Some financial advisers have been moving away from traditional diversified asset allocations and recommending strategies involving structured products, computerized trading models, hedge funds, commodities, and other alternative investments. While these types of investments used to comprise, perhaps, 10% or 15% of an investor's portfolio, some advisers now recommend a much higher level, even up to 100%.
There are a variety of problems with these alternative products. They can be expensive (in terms of fees and trading expenses), opaque (in terms of what they actually involve) and unpredictable. Worst of all, they can be significantly more complex than traditional stocks, bonds and cash equivalents like money market funds.
Complexity is biggest problem of all. If there's a single reason why Wall Street crashed and we're now in the worse recession since the Great Depression, it's that Wall Street got so entangled in complex financial products that even many of its most sophisticated financial engineers and most seasoned executives couldn't figure out how bad things would get. If these people can't handle complexity, how would an ordinary investor deal with it?
Another problem with these complex approaches is that they can mask a fundamental truth: you can't get something for nothing. By now, one would think that's clear. After all, the entire game with derivatives was that somehow risk could be shifted in some magical way to stabilize the financial markets. The joke was on everyone who actually believed that. These new, alternative investment strategies appear to rest on the implication that there is a way to attain portfolio stability while still getting good returns. The last year and a half should have taught investors that there is no easy money in the financial markets.
When you can't stand the ups and downs of the financial markets, reduce your risks by simplifying your portfolio. Decrease the percentages of stocks and bonds you hold and increase the amount of cash and cash equivalents. Two years ago, many investors might have 60%, 70% or more of their portfolios in stocks, 15% or 20% in bonds, and 0 to 10% in cash. Today, if you've developed a heightened appreciation for prudence and stability, put 30% or 20% or even less of your portfolio in stocks and much more in bonds and cash. If you really can't stand volatility, put everything in cash. The great advantage of this approach is that you have a comparatively easy time figuring out what your risks are, and you can easily adjust your risk levels to whatever you're comfortable with. The costs of this approach can be modest, especially if you use low cost index funds.
Keep things simple. There's no need to follow the smart money. The smart money brought us the current financial and economic mess. Investors who think for themselves are the most likely to do well.
Wednesday, April 29, 2009
Sunday, April 26, 2009
Results of the Federal Government's Own Stress Test
We’ll soon know the results of the federal government’s stress tests of the 19 largest banks in America. What we already know, in a sense, are the results of the federal government’s stress test of itself.
Last week, Treasury Secretary Timothy Geithner made clear that banks participating in TARP (which would include just about all those undergoing stress tests), would not be allowed to repay the federal government’s TARP money except if the government allowed it. In other words, once a big bank is in TARP, it doesn’t get to choose the timing of its exit even if it believes it can repay the loan.
One could observe that made guys don’t get to leave the mob just because they feel like it. Indeed, some people believe the federal government is a form of organized crime. But we don’t wave telescopically sighted rifles from ridges and won’t advocate that point of view.
What this no exit (except with our approval) policy reveals is that the financial system remains fragile. If a couple of major banks leave the TARP program, that would imply that the banks remaining in TARP are weak. The latter would be vulnerable to runs, and the federal government seems to be saying that it might have an awfully hard time coping with another run on the banking system. Recall that the last run, after Lehman collapsed, required the ever-more expensive bailout of AIG. Basically, it took a blank check drawn on the United States to prop up the financial system. While members of Federal Reserve Board and other government officials have been dropping hints of the economy sprouting green shoots in a drought, the truth seems more like a Jackson Pollack splatter without the expressiveness than a clear picture.
The bank stress tests are a political event. They are being conducted under the supervision of the Secretary of the Treasury, not the independent bank regulatory process. Evaluate their results with that in mind.
Last week, Treasury Secretary Timothy Geithner made clear that banks participating in TARP (which would include just about all those undergoing stress tests), would not be allowed to repay the federal government’s TARP money except if the government allowed it. In other words, once a big bank is in TARP, it doesn’t get to choose the timing of its exit even if it believes it can repay the loan.
One could observe that made guys don’t get to leave the mob just because they feel like it. Indeed, some people believe the federal government is a form of organized crime. But we don’t wave telescopically sighted rifles from ridges and won’t advocate that point of view.
What this no exit (except with our approval) policy reveals is that the financial system remains fragile. If a couple of major banks leave the TARP program, that would imply that the banks remaining in TARP are weak. The latter would be vulnerable to runs, and the federal government seems to be saying that it might have an awfully hard time coping with another run on the banking system. Recall that the last run, after Lehman collapsed, required the ever-more expensive bailout of AIG. Basically, it took a blank check drawn on the United States to prop up the financial system. While members of Federal Reserve Board and other government officials have been dropping hints of the economy sprouting green shoots in a drought, the truth seems more like a Jackson Pollack splatter without the expressiveness than a clear picture.
The bank stress tests are a political event. They are being conducted under the supervision of the Secretary of the Treasury, not the independent bank regulatory process. Evaluate their results with that in mind.
Thursday, April 23, 2009
Bernie and Abdu
{This is a fantasy.}
Abdu picked up his lunch tray and looked for a place to sit in the inmates cafeteria at the Metropolitan Correctional Center in Manhattan. Almost all the prisoners were clustered together, it seemed, by skin color. The whites were in one corner, the blacks in another corner and the brown prisoners, who mostly spoke a language other than English, were in a third corner. He didn’t see anyone who looked Somali. More than ever, Abdu felt alone.
Then, he noticed an elderly white man sitting by himself. The man gave Abdu a half smile and nodded at the chair across the table from where he was sitting. Since no other American had given Abdu even a quarter smile, he took the invitation and sat down across from the elderly man.
“Hi. How are you?” asked the elderly man.
“Not so well. It’s hard adjusting to America when you’ve lived in Somalia all your life,” sighed Abdu, not saying even the half of it.
“First time here, then?” asked the elderly man.
“Yes,” said Abdu morosely, as he took a bite of his sandwich. Then, he frowned and asked, “What’s in this sandwich?”
“It’s called bologna,” said the elderly man.
“Is there any pork in it? I’m Muslim. I can’t eat pork,” said Abdu.
