Economic Darwinism

Letter to Obama: Losing Political Capital

Posted in Action, Barry Ritholtz, Bernanke, Geithner, Greenspan, Obama, Paulson, The Big Picture by Economic Darwinism on June 18, 2009

Dear President Obama,

I say this as a supporter and as someone who wishes you success as we face extreme challenges on many fronts. I work among conservative Republicans and actually had to sneak out of the office to watch your inauguration. It was a touching and historic moment I will never forget.

You are on the verge of losing whatever political capital you had coming into office due to your refusal to acknowledge that the people you are relying on for economic policy are the very people who are responsible for getting us into this situation. Greenspan, Bernanke, Paulson, and now Geithner (and Summers) all continue to fail to see the causes of the crisis. As a consquence, current proposed regulatory reform is bound to fail yet again.

At this point, the rapid loss of confidence in both Geithner and Bernanke are weakening your ability to push your agenda in other critical matters. You must do something to remove them both or you will  imperil your potential to accomplish lasting and necessary change.

Please listen to Barry Ritholtz*  and others such as Alan Blinder who actually understand what is happening. In particular, see Ritholtz’ article

Obama Reform Plan Fails to Fix Whats Broken

He enunciates six unacceptable weaknesses in your proposal:

1) No major changes for the ratings agencies!

2) Turn Derivatives into Ordinary Financial Products

3) If they are too big to fail, make them smaller.”

4) The Federal Reserve, Despite its Role in Causing the Crisis, Gets MORE Authority

5) Require leverage to be dialed back to its pre-2004 levels.

6) Restore Glass Steagall

All of which suggests that the status-quo-preserving, sacred-cow-loving, upward-failing duo of Lawrence Summers and Tim Geithner are still in control of economic policy. The more pragmatic David Axelrod and the take-no-prisoners, don’t-give-a-shit-about-Wall-Street Rahm Emmanuel have yet to assert authority over the finance sector.

All these should be considered uncompromising requirements of any regulatory reform. Anything less than these six items will have no positive effect and will likely lead to another crisis before the end of your first term.

You are running out of time.

*Author of Bailout Nation and the phenomenal blog The Big Picture.

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Geithner’s Plan: Initial Thoughts

Posted in Action, America, Bailout, Bernanke, Geithner, Greenspan, Obama, Protest by Economic Darwinism on March 23, 2009

Here are my initial thoughts while they are still fresh. From the Wall Street Journal:

No crisis like this has a simple or single cause, but as a nation we borrowed too much and let our financial system take on irresponsible levels of risk. Those decisions have caused enormous suffering, and much of the damage has fallen on ordinary Americans and small-business owners who were careful and responsible. This is fundamentally unfair, and Americans are justifiably angry and frustrated.

So far so good. But why did we borrow too much? Because we could. Why could we? Because the Fed held rates too low on the short end and oil exporting countries and Asian savers (supposedly) kept longer maturity rates anchored. When he says “we borrowed to much”, he must be referring to his predecessors at the Treasury as well as the Fed.

The depth of public anger and the gravity of this crisis require that every policy we take be held to the most serious test: whether it gets our financial system back to the business of providing credit to working families and viable businesses, and helps prevent future crises.

Hold on one second. Working families and viable businesses do have access to credit. Just not at ridiculously unreasonably low yields that do not incorporate risk premia. Anyone who can put 20% down payment on a house should have no problem getting a mortgage even today. Businesses that need a loan may need to pay higher rates that are dependent on what the lender perceives the risk to be. That is how it should be. What he seems to be saying is that we want to give away free credit as if risk premia is a thing of the past. That is precisely what Greenspan and Bernanke have done for the past 20 years and is a primary reason why we are in the situation we are in. I’m worried. I hope it gets better from here.

We launched a broad program to stabilize the housing market by encouraging lower mortgage rates and making it easier for millions to refinance and avoid foreclosure.

