Wednesday Night #1405

Photos  and video

I am still waiting for villains – culprits – somebody with professional standing must have evaluated ABCPs . I think these are people who must be found. Otherwise we think that everybody – or nobody- was guilty and it will go on again. Unless we learn from history, we will repeat it, and now we are repeating it. 

The economic crisis
The dominoes continue to fall in succession and it appears that the end of the game is nowhere in sight.  It is reported  that twenty-seven percent of university graduates in China will be unable to find employment this year and 20 million rural migrant workers have lost their jobs. Unemployment in Japan is also moving higher.   Large amounts of money have been thrown at the problem without any assurance that anything other than time will provide a cure.
President Obama has acted prudently in limiting compensation  (as recommended recently by one vocal Wednesday Nighter) for senior management of institutions receiving federal funds. Somewhat tempering the ‘harshness’ of the cap, is that in lieu of cash executives may be offered share options that would only be exercisable when the government has been paid back, thus giving institutions an incentive to get out of debt more rapidly without contravening the terms of government aid. [Whether or not this is a significant step in the recovery of the institutions, there is no doubt that it has made the headlines around the world and as such is a very successful PR gesture – and was quickly copied in Europe]  For many, the more important part of Obama’s message was his statement: This is America. We don’t disparage wealth. And we believe that success should be rewarded. But what gets people upset – and rightfully so – are executives being rewarded for failure. Several Wednesday Nighters maintain that there is also a responsibility of large shareholders to enforce transparency by exercising oversight of chief executives’ compensation.
The decision to deny Lehman the means to continue, considered by many to have been a gigantic error in judgment, was designed to set an example to other institutions indicating that injudicious use of investors’ money was no longer to be tolerated.
An analysis of what went wrong would indicate that the competition for compensation dictated the the sacrifice of  long-term company strength in favor of the attractiveness of the next balance sheet, which became the report card for the CEO’s compensation as well as an item for his curriculum, thus ensuring continuing highly remunerative employment regardless of the fortune of the company.

The stimulus package too big or not big enough?
Economic advisors on both sides (Larry Summers and Marty Feldstein) fundamentally agree on the policy; the question is whether the amount is related to the need.  Nobody knows at this stage. There is a reasonably high probability of an inflationary period two years from now resulting from the liquidity pumped into the system at this point, and triggering a new cycle of problems including high interest rates, a drop in the stock market and increased inflation.
We have not yet reached 10 percent unemployment – and we must remind ourselves that more than 90 percent of the workforce is still employed – and consuming.  The  positive news is that we are at the worst part of the business cycle; the current recession has been responsible for a rapid decrease in production with a resulting increase in inventories.  Ultimately, perhaps within about two years, the current inventories will have been depleted and demand for manufactured goods will once again slowly increase.
It would appear that the right decisions have been made to shorten the recovery time.  In the United States where sums of virtually unimaginable magnitude have been devoted to start the recovery process, we await evidence of the success of that initiative.
Although the appearance of a turnaround may be premature, there are signs of positive change, whether short term or longer is not yet evident. The panic we have seen in the previous months seems to have stabilized. Technicians believe we may be reaching the bottom and turnaround point.  In the last month 10-year U.S. Treasuries have risen by almost fifty percent. The Baltic Dry Shipping rate is rising dramatically in the last two weeks. The Chinese (Shanghai) market is up by 20% as the European and American markets continue to decline.  The Chinese are restocking.  Commodities appear to be bottoming. As cutbacks due to inability to finance are taking place, there is a real possibility of shortages with consequent demand for restocking . There are some promising returns from southeast Asia and even some Canadian companies.  Dividends are increasing and it seems that the panic may be over for the time being – unfortunately, people are not seeing the positive signs and remain pessimistic.

An historian’s view is often helpful to predict the future. In 1932, when unemployment reached the nadir (25%) in both the U.S. and Canada, as the New Deal kicked in the stock market had almost recovered to the October 1929 levels (not the extremes). A curious parallel exists in that the responsibility for the Great Depression was given to working class Americans for being so greedy, going into debt to buy the things that advertising agencies were selling them. Through GMAC, GM offered  limitless credit to those buying GM products. And who let people have mortgages this time? The people we consider our wise financial advisers who pronounced them assets and sold them as assets around the world, along with the ABCP.
The advent of free or at least freer trade distinguishes this depression from all previous models, namely the export of the manufacturing sector in favor of developing domestic intellectual and service sectors.  Nowhere does this seem more evident than in the United Kingdom where there is said to be no significant remaining manufacturing sector.  North America has outsourced so much of its manufacturing that it too will have a difficult recovery period and because we are important consumers of goods now manufactured in East Asia, those countries are suffering.

