The Economy – What went wrong & What’s next? II

See Part I of this topic/saga ; The evolving bailout plan ; The world after the (bailout) vote
31 October 2008
Reversal of Fortune
How ideology, special-interest pressure, populist politics, and sheer incompetence have left the U.S. economy on life support, Joseph E. Stiglitz puts forth a clear, commonsense plan to reverse the Bush-era follies and regain America’s economic sanity. ( Vanity Fair November 2008 ) and more from Nobel Laureate Stiglitz  below
31 October
How U. S. Politicians and Bankers Built a Financial Debt House of Cards (whose Collapse Threatens to Destroy the World Economy).
by Rodrigue Tremblay
… the problem is both political and financial and this has to be understood in order to disentangle the web of causes that produces a financial and economic collapse. It is that combination of political corruption and racketeering financial and banking practices that creates the right environment for a major crisis to develop. Why each 60-some years? Essentially because the lessons learned the hard way by a grandparents’ generation, sixty some years ago, are forgotten by a succeeding spoiled brats current generation, and the same past mistakes and fresh ones are made anew.
How to Get Out of the Financial Crisis
Joseph Stiglitz
( TIME) The Administration has veered from one half-baked solution to another. Wall Street panicked, but so did the White House, and in that panic, they had a hard time figuring out what to do. The weeks that Paulson and Bush spent pushing Paulson’s orignal bailout plan — in the face of massive opposition — were weeks that could have been spent actually fixing the problem. At this point, we need a comprehensive approach. Another failed faint attempt could be disastrous. Here’s a five-step, comprehensive approach:

1. Recapitalize banks. With all the losses, banks have insufficient equity. Banks will have a hard time raising this equity under current circumstances. The government needs to provide equity. In return, it should have voting stakes in the banks it helps. But equity injections also bail out bondholders. Right now the market is discounting these bonds, saying there is a high probability of default. There needs to be a forced conversion of this debt to equity. If this is done, the amount of government assistance that will be required will be much reduced.
2. Stem the tide of foreclosures.  Even after congressional revisions, too little is being done. We need to help people stay in their homes, by converting the mortgage-interest and property-tax deductions into cashable tax credits; by reforming bankruptcy laws to allow expedited restructuring, which would bring down the value of the mortgage when the price of the house is below that of the mortgage; and even government lending, taking advantage of the government’s lower cost of funds and passing the savings on to poor and middle-income homeowners.
3. Pass a stimulus that works.  The U.S. economy is headed for a serious recession and needs a big stimulus. We need increased unemployment insurance; if states and localities are not helped, they will have to reduce expenditures as their tax revenues plummet, and their reduced spending will lead to a contraction of the economy. But to kick-start the economy, Washington must make investments in the future.  Investments in infrastructure and technology will stimulate the economy in the short run and enhance growth in the long run.
4. Restore confidence through regulatory reform. Underlying the problems are banks’ bad decisions and regulatory failures. These must be addressed if confidence in our financial system is to be restored. Corporate-governance structures that lead to flawed incentive structures designed to generously reward CEOs should be changed and so should many of the incentive systems themselves. It is not just the level of compensation; it is also the form — nontransparent stock options that provide incentives for bad accounting to bloat up reported returns.
5. Create an effective multilateral agency. As the global economy becomes more interconnected, we need better global oversight.

FBI Probe of JPMorgan Fees Focuses on Swaps Roiling Muni Debt
While JPMorgan has been relatively unscathed by the subprime crisis … a little-known part of the largest bank in the U.S. made a tidy profit peddling a different kind of corrosive debt to hundreds of counties and school districts earlier this decade. As the credit crunch froze lending globally, causing stock markets to plunge, local officials who say they trusted JPMorgan faced a crisis of their own. Wall Street’s drive for profits over the past decade has backfired on towns, cities and counties that borrow in the $2.7 trillion municipal bond market.
26 October
The Collapse
(ZNet) Vijay Prashad
The deepening financial crisis in the U.S. forces the neoconservatives to reverse their policies.
(New York) — THE financial dam burst on September 13, 2008. A flood of capital swept out of the stock markets and went into government-backed bank accounts, where they remain, pooled up and inert. These bank accounts are the equivalent of hiding money in one’s mattress. They are shelters from the turbulence of the financial storms. Governments from Japan to the United States struggled to take control over a vast continent of economic life that they had previously given up to the bandits of profit.
