. Unnecessary complexity can be a problem ... if the complexity is used to obfuscate and deceive, or if people do not have good advice on how to use them properly. ...

But any effort to deal with these problems has to recognize that increased complexity offers potential rewards as well as risks. New products must have an interface with consumers that is simple enough to make them comprehensible, so that they will want these products and use them correctly. But the products themselves do not have to be simple.

The advance of civilization has brought immense new complexity to the devices we use every day. ... People do not need to understand the complexity of these devices, which have been engineered to be simple to operate.

Financial markets have in some ways shared in this growth in complexity, with electronic databases and trading systems. But the actual financial products have not advanced as much. We are still mostly investing in plain vanilla products such as shares in corporations or ordinary nominal bonds, products that have not changed fundamentally in centuries.

Why have financial products remained mostly so simple? I believe the problem is trust. ... People are ... worried about hazards of financial products or the integrity of those who offer them. ... When people invest for their children’s education or their retirement, they ... may not be able to rebound from mistaken purchases of faulty financial devices...

Thus, to facilitate financial progress, we need regulators who ensure trust in sophisticated products. ... They must ... be open to ... complex ideas ... that have the potential to improve public welfare.

Unfortunately, the crisis has sharply reduced trust in our financial system..., people do not trust some good innovations that could protect them better. ... I have proposed ... “continuous workout mortgages”...[to] protect against exigencies such as recessions or drops in home prices. Had such mortgages been offered before this crisis, we would not have the rash of foreclosures. Yet, even after the crisis, regulators seem to be assuming a plain vanilla mortgage is just what we need for the future. ...

Another innovation that is underused is retirement annuities... There are ... annuities that protect people against outliving their wealth,... that protect against inflation,... that protect against having problems in old age... and generational annuities that exploit the possibilities of intergenerational risk sharing. But most people do not make use of any of these.

Ideally, all of these protections for retirement income should be rolled into a unified product. Such products are not generally available yet. Certainly, people might be mistrustful of committing their life savings to such a complex new product at first even if it were available. So, such products are not offered and people often do nothing to protect themselves against most of these risks.

Behind the creation of any such new retail products there needs to be an increasingly complex financial infrastructure... It is critical that we take the opportunity of the crisis to promote innovation-enhancing financial regulation and not let this be eclipsed by superficially popular issues. ... Regulatory agencies need to be given a stronger mission of encouraging innovation. ...

Something has to assure people that these product are safe before they will purchase them. We might have expected the market to regulate risk not so long ago, and trusted it to do so, but that seems like a bad bet now. An "interface with consumers that is simple enough to make [the products] comprehensible" could build trust if people could believe that the person doing the simplifying had considered and understood every possible risk that is attached to the product, but did anybody really comprehend the big picture in our most recent crisis? If there were such people, there weren't very many of them, not enough to inspire confidence and trust more generally.

Another method of building confidence is ratings agencies, but they won't be trusted again any time soon. Regulators that make the public confident that nothing can go wrong would help too, but building that kind of trust in regulators after what just happened is a tall order. Private insurance of some sort is an option, but absent some sort of government guarantee, can private insurance companies be trusted with your life savings if there is a severe financial meltdown? People have even lost faith in government's ability to insure people against medical and financial calamity in old age, so when it comes to providing financial insurance, government is not the solid, trusted institution it was not so long ago.

As you tick down the list of ways trust might be restored, you find one failure after another in terms of providing reliable information on the risks of particular financial products or strategies, and no matter what regulators or anyone else tries to do to rebuild the trust in financial institutions and products that has been lost, recent track records make it likely that this will be a long, drawn out process. Given that forgetting about such risks over time seems to be an ingredient in the development of bubbles, I'll let you decide whether that's good or bad.

This post has been republished from Mark Thoma's blog, Economist's View.

Will You Be Seeing Capitalism: A Love Story?

Will you be watching Michael Moore's new movie that basically argues that capitalism is evil? Or are you outraged that Moore would use the recent financial failures to argue against the American economic system? Glen Hall, Editor-In-Chief of The Street, discusses why he will not be seeing this film.

Capitalism (the movie) came to New York on Monday and I missed the premiere.

I'm not too disappointed, mind you, since I haven't seen any of Michael Moore's movies. I can only take so much faux outrage (how's that for irony?).

I do love a good dose of hyprocrisy, though.

For that, I will turn to Michael Corkery, who did attend the premier of Capitalism: A Love Story at New York's Lincoln Center.

Corkery notes in The Wall Street Journal's Deal Journal blog that "before the film, the crowd sipped champagne and cocktails in the "Morgan Stanley Lobby" and then headed to their seats in the "Citi Balcony." Movie tickets were available at the "Bank of New York Box Office" and there's outdoor seating at the "Credit Suisse Information Grandstand."

So Moore owes the glamour and hype of Monday's event to the very institutions he brands as evil in the film. Let's hope Moore selected the venue on purpose to be ironic.

From what I can tell, the idea that capitalism is evil is pretty much the plot of Moore's film. On the movie's official Web site, Capitalism is described as an exploration of the "price that America pays for its love of capitalism."

I love this line from Kenneth Turan's review in the Los Angeles Times: Moore "lays the ills of American society that he's chronicled over all that time at the feet of an out-of-control free-market system he so detests that he puts priests on camera to talk about capitalism as morally evil."

All this makes me wonder where Moore keeps all the money he earns from his films, considering that he seems to hate banks, Wall Street and capitalism with such passion. Frankly, I don't really buy all that posturing. I think he secretly enjoys the fruits of capitalism.