My gut is beginning to twist. You have got it wrong Mr Geithner. You are not “stabilizing the housing market”, you are using taxpayer money to keep house prices artificially inflated and out of reach of responsible people who chose not to purchase because it was obvious to them house prices were ridiculously high. Now those same people are subsidizing your flawed ideas. Someone please save us from you and your cronies.

By providing confidence that banks will have a sufficient level of capital even if the outlook is worse than expected, more credit will be available to the economy at lower interest rates today — making it less likely that the more negative economy they fear will take place.

Why are lower interest rates the objective? Interest rates can be decomposed roughly into a primary “risk free” rate, a “credit risk” premium, and “inflation” premium. By keeping rates low, which of these are you ignoring? You are already manipulating the “risk free” component through quantitative easing and now you are trying to manipulate the “credit risk” component. That credit risk component is critical for the healthy functioning of the credit markets. Without it, you are just going to create another bubble. You are not even thinking about inflation risk. Sorry if I seem to be losing my patience, but I am.

Just this month, we saw a 30% increase in refinancing of mortgages, which means millions of Americans are taking advantage of the lower rates.

And you are also seeing another spike in borrowers who fail to even make their first mortgage payments. Refinancing mortgages at low rates completely ignores credit and inflation risk (you will learn about that soon enough). Mortgage rates should not be artificially lowered. If anything, you should reduce the principal and face the reality that home prices are unsustainably inflated. Oh wait. You cannot do that because principal reductions would impact the senior tranches of those CDOs your friends on Wall Street own so much of. What was I thinking?

This is good for homeowners, and it’s good for the economy.

That may or may not be, I think not, but those that will benefit with absolute certainty are the big banks and hedge funds. Nice try.

The new joint lending program with the Federal Reserve led to almost $9 billion of new securitizations last week, more than in the last four months combined.

Please someone help us. President Obama. Please. Help us. The last thing the Federal Reserve should be doing is encouraging more securitizations. Securitizations are a massive sink hole of economic health. It enriches the middle man and has the potential to lead to irresponsible lending and credit bubbles. Imagine that. Please consider going back to the good old days of responsible banking, where loans stay with the lender. If you ask one of your advisers whether securitizations are detrimental, they are likely going to say “No. Of course not.” Once they say “No” ask them, “Did you foresee this crisis?” If they say “Yes” and can verify it, then perhaps you should listen to them. Otherwise, take it from me. Securitization is not something the Fed should be encouraging right now.

However, the financial system as a whole is still working against recovery.

Maybe I’m just upset now and automatically disagreeing with everything you say, but I even disagree with this statement. What if it is you that are working against recovery? What if the markets are trying to find a sustainable equilibrium? What if markets are actually correcting themselves and prices should be lower? When you artificially try to keep rates unsustainably low and consequently try to keep prices artificially high, maybe it is you that is working against recovery. Think about that.

Market prices for many assets held by financial institutions — so-called legacy assets — are either uncertain or depressed.

No. No. No. If you want a market price, there is a certain way to get it. Try to sell it. The price you get is the market price. What does it even mean for a market price to be depressed? Based on what? If anyone is depressed, it is me after reading this. President Obama. I beg you. Help us. Get rid of these people.

With these pressures at work on bank balance sheets, credit remains a scarce commodity, and credit that is available carries a high cost for borrowers.

I would say the credit that is available carries an appropriately high cost due to the risk involved with lending in this environment. That is as it should be and trying to change that is unnatural.

The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors.

Who do you think you are trying to fool? My goodness! The FDIC is begging for money. Where are they going to get it from? You of course. The Federal Reserve is quickly turning into a sovereign wealth fund. The money is coming from you. And you are us, remember? The capital is coming from taxpayers who had nothing to do with this mess. I’m sure they will be happy to learn about that. Believe me, I will do what I can to inform them.

These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.

That is wonderful. You are going to raid pension funds now. If you are a retiring baby boomer, all I can say is too bad for you. Sorry mom! I hope pension funds learned their lesson to stay away from structured products. If you do not understand something, do not invest in it. Pension funds, for your own sake and for those who depend on you, please do not participate in this monster.

Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.