“They told me it was all-beef bologna,” said the elderly man. “I can’t eat pork either, so I made sure to ask.”
“Why can’t you eat pork?” asked Abdu.
“I’m Jewish,” said the elderly man.
Abdu squirmed in his chair and looked around. But, still, none of the other inmates, or prison staff, were giving him even a quarter smile. So he stayed where he was.
“Say, what’s your name?” asked the elderly man.
“Abdu.”
“Abdu? I’m Bernie.”
Abdu looked at the extended hand. He had never touched a Jew before; in fact he had never seen one before. He had heard about them, of course, and expected something much more monstrous than this seemingly congenial old man. However, considering that no one else was giving him even a quarter smile, he took Bernie’s hand and gave it a perfunctory squeeze.
“So, Abdu, what are you in here for?”
Abdu fidgeted and said, “Stealing . . . I suppose you could call it robbery. I mean . . . well, they say I was a pirate.”
“I see,” said Bernie. “They’ve charged me with stealing as well. And, to tell you the truth, people have called me worse things than a pirate.”
Abdu, not having had anyone to talk to since he had been arrested, couldn’t contain himself. “It’s so unfair. We weren’t pirates. We were . . . uh, fishermen. We approached the ship to see if we could get a glass of water. It was very hot that day.”
“Didn’t you have guns?” asked Bernie, his brow furrowed in puzzlement.
“Well, yes. But it’s very dangerous in that part of the world. There are a lot of pirates.”
“I see,” said Bernie, easing back into his half-smile.
“Do you? Do you understand? We’re very poor people. I never experienced central heating before I was imprisoned here. We struggle just to stay alive.”
“Life is a struggle,” said Bernie sympathetically. “You always have to stay on your toes.”
“I found that out this morning,” said Abdu. “A very large man here, with a name something like ‘Buppa’ . . .”
“You mean Bubba?” asked Bernie.
“Yes. That’s his name. He told me I had to give him the wages I would earn working at the prison laundry room. He raised his fists to make sure I understood what he meant. I can’t believe he would threaten me with violence to extort a little money.”
“Life can be very unfair,” observed Bernie. “Sometimes, you just have to bear up.”
Abdu felt panic welling up inside of him. “Bernie, they told me I could spend the rest of my life in prison. I can’t do that. I’ll go crazy. There has to be a way out.”
Bernie looked around, remaining silent while he scanned the room. Then he spoke in a low whisper.
“It doesn’t look like anyone is listening. Look, Abdu, I can help you get out.”
“You can? How is that?” asked Abdu, for the first time since his arrest feeling a ray of hope.
Bernie now widened his mouth into a full smile. “First, let’s chat about how you can help me.”
Abdu was puzzled. “How could I possibly help you?”
“You or your family probably have some . . . um, savings you might want to invest.”
“Us? Savings? Are you kidding?”
“Oh, come on, Abdu. Surely, you fishermen catch big fish sometimes. Everyone gets lucky now and then. This is important, if you want to get out of here.”
Abdu turned his head slightly, narrowed his eyes, and scrutinized Bernie closely. “Well, maybe we have a few extra shillings,” he said in a low voice.
“Good. I have a friend who controls a bank account in a foreign country, and all you have to do is tell your family to wire, let’s say, a million U.S. dollars to this account,” said Bernie. “Then I’ll tell you how to get out of here.”
“A million dollars?” cried Abdu. “That’s piracy.”
“Not at all. You see, you aren’t giving it to me. You’re investing it with me. I’ll use it to trade stock and options. I have a special, secret strategy that will generate returns of 10 to 12 percent a year, every year. Guaranteed. I’ll bet that’s a better return than you can get in Mogadishu.”
Abdu frowned. “No one can possibly earn a steady return like that. Even in Somalia, we know that markets fluctuate. Why, with the rising interest in piracy, the price of an RPG rocket launcher has doubled in the last two years.”
“Abdu, I tell you, I can get those returns,” said Bernie, the picture of buttery sincerity. “You understand that I’m offering you an exclusive opportunity. I haven’t told the other inmates about it. They’re all staying while you’ll be on your way out.”
Abdu pursed his lips while his mind raced. Then, he sat up in surprise. “Wait a minute. I know who you are. You’re the guy who stole $64 billion dollars. Even in Somalia, we’ve heard of you. You’ve stolen much more money than all the Somali pirates put together.”
“Don’t believe what you read in the newspapers,” said Bernie. “They never get the full story.”
“Forget it,” said Abdu. “I’m not falling for this nonsense. Whatever money my family has, we’re keeping at home, under the mattress, right next to the AK-47.”
Bernie was silent for a moment, but kept smiling. Then, he said, “Well, think about it, Abdu. We have lots of time to talk it over. I’m not going anywhere and neither are you.”
“Bernie,”said Abdu. “You know what you’re saying is a pack of lies. You’ve pled guilty. You’ve admitted you’re a crook. How can you keep saying these things?”
“Because this is what I do,” said Bernie. “I started years ago, and couldn’t stop even though I knew it was wrong. Why stop now? They can’t keep me in jail any longer than they already plan to.”
Abdu slumped back in his chair. He could see the future now. If he was convicted of the charges against him, there would be more lunches—maybe years of lunches--with Bernie, who would pitch him again and again about an exclusive way to escape. He’d listen because no one else would offer him any hope. And Bernie’s promises would be the worst punishment of all, because they’d just be illusions.
Abdu picked up his lunch tray and looked for a place to sit in the inmates cafeteria at the Metropolitan Correctional Center in Manhattan. Almost all the prisoners were clustered together, it seemed, by skin color. The whites were in one corner, the blacks in another corner and the brown prisoners, who mostly spoke a language other than English, were in a third corner. He didn’t see anyone who looked Somali. More than ever, Abdu felt alone.
Then, he noticed an elderly white man sitting by himself. The man gave Abdu a half smile and nodded at the chair across the table from where he was sitting. Since no other American had given Abdu even a quarter smile, he took the invitation and sat down across from the elderly man.
“Hi. How are you?” asked the elderly man.
“Not so well. It’s hard adjusting to America when you’ve lived in Somalia all your life,” sighed Abdu, not saying even the half of it.