I recall bumping into Moore at the 2004 Democratic party convention in Boston. He was the officially uninvited hero of the day because of his Bush-bashing film Fahrenheit 911. He was rather full of himself and certainly enjoying the spotlight. Was he engaging in the time-honored capitalist tradition of self promotion?

I didn't see Moore later that summer at the Republican convention in New York, but I'm sure he would have enjoyed the attention of being the anti-celebrity at the event if he could have found a way to get in.

Earlier this year, I almost bumped into Moore again when I unwittingly stepped onto the set of Capitalism as the film crew staged the scene of Moore driving an armored truck in a trumped up gesture to get taxpayer money back from the offices of AIG (AIG Quote) and Goldman Sachs (GS Quote).

I didn't see Moore. In fact, I hardly saw anyone except for the film crew. No one on the streets of lower Manhattan seemed to care. But then again, I'm sure Moore's message isn't for the folks in New York's financial district anyway.

In any event, Capitalism the movie begins a limited engagement for general audiences in New York tonight.

I won't be going. I prefer the real thing.

This post has been republished from The Street.

Why Going Green Doesn't Hurt The Economy

The cap and trade bill that has already passed the House, will undoubtedly lead to more rigorous debate across America. Opponents may argue that the cap and trade bill would have a significant negative impact on the economy. Paul Krugman discusses why this is a falsehood that has been conjured by misguided talk show hosts. See the following post from Economist's View.

The Waxman-Markley cap-and-trade climate bill won't destroy economic growth:

It’s Easy Being Green, by Paul Krugman:, Commentary, NY Times: So, have you enjoyed the debate over health care reform? Have you been impressed by the civility of the discussion and the intellectual honesty of reform opponents? If so, you’ll love the next big debate: the fight over climate change.

The House has already passed a fairly strong cap-and-trade climate bill, the Waxman-Markey act, which if it becomes law would eventually lead to sharp reductions in greenhouse gas emissions. But on climate change, as on health care, the sticking point will be the Senate. And the usual suspects are doing their best to prevent action.

Some of them still claim that there’s no such thing as global warming, or at least that the evidence isn’t yet conclusive. But that argument is wearing thin — as thin as the Arctic pack ice... So the main argument against climate action probably won’t be the claim that global warming is a myth. It will, instead, be the argument that doing anything to limit global warming would destroy the economy. ...

It’s important, then, to understand that claims of immense economic damage from climate legislation are as bogus, in their own way, as climate-change denial. Saving the planet won’t come free (although the early stages of conservation actually might). But it won’t cost all that much either.

How do we know this? First, the evidence suggests that we’re wasting a lot of energy right now...— a phenomenon known ... as the “energy-efficiency gap.” The existence of this gap suggests that policies promoting energy conservation could, up to a point, actually make consumers richer.

Second, the best available economic analyses suggest that even deep cuts in greenhouse gas emissions would impose only modest costs on the average family. Earlier this month, the Congressional Budget Office released an analysis of the effects of Waxman-Markey, concluding that in 2020 the bill would cost the average family only $160 a year, or ... roughly the cost of a postage stamp a day.

By 2050, when the emissions limit would be much tighter, the burden would rise... But the budget office also predicts ... that G.D.P. per person will rise by about 80 percent. The cost of climate protection would barely make a dent in that growth. And all of this, of course, ignores the benefits of limiting global warming.

So where do the apocalyptic warnings about the cost of climate-change policy come from?

Are the opponents of cap-and-trade relying on different studies that reach fundamentally different conclusions? No, not really. ... Instead, the campaign against saving the planet rests mainly on lies.

Thus, last week Glenn Beck — who seems to be challenging Rush Limbaugh for the role of de facto leader of the G.O.P. — informed his audience of a “buried” Obama administration study showing that Waxman-Markey would actually cost the average family $1,787 per year. Needless to say, no such study exists.

But we shouldn’t be too hard on Mr. Beck. Similar — and similarly false — claims about the cost of Waxman-Markey have been circulated by many supposed experts.

A year ago I would have been shocked by this behavior. But as we’ve already seen in the health care debate, the polarization of our political discourse has forced self-proclaimed “centrists” to choose sides — and many of them have apparently decided that partisan opposition to President Obama trumps any concerns about intellectual honesty.

So here’s the bottom line: The claim that climate legislation will kill the economy deserves the same disdain as the claim that global warming is a hoax. The truth about the economics of climate change is that it’s relatively easy being green.

[See also Can Countries Cut Carbon Emissions Without Hurting Economic Growth? by Robert Stavins.]

This post has been republished from Mark Thoma's blog, Economist's View.

Government Stimulus Boosts Wall Street

Despite the major cuts in consumer spending, the stock market is soaring because the government has more than picked up the slack. While consumers have started saving, it is the government who has gone on a shopping spree, buying cars , mortgages, and maybe even health insurance. See the following post from Economist's View for more on this topic.

There's not a populist bone in Robert Reich's body. Not a one:

Why the Dow is Hitting 10,000 Even When Consumers Can't Buy And Business Cries "Socialism", by Robert Reich: So how can the Dow Jones Industrial Average be flirting with 10,000 when consumers, who make up 70 percent of the economy, have had to cut way back on buying because they have no money? Jobs continue to disappear. One out of six Americans is either unemployed or underemployed. Homes can no longer function as piggy banks because they’re worth almost a third less than they were two years ago. And for the first time in more than a decade, Americans are now having to pay down their debts and start to save.

Even more curious, how can the Dow be so far up when every business and Wall Street executive I come across tells me government is crushing the economy with its huge deficits, and its supposed “takeover” of health care, autos, housing, energy, and finance? Their anguished cries of “socialism” are almost drowning out all their cheering over the surging Dow.