Curioser and curioser. What rabbit hole are you living in? How can you say that with a straight face? Of course the government is going to end up overpaying for these assets. Hopeless.

The new Public-Private Investment Program will initially provide financing for $500 billion with the potential to expand up to $1 trillion over time, which is a substantial share of real-estate related assets originated before the recession that are now clogging our financial system. Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets.

By creating a market that does not exist now, you are playing Market God and unnaturally selecting those who will survive and those who do not. Maybe there is a good reason the market does not exist now. Maybe the market should not exist. The market sets asset values, not you. Let the market continue to dictate prices. If the markets says the asset values are lower than you think they should be, so be it. Who do you think you are?

The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.

It will also allow banks to throw hail Mary passes with taxpayer dollars.

The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses.

Are those the only two options? Whatever happened to Pre-Privatization or Receivership or whatever you want to call it? This entire farce is insulting.

Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.

Has anyone actually proposed “hoping banks … work these assets off over time”? I would have some nice words for such a person. Don’t you see that your proposal will have the same result as the Japanese experience? You are artificially propping up insolvent institutions with special funds. The outcome will be the same. Let them perish and level the playing field so that healthier species can replace them.

Moving forward, we as a nation must work together to strike the right balance between our need to promote the public trust and using taxpayer money prudently to strengthen the financial system, while also ensuring the trust of those market participants who we need to do their part to get credit flowing to working families and businesses — large and small — across this nation.

I believe he is sincere here. I believe that Tim Geithner may not actually be sinister, but hell is full of people with good intentions. This proposal is a colossal mistake and should be rejected. If President Obama will not see it, then I hope the fury taking root across this country will force Congress to do something to stop this debacle.

We have already seen that where our government has provided support and financing, credit is more available at lower costs.

What makes you think this should be the motivation? Credit at unsustainably low costs was the cause of this mess. I fail to see how it will get us out of it.

Our nation deserves better choices than, on one hand, accepting the catastrophic damage caused by a failure like Lehman Brothers

Do you really believe this? I mean, really? I suppose you do, which is scary. Scary!  There was no catastrophic damage caused by Lehman Brother’s failure. If anything good has happened to date, it is that Lehman and Bear Stearns failed. The damage was there already done. The disease (of excess credit) was already coursing through the veins of the entire financial system. The death of one organ did not cause the damage. The death of one organ was a symptom of the disease. Purging these decaying organs was necessary to prevent gangrene from setting in. What you are suggesting is analogous to an embalming. Konnichiwa zombi ginkou!

In conclusion…

I am extremely disappointed.

The common theme and the common error throughout Geithner’s proposal is that credit is too expensive, rates are too high, and asset values are too depressed. The reality is that asset values are what they are. If no one wants an asset, its price goes down until it becomes attractive enough to reconsider. Throwing billions of dollars at unattractive assets with the purpose of artificially inflating their price is completely irresponsible and wasteful on a grand scale.

America, you need to care about this. You are surely facing your own problems like we all are and I understand the last thing you want to think about is some yahoos in Washington D.C., but these guys are hurting you. They are hurting your children and more than likely they are hurting your grandchildren. Both born and unborn. Take notice and if you are as upset about this as I am, then do something. Let your representatives know how unhappy you are. At this point, I think they are the only ones who can put a road block down before this train leaves the station.

Letter to Obama: The Audacity of Hope Squandered

Posted in Anna Schwartz, Bernanke, Confidence, Geithner, Greenspan, Hope, Obama by Economic Darwinism on March 21, 2009

Every article here can be thought of as a letter directed to President Obama, but occasionally I will make the address explicit.

Dear Mr President,

The entire election process including the inauguration was a powerful experience for many people including myself. Clearly we all know that no one person holds all the answers to all the challenges that face us. The one thing that you offered that your rivals didn’t was Hope (with a capital “H”). The Audacity of Hope was a powerful message that resonated with millions not only within the US, but around the globe. We, the American people, need Hope now more than any time in most of our lifetimes.