“First time here, then?” asked the elderly man.
“Yes,” said Abdu morosely, as he took a bite of his sandwich. Then, he frowned and asked, “What’s in this sandwich?”
“It’s called bologna,” said the elderly man.
“Is there any pork in it? I’m Muslim. I can’t eat pork,” said Abdu.
“They told me it was all-beef bologna,” said the elderly man. “I can’t eat pork either, so I made sure to ask.”
“Why can’t you eat pork?” asked Abdu.
“I’m Jewish,” said the elderly man.
Abdu squirmed in his chair and looked around. But, still, none of the other inmates, or prison staff, were giving him even a quarter smile. So he stayed where he was.
“Say, what’s your name?” asked the elderly man.
“Abdu.”
“Abdu? I’m Bernie.”
Abdu looked at the extended hand. He had never touched a Jew before; in fact he had never seen one before. He had heard about them, of course, and expected something much more monstrous than this seemingly congenial old man. However, considering that no one else was giving him even a quarter smile, he took Bernie’s hand and gave it a perfunctory squeeze.
“So, Abdu, what are you in here for?”
Abdu fidgeted and said, “Stealing . . . I suppose you could call it robbery. I mean . . . well, they say I was a pirate.”
“I see,” said Bernie. “They’ve charged me with stealing as well. And, to tell you the truth, people have called me worse things than a pirate.”
Abdu, not having had anyone to talk to since he had been arrested, couldn’t contain himself. “It’s so unfair. We weren’t pirates. We were . . . uh, fishermen. We approached the ship to see if we could get a glass of water. It was very hot that day.”
“Didn’t you have guns?” asked Bernie, his brow furrowed in puzzlement.
“Well, yes. But it’s very dangerous in that part of the world. There are a lot of pirates.”
“I see,” said Bernie, easing back into his half-smile.
“Do you? Do you understand? We’re very poor people. I never experienced central heating before I was imprisoned here. We struggle just to stay alive.”
“Life is a struggle,” said Bernie sympathetically. “You always have to stay on your toes.”
“I found that out this morning,” said Abdu. “A very large man here, with a name something like ‘Buppa’ . . .”
“You mean Bubba?” asked Bernie.
“Yes. That’s his name. He told me I had to give him the wages I would earn working at the prison laundry room. He raised his fists to make sure I understood what he meant. I can’t believe he would threaten me with violence to extort a little money.”
“Life can be very unfair,” observed Bernie. “Sometimes, you just have to bear up.”
Abdu felt panic welling up inside of him. “Bernie, they told me I could spend the rest of my life in prison. I can’t do that. I’ll go crazy. There has to be a way out.”
Bernie looked around, remaining silent while he scanned the room. Then he spoke in a low whisper.
“It doesn’t look like anyone is listening. Look, Abdu, I can help you get out.”
“You can? How is that?” asked Abdu, for the first time since his arrest feeling a ray of hope.
Bernie now widened his mouth into a full smile. “First, let’s chat about how you can help me.”
Abdu was puzzled. “How could I possibly help you?”
“You or your family probably have some . . . um, savings you might want to invest.”
“Us? Savings? Are you kidding?”
“Oh, come on, Abdu. Surely, you fishermen catch big fish sometimes. Everyone gets lucky now and then. This is important, if you want to get out of here.”
Abdu turned his head slightly, narrowed his eyes, and scrutinized Bernie closely. “Well, maybe we have a few extra shillings,” he said in a low voice.
“Good. I have a friend who controls a bank account in a foreign country, and all you have to do is tell your family to wire, let’s say, a million U.S. dollars to this account,” said Bernie. “Then I’ll tell you how to get out of here.”
“A million dollars?” cried Abdu. “That’s piracy.”
“Not at all. You see, you aren’t giving it to me. You’re investing it with me. I’ll use it to trade stock and options. I have a special, secret strategy that will generate returns of 10 to 12 percent a year, every year. Guaranteed. I’ll bet that’s a better return than you can get in Mogadishu.”
Abdu frowned. “No one can possibly earn a steady return like that. Even in Somalia, we know that markets fluctuate. Why, with the rising interest in piracy, the price of an RPG rocket launcher has doubled in the last two years.”
“Abdu, I tell you, I can get those returns,” said Bernie, the picture of buttery sincerity. “You understand that I’m offering you an exclusive opportunity. I haven’t told the other inmates about it. They’re all staying while you’ll be on your way out.”
Abdu pursed his lips while his mind raced. Then, he sat up in surprise. “Wait a minute. I know who you are. You’re the guy who stole $64 billion dollars. Even in Somalia, we’ve heard of you. You’ve stolen much more money than all the Somali pirates put together.”
“Don’t believe what you read in the newspapers,” said Bernie. “They never get the full story.”
“Forget it,” said Abdu. “I’m not falling for this nonsense. Whatever money my family has, we’re keeping at home, under the mattress, right next to the AK-47.”
Bernie was silent for a moment, but kept smiling. Then, he said, “Well, think about it, Abdu. We have lots of time to talk it over. I’m not going anywhere and neither are you.”
“Bernie,”said Abdu. “You know what you’re saying is a pack of lies. You’ve pled guilty. You’ve admitted you’re a crook. How can you keep saying these things?”
“Because this is what I do,” said Bernie. “I started years ago, and couldn’t stop even though I knew it was wrong. Why stop now? They can’t keep me in jail any longer than they already plan to.”
Abdu slumped back in his chair. He could see the future now. If he was convicted of the charges against him, there would be more lunches—maybe years of lunches--with Bernie, who would pitch him again and again about an exclusive way to escape. He’d listen because no one else would offer him any hope. And Bernie’s promises would be the worst punishment of all, because they’d just be illusions.
Tuesday, April 21, 2009
Are People Getting Dumber?
The brain capacity of modern humans is about 15% lower than the brain capacity of the humans of 30,000 to 40,000 years ago (roughly 1,200 cc today vs. 1,400 cc in the Paleolithic). Although there are many variables that affect intelligence, brain size is one of them. A 15% difference between one person and the next may not tell us anything about their individual intelligence. But one must wonder whether such a large overall drop indicates that people are becoming dumber.