With wreckage piling up, Fed eyes another rate cut
(AP) Vanishing jobs and shrinking paychecks have forced consumers to cut back sharply. Millions of ordinary Americans have watched their 401(k)s and other nest eggs shrink and the value of their homes drop, making them feel in even worse financial shape. In turn, businesses have cut back on hiring and other investments as customers hunker down and credit problems make it harder and more costly to get financing.
24 October
If the situation were not so dire, we could almost take pleasure in watching the mea culpas come in thick and fast.
‘Out of Control’ CEOs Spurned Davos Warnings on Risk
Oct. 24 (Bloomberg) — Once upon a time, the World Economic Forum was the ultimate Wall Street jamboree.
Now, in the riptide of the worst financial crisis since the Great Depression, WEF officials and delegates say many of the chief executive officers who gathered in Davos, Switzerland, over the last five years didn’t listen to warnings from their peers. Davos organizers also say they failed to play tough with the financial-industry bosses, opting to accept their funding and let them turn Davos into a rave-up for Wall Street excesses.
The fallout has left the WEF riddled in buyer’s remorse, with officials throughout the organization asking what they have wrought and, like Wall Street, whether they offered too much of a good thing.
Greenspan Concedes Error on Regulation
For years, a Congressional hearing with Alan Greenspan was a marquee event. Lawmakers doted on him as an economic sage. Markets jumped up or down depending on what he said. Politicians in both parties wanted the maestro on their side. But on Thursday, almost three years after stepping down as chairman of the Federal Reserve, a humbled Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending.
5 October  Credit default swaps, etc.for the uninitiated
A Look At Wall Street’s Shadow Market
60 Minutes: How Some Arcane Wall Street Financial Instruments Magnified Economic Crisis
3 October
The world’s headache becomes eastern Europe’s migraine
WHAT does the collapse of the pyramid scheme formerly known as the western financial system mean for the ex-communist world? The short-term answer is bad, and the longer-term answer even worse.
In the 1990s, a downturn in western markets proved to be surprisingly good news for new Europe: rich-world managers wanting to cut costs turned to outsourcing in countries that they had previously seen as too risky. This time will be different. Land and labour cost more … good workers are far more mobile and choosy: that’s nice for them, less so for their bosses. Failure to reform the education systems in most countries has blunted the competitive edge further. So has demography—the end of communism sent the birth rate plunging, so most countries in the region risk growing old before they get rich. The biggest question is what happens in big west European economies: dependence on export markets there is up to 40% of GDP for countries such as the Czech Republic. In short: if Germany gets a headache, eastern Europe gets a migraine.
2 October
(The Economist) More banks went to the wall amid the turmoil in financial markets caused by the uncertainty over the bail-out package. In America’s biggest banking failure, Washington Mutual was seized by federal regulators and its banking operations sold to JPMorgan Chase. Separately, Citigroup stepped in to rescue Wachovia. Both deals were brokered by the Federal Deposit Insurance Corporation. See article
Sarkozy recoils from EU-wide €300bn rescue
(FT) President Nicolas Sarkozy on Thursday distanced himself from a proposed €300bn EU bank rescue scheme that has divided EU governments and left his efforts to galvanise Europe’s response to the financial crisis in tatters.
30 September
The Political Nature of the Economic Crisis
The modern penchant to regard economics as a discrete science parallels the belief that economics is a distinct sphere of existence — at its best when it is divorced from political and even moral considerations. Our view has always been that the economy can only be understood and forecast in the context of politics, and that the desire to separate the two derives from a moral teaching that Smith would not embrace
In Wall Street’s fall from grace, a lift for others?
(IHT) For several years, London has been stealing a march on Wall Street as a hub for trading currencies and financial products. Hong Kong and Tokyo aren’t too far behind. And now, new hubs emerging in developing countries are trying to secure regional, if not international, influence. If Wall Street’s reputation takes a permanent hit as a result of the current woes, it could create space for all of the up-and-comers. At the very least, it could create new incentives for countries outside the United States to develop their investment banking and financial intermediation services.
Lesson From a Crisis: When Trust Vanishes, Worry
25 September
Global storms darken mood in eurozone
(FT) Sharp falls in business confidence were reported across continental Europe on Wednesday as global economic storms drove the eurozone towards recession, adding pressure on the European Central Bank to consider interest rate cuts.