I must tell you now because I care so deeply about this great country of ours that you are on the verge of squandering that Hope. If the Hope you brought into office with you is extinguished, I’m afraid that the next few years could become very bleak leading to even bleaker decades that could see our place in the world stage diminished substantially. The threat is real as you know better than anyone could.

You have only been in office for a short time. You’ve done a lot right, but you have also done a lot wrong. One very serious thing you’ve done wrong is to appoint Timothy Geithner to the Treasury. There are many exceptional candidates with the qualifications required to be Treasury Secretary. The actual qualifications of any nominee are, for the most part, irrelevant compared to the Confidence (with a capital “C”) they can inspire. Sadly, you must see it as plainly as day that Timothy Geithner does not inspire any Confidence. Confidence is a close cousin of Hope and as the former fades, that latter will soon follow.

You boldly admitted to screwing up (your words) with Tom Daschle, so why is it that you are not willing to admit that your appointment of Geithner was a mistake? A good argument could be made that Daschle was not a mistake and if you had withdrawn support for Geithner, it would have made it easier (or at least possible) to confirm Daschle.

It is not too late to have Geithner voluntarily resign. This country needs Hope and Confidence more than anything and we will not get that as long as Geithner remains at the Treasury.

At this moment in history, two institutions are at the center of the maelstrom: The Treasury and the Fed. Unfortunately, both of these institutions are failing us. When the history books are written, it will be hard to judge which of the two Fed chairman, Greenspan or Bernanke, did the most damage to our country. My suspicion is that when the anvil comes down, Bernanke will be found to be the guiltier of the two. Greenspan at least had some success early in his term. Bernanke has been a failure since day one and has only perpetuated the errors of his predecessor. His philosophy was challenged early by many admirable economists including the revered Anna Schwartz. If you want to know who should be Fed chairman, ask Anna Schwartz. She is the wisest person on the planet right now and we should value anything that she is willing to offer while we still have her with us.

You gave us the audacity to Hope. The only thing more audacious than Hope would be the audacity of Hope squandered. Please right this ship before it is too late.

My warmest regards and best wishes.

Embrace the Recession

Posted in Bernanke, Grantham, Greenspan, Monetary Policy, Recession by Economic Darwinism on March 21, 2009

Prior to the current crisis, economists hailed Alan Greenspan as the “maestro”. Volatility in the markets were at historical lows and monetary policy had conquered the business cycle.

Or so they thought.

What was really going on was the inflation of a global asset bubble. In early 2007, the bubble in housing was obvious enough and the general feeling across the fixed-income spectrum was that things were rich. LBO activity was white hot, which helped fuel valuations in equities. But one person said it plainly and simply. Jeremy Grantham’s April 2007 letter had a deep impact on the way I looked at the world.

It’s Everywhere, In Everything: The First Truly Global Bubble
(Observations following a 6-week Round-the-World Trip)

April 2007

From Indian antiquities to modern Chinese art; from land in Panama to Mayfair; from forestry, infrastructure, and the junkiest bonds to mundane blue chips; it’s bubble time!

The necessary conditions for a bubble to form are quite simple and number only two. First, the fundamental economic conditions must look at least excellent – and near perfect is better. Second, liquidity must be generous in quantity and price: it must be easy and cheap to leverage. If these two conditions have ever been present without causing a bubble it has escaped our attention. Conversely, only one of the conditions without the other may cause an ordinary bull market but this is often not the case. For example, good or even excellent fundamentals with tightening credit often result in a falling market.

That these two conditions have been met now hardly needs statistical support, so widely accepted have they become. Never before have all emerging countries outperformed the U.S. in GDP growth over a 12-month period until now, and this when the U.S. has been doing well. Not a single country anywhere – emerging or developed – out of 42 listed by The Economist grew its GDP by less than Switzerland’s 2.2%! Amazingly uniform strength, and yet another sign of how globalized and correlated fundamentals have become, as well as the financial markets that reflect them.

Bubbles, of course, are based on human behavior, and the mechanism is surprisingly simple: perfect conditions create very strong “animal spirits,” reflected statistically in a low risk premium. Widely available cheap credit offers investors the opportunity to act on their optimism. Sustained strong fundamentals and sustained easy credit go one better; they allow for continued reinforcement: the more leverage you take, the better you do; the better you do, the more leverage you take.

