Saturday, December 20, 2008
Obama's Music Video - "Yes We Can"
Watch the music video produced by will.i.am, "Yes We Can". Video courtesy of Barackobama.com.
Hang in there, sell out means you are out of the game
Don't sell out, hold on in there.
The crisis today has many similarities with the Great Depression. We have forgotten our lessons from the past
THE past month must have been one of the toughest periods for investors and advisers. Equities markets collapsed like a pack of stacked cards. Many are saying the world has never seen anything like it before. But is this true? I took a quick trip back to 1929 to find out.
Real estate was the speculative favourite in 1920s America. The mantra was 'leverage up, buy a bigger house, even if you can't afford it'. Interest-only mortgages were already the standard. Then on black Monday, Oct 28, 1929, the stock market crashed.
Americans rushed to withdraw their money. Banks cut lending or closed their doors.
The economy collapsed. Greed, over-borrowing and bad loans led to the world's worst financial crisis - The Great Depression. Seeing similarities between the crises of 1929 and of today, I realised that when it comes to money, history tends to repeat itself. People are cyclical creatures who are generally greedy and cannot help but make the same mistakes.
The current plunge in stock markets has left investors so fearful that many have claimed this is the worst stock market crash in history. I wasn't sure, so I took another trip - all the way back to 1900. Looking at the top 10 stock market crashes since then, things became a lot clearer. The grand-daddy of all crashes was in 1930.
The market went down 86 per cent. Together with the 1929 crash, the Great Depression lasted 34 months and took 89 per cent from the market. The current crisis has brought the Dow down about 39 per cent so far. Although it is not the worst crash and the world has seen worse times than this, the question every investor is asking is whether today's crisis will be prolonged.
In my trip to 1929, I found out that just before Black Monday, everyone - from governments and experts to the newspapers - was bullish about the economy. Soon after the first crash on Oct 28, they quickly became positive again, predicting a quick recovery. Then on April 17, 1930, the market sank even further. Throughout the next two years there were plenty of recovery forecasts. But by the time the carnage was over, three years had passed. No one, not even financial experts or governments, knew how long the bear would last.
I also learned from the past century that no matter how deep and long crises were, markets always recover. The key question is whether you have time to wait for a recovery.
In the summer of 1929, John J Raskob, a senior executive of GM, claimed that US was on the verge of a tremendous industrial expansion. He maintained that by putting just US$15 a month into good common stocks, investors could expect their wealth to grow steadily to US$80,000 over the next 20 years. When the stock market crashed, Mr Raskob's advice was ridiculed and denounced for years to come. But was that fair? If one had followed Mr Raskob's advice and put US$15 a month into the market, after 20 years, the average annual return would have been 7.86 per cent, and after 30 years 12.72 per cent. Far from Mr Raskob's estimate, but not too bad, I must say.
The lesson is this: even in the worst crises, markets still recover with a respectable return. But if you want to shorten the time of your recovery, don't sell out. Keep investing but invest in the right things. If you sell, you are out of the game with no hope of recovery at all.
My trip to the past has taught me that all crises stem from the same cause - greed. Today's crisis is not new. It's just that we have forgotten our lessons. Don't try to time the markets. Michael J Mauboussin, chief investment strategist at Legg Mason Capital Management, found out that if you are able to accurately avoid the worst 50 days of the market, your returns jump to 18.2 per cent per annum. But if you miss the best 50 days, your returns dropped to a mere 1 per cent per annum.
Investors, be strong and courageous. You may be fearful. I am too. But history is behind us and for us. If you stop investing, you will perish. The crisis will surely pass. Don't ever give up.
The crisis today has many similarities with the Great Depression. We have forgotten our lessons from the past
THE past month must have been one of the toughest periods for investors and advisers. Equities markets collapsed like a pack of stacked cards. Many are saying the world has never seen anything like it before. But is this true? I took a quick trip back to 1929 to find out.
Real estate was the speculative favourite in 1920s America. The mantra was 'leverage up, buy a bigger house, even if you can't afford it'. Interest-only mortgages were already the standard. Then on black Monday, Oct 28, 1929, the stock market crashed.
Americans rushed to withdraw their money. Banks cut lending or closed their doors.
The economy collapsed. Greed, over-borrowing and bad loans led to the world's worst financial crisis - The Great Depression. Seeing similarities between the crises of 1929 and of today, I realised that when it comes to money, history tends to repeat itself. People are cyclical creatures who are generally greedy and cannot help but make the same mistakes.
The current plunge in stock markets has left investors so fearful that many have claimed this is the worst stock market crash in history. I wasn't sure, so I took another trip - all the way back to 1900. Looking at the top 10 stock market crashes since then, things became a lot clearer. The grand-daddy of all crashes was in 1930.
The market went down 86 per cent. Together with the 1929 crash, the Great Depression lasted 34 months and took 89 per cent from the market. The current crisis has brought the Dow down about 39 per cent so far. Although it is not the worst crash and the world has seen worse times than this, the question every investor is asking is whether today's crisis will be prolonged.
In my trip to 1929, I found out that just before Black Monday, everyone - from governments and experts to the newspapers - was bullish about the economy. Soon after the first crash on Oct 28, they quickly became positive again, predicting a quick recovery. Then on April 17, 1930, the market sank even further. Throughout the next two years there were plenty of recovery forecasts. But by the time the carnage was over, three years had passed. No one, not even financial experts or governments, knew how long the bear would last.
I also learned from the past century that no matter how deep and long crises were, markets always recover. The key question is whether you have time to wait for a recovery.
In the summer of 1929, John J Raskob, a senior executive of GM, claimed that US was on the verge of a tremendous industrial expansion. He maintained that by putting just US$15 a month into good common stocks, investors could expect their wealth to grow steadily to US$80,000 over the next 20 years. When the stock market crashed, Mr Raskob's advice was ridiculed and denounced for years to come. But was that fair? If one had followed Mr Raskob's advice and put US$15 a month into the market, after 20 years, the average annual return would have been 7.86 per cent, and after 30 years 12.72 per cent. Far from Mr Raskob's estimate, but not too bad, I must say.
The lesson is this: even in the worst crises, markets still recover with a respectable return. But if you want to shorten the time of your recovery, don't sell out. Keep investing but invest in the right things. If you sell, you are out of the game with no hope of recovery at all.
My trip to the past has taught me that all crises stem from the same cause - greed. Today's crisis is not new. It's just that we have forgotten our lessons. Don't try to time the markets. Michael J Mauboussin, chief investment strategist at Legg Mason Capital Management, found out that if you are able to accurately avoid the worst 50 days of the market, your returns jump to 18.2 per cent per annum. But if you miss the best 50 days, your returns dropped to a mere 1 per cent per annum.
Investors, be strong and courageous. You may be fearful. I am too. But history is behind us and for us. If you stop investing, you will perish. The crisis will surely pass. Don't ever give up.
Friday, December 19, 2008
Keynes’s economics revived
“Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.” - John Maynard Keynes: 1883-1946
December 14, 2008
The Way We Live Now
The Remedist
By ROBERT SKIDELSKY
Among the most astonishing statements to be made by any policymaker in recent years was Alan Greenspan’s admission this autumn that the regime of deregulation he oversaw as chairman of the Federal Reserve was based on a “flaw”: he had overestimated the ability of a free market to self-correct and had missed the self-destructive power of deregulated mortgage lending. The “whole intellectual edifice,” he said, “collapsed in the summer of last year.”
What was this “intellectual edifice”? As so often with policymakers, you need to tease out their beliefs from their policies. Greenspan must have believed something like the “efficient-market hypothesis,” which holds that financial markets always price assets correctly. Given that markets are efficient, they would need only the lightest regulation. Government officials who control the money supply have only one task — to keep prices roughly stable.
I don’t suppose that Greenspan actually bought this story literally, since experience of repeated financial crises too obviously contradicted it. It was, after all, only a model. But he must have believed something sufficiently like it to have supported extensive financial deregulation and to have kept interest rates low in the period when the housing bubble was growing. This was the intellectual edifice, of both theory and policy, which has just been blown sky high. As George Soros rightly pointed out, “The salient feature of the current financial crisis is that it was not caused by some external shock like OPEC raising the price of oil. . . . The crisis was generated by the financial system itself.”
This is where the great economist John Maynard Keynes (1883-1946) comes in. Today, Keynes is justly enjoying a comeback. For the same “intellectual edifice” that Greenspan said has now collapsed was what supported the laissez-faire policies Keynes quarreled with in his times. Then, as now, economists believed that all uncertainty could be reduced to measurable risk. So asset prices always reflected fundamentals, and unregulated markets would in general be very stable.
By contrast, Keynes created an economics whose starting point was that not all future events could be reduced to measurable risk. There was a residue of genuine uncertainty, and this made disaster an ever-present possibility, not a once-in-a-lifetime “shock.” Investment was more an act of faith than a scientific calculation of probabilities. And in this fact lay the possibility of huge systemic mistakes.