The explanation is simple. The great consumer retreat from the market is being offset by government’s advance into the market. Consumer debt is way down from its peak in 2006; government debt is way up. Consumer spending is down, government spending is up. Why have new housing starts begun? Because the Fed is buying up Fannie and Freddie’s paper, and government-owned Fannie and Freddie are now just about the only mortgage games remaining in play.

Why are health care stocks booming? Because the government is about to expand coverage to tens of millions more Americans, and the White House has assured Big Pharma and health insurers that their profits will soar. Why are auto sales up? Because the cash-for-clunkers program has been subsidizing new car sales. Why is the financial sector surging? Because the Fed is keeping interest rates near zero, and ... the government is still guaranteeing any bank too big to fail will be bailed out. Why are federal contractors doing so well? Because the stimulus has kicked in.

In other words, the Dow is up despite the biggest consumer retreat from the market since the Great Depression because of the very thing so many executives are complaining about, which is government’s expansion. And regardless of what you call it – Keynesianism, socialism, or just pragmatism – it’s doing wonders for business, especially big business and Wall Street. Consumer spending is falling back to 60 to 65 percent of the economy, as government spending expands to fill the gap.

The problem is, our newly expanded government isn't doing much for average working Americans who continue to lose their jobs and whose belts continue to tighten, and who are getting almost nothing out of the rising Dow because they own few if any shares of stock. Despite ... all their cries of "socialism" -- big business and Wall Street are more politically potent than ever.

It would have been better if the effort to revive the economy had a stronger trickle up component, i.e. give the tax cuts or transfers to the people who need it rather than those who don't, they will spend the extra money, it will trickle up as profits to the owners of businesses as the money is spent and re-spent through the multiplier process, and the owners will use the profits to hire more workers and to make productive investments (and even if the money doesn't trickle up as expected, at least you've helped people in need, when tax cuts for the wealthy don't trickle down, the consolation prize isn't as attractive).

This post has been republished from Mark Thoma's blog, Economist's View.

No Gold Bubble This Time

With gold reaching an all time inter-day high of $1,033, the skeptics might say this is starting to look like another bubble. However Chris Weber explains why there are simple signs that show that we are not seeing a bubble but rather an opportunity. See the following post from Daily Wealth for more.

When spot gold closed on September 11 in New York at $1,005.10, it was the highest price on record... though by the time you read this, it may have been surpassed.

Gold traded higher than this, back on March 17, 2008. When that day opened in Asia, the early morning Australian and Hong Kong markets pushed gold quickly up from $1,000 to a high – so far an all-time inter-day high – of $1,033.

But as Europe opened later in the day, the price fluctuated between $1,020 and $1,030. As the U.S. markets opened, the price plunged down to $1,000 and ended just three dollars more than this.

So if you are going by the closing trade of that day, which happens to be New York as time zones go, then what happened on Friday, September 11 broke the record.

This breakthrough has drawn a lot of publicity. Hedge funds are now heavily tilted toward the long side of the gold futures market. Many gold stocks sit near all-time highs. Mainstream newspapers and magazines are starting to carry stories about gold.

This bullish sentiment has led many people to ask me if gold is far too popular now... or even in a "bubble."

My answer: I see nothing like a bubble yet. Ask your friends or neighbors these questions:

"What do you think about gold or silver as an investment?" and if they answer in a positive manner, further ask: "What are the best ways to own it? How do you own it? What percentage of your assets do you have in the precious metals area?" If this seems too invasive, ask, "What percentage of a person's assets do you think should be in the precious metals area?"

That's what I do. The people I ask have no idea what I think about gold or silver. I ask just as a sort of person – maybe on the slow side and not that bright – who wants to know about the area.

From what I'm told, almost no one is in gold or silver. Maybe a few shares of Newmont Mining, but as a percentage of their total net worth, we are talking tiny here.

People who think gold is in a bubble are often people who did not see real bubbles when they happened. In the real estate boom, the easy profits were on everyone's lips. Same with the Internet bubble 10 years ago.

When I mentioned gold back in 2001 and 2002, when I accumulated it, I got looks from people as if I were crazy.

These days, the crazy looks are gone. But now I often only get answers that gold or silver may be a good investment, but they don't have any themselves. Try it yourself.

Of course, if you've been mouthing off about how great gold and silver are, you probably want to ask people who don't already know your views: They won't think you are trying to "lay your propaganda" on them.

Granted, the public awareness of gold and silver as investments is much, much higher today than in 2001. No one was buying then, and people thought you were crazy if you told them you were. But things haven't changed in that the average person still does not own any.

When everyone you know is talking about how to make "easy money" buying gold or silver, then we may be in a different era. But right now, I think both metals have more room, and most likely much more room, to go.

This post has been republished from Dr.Steve Sjuggerud's blog, Daily Wealth.

Democratic Presidents Have Better Stock Market Performance

Research suggests that stock market performance can be connected to the election cycle and the party that is in power. Interestingly, one paper found that 1 year after an election, democratic presidents presided over better performing stock markets than republican presidents. See the following post by James Picerno, for more on this.

Studying the election cycle and the stock market isn't new, but that doesn't stop inquiring minds from taking a fresh look at the numbers. CXO Advisory Group offers yet another perspective, albeit with middling results. As this research concludes,

"..there appear to be both long-term and short-term connections between the U.S. national election cycle and stock market performance, with presidential term year 3 (1) the best (worst) and a tendency for a brief election-time rally. However, the subsamples for presidential term year analysis are very small, so confidence in related tendencies is very low."