(The Economist) The Federal Reserve gave America’s last two big investment banks, Goldman Sachs and Morgan Stanley, permission to change their status to bank holding firms. They will be subject to stiffer regulation, but allowed to take deposits. Goldman Sachs raised $5 billion to shore up its capital by selling shares to Berkshire Hathaway, the firm run by Warren Buffett, a celebrated investor. The next day, it raised $5 billion more from a share offering. Mitsubishi-UFJ, Japan’s largest bank, agreed to buy up to 20% of Morgan Stanley for $8.4 billion. And then there were none
The Bush Administration’s Banking Rescue Plan
By Rodrigue Tremblay
Even though it is the primary responsibility of a government to make sure that financial markets and institutions function properly, the Bush administration’s banking rescue plan leaves a lot to be desired before being called economically efficient, and socially and politically acceptable.
24 September
Issue Is Payback, Not Bailout
By David Leonhardt, NYT
… in just a few days’ time, members of Congress have to figure out how to improve the bare-bones $700 billion plan submitted by Henry Paulson, the Treasury secretary, and ultimately whether to vote for it.
Their best shot at success depends on keeping the debate tightly focused on the questions that matter most. There are really only two: What steps are most likely to solve the immediate crisis? And how can the long-term cost to taxpayers be minimized?
World leaders angered by U.S. financial crisis
The American financial markets and the current U.S. administration’s oversight came under fire at the United Nations Tuesday as almost every single world leader to speak made overt mention of the current crisis. The New York Times (9/24)
23 September
Carping about the TARP
(The Economist) Congress wrangles over how best to avoid financial Armageddon
Buyout Plan for Wall Street Is a Hard Sell on Capitol Hill
WASHINGTON — Treasury Secretary Henry M. Paulson Jr. received an angry and skeptical reception on Tuesday when he appeared before the Senate Banking Committee to ask Congress to promptly give him wide authority to rescue the nation’s financial system.
Dodd On Paulson Plan: “Not Just Our Economy At Risk…Our Constitution As Well”
Senator Christopher Dodd … squarely aimed a shot at Section 8 of the proposal, which stipulates that, under the plan, the Secretary’s actions would be “non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”
A Bailout Above the Law
(NYT) …  the Treasury secretary — whoever that may be in a few months — will be with vested with perhaps the most incredible powers ever bestowed on one person over the economic and financial life of the nation. It is the financial equivalent of the Patriot Act.
22 September
Democrats Seek Oversight and Aid for Borrowers
(NYT) WASHINGTON — Senate and House Democratic leaders said on Monday that they had reached an agreement on their conditions for approving a $700 billion rescue plan for the financial system, including more oversight of the program and a requirement that the government do more to help troubled borrowers refinance their mortgages. But even as Congressional Democrats and the administration began to narrow their differences, Democrats are bracing for a battle over efforts to limit the pay of executives whose firms seek help and over whether to grant bankruptcy judges authority to modify the mortgages of borrowers in danger of foreclosure.
(Bloomberg) Democrats Say They Narrowed Differences With Paulson on Rescue
Probably more than any other, the headline below indicates what to most of us has been – and is – wrong with the economy.
Fury at $2.5bn bonus for Lehman’s New York staff
Up to 10,000 staff at the New York office of the bankrupt investment bank Lehman Brothers will share a bonus pool set aside for them that is worth $2.5bn (£1.4bn). The revelation sparked fury among … Lehman’s 5,000 staff based in London, who currently have no idea how long they will go on receiving even their basic salaries, let alone any bonus payments. It also prompted a renewed backlash over the compensation culture in global finance.

21 September
The shadow banking system is unravelling
By Nouriel Roubini
(FT Op-Ed) Last week saw the demise of the shadow banking system that has been created over the past 20 years. Because of a greater regulation of banks, most financial intermediation in the past two decades has grown within this shadow system whose members are broker-dealers, hedge funds, private equity groups, structured investment vehicles and conduits, money market funds and non-bank mortgage lenders.
Like banks, most members of this system borrow very short-term and in liquid ways, are more highly leveraged than banks (the exception being money market funds) and lend and invest into more illiquid and long-term instruments. Like banks, they carry the risk that an otherwise solvent but liquid institution may be subject to a self­-fulfilling and destructive run on its ­liquid liabilities.
But unlike banks, which are sheltered from the risk of a run – via deposit insurance and central banks’ lender-of-last-resort liquidity – most members of the shadow system did not have access to these firewalls that ­prevent runs.
20 September
A Professor and a Banker Bury Old Dogma on Markets
Along the way, they have cast aside the administration’s long-held views about regulation and government involvement in private business, even reversing decisions over the space of 24 hours and justifying them as practical solutions to dire threats.