It's not hard to guess why brain size would decrease. Organs atrophy if the need for them diminishes. One might think that with all the technological advance of the last five centuries, the need for human brain capacity would have increased. But technology makes people less competent. The Welsh long bow, a fearsome weapon that could send a arrow through the heavy plate armor of French knights, required years of training before the archers became proficient. The gun--the heavy, clumsy, slow-firing matchlock musket of the 1500s--replaced the long bow because it was much easier to use and large numbers of men could be easily trained in its use. The exceptional proficiency required to shoot the long bow accurately was lost. Fast forward 500 years. How many people today can do simple multiplication and division in their heads? Indeed, how many people can do simple addition and subtraction in their heads? With the advent of the calculator and then the personal computer, arithmetic skills that were commonplace in 1950 are largely lost today.
The large brains of the Paleolithic allowed humans to become proficient hunters and survive in very hostile environments. Then, these really smart people figured out how seeds worked (think about what an incredible insight that was), and then develop agriculture. Farming provided humans with a much steadier food supply than hunting. (Do you know of any licensed hunters today who don't have a day job?) With food becoming much more readily available, people had time to develop written languages and recordkeeping systems. That reduced the need for keen memories.
Agriculture demanded stable, rich, well-watered fields, and flood plains were attractive places to grow. But they were vulnerable to floods. The best agricultural areas required large numbers of people to work together to control the floods. Thus, the development of large social structures in flood plains (think Egypt, Mesopotamia and China's Yellow River Valley). In a large society, there are small numbers of leaders and large numbers of followers. The followers don't have to individually think as hard; they just need to do what they are told. Obedience becomes a valued trait. There is less of an advantage to thinking for oneself.
What does all of this mean today? First, let us consider the 20th century, which is fresh in our memories. It was the most destructive century in human history, with over 100 million people being killed in wars. World War I started for the most ridiculous of reasons--childish ambitions of an insular aristocracy coupled with misguided notions of honor and allegiance that can only be described as idiotic--and swept destructively through a continent that prides itself on sophistication and knowledge. World War II, which was really a continuation of World War I, was triggered by fascist ideologies adopted by entire nations that abandoned all effort at thought and intelligence, and indulged in the basest of emotions. Cro-Magnons probably would have been aghast at what was wrought by their 20th century descendants.
The current financial and economic crisis is an updated version of speculative bubbles and financial panics that have occurred repeatedly over the centuries. These crises are the product, not of intelligence or thoughtfulness, but of unvarnished greed and the cunning use of fraud and financial innovation to fleece investors too eager to believe that they can get rich without risk or effort. The reason we are in a severe recession today is that we can't control our emotions or our willingness to believe people who say what we want to hear. The Cro-Magnon hunters of 40,000 years ago couldn't feed their families by indulging in food fantasies. They had to deal with reality, climb to high elevations or wade into dense, thorn-filled marshes, track down elusive animals, bring their game down with primitive, short range weapons, and then haul the food perhaps miles back to where their families waited. Their success suggests that they may have been better people than many alive today.
While there's much talk of reforming governmental regulation of the financial sector, there has been little discussion of reforming the human tendencies that created the problem. Of course, the government can't make people better. They have to make themselves better. Americans have always embraced risk. The first colonists to land on the James River and on Cape Cod took bigger risks than any hedge fund manager has ever taken. There's nothing wrong per se with a culture that, unlike Europe, favors risk taking and entrepreneurship. But uncontrolled, reckless risk taking and entrepreneurship brought us the 1929 stock market crash, the late 1990s tech bubble and crash, and now today's financial crisis. Corporate executives, board members, asset managers, investors and ordinary citizens are all guilty of believing that they could get rich without really having to work for it, that they're such good drivers they could skip wearing a seat belt. Perhaps we are collectively dumber than our ancestors. There is substantial evidence to that effect. Our hope lies in the fact that the process of evolution hasn't necessarily stopped.
It's not hard to guess why brain size would decrease. Organs atrophy if the need for them diminishes. One might think that with all the technological advance of the last five centuries, the need for human brain capacity would have increased. But technology makes people less competent. The Welsh long bow, a fearsome weapon that could send a arrow through the heavy plate armor of French knights, required years of training before the archers became proficient. The gun--the heavy, clumsy, slow-firing matchlock musket of the 1500s--replaced the long bow because it was much easier to use and large numbers of men could be easily trained in its use. The exceptional proficiency required to shoot the long bow accurately was lost. Fast forward 500 years. How many people today can do simple multiplication and division in their heads? Indeed, how many people can do simple addition and subtraction in their heads? With the advent of the calculator and then the personal computer, arithmetic skills that were commonplace in 1950 are largely lost today.
The large brains of the Paleolithic allowed humans to become proficient hunters and survive in very hostile environments. Then, these really smart people figured out how seeds worked (think about what an incredible insight that was), and then develop agriculture. Farming provided humans with a much steadier food supply than hunting. (Do you know of any licensed hunters today who don't have a day job?) With food becoming much more readily available, people had time to develop written languages and recordkeeping systems. That reduced the need for keen memories.
Agriculture demanded stable, rich, well-watered fields, and flood plains were attractive places to grow. But they were vulnerable to floods. The best agricultural areas required large numbers of people to work together to control the floods. Thus, the development of large social structures in flood plains (think Egypt, Mesopotamia and China's Yellow River Valley). In a large society, there are small numbers of leaders and large numbers of followers. The followers don't have to individually think as hard; they just need to do what they are told. Obedience becomes a valued trait. There is less of an advantage to thinking for oneself.
What does all of this mean today? First, let us consider the 20th century, which is fresh in our memories. It was the most destructive century in human history, with over 100 million people being killed in wars. World War I started for the most ridiculous of reasons--childish ambitions of an insular aristocracy coupled with misguided notions of honor and allegiance that can only be described as idiotic--and swept destructively through a continent that prides itself on sophistication and knowledge. World War II, which was really a continuation of World War I, was triggered by fascist ideologies adopted by entire nations that abandoned all effort at thought and intelligence, and indulged in the basest of emotions. Cro-Magnons probably would have been aghast at what was wrought by their 20th century descendants.