Meanwhile, a popular research paper from recent history advises that "the excess return in the stock market is higher under Democratic than Republican presidencies." Of course, that was from the vantage of 2003. Will the trend hold over the remaining years for the present incumbent? Based on the year-to-date returns so far, one might argue in the affirmative. But with the election more than three years away, a touch of modesty might still be in order.

SEI came to a similar conclusion last year, writing in a research note that "one year following [an] election, the average return of the DJIA was 2.18%. Here, the advantage goes to the Democrats, who averaged 5.43%, with the best year credited to Franklin D. Roosevelt, at 29.96% in 1944. Roosevelt also had the most negative return here; -28.68 during the first year of his first term in 1936. The average during the 9 Republican administrations was -1.07%."

Of course, some think there's enough of a challenge in predicting election outcomes alone without muddying the waters with adding stock market predictions to the game. If you're of a similar persuasion, Professor Ray Fair of Yale is your man. As one of the leading academics parsing the finer points of forecasting elections, he's well versed in the opportunities and limits of quantitative analysis and politics.

This post has been republished from James Picerno's blog, The Capital Spectator.

How To Stop The Next Financial Crisis

Are financial crises unpredictable or can we put simple financial indicators in place that will warn us before it is too late? An early detection system for financial danger that accurately pinpoints the type of danger we are facing could help prevent the next crisis. See the following post by Mark Thoma for more on this topic.

David Levine "aggressively argues":

our models don't just fail to predict the timing of financial crises - they say that we cannot.

The San Francisco Fed's Bharat Trehan says:

simple indicators based on asset market developments can provide early warnings about potentially dangerous financial imbalances. ... [W]e have taken two simple indicators off the shelf and shown that both would have signaled impending trouble prior to the current crisis. That makes it harder to argue that financial crises are, by their nature, unpredictable. And it shows that such simple indicators can be useful ... as signals of rising levels of risk in the economy.

See here. Or here.

We ought to be able to say, at the very least, something like:

If you keep eating that junky credit instead of a healthier financial diet, your monetary circulatory system is likely to have severe problems at some point in the future.

Many people had a sense things were out of balance and that at some point it would cause us problems, but the indicators most people looked at pointed to a diagnosis involving exchange rate movements and an international unwinding. The discussion centered on issues such as whether we would have a hard or a soft landing as this process unfolded, there was little discussion of the type of crisis that actually occurred.

So we need two things. First, we need indicators such as those identified in the SF Fed article that can tell us when danger is building in the financial sector.

But that is not enough. Though many people had a sense from the indicators they looked at that things were out of balance, the indicators pointed to international financial issues rather than the true problem, and hence most of the analysis and policy discussions were devoted to guarding against problems related to international financial flows.

Thus, the second thing we have a need for is a set of indicators that do a better job of telling us where the problems are likely to occur. That is where we made the biggest mistake, misdiagnosing the type of crisis that was coming. Having indicators that can do a better job of identifying the type of financial crisis we are facing will allow us to design and implement effective policy responses rather than wasting time analyzing and planning for the wrong type of crisis.

This post has been republished from Mark Thoma's blog, Economist's View.

Shiller Says We Need More Research On Economic Bubbles

With the failure of current economic models to give adequate warning of the current financial crisis, Robert Shiller says we need more research of bubbles and what their role should be in economic models. If we had a better understanding of bubbles, could we prevent them from reaching dangerous levels or detect trouble much sooner? The following article summarized by the Economist's View discusses this topic.

Robert Shiller says economists and their models need to take bubbles seriously (compare Dani Rodrik's "Blame Economists, not Economics"):

Economists need to study bubbles, reinvent models, by Robert Shiller, Commentary, Project Syndicate: The widespread failure of economists to forecast the financial crisis ... has much to do with faulty models. This lack of sound models meant that economic policymakers and central bankers received no warning of what was to come. ...

[T]he current financial crisis was driven by speculative bubbles in the housing market, the stock market, energy and other commodities markets. ... You won’t find the word “bubble,” however, in most economics treatises or textbooks. Likewise, a search of working papers produced by central banks and economics departments in recent years yields few instances of “bubbles” even being mentioned. Indeed, the idea that bubbles exist has become so disreputable ... that bringing them up in an economics seminar is like bringing up astrology to a group of astronomers.

The fundamental problem is that a generation of mainstream macroeconomic theorists has come to accept a theory that has an error at its very core — the axiom that people are fully rational. ...

[E]conomists assume that people ... use all publicly available information and know, or behave as if they know, the probabilities of all conceivable future events. ... They update these probabilities as soon as new information becomes available and so any change in their behavior must be attributable to their rational response to genuinely new information. If economic actors are always rational, then no bubbles — irrational market responses — are allowed. ...

In fact, people almost never know the probabilities of future economic events. They live in a world where economic decisions are fundamentally ambiguous, because the future doesn’t seem to be a mere repetition of a quantifiable past. ...

To be sure, the purely rational theory remains useful for many things. ... Economists have also been right to apply his theory to a range of microeconomic issues... The theory, however, has been overextended. For example, the “Dynamic Stochastic General Equilibrium Model of the Euro Area,” developed by Frank Smets ... and Raf Wouters..., is very good at giving a precise list of external shocks that are presumed to drive the economy, but nowhere are bubbles modeled. The economy is assumed to do nothing more than respond in a completely rational way to these external shocks.

Milton Friedman and Anna Schwartz, in their 1963 book A Monetary History of the United States, showed that monetary-policy anomalies — a prime example of an external shock — were a significant factor in the Great Depression of the 1930s. ... To some, this revelation represented a culminating event for economic theory. The worst economic crisis of the 20th century was explained — and a way to correct it suggested — with a theory that does not rely on bubbles.