The combination of the enactment of the Commodity Futures Modernization Act of 2000 with easy monetary policy in the US and Japan created an abundance of liquidity together with an increasing need for “yield” for pension funds and endowments. Institutional investors were increasingly drawn to non-traditional assets after the stellar performance of the Harvard and Yale endowments. At the same time, large financial institutions represented a huge brain drain attracting many of the worlds brightest scientists to the promise of riches on Wall Street. These scientists built hugely complex risk models based heavily on market volatility. During a period of decreasing volatility, these models were signaling “Full Speed Ahead!” The credit derivatives boom was born.

Bubbles are natural phenomena and our ability to control them is limited. One might question whether we should even try. Greenspan (and Bernanke for that matter) was firmly in the camp that believed we should only concern ourselves with asset bubbles to the extent that they directly impact core inflation. When a bubble forms, you let it continue until it bursts and then come in with sweeping monetary easing to help clean up the mess. Upon seeing this happen after the crash of 1987, after the Asian crisis of 1997, and after LTCM in 1998 among others, the pattern had been established. The Greenspan put was born and moral hazard had been introduced to the financial system.

In each case, the overriding fear was a recession. At some point along the way, recessions became sinister. Something to be avoided at all costs. Well, we are now seeing what those costs were.

Recessions are a necessary part of healthy, dynamic, long-term economic growth. By attempting to avoid recessions like the plague, elements of the economy that were ill-equipped for survival were unnaturally placed on life support. If recessions had been allowed to take their course, enough shocks would have occurred along the way that would have knocked down houses of cards long before they grew to become “too big to fail”. The business of insuring pools of bonds could not have grown to behemoth proportions if historically sensible rates of defaults had occurred. Mortgage originators would not have been able to offload loans into these pools so profitably if they were paying historically sensible risk premiums.

It all comes down to a common mistake we’ve made and continue to make since Greenspan took over at the Fed in 1987. Trying to avoid recession at all costs.

When you embrace recessions, you can deal with them. You can try to soften the blow to the unemployed and help prepare them for newer and economically healthier opportunities. The alternative is to keep people unnaturally employed in economically inefficient roles. The various impacts of recessions are fairly foreseeable and hence plans can be made to deal with them.

After repeatedly making the same policy mistakes year after year, here we are again putting elements of the economy on life support that should be put out of their misery. Of course those who work in financial institutions will try to tell you that the entire economy will come crumbling down if you let a large bank or insurance company fail. It is time to call their bluff. These institutions are simply doing what they have always done. They are doing what they are good at. They are doing what they should be doing. Making money. I don’t blame them for benefiting from bailout funds in multiple convoluted ways. It is ingenious. The people I am disappointed in are those who fell for the joke: Bernanke, Geithner and ultimately Obama.

It is time we see through the charade. The financial system will not collapse on itself if we let large institutions fail. On the contrary, the likelihood of a systemic collapse is higher if we do not allow them to fail. Let entrepreneurs step in. There is a lot of money to be made lending to corporations and consumers alike if you have capital and people do have capital. By artificially propping up banks, the playing field is not level. Small banks cannot compete with large banks. It is a perverse path we are on and I hope that if enough people voice their opinion, those in power will see the light.

You cannot stop the pain. Poor policies of the last 20 years have put us in a position where no matter what we do now, there is going to be severe pain felt by everyone. Lives will be forever changed. Businesses will fall into bankruptcy. Overextended derivatives insurers will burn. Overextended consumers will lose their homes and cars. It is inevitable and the more we try to stop it, the worse it will be in the end. Instead, we should embrace it. Like battling a flaming inferno. Sometimes you need to tactically burn down strategic areas to stop the destruction. We need to recognize that we have failed. Get over it and stop trying to prevent the inevitable. Let’s let natural selection work its course so that we can evolve into something healthier and more be able to survive the new ecosystem we find ourselves in.