The basic question Keynes asked was: How do rational people behave under conditions of uncertainty? The answer he gave was profound and extends far beyond economics. People fall back on “conventions,” which give them the assurance that they are doing the right thing. The chief of these are the assumptions that the future will be like the past (witness all the financial models that assumed housing prices wouldn’t fall) and that current prices correctly sum up “future prospects.” Above all, we run with the crowd. A master of aphorism, Keynes wrote that a “sound banker” is one who, “when he is ruined, is ruined in a conventional and orthodox way.” (Today, you might add a further convention — the belief that mathematics can conjure certainty out of uncertainty.)
But any view of the future based on what Keynes called “so flimsy a foundation” is liable to “sudden and violent changes” when the news changes. Investors do not process new information efficiently because they don’t know which information is relevant. Conventional behavior easily turns into herd behavior. Financial markets are punctuated by alternating currents of euphoria and panic.
Keynes’s prescriptions were guided by his conception of money, which plays a disturbing role in his economics. Most economists have seen money simply as a means of payment, an improvement on barter. Keynes emphasized its role as a “store of value.” Why, he asked, should anyone outside a lunatic asylum wish to “hold” money? The answer he gave was that “holding” money was a way of postponing transactions. The “desire to hold money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future. . . . The possession of actual money lulls our disquietude; and the premium we require to make us part with money is a measure of the degree of our disquietude.” The same reliance on “conventional” thinking that leads investors to spend profligately at certain times leads them to be highly cautious at others. Even a relatively weak dollar may, at moments of high uncertainty, seem more “secure” than any other asset, as we are currently seeing.
It is this flight into cash that makes interest-rate policy such an uncertain agent of recovery. If the managers of banks and companies hold pessimistic views about the future, they will raise the price they charge for “giving up liquidity,” even though the central bank might be flooding the economy with cash. That is why Keynes did not think that cutting the central bank’s interest rate would necessarily — and certainly not quickly — lower the interest rates charged on different types of loans. This was his main argument for the use of government stimulus to fight a depression. There was only one sure way to get an increase in spending in the face of an extreme private-sector reluctance to spend, and that was for the government to spend the money itself. Spend on pyramids, spend on hospitals, but spend it must.
This, in a nutshell, was Keynes’s economics. His purpose, as he saw it, was not to destroy capitalism but to save it from itself. He thought that the work of rescue had to start with economic theory itself. Now that Greenspan’s intellectual edifice has collapsed, the moment has come to build a new structure on the foundations that Keynes laid.
Worldwide problem in 2009
The president of the World Bank warned Thursday of a worldwide struggle in the first half of 2009 as a deepening global economic crisis hits Asian countries.
Robert Zoellick also cautioned against a return to trade protectionism that could worsen the crisis.
Asia-Pacific region remained reasonably well-placed to weather the global slowdown but will see growth ease to 5.3 percent in 2009 from 7.0 percent this year.
It said the global economy would expand a mere 0.9 percent next year and world trade volume would fall 2.1 percent, the first drop in 26 years.
"In the discussions that I have had with people around the world, no one has a very good prediction for the length and depth of this crisis," Zoellick said.
Government monetary and fiscal policy, as well as open trade systems, will determine whether the situation can improve later next year, he said.
"Particularly I am concerned about the rising dangers of protectionism," he added, describing as "unfortunate" the difficulties encountered during the Doha Round of talks on a new global trade pact.
"The international system needs to stay on offence on trade because protectionist forces will raise their heads," he said.
The so-called Doha talks started at the end of 2001 in the Qatari capital.
They aim to boost international commerce by removing trade barriers and subsidies, but a deal has proved elusive.
Developing countries, including China and India, want the industrialised world to scrap agricultural subsidies, while Western powers are seeking greater access for their products in emerging markets.
"Whatever parties can do to try to get the Doha Round back on track would be vitally important," Zoellick said later at a dialogue session with students from a local university.
"This financial and economic and unemployment problem is serious enough.
"If we start to trigger a round of protectionism, as you saw in the 1930s, it could deepen (the global crisis)."
Pascal Lamy, the head of the World Trade Organisation (WTO), last Friday scrapped plans to hold a ministerial meeting on the trade talks, citing the "unacceptably high" risk of failure and dashing hopes that the long-delayed global trade pact could be clinched this month.
The World Bank, which provides financial and technical assistance to developing countries, said last week that healthy growth in recent years had left major economies such as China in good shape to fight the global crisis with macroeconomic measures.
But it said "in the near term, downside risks are substantial" due to recessions in developed markets.
Robert Zoellick also cautioned against a return to trade protectionism that could worsen the crisis.
Asia-Pacific region remained reasonably well-placed to weather the global slowdown but will see growth ease to 5.3 percent in 2009 from 7.0 percent this year.
It said the global economy would expand a mere 0.9 percent next year and world trade volume would fall 2.1 percent, the first drop in 26 years.
"In the discussions that I have had with people around the world, no one has a very good prediction for the length and depth of this crisis," Zoellick said.
Government monetary and fiscal policy, as well as open trade systems, will determine whether the situation can improve later next year, he said.
"Particularly I am concerned about the rising dangers of protectionism," he added, describing as "unfortunate" the difficulties encountered during the Doha Round of talks on a new global trade pact.
"The international system needs to stay on offence on trade because protectionist forces will raise their heads," he said.
The so-called Doha talks started at the end of 2001 in the Qatari capital.
They aim to boost international commerce by removing trade barriers and subsidies, but a deal has proved elusive.
Developing countries, including China and India, want the industrialised world to scrap agricultural subsidies, while Western powers are seeking greater access for their products in emerging markets.
"Whatever parties can do to try to get the Doha Round back on track would be vitally important," Zoellick said later at a dialogue session with students from a local university.
"This financial and economic and unemployment problem is serious enough.
"If we start to trigger a round of protectionism, as you saw in the 1930s, it could deepen (the global crisis)."
Pascal Lamy, the head of the World Trade Organisation (WTO), last Friday scrapped plans to hold a ministerial meeting on the trade talks, citing the "unacceptably high" risk of failure and dashing hopes that the long-delayed global trade pact could be clinched this month.
The World Bank, which provides financial and technical assistance to developing countries, said last week that healthy growth in recent years had left major economies such as China in good shape to fight the global crisis with macroeconomic measures.
But it said "in the near term, downside risks are substantial" due to recessions in developed markets.
Oil futures tumble 10% to end below $37 a barrel
J.P. Morgan analysts cut their 2009 oil price forecast to $43 a barrel from $69
Crude tumbled below $37 a barrel Thursday to their lowest level in at least four years, underscoring the market's preoccupation with a sharp slowdown in oil demand.
Year to date, oil prices have fallen 59% and are 75% since their record level above $147 a barrel in July.
Oil for January delivery fell $3.84, or 9.6%, to end at $36.22 a barrel on the New York Mercantile Exchange. Not since the middle of 2004 has the price reached this level.
Earlier, the contract hit an intraday low of $35.98 a barrel on Globex. The January contract will expire at the end of trading on Friday.
The February crude contract, which showed greater trading volume, fell $2.94 to end at $41.67 a barrel on Nymex.
"Below $38, we don't see anything until the $25 level," said Edward Meir, an analyst at MF Global. "This is admittedly a rather dramatic set of chart-based forecasts for a complex that only six months ago looked like it could do no wrong on the upside."
Traders have paid little heed to a production cut of 2.2 million barrels in current oil output by the Organization of the Petroleum Exporting Countries.
OPEC agreed Wednesday to cut 4.2 million barrels a day from its actual September production level of 29.045 million barrels a day.
The reduction in member nations' quota levels is effective on Jan. 1. Excluding previously announced cuts, OPEC will actually cut its daily production by 2.2 million barrels from current levels.
"There are doubts among market participants of OPEC's ability to comply with these cuts given the magnitude of the cut and their previous history," said Nimit Khamar, an analyst at Sucden Financial.
"Yes, it is a large cut by OPEC, which is positive, but going forward oil prices will only be supported by evidence of compliance and provided weakening demand does not deteriorate too much," Khamar said.
OPEC, which controls about 40% of the world's oil production, will hold its next scheduled meeting on March 15 in Vienna.
"If prices slide toward $30, no doubt OPEC will be meeting before then and perhaps announcing further cuts, which will be required in our opinion," Khamar said.
J.P. Morgan cuts oil price forecast
Strategists at J.P. Morgan slashed their forecast for oil prices in 2009 to $43 a barrel from $69 a barrel, citing "the ongoing deterioration in the world economic environment and the ensuing sharp contraction in global oil demand in both 2008 and 2009."
Commercial oil stocks have already risen to close to 60 days of forward consumption and are set to rise further before OPEC gets the market under control, which is estimated to take until the second quarter, the strategists said in a research report dated Dec. 17.