Yet events like the Great Depression, as well as the recent crisis, will never be fully understood without understanding bubbles. The fact that monetary policy mistakes were an important cause of the Great Depression does not mean that we completely understand that crisis, or that other crises fit that mold.

In fact, the failure of economists’ models to forecast the current crisis will mark the beginning of their overhaul. This will happen as economists’ redirect their research efforts by listening to scientists with different expertise. Only then will monetary authorities gain a better understanding of when and how bubbles can derail an economy and what can be done to prevent that outcome.

This post has been republished from Mark Thoma's blog, Economist's View.

Saving Money Could Become Popular Again

According to a poll by American Express, it looks like Americans have shifted their consumer behavior to be more likely to save extra dollars. However according to Alan Greenspan, this could slow economic growth in an economy driven by personal consumption. For more on this, see the post below by Tim Iacono.

We're all going to be hearing a lot about the "paradox of thrift" in the months (and probably years) ahead, the well worn maxim that economic growth suffers when more people save, due to the fact that more saving means less spending.

This report in the LA Times covers the topic quite well.

After the most punishing downturn in half a century, the U.S. economy has finally begun showing signs of renewed life. Stock prices and factory orders are up. The housing market appears to be stabilizing. Job losses are moderating. Overall, the economy has begun to grow, officials believe.

Welcome as all those developments are, many analysts worry that they may not be enough to offset another trend: the continuing refusal -- or in many cases the inability -- of millions of U.S. consumers to go out and spend money the way they did before the crash.

Yes, conventional economic "wisdom" has it that there was nothing fundamentally wrong with an economy where more than 70 percent of all activity came from personal consumption.

As formerly spendthrift consumers all across the country begin to rebuild their personal balance sheets, now realizing that their home equity isn't going to fund their kids' higher education and their own retirement, more traditional methods of saving (e.g., spending less than you make) are becoming popular again.

No less an economic expert than former Fed chairman Alan Greenspan feared this development not long ago, noting that a higher personal saving rate (after tax income minus spending) could make an economic recovery difficult.

He seems to be right about a lot more things in retirement than when he ran the central bank.

When American Express asked a sampling of 2,032 people late last month what they would do if they found $500, the answers were like a pitcher of ice water in the face of retailers. Survey respondents were offered a list of possible spending choices that included splurging at a restaurant, going on a shopping spree and taking a trip.

But a mere 10% or fewer marked one of those items. Most went down the list and checked off paying regular bills, reducing credit card debt or simply saving the money.

"What we see consumers doing is exhibiting a level of discipline that we didn't know," said Gail Wasserman, a spokeswoman for American Express, which like other card companies has reinforced the reduced- spending trend by issuing fewer cards and slashing credit lines to lower their own risks.

"It's very clear consumers have hit the reset button. They've reevaluated their priorities and separated their wants from their needs," Wasserman said.

Apparently, that's what happens when you reach the maximum level of debt that a system can sustain and asset prices can be pushed no higher - you hit the reset button.

That is an odd analogy - hitting the reset button.

For example, when computers are functioning properly, there is no need to reboot. Normally, it is only when things go awry that a restart is needed. It seems that if the system had been designed a little better, there would be no need to reset it...

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Could China's Government Send Gold Soaring?

As the value of the US dollar goes down, holding dollars could become more of a risk to your portfolio. That is why hedging your investments in gold could be a smart move. The following post from Daily Wealth discusses the possibility of a looming gold bubble.

Inside sources have recently confirmed the Chinese government is actively promoting gold and silver investment to the masses.

Some analysts now contend that China can no longer afford to let the gold or silver price slump.

The rationale behind that contention is that with the Chinese government now telling the general populace to buy precious metals, it would be highly problematic should gold and silver subsequently take a nose dive.

In many cases, what a government wants and what ultimately occurs can be wildly different, due to unintended consequences rarely foreseen by officialdom, and because once the masses get it into their heads to break one way or another, government's desires are largely ignored.

"You shall not smoke marijuana," says the government. "Roll me another," says John Q. Public.

But in the case of gold, interestingly enough, the Chinese government has the means at its disposal to actually do something about prices. Namely, at $1,000 an ounce, the total value of all the gold ever mined comes to about $5 trillion.

Of that amount, less than $1 trillion is held in official reserves, the rest under mattresses, in jewelry and family heirlooms, and in various ETFs – GLD being the biggest, by far, holding about $34 billion worth of gold.

Against these totals, China has foreign reserves in excess of $2 trillion.

In other words, more than enough to push the tiny gold market around in any way it wishes. Given that much of its reserves are now denominated in fragile U.S. dollars that it would sorely love to replace with something more tangible, and that China is the world's largest gold producer, the country's involvement with gold is something more than just a passing fancy.

Simply, there is a new gorilla in the room in global gold markets. The extent to which the broader market hasn't yet figured this out is the extent to which you as an early mover can ultimately profit. Especially in the more leveraged gold stocks, which continue to be strong even as the broader markets show weakness.

That all of this comes before the dollar hits the wall it must hit, or before the inflation that is now baked in the cake arises, lends a lot of credibility to the idea that when the gold bubble begins to expand, it could reach all the way to the moon.

No need to chase gold at these levels, as opposed to buying on dips. But buy.

This post has been republished from Steve Sjuggerud's blog, DailyWealth.