The current financial and economic crisis is an updated version of speculative bubbles and financial panics that have occurred repeatedly over the centuries. These crises are the product, not of intelligence or thoughtfulness, but of unvarnished greed and the cunning use of fraud and financial innovation to fleece investors too eager to believe that they can get rich without risk or effort. The reason we are in a severe recession today is that we can't control our emotions or our willingness to believe people who say what we want to hear. The Cro-Magnon hunters of 40,000 years ago couldn't feed their families by indulging in food fantasies. They had to deal with reality, climb to high elevations or wade into dense, thorn-filled marshes, track down elusive animals, bring their game down with primitive, short range weapons, and then haul the food perhaps miles back to where their families waited. Their success suggests that they may have been better people than many alive today.
While there's much talk of reforming governmental regulation of the financial sector, there has been little discussion of reforming the human tendencies that created the problem. Of course, the government can't make people better. They have to make themselves better. Americans have always embraced risk. The first colonists to land on the James River and on Cape Cod took bigger risks than any hedge fund manager has ever taken. There's nothing wrong per se with a culture that, unlike Europe, favors risk taking and entrepreneurship. But uncontrolled, reckless risk taking and entrepreneurship brought us the 1929 stock market crash, the late 1990s tech bubble and crash, and now today's financial crisis. Corporate executives, board members, asset managers, investors and ordinary citizens are all guilty of believing that they could get rich without really having to work for it, that they're such good drivers they could skip wearing a seat belt. Perhaps we are collectively dumber than our ancestors. There is substantial evidence to that effect. Our hope lies in the fact that the process of evolution hasn't necessarily stopped.
Sunday, April 19, 2009
Essentials for Surviving a Downturn
Surviving a financial downturn, such as a layoff or major illness, isn't quite the same as in times past. The basic principle is to hold onto what is essential. But the list of essential items is different now than in earlier recessions. Here are some things to keep in mind.
Computer. Vast amounts of information needed for daily life (like new employment opportunities) are placed on the Internet. And who doesn't use e-mail? A computer is essential. The waiting times for the computers at public libraries can be hours. It's best to have your own computer. A laptop is preferred, since it can be easily carried (in case you have to change living arrangements) and Internet access is as close as the nearest WiFi source. If you have a Windows based machine, don't skimp on the anti-virus software.
Cell Phone. You understand why you need a telephone. A cell phone is better than a land line because it can be used anywhere you get reception, and doesn't need to be re-connected in case your living arrangements change. If your monthly plan is too expensive, switch to a pay as needed account and don't talk so much on the phone.
Credit Card. It's almost impossible to get by on cash alone. Debit cards tend not to have as much consumer protection as credit cards. So you pretty much need a credit card. Minimize the number of credit cards you hold (fewer cards will tend to have a positive impact on your credit rating). Try not to carry a balance over from month to month. If you're carrying a balance, try to pay it down because, recently, banks have gone wild trying to raise rates on credit cards.
Car. Unless you live in New York City, you pretty much need a car. Maybe a few people with narrowly focused lifestyles in Boston, San Francisco and Washington, D.C. can get away without a car. Many of those find themselves signing up for car sharing services after shelling out too much money to hostile cabbies. The other 97% of Americans find it really difficult to get by without a personal vehicle. Downsize your wheels if you find the lease on the Escalade too expensive. Besides, real millionaires are more likely to drive a Camry, Accord, Taurus, or Impala, so chose a more modest vehicle and project the image of quiet prosperity.
Cash. When economic times are tough, cash is the emperor. Put as much as you can in an FDIC insured bank or credit union account. Or, if you have an amount that exceeds FDIC limits, put it in a money market mutual fund that invests only in U.S. Treasury securities.
Health Insurance. Sooner or later, you or someone in your family, will have a health problem. Most people can't pay cash for health care. Health insurance is outrageously expensive, and we should all hope the government can find a sound solution to the health insurance problem. Until then (and then could be a long time), make sure you've got health coverage. Drop other types of insurance (except mandatory auto coverage) before dropping your health coverage. Uninsured health care costs are perhaps the biggest reason why people end up in bankruptcy, so this is not an expense where being pennywise pays off.
Flexibility. Flexibility about what job you'll take, and what region you'll move to in order to get a new job, can make a substantial difference in your future. Bear in mind the cost of living. Quality housing in nice suburbs with good schools is available for a small fraction of the Northeastern U.S. or coastal California cost in cities between the Alleghenies and the Sierra Nevadas. A couple in Dallas making $150,000 a year and living a middle class lifestyle can retire as millionaires, while a couple in the suburbs of New York making $200,000 a year and having a similar lifestyle might just manage to get by. If you have an open mind, you'll open up possibilities for yourself.
Housing? The advice of older generations to do whatever it takes to hold onto the house makes less sense today, when homes are falling in value. There's not much rationality to sinking good money in a depreciating asset when you have other options. With real estate overbuilt, there are more residential options available. Some people in the bubbliest of markets--which today are the most deflated markets--are walking away from the expensive homes they bought two to four years ago and buying a cheaper home (sometimes at half the price) a few miles away. This strategy, although not nice, makes sense if you put little or no money down on the first house and aren't legally on the hook to reimburse the lender for its losses. Your credit rating might take a hit, so you'd have to figure out how to finance the cheaper house (one cynical maneuver is to buy it and then walk away from the more expensive house). As a matter of morals and ethics, we can't endorse this sort of behavior. But when Wall Street has screwed up phenomenally, and then used its political muscle to get extraordinarily generous bailouts from middle class taxpayers, it's not surprising that we are creating a generation of cynics whose me first attitude is simply taken from the wealthy who have exploited them.
Computer. Vast amounts of information needed for daily life (like new employment opportunities) are placed on the Internet. And who doesn't use e-mail? A computer is essential. The waiting times for the computers at public libraries can be hours. It's best to have your own computer. A laptop is preferred, since it can be easily carried (in case you have to change living arrangements) and Internet access is as close as the nearest WiFi source. If you have a Windows based machine, don't skimp on the anti-virus software.