"While in the near term, recent extremely high volatility means a range of $15 a barrel around the mid-price forecast is appropriate, once a supply/demand balance is achieved, the stock overhang will mean that volatility is likely to fall sharply," J.P. Morgan said.
Also on Globex Thursday, January reformulated gasoline fell 5 cents to end at 92 cents a gallon and January heating oil dropped 7 cents to $1.37 a gallon.
Natural gas inventories fell by 124 billion cubic feet to stand at 3,167 billion cubic feet during the week ended Dec. 12, the U.S. Energy Information Administration reported Thursday. Analysts polled by Platts expected a reduction of between 107 billion cubic feet and 112 billion cubic feet.
January natural gas futures fell 7 cents to finish at $5.55 per million British thermal units.
Crude tumbled below $37 a barrel Thursday to their lowest level in at least four years, underscoring the market's preoccupation with a sharp slowdown in oil demand.
Year to date, oil prices have fallen 59% and are 75% since their record level above $147 a barrel in July.
Oil for January delivery fell $3.84, or 9.6%, to end at $36.22 a barrel on the New York Mercantile Exchange. Not since the middle of 2004 has the price reached this level.
Earlier, the contract hit an intraday low of $35.98 a barrel on Globex. The January contract will expire at the end of trading on Friday.
The February crude contract, which showed greater trading volume, fell $2.94 to end at $41.67 a barrel on Nymex.
"Below $38, we don't see anything until the $25 level," said Edward Meir, an analyst at MF Global. "This is admittedly a rather dramatic set of chart-based forecasts for a complex that only six months ago looked like it could do no wrong on the upside."
Traders have paid little heed to a production cut of 2.2 million barrels in current oil output by the Organization of the Petroleum Exporting Countries.
OPEC agreed Wednesday to cut 4.2 million barrels a day from its actual September production level of 29.045 million barrels a day.
The reduction in member nations' quota levels is effective on Jan. 1. Excluding previously announced cuts, OPEC will actually cut its daily production by 2.2 million barrels from current levels.
"There are doubts among market participants of OPEC's ability to comply with these cuts given the magnitude of the cut and their previous history," said Nimit Khamar, an analyst at Sucden Financial.
"Yes, it is a large cut by OPEC, which is positive, but going forward oil prices will only be supported by evidence of compliance and provided weakening demand does not deteriorate too much," Khamar said.
OPEC, which controls about 40% of the world's oil production, will hold its next scheduled meeting on March 15 in Vienna.
"If prices slide toward $30, no doubt OPEC will be meeting before then and perhaps announcing further cuts, which will be required in our opinion," Khamar said.
J.P. Morgan cuts oil price forecast
Strategists at J.P. Morgan slashed their forecast for oil prices in 2009 to $43 a barrel from $69 a barrel, citing "the ongoing deterioration in the world economic environment and the ensuing sharp contraction in global oil demand in both 2008 and 2009."
Commercial oil stocks have already risen to close to 60 days of forward consumption and are set to rise further before OPEC gets the market under control, which is estimated to take until the second quarter, the strategists said in a research report dated Dec. 17.
"While in the near term, recent extremely high volatility means a range of $15 a barrel around the mid-price forecast is appropriate, once a supply/demand balance is achieved, the stock overhang will mean that volatility is likely to fall sharply," J.P. Morgan said.
Also on Globex Thursday, January reformulated gasoline fell 5 cents to end at 92 cents a gallon and January heating oil dropped 7 cents to $1.37 a gallon.
Natural gas inventories fell by 124 billion cubic feet to stand at 3,167 billion cubic feet during the week ended Dec. 12, the U.S. Energy Information Administration reported Thursday. Analysts polled by Platts expected a reduction of between 107 billion cubic feet and 112 billion cubic feet.
January natural gas futures fell 7 cents to finish at $5.55 per million British thermal units.
Thursday, December 18, 2008
Madoff big lie theory explained in simple terms
Today, after the fact, many are falling over themselves asserting that investors in Madoff's funds should have known better than to believe such performance claims. They're right, but the more interesting question is: Why did so few actually know better in advance?
A clinical psychologist, assures me that it's because we're primarily emotional beings. We like to think of ourselves as objectively analyzing the data under the cool light of reason, but far more often than not our emotions are running the show.
It takes courage to say that the king has no clothes, especially when the king is paying you handsomely.
That's why I often tell my clients to subject their strategies and their chosen advisers to special scrutiny during those times when they are performing well. That's when we are most likely to be lulled into a dangerous complacency.
Far better to find out then than later that if something is too good to be true, it probably is.
A clinical psychologist, assures me that it's because we're primarily emotional beings. We like to think of ourselves as objectively analyzing the data under the cool light of reason, but far more often than not our emotions are running the show.
It takes courage to say that the king has no clothes, especially when the king is paying you handsomely.
That's why I often tell my clients to subject their strategies and their chosen advisers to special scrutiny during those times when they are performing well. That's when we are most likely to be lulled into a dangerous complacency.
Far better to find out then than later that if something is too good to be true, it probably is.
Wednesday, December 17, 2008
Tale of the TED
The TED spread, or the difference between US Treasury bill and eurodollar interest rates, is an indicator of perceived credit risk in the general economy. US government Treasury bills are considered risk-free while eurodollar borrowing costs, measured by the London interbank offered rate (LIBOR), reflect the credit risk of lending to commercial banks.
When the TED spread increases it is a sign that lenders believe the risk of default on interbank loans is increasing. Interbank lenders therefore demand a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of banks defaults is considered to be decreasing, the TED spread decreases. The TED spread fluctuates over time but has often remained within the range of 10 and 50 basis points (0.1% and 0.5%), at least until 2007. A rising TED spread often presages a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn.
When the TED spread increases it is a sign that lenders believe the risk of default on interbank loans is increasing. Interbank lenders therefore demand a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of banks defaults is considered to be decreasing, the TED spread decreases. The TED spread fluctuates over time but has often remained within the range of 10 and 50 basis points (0.1% and 0.5%), at least until 2007. A rising TED spread often presages a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn.
US Fed promises explained - Central bank policy makers step up to assure banks and act as the "invisible hand."
The Federal Reserve made a few promises on Tuesday that are important to the ultimate recovery of the economy and financial markets.
First, the Fed cut its target for short term rates to just above zero and pledged to keep its target for short-term rates low "for some time."
This should give banks assurance that they will have access to cheap funds, economists said. This could help spur bank lending.
"Bank confidence in its ability to finance itself today and in the future is an essential for making loans," noted Stephen Gallagher, chief economist at Societe Generale.
Secondly, the Fed promised to employ "all available tools" to help the economy and financial markets.
In essence, the Fed intends to be "the invisible hand" in all financial markets, according to Joel Naroff, president of Naroff Economic Advisors.
"Wherever market failures exist, the Fed will be the market maker," Naroff said.
The Fed has already become the market maker for corporate paper and mortgages and mortgage-backed securities.
It has plans to become a market maker in loans to households and small businesses.
And a senior Fed official said that other credit markets could be helped.
At the moment, the spread between government credit and private credit are very wide. No one wants to take the risk on a private company.
The Fed hopes that its action will reduce the spread.
Will the Fed's action work? But by keeping credit flowing, the Fed is buying time for banks to heal.
In the mortgage market, the Fed purchases have already brought down the cost of mortgages, resulting in a spurt of activity.
"This latest change in monetary policy strategy by the Fed has the potential to be highly effective in our view, and will better reduce the cost of borrowing for a vast majority of consumers and businesses," said the economic team at Wells Fargo.
But how long will it take? That nobody knows.
Former Fed governor Robert Heller said the aggressive Fed easing campaign began in earnest after the collapse of Lehman Brothers in mid-September. He calculated that the lag on policy would take eight months, putting the recovery in mid-May.
Naroff said that the Fed's statement reminded him of John F Kennedy's inaugural address -- that the Fed would "pay any price, bear any financial market burden, meet any economic hardship, support any frozen market, oppose any negative economic activity in order to assure the survival and the success of the economy."
But Robert Brusca, chief economist at FAO Economics, noted that the Fed is like a backup quarterback on a football team. Like a team with a second-string quarterback, the market may be able to function somewhat but it could be bumpy.
First, the Fed cut its target for short term rates to just above zero and pledged to keep its target for short-term rates low "for some time."
This should give banks assurance that they will have access to cheap funds, economists said. This could help spur bank lending.
"Bank confidence in its ability to finance itself today and in the future is an essential for making loans," noted Stephen Gallagher, chief economist at Societe Generale.
Secondly, the Fed promised to employ "all available tools" to help the economy and financial markets.
In essence, the Fed intends to be "the invisible hand" in all financial markets, according to Joel Naroff, president of Naroff Economic Advisors.
"Wherever market failures exist, the Fed will be the market maker," Naroff said.