A Closer Look At The $2 Trillion Increase In Household Net Worth

According to the Fed, Americans are $2 trillion richer in the second quarter, but is this an accurate reflection of reality? It turns out that almost all of the gains were in equities and mutual funds which accounted for a $1.6 trillion of the increase, while liabilities shrunk by $35 billion. For more on this, see the following post by Tim Iacono.

The Federal Reserve's Flow of Funds report with data through the second quarter of 2009 was released yesterday and the $2 trillion improvement in household net worth was in all the headlines. As shown in the slight expansion of the green portion of the chart below, it was all about a rising stock market.



The rising value of equities and mutual funds accounted for a whopping $1.6 trillion of the overall increase of $1.9 trillion in assets while liabilities fell by about $35 billion.

Overall household liabilities declined for the third consecutive quarter which, while understandable, given the change in attitude toward debt by the American consumer, does not bode well for an economy where asset prices must be perpetually pushed higher by rising levels of debt in order for us all to succeed.

Clearly, the plan here is that, since consumers can't really handle any more debt (especially since a growing number of them don't have jobs), the government is stepping in to fill the void.

As for real estate, there is some good news for homeowners as the overall value of property ticked up during the second quarter.



While the amount of outstanding mortgage debt owed by households fell by about $30 billion to $10.4 trillion in the second quarter, the value of real estate reportedly increased by 1.8 percent, from $17.949 trillion to $18.272 trillion.

This is largely consistent with the Case-Shiller national home price index that rose 2.9 percent from the first quarter to the second, though it's hard to believe that this is the beginning of a new trend of rising home prices.

Then again, since the Federal Reserve has pushed mortgage lending rates down to freakishly low levels by printing money and the U.S. government now owns or guarantees virtually the entire U.S. mortgage market while Congress appears ready to double the $8,000 home buyer tax incentive ... anything could happen.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Should We Tolerate A Jobless Recovery?

Although the recession may have technically ended, millions are still without jobs and thousands are still losing their jobs. Should the federal government do more to fight the jobless recovery or should we tolerate a slower recovery without jobs? Economist Mark Thoma from Economist's View discusses this topic in the following post.

There is news on weekly jobless claims. Despite all the attempts to paint this as good news, the fall of 12,000 from the previous week is being highlighted in many places, 545,000 new claims is still very high and indicates that the recession is not yet over for workers:

Jobless Claims Decline, WSJ: Initial claims for jobless benefits fell 12,000 to 545,000 in the week ended Sept. 12...

The four-week average of new claims, which aims to smooth volatility in the data, fell by 8,750 to 563,000 from the previous week's revised figure of 571,750.

With claims still at a fairly high level, the data seems to reinforce the idea expressed earlier this week by U.S. Federal Reserve Chairman Ben Bernanke that the recession is most likely over from a technical standpoint but it will take time for the labor and credit markets to recover...

The ... number of continuing claims -- those drawn by workers for more than one week in the week ended Sept. 5 -- rose by 129,000 to 6,230,000 from the preceding week's revised level of 6,101,000.

Amid all the optimism that seems to be pervading the coverage of the economy, a mood that is being intentionally stoked by policymakers eager to rebuild confidence, we'll have to keep reminding everyone that workers still need help (I'm seeing more and more stories, for example, about unemployment benefits running out for some workers even as long-term unemployment continues to rise). As this picture from the SF Fed shows, the employment series does not yet display the "fishhook" shape shown in other series that are the source of the declarations that the worst is behind us. And as the experience of the last recession in the graph below shows, the trough in employment can be far behind the trough in output:

One more note on this. I was pleased to see McClatchy News at least asking the question in "Will Obama, Fed tolerate another jobless recovery?," so it's not completely off the radar and perhaps this will help to get the message to policymakers in congress. As for the Fed, as the futures market for the federal funds rate shows, markets believe rate hikes aren't far away indicating a belief among market participants that as output begins recovering, inflation worries will trump concerns about employment:

Have We Learned Nothing From The Financial Crash?

A year after the Lehman fiasco, it seems as if Wall Street has learned nothing from the financial implosion. Banks are still growing larger and risk taking behavior has returned. Stanley Bing from The Street explains why we should not be surprised.

The news is full of pundits, analysts and even a president opining on the state of the finance business one year after the big plotz. Consensus is that we've all learned nothing. The big banks are getting bigger. Risky instruments are reappearing. The Street is once again getting on its high horse about over-regulation. Thinking people, quite naturally, are worried. We're not even out of the woods yet and here come the same old players starting to sing the same crazy tune.

The critics just don't get it. Wall Street isn't a rational, thinking creature. Oh sure, it's got charts and graphs and metrics and fetrics. But if you want to know the way things really operate, you have to look at a creature that isn't driven by its brain, but by its heart... and by any other organ that responds to that beat.

In short, Wall Street has all the sentience, maturity and emotional self-control of a teenager... or maybe of a 50-year-old guy with a tiny ponytail and a red BMW Z4.

Last year, before the breakup, he was so excited. Love was in the air, and with it lots of money. Love involves risk, of course. But that's at the core of what's so exciting! No risk? No passion. Particularly for an entity whose emotions are quite immature, who needs daily stimulation to remain engaged, who requires the tang of danger to feel fully alive. Those were great days! Ah, to be rich and in love!

Then... the unthinkable happened. The big breakup. Poor Street's heart was broken and what was worse, his belief that the risk was worth taking ever again was smashed to pieces. Poor guy. He languished for months, afraid to grant credit, terrified of incurring debt, sleeping much of the day away, waiting for nighttime when it was permissible to drown his sorrows.