Cell Phone. You understand why you need a telephone. A cell phone is better than a land line because it can be used anywhere you get reception, and doesn't need to be re-connected in case your living arrangements change. If your monthly plan is too expensive, switch to a pay as needed account and don't talk so much on the phone.
Credit Card. It's almost impossible to get by on cash alone. Debit cards tend not to have as much consumer protection as credit cards. So you pretty much need a credit card. Minimize the number of credit cards you hold (fewer cards will tend to have a positive impact on your credit rating). Try not to carry a balance over from month to month. If you're carrying a balance, try to pay it down because, recently, banks have gone wild trying to raise rates on credit cards.
Car. Unless you live in New York City, you pretty much need a car. Maybe a few people with narrowly focused lifestyles in Boston, San Francisco and Washington, D.C. can get away without a car. Many of those find themselves signing up for car sharing services after shelling out too much money to hostile cabbies. The other 97% of Americans find it really difficult to get by without a personal vehicle. Downsize your wheels if you find the lease on the Escalade too expensive. Besides, real millionaires are more likely to drive a Camry, Accord, Taurus, or Impala, so chose a more modest vehicle and project the image of quiet prosperity.
Cash. When economic times are tough, cash is the emperor. Put as much as you can in an FDIC insured bank or credit union account. Or, if you have an amount that exceeds FDIC limits, put it in a money market mutual fund that invests only in U.S. Treasury securities.
Health Insurance. Sooner or later, you or someone in your family, will have a health problem. Most people can't pay cash for health care. Health insurance is outrageously expensive, and we should all hope the government can find a sound solution to the health insurance problem. Until then (and then could be a long time), make sure you've got health coverage. Drop other types of insurance (except mandatory auto coverage) before dropping your health coverage. Uninsured health care costs are perhaps the biggest reason why people end up in bankruptcy, so this is not an expense where being pennywise pays off.
Flexibility. Flexibility about what job you'll take, and what region you'll move to in order to get a new job, can make a substantial difference in your future. Bear in mind the cost of living. Quality housing in nice suburbs with good schools is available for a small fraction of the Northeastern U.S. or coastal California cost in cities between the Alleghenies and the Sierra Nevadas. A couple in Dallas making $150,000 a year and living a middle class lifestyle can retire as millionaires, while a couple in the suburbs of New York making $200,000 a year and having a similar lifestyle might just manage to get by. If you have an open mind, you'll open up possibilities for yourself.
Housing? The advice of older generations to do whatever it takes to hold onto the house makes less sense today, when homes are falling in value. There's not much rationality to sinking good money in a depreciating asset when you have other options. With real estate overbuilt, there are more residential options available. Some people in the bubbliest of markets--which today are the most deflated markets--are walking away from the expensive homes they bought two to four years ago and buying a cheaper home (sometimes at half the price) a few miles away. This strategy, although not nice, makes sense if you put little or no money down on the first house and aren't legally on the hook to reimburse the lender for its losses. Your credit rating might take a hit, so you'd have to figure out how to finance the cheaper house (one cynical maneuver is to buy it and then walk away from the more expensive house). As a matter of morals and ethics, we can't endorse this sort of behavior. But when Wall Street has screwed up phenomenally, and then used its political muscle to get extraordinarily generous bailouts from middle class taxpayers, it's not surprising that we are creating a generation of cynics whose me first attitude is simply taken from the wealthy who have exploited them.
Wednesday, April 15, 2009
Hitting the Limits of Governmental Action
Even as various government programs aimed at easing the recession and financial crisis are reaching the implementation stage, we are already seeing their limitations.
Bank Bailouts. Several small banks have recently repaid their TARP money, and Goldman Sachs will do so very soon. It's understandable why banks want out of TARP. No business likes the government to dictate executive compensation and other market-driven business policies and practices. But, considering that TARP was meant to stimulate lending, and do so in a way that did not make any bank look weak or endangered, action by a few stronger banks to opt out begins to push TARP down the slippery slope. For competitive reasons, other banks may decide to repay their TARP money, and rely on the FASB's recently relaxed accounting standards for toxic assets to look good while staying in business. TARP's effectiveness could be damaged in the process.
Foreclosures rising even as mortgage modifications increase. The Obama administration's mortgage modification program has officially begun, with some homeowners now receiving relief. However, banks and mortgage companies have also increased foreclosures of mortgages that aren't eligible for modification. Apparently, lenders have been holding a large number of foreclosures in abeyance will waiting to see which loans would be eligible for government subsidized relief. Now that the picture is clearer, those eligible proceed to the winner's circle and those ineligible lose their homes. Thus, while many homeowners may get to stay in their homes, housing prices may continue to experience downward pressure from the increase in foreclosure activity.
GM and Chrysler bankruptcies more likely. In any bailout situation, lenders and investors try to shove as much of their losses as possible onto the taxpayers. In the cases of the Bear Stearns, Fannie Mae, Freddie Mac and AIG bailouts, financial market counterparties and bondholders were quite successful in getting taxpayers to cover lousy bets these creditors had made. Meanwhile, shareholders took it on the chin. This precedent appears to have emboldened GM and Chrysler bondholders, leading them to take hard lines in bailout related negotiations. The Obama administration in turn is talking tough to bondholders, both to avoid yet more moral hazard and the spectacle of struggling middle class taxpayers bailing out the institutions and mostly wealthy individuals who hold GM and Chrysler bonds. If they deadlock, bankruptcy will follow. While there is a theoretical framework for a government funded restructuring of GM and Chrysler in bankruptcy proceedings, there is no real world track record. One thing that lawyers know is that when you're in court, you can't be sure of what's going to happen. One or two unanticipated rulings by the court, and the government funded restructuring could evaporate. If that happens, GM and Chrysler would almost surely be liquidated and the administration's goal of preserving jobs undermined.