The Fed has already become the market maker for corporate paper and mortgages and mortgage-backed securities.
It has plans to become a market maker in loans to households and small businesses.
And a senior Fed official said that other credit markets could be helped.
At the moment, the spread between government credit and private credit are very wide. No one wants to take the risk on a private company.
The Fed hopes that its action will reduce the spread.
Will the Fed's action work? But by keeping credit flowing, the Fed is buying time for banks to heal.
In the mortgage market, the Fed purchases have already brought down the cost of mortgages, resulting in a spurt of activity.
"This latest change in monetary policy strategy by the Fed has the potential to be highly effective in our view, and will better reduce the cost of borrowing for a vast majority of consumers and businesses," said the economic team at Wells Fargo.
But how long will it take? That nobody knows.
Former Fed governor Robert Heller said the aggressive Fed easing campaign began in earnest after the collapse of Lehman Brothers in mid-September. He calculated that the lag on policy would take eight months, putting the recovery in mid-May.
Naroff said that the Fed's statement reminded him of John F Kennedy's inaugural address -- that the Fed would "pay any price, bear any financial market burden, meet any economic hardship, support any frozen market, oppose any negative economic activity in order to assure the survival and the success of the economy."
But Robert Brusca, chief economist at FAO Economics, noted that the Fed is like a backup quarterback on a football team. Like a team with a second-string quarterback, the market may be able to function somewhat but it could be bumpy.
Fed cuts rates to record low range of zero to 0.25%
The Federal Reserve pulled out all the stops in its campaign to save the U.S. economy Tuesday, slashing interest rates to just above zero and promising to try an array of new economic measures to stimulate spending.
The central bank's Federal Open Market Committee established a target range for the federal funds rate of zero to 0.25%, effectively cutting its key rate for overnight lending to banks by between 0.75% and 1%.
Rates would need to be kept low "for some time," the central bank said.
'The Fed will employ all available tools to promote the resumption of sustainable economic growth.' — Federal Reserve
Ian Shepherdson, chief U.S. economist at High Frequency Economics, said the funds rate has "hit rock bottom."
U.S. stocks leaped after the decision, with the Dow Jones Industrial Average closing up 359 points.
A senior Fed official told reporters that the Fed has switched tactics and will now focus on aiding credit.
The Fed has already targeted a few debt classes for assistance. The senior officials said that other classes, including below triple-AAA quality debt, may be purchased.
The official said the program was not quantitative easing as practiced by Japan in the 1990s.
While Japan simply wanted to increase the quantity of money, the Fed wants to focus on the asset side of the balance sheet.
The moves are just about as aggressive as the central bank could be on monetary policy.
The Fed gave clear signals that it has moved on to other measures beyond setting interest rates in its fight to keep the economy rolling.
Josh Shapiro, chief economist at MFR Inc., said the Fed is "petrified" about the economic outlook.
But the senior Fed official said that economists at the central bank generally are in agreement with Wall Street economists about the duration and depth of the recession.
After two quarters of very weak growth, the economy should start a slow recovery after mid-year, the official said.
The Fed statement said that inflation should continue to moderate in coming months.
The senior Fed official said that deflation, or a general price decline, was not a major risk at the moment, but that price data would be watched carefully.
"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth," the central bank pledged in its policy statement.
Going into next year, the focus of the Fed's policy will be to support financial markets and stimulate the economy "through open market operations and other measures that sustain the size of the Fed's balance sheet at a high level."
So the key will be the quantity of money in the system, not the price.
The Fed's balance sheet has risen to $2.25 trillion over the past two months from $850 billion and has made promises to spend about a $1 trillion more.
The Fed is using the money to ease strains in the market for the debt of Fannie Mae and Freddie Mac and mortgage-backed securities issued by these GSEs.
These purchases may be expanded, the Fed said.
"The FOMC is also evaluating the potential benefits of purchasing longer-term Treasury securities," the Fed said.
Some economists have questioned the necessity of buying longer-term Treasury securities, with the prices already low.
By February, the Fed is also going to begin buying credit card debt and student loans. This template could be expanded. Under this plan, the Treasury is assuming the risk of loss while the Fed is making the purchases.
Economists applauded this laser-beam approach.
Adding "$100 billion here and $100 there strategically injected into the right places" can have a big impact, said Steve Stanley, chief economist at RBS Greenwich Capital.
Other markets are clearly on the Fed's radar screen.
"The Fed will continue to consider ways of using its balance sheet to further support credit markets and economic activity," the statement said.
The senior official said that lower quality assets could be purchased.
The Fed's moves followed some of the worst economic data in decades reported in the past few days, including monthly consumer sales numbers that fell the most since 1932.
The vote to lower the fed funds rate was unanimous.
The central bank's Federal Open Market Committee established a target range for the federal funds rate of zero to 0.25%, effectively cutting its key rate for overnight lending to banks by between 0.75% and 1%.
Rates would need to be kept low "for some time," the central bank said.
'The Fed will employ all available tools to promote the resumption of sustainable economic growth.' — Federal Reserve
Ian Shepherdson, chief U.S. economist at High Frequency Economics, said the funds rate has "hit rock bottom."
U.S. stocks leaped after the decision, with the Dow Jones Industrial Average closing up 359 points.
A senior Fed official told reporters that the Fed has switched tactics and will now focus on aiding credit.
The Fed has already targeted a few debt classes for assistance. The senior officials said that other classes, including below triple-AAA quality debt, may be purchased.
The official said the program was not quantitative easing as practiced by Japan in the 1990s.
While Japan simply wanted to increase the quantity of money, the Fed wants to focus on the asset side of the balance sheet.
The moves are just about as aggressive as the central bank could be on monetary policy.
The Fed gave clear signals that it has moved on to other measures beyond setting interest rates in its fight to keep the economy rolling.
Josh Shapiro, chief economist at MFR Inc., said the Fed is "petrified" about the economic outlook.
But the senior Fed official said that economists at the central bank generally are in agreement with Wall Street economists about the duration and depth of the recession.
After two quarters of very weak growth, the economy should start a slow recovery after mid-year, the official said.
The Fed statement said that inflation should continue to moderate in coming months.
The senior Fed official said that deflation, or a general price decline, was not a major risk at the moment, but that price data would be watched carefully.
"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth," the central bank pledged in its policy statement.
Going into next year, the focus of the Fed's policy will be to support financial markets and stimulate the economy "through open market operations and other measures that sustain the size of the Fed's balance sheet at a high level."
So the key will be the quantity of money in the system, not the price.
The Fed's balance sheet has risen to $2.25 trillion over the past two months from $850 billion and has made promises to spend about a $1 trillion more.
The Fed is using the money to ease strains in the market for the debt of Fannie Mae and Freddie Mac and mortgage-backed securities issued by these GSEs.
These purchases may be expanded, the Fed said.
"The FOMC is also evaluating the potential benefits of purchasing longer-term Treasury securities," the Fed said.
Some economists have questioned the necessity of buying longer-term Treasury securities, with the prices already low.
By February, the Fed is also going to begin buying credit card debt and student loans. This template could be expanded. Under this plan, the Treasury is assuming the risk of loss while the Fed is making the purchases.
Economists applauded this laser-beam approach.
Adding "$100 billion here and $100 there strategically injected into the right places" can have a big impact, said Steve Stanley, chief economist at RBS Greenwich Capital.
Other markets are clearly on the Fed's radar screen.
"The Fed will continue to consider ways of using its balance sheet to further support credit markets and economic activity," the statement said.
The senior official said that lower quality assets could be purchased.
The Fed's moves followed some of the worst economic data in decades reported in the past few days, including monthly consumer sales numbers that fell the most since 1932.
The vote to lower the fed funds rate was unanimous.
Drop in consumer prices is most since 1932
U.S. consumer prices fell in November at the fastest rate since 1932, the darkest days of the Great Depression, the Labor Department reported Tuesday, as prices for energy, commodities and airline fares plunged across the country. Core CPI flat in the month as energy prices plunge
The U.S. consumer price index fell by a seasonally adjusted 1.7%, the department reported, the biggest drop since the government began adjusting the CPI for seasonal factors in 1947.
But on a non-seasonally adjusted basis, the CPI fell by 1.9%, the biggest decline since January 1932, at the nadir of the Great Depression. Read MarketWatch First Take commentary.
"This is scary stuff," said Mike Schenk, an economist for Credit Union National Association. "We are teetering on the brink of a massive downward spiral. Deflation is a threat."
The seasonally adjusted core CPI was flat in November. Read the report.
Economists surveyed by MarketWatch were expecting the CPI to fall by 1.4%. They forecast that the core CPI would rise by 0.1%. See Economic Calendar.
Energy prices declined by a seasonally adjusted 17%, the most since February 1957. Gasoline prices plunged by 29.5% in November, the most since the government began keeping records in February 1967. Fuel oil prices dropped by 7.2%. Commodities prices declined by 4.1% in November.