Banks
There has been a shift over the past 20 years. Banks came to believe that it is ‘their’ money and stopped believing that they were a service institution.
The model with which most of us have grown up was one of the bank as a local, community-based institution accepting deposits to finance loans to reliable borrowers.  That disappeared with the decision in 1999 to permit commercial banks to acquire investment banks and abandon their traditional role in favor of investment, finance, insurance and other roles, thus making credit less available to those borrowers who have the potential to rebuild the economy [Paul Krugman concurs] , and, not incidentally, creating the problems that have gutted the big banks. There is a need to separate the two models – as was done in the 30s – reverting to the old fashioned community-based service, in addition to the trading entities. This will not be an easy regulatory exercise.

Real estate values
There is some apprehension over a drop in the price of real estate. The picture in Montreal is patchwork, and in any event, as real estate has not known the highs of Toronto or Vancouver, it will likely not see the dramatic lows. Housing starts are slowing, but for the past three years they have tripled each year. A slow-down may not be bad.   Historically, the real estate market has appreciated over the long term at a rate of two percent above inflation and each sudden exponential rise is compensated for by a return to the long term historical appreciation. An interesting difference between Canada and the U.S. — in Canada, one can default on the mortgage and hand in the keys without being put into bankruptcy. This is not true in the U.S.

The state of Canada’s military equipment and morale
For many years the Canadian Armed Forces were not adequately equipped for modern warfare.  Modern weaponry is costly, not usually high on the agenda of a government in peacetime, but is generally judged necessary to be renewed at half century intervals.  The war in Iraq and Afghanistan has provided the government of Canada with the incentive to bring the equipment for the Armed Forces into the twenty-first century, a move that had been too long delayed.  However the environment of sand and air in those war zones has aged the new equipment to a point beyond their intended lifespan at great expense to the collective Canadian and American purses.
People wear out. The often-overlooked psychological human cost exceeds the cost of weaponry as has happened with each war, changing names with each new conflict. World War I shell shock has morphed into operational stress disorder (OSD), a condition that ultimately affects all combatants as a function of the time spent on the battlefield and the number of tours of duty.  It is clear that it bears no relationship to bravery or cowardice, but the stigma, or perhaps the treatment cost, appears to prevent the governments of both Canada and the U.S. from adequately recognizing the condition and dealing with it as deserved. In the U.S., which lacks Medicare, the situation is even more acute.

Afghanistan and Iraq
Ultimately the United States will be leaving Iraq, very much as it did Vietnam, undoubtedly without the presence of news cameras. What will be left behind? A people who have been exhausted by a state of war for over 20 years, suffering the same consequences of unremitting stress, and whose morale and productivity are understandably low. In contrast, Afghanistan is used to invaders (none of whom have been successful) and turmoil. Kandahar is the exception and in the view of one experienced observer, the allies should concentrate their efforts there. President Obama has indicated that the end of U.S. involvement in Afghanistan is not in the cards, but seasoned observers raise concerns that the NATO allies are culturally out of touch with the needs, problems, resources and views and doubt that much will be accomplished before Canada withdraws its forces in 2011.

Charitable donations and  the current economic climate
There are some 82,000 charities in Canada and their employees represent ten percent of the workforce. Today, the nature of charities is very different from 50 years ago. What is a charity and who is in need is today very different. Every orchestra, ballet company, museum has become a charity. Religious groups still receive 52% of every dollar donated. As the economy slows, there is more demand for the social services supplied by charitable organizations, both large and small, but concurrently, the economic slowdown is inevitably reflected in a corresponding decrease in charitable donations (15 – 18 percent) from individuals. Corporations rarely give more than one percent of their profits – and there are fewer manufacturing corporations. When Alcan was bought out, a foundation was created with $25million, – a lot less than what the company had given historically.  How much will banks, always one of the core supports of a major charitable organization, give now? These mainstays have been replaced by the service companies: accountants, engineering firms, consultants, who often give ‘sweat labour’ in lieu of cash. Private foundations’ income and asset values have  diminished by a very serious amount. While maintaining their commitments, they do not have the same cushion and are suggesting that their donations must be postponed.  Front-line charities are hurting and will likely suffer for the next two years. The situation is  exacerbated by the increasing numbers of victims of the slowdown dependent on charity, as well as the new causes for which new charitable foundations have been created. The aggressive response of some of these organizations to the drying-up of individual contributions may turn off those donors who simply are not able to respond to requests in the current economic climate. This raises the issue of the costs of fund raising at a time when more and more people are leaving the volunteer sector. The salaries of professional  fundraisers in some cases exceed the salary of the CEO of the organization for which funds are being raised. There is a moral and ethical issue to be addressed.   One solution proposed is that charities should behave counter cyclically – when the economy is doing well, they should put money aside whose yield might help meet the increasing demands placed upon them in difficult times such as these.