Bank Stress Tests. The administration is struggling with the issue of how much to reveal of the results of the ongoing stress tests of the 19 largest American banks. Basically, these tests are analyses of how these banks would fare under various economic scenarios ranging from good to bad to ugly. Traditionally, federal regulatory examinations of banks have been conducted confidentially, to avoid precipitating runs by depositors when it turns out that a bank is in trouble. The problem with the stress tests is that they are not routine examinations, but instead highly touted elements of the administration's financial recovery program. By heightening public awareness of the stress tests, the administration is damned if it doesn't disclose and damned if it does. Not disclosing only feeds the rumor mill and fuels concerns that the entire banking sector is insolvent. That would probably freeze the still very cold credit markets. Disclosure would reveal differences in strength among the banks, and the weak would be vulnerable to funding problems and runs. Rosy disclosure would be perceived as grade inflation and heavily discounted. Investors and depositors are well past the point where they believe that all banks are headquartered on the shores of Lake Wobegon. The administration could have conducted the equivalent of stress tests through the routine bank examination process, since federal examiners pretty much continually work onsite at the major banks. But using the stress tests for public relations purposes--indeed, to raise public confidence--may easily fracture public confidence.
Today's stock market is all government, all the time. The value of stocks appears to depend almost entirely on the extent and efficacy of governmental intervention in the economy and the financial system. When the government hits the limits of its power, the stock market will squirm and perhaps swoon.
Bank Bailouts. Several small banks have recently repaid their TARP money, and Goldman Sachs will do so very soon. It's understandable why banks want out of TARP. No business likes the government to dictate executive compensation and other market-driven business policies and practices. But, considering that TARP was meant to stimulate lending, and do so in a way that did not make any bank look weak or endangered, action by a few stronger banks to opt out begins to push TARP down the slippery slope. For competitive reasons, other banks may decide to repay their TARP money, and rely on the FASB's recently relaxed accounting standards for toxic assets to look good while staying in business. TARP's effectiveness could be damaged in the process.
Foreclosures rising even as mortgage modifications increase. The Obama administration's mortgage modification program has officially begun, with some homeowners now receiving relief. However, banks and mortgage companies have also increased foreclosures of mortgages that aren't eligible for modification. Apparently, lenders have been holding a large number of foreclosures in abeyance will waiting to see which loans would be eligible for government subsidized relief. Now that the picture is clearer, those eligible proceed to the winner's circle and those ineligible lose their homes. Thus, while many homeowners may get to stay in their homes, housing prices may continue to experience downward pressure from the increase in foreclosure activity.
GM and Chrysler bankruptcies more likely. In any bailout situation, lenders and investors try to shove as much of their losses as possible onto the taxpayers. In the cases of the Bear Stearns, Fannie Mae, Freddie Mac and AIG bailouts, financial market counterparties and bondholders were quite successful in getting taxpayers to cover lousy bets these creditors had made. Meanwhile, shareholders took it on the chin. This precedent appears to have emboldened GM and Chrysler bondholders, leading them to take hard lines in bailout related negotiations. The Obama administration in turn is talking tough to bondholders, both to avoid yet more moral hazard and the spectacle of struggling middle class taxpayers bailing out the institutions and mostly wealthy individuals who hold GM and Chrysler bonds. If they deadlock, bankruptcy will follow. While there is a theoretical framework for a government funded restructuring of GM and Chrysler in bankruptcy proceedings, there is no real world track record. One thing that lawyers know is that when you're in court, you can't be sure of what's going to happen. One or two unanticipated rulings by the court, and the government funded restructuring could evaporate. If that happens, GM and Chrysler would almost surely be liquidated and the administration's goal of preserving jobs undermined.
Bank Stress Tests. The administration is struggling with the issue of how much to reveal of the results of the ongoing stress tests of the 19 largest American banks. Basically, these tests are analyses of how these banks would fare under various economic scenarios ranging from good to bad to ugly. Traditionally, federal regulatory examinations of banks have been conducted confidentially, to avoid precipitating runs by depositors when it turns out that a bank is in trouble. The problem with the stress tests is that they are not routine examinations, but instead highly touted elements of the administration's financial recovery program. By heightening public awareness of the stress tests, the administration is damned if it doesn't disclose and damned if it does. Not disclosing only feeds the rumor mill and fuels concerns that the entire banking sector is insolvent. That would probably freeze the still very cold credit markets. Disclosure would reveal differences in strength among the banks, and the weak would be vulnerable to funding problems and runs. Rosy disclosure would be perceived as grade inflation and heavily discounted. Investors and depositors are well past the point where they believe that all banks are headquartered on the shores of Lake Wobegon. The administration could have conducted the equivalent of stress tests through the routine bank examination process, since federal examiners pretty much continually work onsite at the major banks. But using the stress tests for public relations purposes--indeed, to raise public confidence--may easily fracture public confidence.
Today's stock market is all government, all the time. The value of stocks appears to depend almost entirely on the extent and efficacy of governmental intervention in the economy and the financial system. When the government hits the limits of its power, the stock market will squirm and perhaps swoon.
Monday, April 13, 2009
The Recession and Unemployment: Then There Are Statistics
You've heard the adage about there being lies, damned lies and then statistics. Plenty of statistics are tossed around in the discussions of the ongoing economic crisis. One such statistical claim is that unemployment levels are a lagging indicator of recession, and that rising unemployment is not a sign of a worsening economy. That may have been true in the relatively mild recessions caused in the past by the ebb and flow of the business cycle. The current recession, however, was caused by asset and credit bubbles that crippled the financial sector. Fixing the financial sector remains a critical step toward recovery. As long as the financial sector is burdened by toxic assets, it cannot revive.
Today, CNNMoney.com reported that high unemployment is a more important factor in mortgage defaults than escalating payments in adjustable rate mortgages. http://money.cnn.com/2009/04/13/real_estate/foreclosure_unemployment.reut/index.htm?postversion=2009041313. In other words, as unemployment rises, more mortgage defaults can be expected. This only stands to reason, since the loss of a job deprives borrowers of the income needed to pay the mortgage. It also means that rising unemployment is a leading indicator of worsening problems for the financial sector. When the unemployed default on more mortgages (and other consumer debt like credit cards and car loans), the toxic assets plaguing the financial sector (which are mostly derivatives of these debts) will fall further from their already depressed levels. The banks' problems--and the recession--may well worsen. The unemployed will also spend less, adding to the drag on the economy. Unemployment, therefore, exacerbates the recession and is a leading, not lagging, indicator of yet more bad times.