The CPI data is one of the last pieces of the economic puzzle that the Federal Reserve will have to mull before its announcement about interest rates later Tuesday. The policy-making Federal Open Market Committee is almost universally expected to cut its target for overnight interest rates to 0.5% from 1%.
U.S. stock indexes rose after the price data and data about housing starts were released Tuesday.
Over the past year, overall consumer prices have risen by 1.1%, down from their peak of 5.6% in July. Core prices have risen by 2% in the last 12 months.
Medical, food, clothing costs rise
Prices for certain goods rose in November, even as the overall number fell. Medical care prices, for example, climbed by 0.2%. They are up 2.7% in the past year. Also, food prices rose by 0.2% in November.
The cost of owning a house, meanwhile, rose 0.3% in November.
Falling transportation prices contributed to the overall decline. Those prices dropped 9.8% in November, the most in 61 years. They are down 8.9% over the past year.
The Labor Department also reported Tuesday that real average weekly earnings rose by 2.3% from October to November.
Within transportation, new vehicle prices fell 0.6%. Airline fares, meanwhile, dropped 4%.
In a separate report on Tuesday, the Commerce Department said that housing starts fell by a whopping 18.9% to a seasonally adjusted annual rate of 625,000, the lowest since the department began keeping records in 1959.
The U.S. consumer price index fell by a seasonally adjusted 1.7%, the department reported, the biggest drop since the government began adjusting the CPI for seasonal factors in 1947.
But on a non-seasonally adjusted basis, the CPI fell by 1.9%, the biggest decline since January 1932, at the nadir of the Great Depression. Read MarketWatch First Take commentary.
"This is scary stuff," said Mike Schenk, an economist for Credit Union National Association. "We are teetering on the brink of a massive downward spiral. Deflation is a threat."
The seasonally adjusted core CPI was flat in November. Read the report.
Economists surveyed by MarketWatch were expecting the CPI to fall by 1.4%. They forecast that the core CPI would rise by 0.1%. See Economic Calendar.
Energy prices declined by a seasonally adjusted 17%, the most since February 1957. Gasoline prices plunged by 29.5% in November, the most since the government began keeping records in February 1967. Fuel oil prices dropped by 7.2%. Commodities prices declined by 4.1% in November.
The CPI data is one of the last pieces of the economic puzzle that the Federal Reserve will have to mull before its announcement about interest rates later Tuesday. The policy-making Federal Open Market Committee is almost universally expected to cut its target for overnight interest rates to 0.5% from 1%.
U.S. stock indexes rose after the price data and data about housing starts were released Tuesday.
Over the past year, overall consumer prices have risen by 1.1%, down from their peak of 5.6% in July. Core prices have risen by 2% in the last 12 months.
Medical, food, clothing costs rise
Prices for certain goods rose in November, even as the overall number fell. Medical care prices, for example, climbed by 0.2%. They are up 2.7% in the past year. Also, food prices rose by 0.2% in November.
The cost of owning a house, meanwhile, rose 0.3% in November.
Falling transportation prices contributed to the overall decline. Those prices dropped 9.8% in November, the most in 61 years. They are down 8.9% over the past year.
The Labor Department also reported Tuesday that real average weekly earnings rose by 2.3% from October to November.
Within transportation, new vehicle prices fell 0.6%. Airline fares, meanwhile, dropped 4%.
In a separate report on Tuesday, the Commerce Department said that housing starts fell by a whopping 18.9% to a seasonally adjusted annual rate of 625,000, the lowest since the department began keeping records in 1959.
The US Fed goes to Defcon 1
The Federal Reserve declared war on Tuesday, promising to do whatever it takes to prevent a depression. A promise to do everything it must to avert a depression
With the economy teetering on the edge of a prolonged slump, the central bank's policy-making Federal Open Market Committee slashed interest rates on Tuesday to near zero, and vowed to use "all available tools" to keep the economy from collapsing into a depression.
After a two-day meeting in Washington, Bernanke rounded up even the most reluctant members of the FOMC to unanimously endorse the most drastic actions this central bank has ever taken.
To no one's surprise, the Fed said the economic outlook had "weakened further," and it set aside any immediate worries about inflation. For the next while, all of the Fed's focus will be on easing the credit crunch, pumping money through the financial system, and getting the economy growing again.
"The committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the statement said.
Now that traditional monetary policy as we know it has been exhausted, the Fed will take ever-more creative steps to boost growth. In simple terms, the Fed will flood the financial system and economy with as much money as it has to.
How does it do that? The Fed will buy debt and mortgage-backed securities issued by Fannie Mae and Freddie Mac. It's considering buying longer-term Treasurys, including notes and bonds. It will also implement a new lending program to support credit for households and small businesses.
And the Fed said it wouldn't stop there. "The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity," the committee said.
Critics will say Helicopter Ben has taken off and is now prepared to drop billions of dollars across the landscape, destroying the economy with a hyperinflationary spiral. But cooler heads will counter: What choice does he have?
With the economy teetering on the edge of a prolonged slump, the central bank's policy-making Federal Open Market Committee slashed interest rates on Tuesday to near zero, and vowed to use "all available tools" to keep the economy from collapsing into a depression.
After a two-day meeting in Washington, Bernanke rounded up even the most reluctant members of the FOMC to unanimously endorse the most drastic actions this central bank has ever taken.
To no one's surprise, the Fed said the economic outlook had "weakened further," and it set aside any immediate worries about inflation. For the next while, all of the Fed's focus will be on easing the credit crunch, pumping money through the financial system, and getting the economy growing again.
"The committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the statement said.
Now that traditional monetary policy as we know it has been exhausted, the Fed will take ever-more creative steps to boost growth. In simple terms, the Fed will flood the financial system and economy with as much money as it has to.
How does it do that? The Fed will buy debt and mortgage-backed securities issued by Fannie Mae and Freddie Mac. It's considering buying longer-term Treasurys, including notes and bonds. It will also implement a new lending program to support credit for households and small businesses.
And the Fed said it wouldn't stop there. "The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity," the committee said.
Critics will say Helicopter Ben has taken off and is now prepared to drop billions of dollars across the landscape, destroying the economy with a hyperinflationary spiral. But cooler heads will counter: What choice does he have?
Four times, US financial regulation is in question
US financial regulation have failed as a result of unacceptable face of human greed. Here are the four examples of such failure;
1. Dec 2008
Multi-billion-dollar swindle run by ex-Wall Street heavyweight Bernard Madoff which defrauding investors of 50 billion dollars in a scam that collapsed after clients asked for their money back due to the global financial crisis. He delivered consistently strong returns to clients by secretly using the principal investment from new investors for payments to other investors, in what is known as a pyramid scam.
2. Sept 2008
The collapse in September 2008 of the Lehman Brothers bank and followed by AIG.
3. 2001
The 2001 false-accounting scandal involving energy giant Enron;
4. 1998
The 1998 collapse of US hedge fund managers Long Term Capital Management.
1. Dec 2008
Multi-billion-dollar swindle run by ex-Wall Street heavyweight Bernard Madoff which defrauding investors of 50 billion dollars in a scam that collapsed after clients asked for their money back due to the global financial crisis. He delivered consistently strong returns to clients by secretly using the principal investment from new investors for payments to other investors, in what is known as a pyramid scam.
2. Sept 2008
The collapse in September 2008 of the Lehman Brothers bank and followed by AIG.
3. 2001
The 2001 false-accounting scandal involving energy giant Enron;
4. 1998
The 1998 collapse of US hedge fund managers Long Term Capital Management.
Tuesday, December 16, 2008
Robert Reich: The New Shape of Capitalism to Come?
World Affairs Council of Northern California
San Francisco, CA
Sep 24th, 2008
Robert Reich is one of America's most respected economic and political thinkers, as well as a distinguished public servant in three national administrations.
As the nation's 22nd Secretary of Labor, he implemented the Family and Medical Leave Act, led a national fight against sweatshops in the and illegal child labor around the world, and headed a successful effort to raise the minimum wage.
Concerned with the transformation of business and democracy, Robert Reich joins the Council for a discussion on the future course of global capitalism and its impact on democratic decision making - World Affairs Council of Northern California
Robert Reich: What's at Stake in the Election?
The Commonwealth Club of California
Lafayette, CA
Oct 1st, 2008
Robert Reich discusses What's at Stake in the Election: Trickle-Down Versus Bottom-Up Economics
The state of the economy and the welfare of American jobs are pressing issues in the current election cycle.
Former secretary of labor and author of multiple best sellers, Reich warns that democracy and capitalism are not fundamentally intertwined; there can be one without the other, he says. For this reason, he asserts that understanding the economic policies of the presidential hopefuls is of dire importance.