T H E  I N V I T A T I O N

As only a small band of remarkably determined hardy individuals – and not a single economist (we do not know if that is significant) – made it through the storm last Wednesday Night, we have decided to reprise part of last week’s proposed agenda, with a few time sensitive changes, for this week.
Before listing the dismal topics of global economy, budget and related matters, we would, however like to call to your attention two much more pleasant events:
Tuesday, February 9
Launch and book signing of Right Relationship: Building a whole earth economy by Wednesday Nighter Peter G. Brown and Geoffrey Garver at Paragraphe Bookstore 6:30 pm, — Gazette review of Right Relationship and More raves about the book. We encourage all to attend.
Saturday, February 14
Holly Jonas proposes a Choral Extravaganza for Valentine’s Day
Gala Fundraiser for La Scena Musicale
This concert will be an exciting gathering of 3 extraordinary choirs from Montreal: Concerto Della Donna, directed by Iwan Edwards, Studio de musique ancienne de Montréal, directed by Christopher Jackson, and Musica Orbium, conducted by Patrick Wedd. Three of Montreal’s top choirs support La Scena Musicale in Valentine’s Benefit Concert
The choirs are singing separately as well as joining forces, covering a wide range of repertoire, including selections of pieces by Brahms, Copland, Gershwin, Victoria, and the oh-so-romantic Song of Songs cycle by Palestrina. Scena Musicale

Okay, the fun is over and from here on it’s all about the economy, the budget aftermath, and the global economic downturn. No matter what the other news slipping through our mail slots (e- or otherwise), there really is only one topic that endures.
Now we know that Canada is not going to turn into another Iceland – at least our PM has not asked the Governor of the Bank of Canada to resign. Will he?
Which of the recent forecasts do you believe: the Bank of Canada outlook or Kevin Page’s grimmer forecast?
We have seen THE BUDGET – a total rejection of Conservative values according to commentators such as Andrew Coyne (shades of Pogo – ‘we have met the enemy and they are us’ -?) and watched Mr. Ignatieff spurn the coalition while insisting that he receive a Report Card on the profligacy (or not) of the government’s spending. This may be a wise move given that we have learned that the Conservatives have a filled-to-overflowing war chest and the Liberal cupboard is bare  So bare, according to the Hill Times, that Michael Ignatieff cannot afford to hire a Chief of Staff.
As we suggested last week, the World Economic Form (Davos) did indeed provide schadenfreude, amusement and dismay. One of the more entertaining round-ups is from Market Watch Dump Davos: Economic summit is a waste of time and money. We note that although he scornfully refers to the meeting as ‘pretty much the ultimate expense-account boondoggle’ for the media, Mr. Weidner has no hesitation in biting the hand(s) that feed, after being fed. Even the WSJ dumped on Davos this year and also managed to use the word ‘boondoggle’.
The main news we saw emanating from Davos was about everybody’s opposition to the Buy American proposed policy. After the chill of the last few days during which Canada was joined by the EU and some very large American manufacturers like Caterpillar, Times Online offers some relief “Last night [that would be tonight, ET] Mr Obama gave a strong signal that he would remove the most provocative passages from the Bill. [saying] ‘I think it would be a mistake, though, at a time when worldwide trade is declining, for us to start sending a message that somehow we’re just looking after ourselves and not concerned with world trade’.” Ah, perhaps one less thing to go wrong on the President’s Feb 19 visit to Ottawa
We remind you of Tony Deutsch’s latest addition to our Required Reading, Alan S. Blinder’s recent New York Times piece,  Six Errors on the Path to the Financial Crisis  about which Tony succinctly says: “I think he has it right”.
We were slightly surprised to find Diane Francis posting on the HuffPost site and await your views on her discussion  of “a massive pre-emptive devaluation of the U.S. dollar as Team Obama readies itself to announce the ‘Big Bang’ — a gigantic bailout of the frozen U.S. economy involving trillions of dollars.”
Of special interest these days is Purdy Crawford Faces Canadian ABCP Retail Noteholders in Public Meetings – Read and weep! And if you still have tears to shed over ABCP, don’t miss How [the] Caisse’s bet on quants went wrong
And more topics that were not addressed last week.
.