And yet, the heart of the crazy, irrational Street is strong. He can't live without that rush of endorphins that comes with the high-wire act! So now he's coming back, ready to love again, to make the plunge, to take those risks, even the stupid ones he knows will lead to his destruction again.

It this wise? Is this the behavior of a thoughtful, mature person? Certainly not. He's a mad, impetuous fool! He can't live without the thrill of the chase, the agony of anticipation, the ache, the yearning, the oasis of glory and satisfaction in the desert of life! He won't! Step aside, world! Love is in the air! He's apt to do just about anything!

Can't anybody keep an eye on him, for his own good?

This post has been republished from The Street.

We Need Answers On Financial Reform

Daniel Dicker from The Street says we need more specifics about financial reform. With financial reform seeming to have fallen behind health care as the top priority of the Obama administration, Dicker fears that we may be missing an opportunity to regulate potentially harmful financial instruments. See the following post from The Street for more on this.

In the wake of President Obama's speech Monday, one piece of possible finance reform less explored is with derivatives, including credit default swaps, commodities and other over-the-counter issues. Despite the president's inspired speech preaching responsibility on Wall Street, we really haven't come very far in this area in the year since the demise of Lehman Brothers.

Part of the problem I had with his impassioned speech was with the lack of specifics. Despite being a great supporter of the president and having voted for him, I find many of his speeches great oratory events with little substance contained in them.

In his talk of finance reform, Obama made some vague calls for increased capital requirements for the big banks, a requirement that in and of itself wouldn't have prevented the cataclysm we experienced last year.

As to the most important ideas of transparency in markets, Obama focused on the idea of a "consumer czar" or other advocate in Washington who would somehow prevent the sale of mortgages that people couldn't understand or afford. How this would be done, however, remains a mystery.

But derivatives, which clearly exacerbated the financial downturn last year, were left conspicuously out of the president's speech. This is an interesting omission because they had gotten so much interest in their operation and their reform last year, but now seem to be on a very far back burner and not gaining much attention anymore.

This is a shame because I believe that derivatives, much more than shady mortgage practices, create a far greater threat to our financial health going forward.

What's interesting is that the Bush administration had taken the greatest strides in bringing transparency to this market, and the Obama administration, while having public sentiment and great momentum on their side, has really dropped the ball here and squandered a great opportunity.

It was former Treasury Secretary Henry Paulson who issued the ultimatum for transparency in credit default swaps, requiring a clearinghouse structure for clearing of these instruments. But since President Obama was inaugurated, Treasury Secretary Tim Geithner has done nothing to follow up on these initiatives, essentially leaving the market exactly as it was and leaving us open again for another "AIG(AIG Quote)-like" problem.

To the detriment of our economy, especially consumers, oil and other commodity markets have continued to show increased and unceasing volatility. They are being moved by investment capital, hedge funds, uncontrolled ETFs and just about everything except the fundamentals.

Despite our new president's impressive speeches, absolutely nothing has been proposed or undertaken to get a better handle on the roiling commodity markets.

And those markets are just a microcosm of the rest of the enormous over-the-counter markets of specialized and non-standardized forwards and swaps.

While the CDS market with its $26 trillion notional value has been the most visible of the OTC markets because of the trouble they've caused, other markets traded in the shadows of the investment banks pose as much or more of the same kind of risks in the future. In getting a handle on credit default swaps, a model for dealing with systemic risk in all of the OTC markets might be found.

You won't find enthusiasm from the biggest investment banks like Goldman Sachs(GS Quote), Morgan Stanley(MS Quote), UBS(UBS Quote), JPMorgan Chase(JPM Quote) and others, who derive terrific percentages of their profits from OTC trading for reform in these markets, many of which they created.

And other open exchanges that would benefit from transparency in the trading of CDS issues and other OTC swaps like the Chicago Mercantile Exchange(CME Quote), IntercontinentalExchange(ICE Quote) and the NYSE Euronext(NYX Quote) are less apt to push hard for reform because their biggest potential clients in these new markets are those same investment banks. You can't bite the hand that ultimately feeds you.

Good results from the stimulus package, bank bailouts and Fed guarantees of mortgages that halted the stock market slide and a total seizure of the credit markets have also stemmed the interest of market reform that got us into this mess in the first place.

This is a dangerous, if perfectly understandable reaction. Nobody ever thinks of fixing a hole in the ceiling more desperately than when it's raining. But when the rain stops and water isn't dripping on your head, that hole seems far less important to fix.

And Obama may be even less able to tackle these problems than his predecessor, despite his greater natural ease towards reform. The current administration has taken on quite a few issues at once and while the economy was clearly job one immediately after inauguration, it now feels as if it has taken a back seat to health care reform. One visit to Federal Hall yesterday on Wall Street and one speech, no matter how rousing, can change the amount of political capital that any president has and where he spends it first.

So a year after the fall of Lehman, it seems that we are nowhere closer to reforming or even creating new rules for the markets that were the source of all the difficulties last year -- including credit default swaps, commodities and other OTC markets.

I think we will live to regret having missed this opportunity.

This article has been republished from The Street.

Government Stimulus: No Exit In Sight

While most experts are in agreement that we are in the early stages of economic recovery, there is still no signs of a plan to wean the country off the cocktail of stimulus medicine. Is it time for the government to start reducing the monetary and fiscal tools that are artificially propping up the economy, or should it wait until it is obvious that the economy is on solid footing? See the following post from Capital Spectator for more on this topic.


We've been writing for months that the recession appears close to a "technical" finale but that the recovery would be slow, sluggish and generally vulnerable for an unusually extended period of time. Two stories in the latest news cycle echo our long-running commentary. In fact, the pair of stories makes the point better than we could.