Reich (who, it has been widely reported, is beginning to advise Barack Obama on economic matters) will discuss the repercussions of our economic options - The Commonwealth Club of California
Coming to the end of the line on rate cuts
New tactics under discussion as Fed starts two-day meeting
The Federal Reserve is likely to cut the federal funds rate as low as it can go at this week's meeting, without adopting a zero-interest policy, and to begin shifting its focus to nontraditional policies.
"It would make the most sense for this meeting to be the last rate cut rather than dragging it out to the January meeting," wrote Chris Rupkey, chief financial economist at Bank of Tokyo Mitsubishi, adding that a "hallmark of the Bernanke Fed has been to move quickly and aggressively."
Rupkey's forecast calls for the Fed to cut rates by three-quarters of a percentage point to 0.25%. Most Wall Street firms expect a rate cut of a half point to 0.50%.
The size of the move is in large part psychological," said the economic team at Bank of America.
Rates are already very low and are not playing much part in the credit crunch that is strangling the economy.
Investors should know that the Fed still has plenty of ways to stimulate the economy, even with rates near or at zero, economists said.
Rates are already very low and are not playing much part in the credit crunch that is strangling the economy.
Investors should know that the Fed still has plenty of ways to stimulate the economy, even with rates near or at zero, economists said.
The bottom line on Fed policy is supply of money. The Fed typically targets the price of money, but, with the price so low, it will focus on increasing the quantity of money through its balance sheet.
Vince Reinhart, a former senior Fed staffer who is now at the American Enterprise Institute, said the Fed will make a promise in its policy statement "to use the balance sheet to help foster economic recovery and better-functioning markets."
The two-day meeting got underway Monday afternoon. A public statement is expected at 2:15 p.m. Eastern time Tuesday.
Since the last Fed meeting, economic conditions have deteriorated, and many economic indicators have been setting multiyear lows.
The recession has turned into a global downturn, with similar weakness in Europe and Japan and many emerging economies.
The Fed meeting was originally set to last just one day, but an extra day was added to discuss various options for "quantitative easing" operations.
Economists at Barclays Capital said they expect the Fed statement "to give some guidance on how the Fed expects to proceed" in the area of nontraditional monetary policy.
In essence, the Fed is providing credit directly to market participants, bypassing the fragile banking sector. The Fed's balance sheet has already expanded dramatically as the Fed has lent money to banks, securities firms and public companies.
"A lot has been done already," said J. Alfred Broaddus, a former president of the Richmond Fed.
Total Fed assets on its balance sheet have soared $1.3 trillion of 145% since Sept. 10, according to the UBS economic team.
Fed officials have already signaled that more balance-sheet expansion is planned. The Fed is expected to make plain that its monetary-policy focuses include the funds rate and balance-sheet growth, said the economic team at Bank of America. The Fed may also add that it plans to purchase securities in markets that particularly need liquidity.
With this money flowing into the banking sector, many economists are worried about inflation down the road. But other economists do not believe that will pose a significant threat.
The Federal Reserve is likely to cut the federal funds rate as low as it can go at this week's meeting, without adopting a zero-interest policy, and to begin shifting its focus to nontraditional policies.
"It would make the most sense for this meeting to be the last rate cut rather than dragging it out to the January meeting," wrote Chris Rupkey, chief financial economist at Bank of Tokyo Mitsubishi, adding that a "hallmark of the Bernanke Fed has been to move quickly and aggressively."
Rupkey's forecast calls for the Fed to cut rates by three-quarters of a percentage point to 0.25%. Most Wall Street firms expect a rate cut of a half point to 0.50%.
The size of the move is in large part psychological," said the economic team at Bank of America.
Rates are already very low and are not playing much part in the credit crunch that is strangling the economy.
Investors should know that the Fed still has plenty of ways to stimulate the economy, even with rates near or at zero, economists said.
Rates are already very low and are not playing much part in the credit crunch that is strangling the economy.
Investors should know that the Fed still has plenty of ways to stimulate the economy, even with rates near or at zero, economists said.
The bottom line on Fed policy is supply of money. The Fed typically targets the price of money, but, with the price so low, it will focus on increasing the quantity of money through its balance sheet.
Vince Reinhart, a former senior Fed staffer who is now at the American Enterprise Institute, said the Fed will make a promise in its policy statement "to use the balance sheet to help foster economic recovery and better-functioning markets."
The two-day meeting got underway Monday afternoon. A public statement is expected at 2:15 p.m. Eastern time Tuesday.
Since the last Fed meeting, economic conditions have deteriorated, and many economic indicators have been setting multiyear lows.
The recession has turned into a global downturn, with similar weakness in Europe and Japan and many emerging economies.
The Fed meeting was originally set to last just one day, but an extra day was added to discuss various options for "quantitative easing" operations.
Economists at Barclays Capital said they expect the Fed statement "to give some guidance on how the Fed expects to proceed" in the area of nontraditional monetary policy.
In essence, the Fed is providing credit directly to market participants, bypassing the fragile banking sector. The Fed's balance sheet has already expanded dramatically as the Fed has lent money to banks, securities firms and public companies.
"A lot has been done already," said J. Alfred Broaddus, a former president of the Richmond Fed.
Total Fed assets on its balance sheet have soared $1.3 trillion of 145% since Sept. 10, according to the UBS economic team.
Fed officials have already signaled that more balance-sheet expansion is planned. The Fed is expected to make plain that its monetary-policy focuses include the funds rate and balance-sheet growth, said the economic team at Bank of America. The Fed may also add that it plans to purchase securities in markets that particularly need liquidity.
With this money flowing into the banking sector, many economists are worried about inflation down the road. But other economists do not believe that will pose a significant threat.
Monday, December 15, 2008
The Financial Crisis, US Economy and New Administration
The New School, New York, NY. Nov 14th, 2008
James K. Galbraith discusses the history leading up to the recent economic collapse, and suggests how the American government can get back on its feet.
Then, a panel of leading experts headed by Joseph Stiglitz tackles the issue, and discuss the challenges facing the Obama administration in managing the financial crisis.
They argue that its implications run well beyond the US economy to concerns about international security.
Stiglitz: Gov't Should Bail Out Homeowners, Not Banks
Economist Joseph E. Stiglitz argues bailing out the banks is only another short-term fix and will fail unless people are living in houses and paying mortgages. He suggests the government should instead help people maintain homeownership
Joseph Stiglitz dissects the economic crisis
Stiglitz says the 2001 and 2003 tax cuts "put the burden" of responding to the tech bubble on "monetary policy."
A couple months ago, ex Federal Reserve Bank chairman Alan Greenspan, in testimony before Congress confessed he had found a flaw in his philosophy of managing markets. Mr. Greenspan, like many others, believed markets are self regulating and government intrusion should be minimal.
Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said.
It must have been a difficult admission for Mr. Greenspan. The much admired, highly praised ex Fed chair was admitting some culpability in the current financial meltdown in the U.S. And while it may be painful and embarrassing for some, Nobel Prize winning economist Joseph Stiglitz (who, inexplicably, is not a part of the Obama economic team) argues, in a Vanity Fair article, the wrong decisions, the bad moves leading up to our economist crisis needs to be well understood so as not to be repeated.
Mr. Stiglitz argues the collapse was a "system failure", but five key events are chiefly responsible:
The first is Ronald Reagan's replacement of Fed Chairman Paul Volcker with Alan Greenspan in 1987.
Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.
Breaking down the barriers between commercial and investment banks and allowing commercial banking to increase debt to equity ratios were the components of the second key event.
The most important consequence of the repeal of Glass-Steagall (in 1999) was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.
The third key event were the Bush tax cuts.
The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods.
Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow.
The accounting scandals early in the decade and the subsequent failure of Sarbanes-Oxley to address the issue of stock options prompted the continued fudging of the books for many corporations. The failure of regulators to address these kinds of conflicts of interest is Stiglitz's fourth key event.
Accounting is a sleep-inducing topic for most people, but if you can’t have faith in a company’s numbers, then you can’t have faith in anything about a company at all.
But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
And, finally, Mr. Stiglitz calls the $700B Congressional bailout the fifth key event. The bailout finally passed by Congress was without any means to force the banks to begin lending again, and some banks chose to use the federal funds to pay shareholders, prop up their balance sheets and provide management bonuses.
The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues—they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely—which they hadn’t—the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.
A couple months ago, ex Federal Reserve Bank chairman Alan Greenspan, in testimony before Congress confessed he had found a flaw in his philosophy of managing markets. Mr. Greenspan, like many others, believed markets are self regulating and government intrusion should be minimal.
Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said.
It must have been a difficult admission for Mr. Greenspan. The much admired, highly praised ex Fed chair was admitting some culpability in the current financial meltdown in the U.S. And while it may be painful and embarrassing for some, Nobel Prize winning economist Joseph Stiglitz (who, inexplicably, is not a part of the Obama economic team) argues, in a Vanity Fair article, the wrong decisions, the bad moves leading up to our economist crisis needs to be well understood so as not to be repeated.