The improvisational nature of their effort has turned President Bush and Congressional Democrats into virtual bystanders, sometimes uncertain about what comes next and left to wonder about the new power dynamics in the capital. Seemingly every time lawmakers tried to get a handle on what was happening and what role they might play with elections around the corner, Mr. Paulson and Mr. Bernanke would show up again on Capitol Hill for another evening meeting with another surprise development.
Rebuilding Wall Street
Conrad Black
‘Capitalism carries the seeds of its own destruction: As odious as government intrusions may be, laissez-faire economics brings the roof down eventually –just as it did in 1929’
Hard Truths About the Bailout
(NYT Editorial) If done right, this bailout could succeed where the others have failed and remove the threat of a systemwide financial collapse. But the upfront cost will be enormous. So will the risk of losses in the long run — on top of the risks already incurred.
The new plan would commit taxpayer money to buy hundreds of billions of dollars of troubled loans and other mortgage-related securities from banks and Wall Street firms. It is based on the reasonable premise that as long as institutions are stuck with those assets, the flow of credit, the economy’s lifeblood, will be constrained, or as in the past week, all but frozen.
Bush Officials Urge Swift Action on Rescue Powers
Henry M. Paulson Jr., the Treasury secretary, made it clear that the upfront cost of the rescue proposal could easily be $500 billion, and outside experts predicted that it could reach $1 trillion.
19 September
(Politico) President Bush Goes AWOL During Financial Crisis
18 September
(Federal Reserve Press Release) Today, the Bank of Canada, the Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank are announcing coordinated measures designed to address the continued elevated pressures in U.S. dollar short-term funding markets. These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets. The central banks continue to work together closely and will take appropriate steps to address the ongoing pressures.
Wall Street’s bad dream
(The Economist) special nine-page report looks at how the global financial system has fallen into the grip of panic
Moscow suspends trading
(FT) Russia was facing one of the biggest tests of its market economy after it was forced to close its two main stock exchanges to halt a rout that has led to the steepest declines since the August 1998 crisis.
17 September
Modern history’s greatest regulatory failure
by Roger Altman
(Op-ed, FT) This will come to be seen as the greatest regulatory failure in modern history. The degree of leverage that these institutions took on is indefensible. The average large securities firm was leveraged 27 to one in mid-2007. They were not regulated by any prudential supervisor. In effect, they regulated themselves. The lack of transparency was stunning. Many big lenders did not disclose off-balance-sheet risks. In some cases, they did not understand these risks themselves. More fundamentally, we allowed a second, huge financial system to develop outside the normal banking network. It consisted of investment banks, mortgage finance companies and the like. It was unregulated, not transparent and way too leveraged. But with nine separate and mostly ineffective financial regulators, these risks were ignored. That is, until this second system crashed.
We will be climbing out of this financial hole for a long time. Three or four years may pass before normal lending functions are resumed. In the interim, our economy will not have access to all of the credit it needs and may underperform, at great cost to our society. All of this could have been prevented.
Banks’ exposure to Lehman emerges
Bill Copp reminds us today: When the tech/telecommunication stocks crashed in 2000/01 many companies in the sector that had once traded in triple digits disappeared. The survivors however went on to bigger and better things, in short neither the internet or wireless communication went away …they grew. One such success story in Canada was Telus which fell from the mid 40’s to under 10 dollars during the rough times but rebounded to 65$ over the following few years.
A Failure Tax
By JONATHAN G S KOPPELL, director of the Millstein Center for Corporate Governance and Performance at Yale.
(NYT) Why not make investment banks and other companies pay premiums for this catastrophic risk insurance? The government already provides flood, bank and crop insurance. Unlike participants in those programs, however, the companies that qualify for “too big to fail” insurance do not pay for the privilege.
Now fear stalks British banks
Speculators hunting for next victim target UK institutions
The storm sweeping the financial world crossed the Atlantic yesterday, with Halifax Bank of Scotland, the UK’s largest mortgage provider, hit hard by a cyclone of speculation. … traders asked “Who next?” and seized on the slightest hint of real or perceived weakness in the British banks to sell into a plummeting market.
The Fed reckons the financial crisis has not yet seriously undermined the economic outlook
(The Economist) The likeliest explanation for the Fed’s decision to stand pat is that it is too soon to know whether the recent developments have affected growth. The Fed may reckon that a 2% funds rate should be sufficient to get the economy through its current slump. There are also other tools to contain the risk: the Fed expanded the size of one of its lending programmes and broadened the type of collateral it accepts in another, and the Treasury has the ability to purchase mortgage-backed securities.

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