First, Fed Chairman Ben Bernanke yesterday stated: "From a technical perspective, the recession is very likely over at this point" but "it's still going to feel like a very weak economy for some time," via MarketWatch.com.

Meanwhile, today's New York Times has a story that raises questions about how soon the housing market can function under its own power. At issue is a key piece of the government's fiscal stimulus—the $8,000 tax credit for first-time home buyers. As the Times observes, "When Congress passed an $8,000 tax credit for first-time home buyers last winter, it was intended as a dose of shock therapy during a crisis. Now the question is becoming whether the housing market can function without it." Although housing is but one piece of the economy, its trials and tribulations capture a core element of the economic turmoil of late. It may be too much to say that the housing market is a bellwether for the general economy, but it's close.

More to the point, the Times story reminds us of one of the potential drawbacks of stimulus, monetary or otherwise: markets may get used to the idea and so taking it away, which can cause secondary problems, depending on the exit strategy. That's not to say that stimulus was unnecessary. But in the rush to smooth over the crisis of the past year, cleaning up the mess born of the emergency financial and economic surgery promises to be the new new challenge in the months and years ahead.

Arguably that's a challenge that's superior to letting an economy implode, if in fact that really was a risk, as it seemed to be at times last fall. But the nature of trying to manage the business cycle imposes costs too. In effect, we're now faced with managing a chronic risk in the economy in exchange for minimizing if not sidestepping the acute risk that arose last autumn. Was the exchange worth it? The default answer is that the outcome will be a wash, when measured over the long run. In the short term, however, the details are messy.

This article has been republished from James Picerno's blog, The Capital Spectator.

Dollar Could Be Weak For Next Six To 12 Months

While the US economy may be on the way up, the outlook for the dollar is tumbling. According to Giles Keating, head of the Credit Suisse Global Economics and Strategy Group, the dollar could be weakened for the next six to 12 months as international investors find themselves with too many dollars. See the following post from HousingWire Buzzpost for more on this.

After beating up on the brokers, let’s give them a rest and bash the greenbacks!

Well, a report from Credit Suisse may do that for us. When the firm sat down with Giles Keating, the head of Credit Suisse Global Economics and Strategy Group, he noted that the dollar would be the first victim of the global economy’s recovery.

So, does that mean we’re recovering? Keating thinks so, even though he states that the resurgence is starting from a very low base and that we still have lots of unused capacity and high unemployment.

He points to the investors who were left behind by the initial pick-up in the stock market and their eagerness to put their money back to work, and he notes that policy makers have signaled that they would maintain a “very expansive economic policy” that will keep interest rates low and continued fiscal spending.

But the dollar could be left behind, he says. In fact, it’s already showing a downturn.

“The dollar has seen some big downward movements over the last couple of weeks, and although we think that this won’t continue in a straight line, we do think it likely that the dollar will continue to weaken over the next six to 12 months,” Keating says.

Russia and China aren’t helping with their push for a new currency at the recent G20 hearings, and Keating points to the low interest rates, almost zero, set in the US. He says the dollar has always needed an interest rate premium greater than that in Europe in order to remain stable or rise in value.

“Another key reason is that, strangely, as financial conditions get less risky and become more stable, people tend to move out of the dollar,” Keating says. “Moreover, a lot of people put money into the dollar during the crisis, and now they have too many dollars.”

This post has been republished from HousingWire Buzzpost.

Commercial Bank Money Supply Falling At Alarming Rate

Ambrose Evans-Pritchard warns that the commercial bank money supply has been contracting by levels comparable to the Great Depression. Futhermore, bank lending has shrunken a worrying 14 percent over the past three months. See the following post from The Mess That Greenspan Made for more on this.

Ambrose Evans-Pritchard writes in the Telegraph of the mounting concern (at least, in some quarters) about the rapid contraction in money supply and credit. Along with his Cheshire grin, Pritchard offers up something that we haven't heard for months now - a few comparisons to the Great Depression.

Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation.

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

The M3 "broad" money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate.

Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc.

"For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said.

Not having looked at M3 for some time now, the broadest measure of money supply but one that is no longer reported by the U.S. government, the graphic you see below was something of a surprise when recently spotted over at NowAndFutures.

This is not what most cynics thought the Federal Reserve would be trying to hide when they discontinued this data series a few yeas ago.



The inflation/deflation debate is clearly not yet over, though, given the looks of asset markets and commodity prices all around the world, it looks like the former has the upper hand - at least for the time being.

Back to Ambrose...

It is unclear why the US Federal Reserve has allowed this to occur.

Chairman Ben Bernanke is an expert on the "credit channel" causes of depressions and has given eloquent speeches about the risks of deflation in the past.

He is not a monetary economist, however, and there are indications that the Fed has had to pare back its policy of quantitative easing (buying bonds) in order to reassure China and other foreign creditors that the US is not trying to devalue its debts by stealth monetisation.
...
US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.

Mr Congdon said IMF chief Dominique Strauss-Kahn is wrong to argue that the history of financial crises shows that "speedy recovery" depends on "cleansing banks' balance sheets of toxic assets". "The message of all financial crises is that policy-makers' priority must be to stop the quantity of money falling and, ideally, to get it rising again," he said.

He predicted that the Federal Reserve and other central banks will be forced to engage in outright monetisation of government debt by next year, whatever they say now.

That would appear to be a good bet at the moment, however, it is a matter of degree.

In the U.S., the Fed's purchase of up to $300 billion in U.S. Treasuries along with a trillion dollars or so in GSE MBSs and other agency debt hasn't brought the world to an end, however, the Chinese aren't all that happy about it.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.