Mr. Stiglitz argues the collapse was a "system failure", but five key events are chiefly responsible:
The first is Ronald Reagan's replacement of Fed Chairman Paul Volcker with Alan Greenspan in 1987.
Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.
Breaking down the barriers between commercial and investment banks and allowing commercial banking to increase debt to equity ratios were the components of the second key event.
The most important consequence of the repeal of Glass-Steagall (in 1999) was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.
The third key event were the Bush tax cuts.
The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods.
Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow.
The accounting scandals early in the decade and the subsequent failure of Sarbanes-Oxley to address the issue of stock options prompted the continued fudging of the books for many corporations. The failure of regulators to address these kinds of conflicts of interest is Stiglitz's fourth key event.
Accounting is a sleep-inducing topic for most people, but if you can’t have faith in a company’s numbers, then you can’t have faith in anything about a company at all.
But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
And, finally, Mr. Stiglitz calls the $700B Congressional bailout the fifth key event. The bailout finally passed by Congress was without any means to force the banks to begin lending again, and some banks chose to use the federal funds to pay shareholders, prop up their balance sheets and provide management bonuses.
The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues—they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely—which they hadn’t—the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.
Stiglitz: Bush Admin Economic Policy Too Little Too Late
Nobel Prize-winning economist Joseph E. Stiglitz explains why the Bush administration's economic policies not only failed to stimulate the economy, but also contributed to the current economic crisis.
The fruit of hypocrisy
Joseph E Stiglitz is university professor at Columbia University and recipient of the 2001 Nobel prize in economics
Dishonesty in the finance sector dragged us here, and Washington looks ill-equipped to guide us out
Houses of cards, chickens coming home to roost - pick your cliche. The new low in the financial crisis, which has prompted comparisons with the 1929 Wall Street crash, is the fruit of a pattern of dishonesty on the part of financial institutions, and incompetence on the part of policymakers.
We had become accustomed to the hypocrisy. The banks reject any suggestion they should face regulation, rebuff any move towards anti-trust measures - yet when trouble strikes, all of a sudden they demand state intervention: they must be bailed out; they are too big, too important to be allowed to fail.
Eventually, however, we were always going to learn how big the safety net was. And a sign of the limits of the US Federal Reserve and treasury's willingness to rescue comes with the collapse of the investment bank Lehman Brothers, one of the most famous Wall Street names.
The big question always centres on systemic risk: to what extent does the collapse of an institution imperil the financial system as a whole? Wall Street has always been quick to overstate systemic risk - take, for example, the 1994 Mexican financial crisis - but loth to allow examination of their own dealings. Last week the US treasury secretary, Henry Paulson, judged there was sufficient systemic risk to warrant a government rescue of mortgage giants Fannie Mae and Freddie Mac; but there was not sufficient systemic risk seen in Lehman.
The present financial crisis springs from a catastrophic collapse in confidence. The banks were laying huge bets with each other over loans and assets. Complex transactions were designed to move risk and disguise the sliding value of assets. In this game there are winners and losers. And it's not a zero-sum game, it's a negative-sum game: as people wake up to the smoke and mirrors in the financial system, as people grow averse to risk, losses occur; the market as a whole plummets and everyone loses.
Financial markets hinge on trust, and that trust has eroded. Lehman's collapse marks at the very least a powerful symbol of a new low in confidence, and the reverberations will continue.
The crisis in trust extends beyond banks. In the global context, there is dwindling confidence in US policymakers. At July's G8 meeting in Hokkaido the US delivered assurances that things were turning around at last. The weeks since have done nothing but confirm any global mistrust of government experts.
How seriously, then, should we take comparisons with the crash of 1929? Most economists believe we have the monetary and fiscal instruments and understanding to avoid collapse on that scale. And yet the IMF and the US treasury, together with central banks and finance ministers from many other countries, are capable of supporting the sort of "rescue" policies that led Indonesia to economic disaster in 1998. Moreover, it is difficult to have faith in the policy wherewithal of a government that oversaw the utter mismanagement of the war in Iraq and the response to Hurricane Katrina. If any administration can turn this crisis into another depression, it is the Bush administration.
America's financial system failed in its two crucial responsibilities: managing risk and allocating capital. The industry as a whole has not been doing what it should be doing - for instance creating products that help Americans manage critical risks, such as staying in their homes when interest rates rise or house prices fall - and it must now face change in its regulatory structures. Regrettably, many of the worst elements of the US financial system - toxic mortgages and the practices that led to them - were exported to the rest of the world.
It was all done in the name of innovation, and any regulatory initiative was fought away with claims that it would suppress that innovation. They were innovating, all right, but not in ways that made the economy stronger. Some of America's best and brightest were devoting their talents to getting around standards and regulations designed to ensure the efficiency of the economy and the safety of the banking system. Unfortunately, they were far too successful, and we are all - homeowners, workers, investors, taxpayers - paying the price.
Dishonesty in the finance sector dragged us here, and Washington looks ill-equipped to guide us out
Houses of cards, chickens coming home to roost - pick your cliche. The new low in the financial crisis, which has prompted comparisons with the 1929 Wall Street crash, is the fruit of a pattern of dishonesty on the part of financial institutions, and incompetence on the part of policymakers.
We had become accustomed to the hypocrisy. The banks reject any suggestion they should face regulation, rebuff any move towards anti-trust measures - yet when trouble strikes, all of a sudden they demand state intervention: they must be bailed out; they are too big, too important to be allowed to fail.
Eventually, however, we were always going to learn how big the safety net was. And a sign of the limits of the US Federal Reserve and treasury's willingness to rescue comes with the collapse of the investment bank Lehman Brothers, one of the most famous Wall Street names.
The big question always centres on systemic risk: to what extent does the collapse of an institution imperil the financial system as a whole? Wall Street has always been quick to overstate systemic risk - take, for example, the 1994 Mexican financial crisis - but loth to allow examination of their own dealings. Last week the US treasury secretary, Henry Paulson, judged there was sufficient systemic risk to warrant a government rescue of mortgage giants Fannie Mae and Freddie Mac; but there was not sufficient systemic risk seen in Lehman.
The present financial crisis springs from a catastrophic collapse in confidence. The banks were laying huge bets with each other over loans and assets. Complex transactions were designed to move risk and disguise the sliding value of assets. In this game there are winners and losers. And it's not a zero-sum game, it's a negative-sum game: as people wake up to the smoke and mirrors in the financial system, as people grow averse to risk, losses occur; the market as a whole plummets and everyone loses.
Financial markets hinge on trust, and that trust has eroded. Lehman's collapse marks at the very least a powerful symbol of a new low in confidence, and the reverberations will continue.
The crisis in trust extends beyond banks. In the global context, there is dwindling confidence in US policymakers. At July's G8 meeting in Hokkaido the US delivered assurances that things were turning around at last. The weeks since have done nothing but confirm any global mistrust of government experts.
How seriously, then, should we take comparisons with the crash of 1929? Most economists believe we have the monetary and fiscal instruments and understanding to avoid collapse on that scale. And yet the IMF and the US treasury, together with central banks and finance ministers from many other countries, are capable of supporting the sort of "rescue" policies that led Indonesia to economic disaster in 1998. Moreover, it is difficult to have faith in the policy wherewithal of a government that oversaw the utter mismanagement of the war in Iraq and the response to Hurricane Katrina. If any administration can turn this crisis into another depression, it is the Bush administration.
America's financial system failed in its two crucial responsibilities: managing risk and allocating capital. The industry as a whole has not been doing what it should be doing - for instance creating products that help Americans manage critical risks, such as staying in their homes when interest rates rise or house prices fall - and it must now face change in its regulatory structures. Regrettably, many of the worst elements of the US financial system - toxic mortgages and the practices that led to them - were exported to the rest of the world.
It was all done in the name of innovation, and any regulatory initiative was fought away with claims that it would suppress that innovation. They were innovating, all right, but not in ways that made the economy stronger. Some of America's best and brightest were devoting their talents to getting around standards and regulations designed to ensure the efficiency of the economy and the safety of the banking system. Unfortunately, they were far too successful, and we are all - homeowners, workers, investors, taxpayers - paying the price.
Bernard Madoff's Ponzi Scheme
Another large-scale scandal rocks Wall Street as Bernard Madoff, a Wall Street titan and investment advisor was arrested for an alleged $50 billion dollar fraud against investors,
Bernard Madoff's Ponzi scheme arrested
A Ponzi scheme, defined as a "fraudulent investment scheme that involves promising high returns to early investors out of the money paid in by later investors" was named for Charles Ponzi, the infamous 1920s swindler.
First some definitions:
A Ponzi scheme is loosely defined as a fraudulent investment scheme that involves promising high returns to early investors out of the money paid in by later investors. Basically, in a Ponzi scheme, the business only makes money by suckering more and more investors into pouring money into the fund. This is illegal because investors think they are investing in an underlying business that will generate profits and revenue and lead to long-term returns to the investors. The head of the scheme knows this will never happen.
To elaborate a bit more on the workings of a Ponzi scheme, it entails seeking a continuous flow of investors. The business makes money when you get more investors to sink their money into the Ponzi scheme, under the false pretense that they are investing in a business that will be generating profit, continuing to produce money for them in the long term.
Of course this doesn't actually occur-- and any money an investor may see from the scam is generated purely by the investments of others, which is why the growing number of investors seems critical.
A Hedge Fund is a private investment fund open to a limited range of investors that is allowed to engage in a wider range of risky activities than most investment funds (i.e. your 401k, which is heavily regulated). Hedge funds are able to use methods not available to other investments, like short selling (borrowing shares to sell immediately on the open market), derivative contracts, and leverage (borrowing money to buy securities). Using these different methods allows the fund to “hedge” the risk, like a gambler “hedges” his bets by making a variety of bets.
Complicated? Yes, it is. As a matter of fact, very few people outside of Wall Street understand what hedge funds do and how they make money. There are very few regulations governing hedge funds because they are so complex. Also, generally, the Securities and Exchange Commission only lets really rich people invest in hedge funds.
A modern day Ponzi scheme was apparently perpetrated by investor Bernard Madoff -- by his own admission -- as the head of a hedge fund off Wall Street was arrested today for allegations of the financial fraud. Bernard Madoff, 70, who has operated his own multi-billion dollar investment company since 1960, apparently remarked to his staff earlier in the week that the hedge fund ran out of his company was a "giant Ponzi scheme."
Hedge funds are a mysterious, barely regulated type of investing that apparently few not fully immersed in the world and technicalities of Wall Street truly understand, claims Reilly. Only very rich people may make such investments, and a lot of it involves borrowing assets to turn around and resell right away. With hedge funds, you spread the risk to multiple arenas, increasing the chance for gain despite the shadiness of the gamble.
Madoff's hedge fund had $50 billion of investors money, reported Reilly.
This crime could earn Madoff up to 20 years in jail and millions of dollars worth of fines. He has already made bail, however, at an easy $10 million.
While people like Reilly suggest that this incident could cause financial panic amidst our already poor economic state, making people lose faith in hedge funds, there are others more like myself who say-- "who cares"? Those who actually made hedge fund investments likely had very little understanding of where their money was truly going, and they accepted that.
To the very wealthy, this is just part of the financial world and investing. It's probably an exciting gamble with throw-away money, to many of them. Hedge fund investors do not represent every day man. The things which Madoff, his company, and his investors partake in on a daily basis are over our heads yet may somehow financially affect us-- and naturally that deserves justice. But what do I know? I'm just the little guy, looking up at the great big rich fatties, thinking of all the wonderful good that could have been done with all of those billions of wasted dollars, played with like mere Monopoly money. Me, sympathize with those shaken by the instability obvious in the world of hedge funds。
Bernard Madoff was the head of a multi-billion dollar hedge fund on Wall Street. Today, he was arrested for allegedly running a Ponzi Scheme.
For financial beginners, I’m going to break this down to the very basics because this arrest is one of the biggest financial frauds in American history, and the ramifications are potentially enormous. People need to be informed.
THE BERNARD MADOFF ALLEGATIONS
Bernard Madoff, 70, is the founder of Bernard L. Madoff Investment Securities LLC, which has grown into a multi-billion institution since its founding in 1960. Public information on Madoff’s company is available here at its website.
Madoff’s company included a brokerage house and a hedge fund. According to state prosecutors, Madoff told his staff this week that the hedge fund was “basically, a giant Ponzi scheme.” Investors have put in $50 billion into the hedge fund.
In court today, state prosecutors charged Madoff with securities fraud. The maximum sentence is 20 years in prison and a fine of up to $5 million. Madoff is currently out on $10 million bail. The Securities and Exchange Commission is filing separate charges.
Why is this such a big deal?
According to the Wall Street Journal, approximately $2 trillion are currently invested in hedge funds. The hedge fund world is the financial Wild West, with little regulation and very few people with an actual clue as to where the money is really going. Given today’s crisis in the financial markets, allegations of fraud may shake investors confidence in the hedge fund world.
Hopefully, Madoff’s case turns out to be an isolated incident and the hedge fund world will survive.
First some definitions:
A Ponzi scheme is loosely defined as a fraudulent investment scheme that involves promising high returns to early investors out of the money paid in by later investors. Basically, in a Ponzi scheme, the business only makes money by suckering more and more investors into pouring money into the fund. This is illegal because investors think they are investing in an underlying business that will generate profits and revenue and lead to long-term returns to the investors. The head of the scheme knows this will never happen.
To elaborate a bit more on the workings of a Ponzi scheme, it entails seeking a continuous flow of investors. The business makes money when you get more investors to sink their money into the Ponzi scheme, under the false pretense that they are investing in a business that will be generating profit, continuing to produce money for them in the long term.
Of course this doesn't actually occur-- and any money an investor may see from the scam is generated purely by the investments of others, which is why the growing number of investors seems critical.
A Hedge Fund is a private investment fund open to a limited range of investors that is allowed to engage in a wider range of risky activities than most investment funds (i.e. your 401k, which is heavily regulated). Hedge funds are able to use methods not available to other investments, like short selling (borrowing shares to sell immediately on the open market), derivative contracts, and leverage (borrowing money to buy securities). Using these different methods allows the fund to “hedge” the risk, like a gambler “hedges” his bets by making a variety of bets.
Complicated? Yes, it is. As a matter of fact, very few people outside of Wall Street understand what hedge funds do and how they make money. There are very few regulations governing hedge funds because they are so complex. Also, generally, the Securities and Exchange Commission only lets really rich people invest in hedge funds.
A modern day Ponzi scheme was apparently perpetrated by investor Bernard Madoff -- by his own admission -- as the head of a hedge fund off Wall Street was arrested today for allegations of the financial fraud. Bernard Madoff, 70, who has operated his own multi-billion dollar investment company since 1960, apparently remarked to his staff earlier in the week that the hedge fund ran out of his company was a "giant Ponzi scheme."
Hedge funds are a mysterious, barely regulated type of investing that apparently few not fully immersed in the world and technicalities of Wall Street truly understand, claims Reilly. Only very rich people may make such investments, and a lot of it involves borrowing assets to turn around and resell right away. With hedge funds, you spread the risk to multiple arenas, increasing the chance for gain despite the shadiness of the gamble.
Madoff's hedge fund had $50 billion of investors money, reported Reilly.
This crime could earn Madoff up to 20 years in jail and millions of dollars worth of fines. He has already made bail, however, at an easy $10 million.
While people like Reilly suggest that this incident could cause financial panic amidst our already poor economic state, making people lose faith in hedge funds, there are others more like myself who say-- "who cares"? Those who actually made hedge fund investments likely had very little understanding of where their money was truly going, and they accepted that.
To the very wealthy, this is just part of the financial world and investing. It's probably an exciting gamble with throw-away money, to many of them. Hedge fund investors do not represent every day man. The things which Madoff, his company, and his investors partake in on a daily basis are over our heads yet may somehow financially affect us-- and naturally that deserves justice. But what do I know? I'm just the little guy, looking up at the great big rich fatties, thinking of all the wonderful good that could have been done with all of those billions of wasted dollars, played with like mere Monopoly money. Me, sympathize with those shaken by the instability obvious in the world of hedge funds。
Bernard Madoff was the head of a multi-billion dollar hedge fund on Wall Street. Today, he was arrested for allegedly running a Ponzi Scheme.
For financial beginners, I’m going to break this down to the very basics because this arrest is one of the biggest financial frauds in American history, and the ramifications are potentially enormous. People need to be informed.
THE BERNARD MADOFF ALLEGATIONS
Bernard Madoff, 70, is the founder of Bernard L. Madoff Investment Securities LLC, which has grown into a multi-billion institution since its founding in 1960. Public information on Madoff’s company is available here at its website.
Madoff’s company included a brokerage house and a hedge fund. According to state prosecutors, Madoff told his staff this week that the hedge fund was “basically, a giant Ponzi scheme.” Investors have put in $50 billion into the hedge fund.
In court today, state prosecutors charged Madoff with securities fraud. The maximum sentence is 20 years in prison and a fine of up to $5 million. Madoff is currently out on $10 million bail. The Securities and Exchange Commission is filing separate charges.
Why is this such a big deal?
According to the Wall Street Journal, approximately $2 trillion are currently invested in hedge funds. The hedge fund world is the financial Wild West, with little regulation and very few people with an actual clue as to where the money is really going. Given today’s crisis in the financial markets, allegations of fraud may shake investors confidence in the hedge fund world.
Hopefully, Madoff’s case turns out to be an isolated incident and the hedge fund world will survive.
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