To be sure, the government's program for buying toxic assets from banks may reduce the impact of rising unemployment on crippled banks. Accomplishing that, though, requires that the program be implemented. To date, it has been very well announced, but nothing is operational. The devil, as always, lurks in the details and the weight of the available evidence indicates that the government and the banks remain seriously bedeviled.
We're not saying that the recession will definitely worsen or that the stock market will nosedive. We're saying that the conventional wisdom about unemployment levels and recessions probably doesn't work in our current unconventional circumstances. There are many factors that would affect the future direction of the economy. But don't, like too many supposed experts on cable TV, dismiss the significance of rising unemployment.
Today, CNNMoney.com reported that high unemployment is a more important factor in mortgage defaults than escalating payments in adjustable rate mortgages. http://money.cnn.com/2009/04/13/real_estate/foreclosure_unemployment.reut/index.htm?postversion=2009041313. In other words, as unemployment rises, more mortgage defaults can be expected. This only stands to reason, since the loss of a job deprives borrowers of the income needed to pay the mortgage. It also means that rising unemployment is a leading indicator of worsening problems for the financial sector. When the unemployed default on more mortgages (and other consumer debt like credit cards and car loans), the toxic assets plaguing the financial sector (which are mostly derivatives of these debts) will fall further from their already depressed levels. The banks' problems--and the recession--may well worsen. The unemployed will also spend less, adding to the drag on the economy. Unemployment, therefore, exacerbates the recession and is a leading, not lagging, indicator of yet more bad times.
To be sure, the government's program for buying toxic assets from banks may reduce the impact of rising unemployment on crippled banks. Accomplishing that, though, requires that the program be implemented. To date, it has been very well announced, but nothing is operational. The devil, as always, lurks in the details and the weight of the available evidence indicates that the government and the banks remain seriously bedeviled.
We're not saying that the recession will definitely worsen or that the stock market will nosedive. We're saying that the conventional wisdom about unemployment levels and recessions probably doesn't work in our current unconventional circumstances. There are many factors that would affect the future direction of the economy. But don't, like too many supposed experts on cable TV, dismiss the significance of rising unemployment.
Sunday, April 12, 2009
Pirates, Good Government and Bainbridge's Legacy
The piracy problems off the coast of Somalia illustrate, among other things, the need for good government. Somalia has been lawless for close to two decades and its putative government has effective jurisdiction perhaps to the doors of its offices. Regional warlords have carved out fiefdoms for themselves and their clans; some of those warlords run the piracy operations that have so recently been in the news. There is no government to restrain them. There is no government to foster a healthy legitimate economy that would serve as an alternative to piracy.
For historical reasons, Americans have sought to limit the power of government. But the absence of government can be costly. The reckless mortgage lending and derivatives trading of recent years happened in an atmosphere of regulatory neglect. The Bernie Madoffs of the world can prosper when government is inattentive. While the nation's financial problems don't approach the moral depravity of seizing ships on the high seas and holding sailors and passengers as hostages, rats and other vermin flourish whenever the cat is asleep or away. The Obama administration's regulatory push is good news.
A remarkable coincidence of today's rescue of an American ship captain from Somali pirates is that the first U.S. Navy ship on the scene, the U.S.S. Bainbridge, is named after Commodore William Bainbridge. Commodore Bainbridge spent much of the first decade of the nineteenth century fighting the Barbary pirates of North Africa. Indeed, he was captured in 1803 and held hostage by the Pasha of Tripoli for almost three years. His release came as a result of the first overseas expedition by the U.S. Marine Corps. In 1805, a Marine lieutenant named Presley O'Bannon, together with an American diplomat named William Eaton, led a detachment of eight Marines (not a typo: 8), and some 500 mercenaries recruited in North Africa on a 500 mile trek from Alexandria, Egypt westward to the city of Derna, which was part of the Pasha of Tripoli's domain. Eaton and O'Bannon then led an assault that captured Derna. This achievement, astonishing for the small and weak United States of the time, convinced the Pasha of Tripoli to negotiate a peace treaty with the Americans and eventually release Bainbridge and other American captives. Today's remarkable rescue of Captain Richard Phillips is in keeping with the U.S. Navy's tradition in combating piracy.
Piracy, in purely financial terms, has had a minor impact on overall global commerce. That's why shipping companies and insurers pay ransoms rather than incur the increased cost of routing ships away from dangerous shipping lanes and arming sailors. But as the pirates have accumulated more loot, they've been able to buy better ships with more sophisticated equipment and more powerful weapons. With their armament thusly enhanced, they are able to seize larger and more valuable ships farther out at sea, increase their loot, and buy even more powerful ships and weapons. Piracy is becoming a bubble. The pirates' defeat today at the hands of the U.S. Navy won't be enough to pop the bubble. But it is heartening for a nation beset by recession, rising unemployment and a futile war in Iraq. The world is a better place when, at least once in a while, right prevails over wrong, the good guys win, and heroes get to ride happily off into the sunset.
For historical reasons, Americans have sought to limit the power of government. But the absence of government can be costly. The reckless mortgage lending and derivatives trading of recent years happened in an atmosphere of regulatory neglect. The Bernie Madoffs of the world can prosper when government is inattentive. While the nation's financial problems don't approach the moral depravity of seizing ships on the high seas and holding sailors and passengers as hostages, rats and other vermin flourish whenever the cat is asleep or away. The Obama administration's regulatory push is good news.
A remarkable coincidence of today's rescue of an American ship captain from Somali pirates is that the first U.S. Navy ship on the scene, the U.S.S. Bainbridge, is named after Commodore William Bainbridge. Commodore Bainbridge spent much of the first decade of the nineteenth century fighting the Barbary pirates of North Africa. Indeed, he was captured in 1803 and held hostage by the Pasha of Tripoli for almost three years. His release came as a result of the first overseas expedition by the U.S. Marine Corps. In 1805, a Marine lieutenant named Presley O'Bannon, together with an American diplomat named William Eaton, led a detachment of eight Marines (not a typo: 8), and some 500 mercenaries recruited in North Africa on a 500 mile trek from Alexandria, Egypt westward to the city of Derna, which was part of the Pasha of Tripoli's domain. Eaton and O'Bannon then led an assault that captured Derna. This achievement, astonishing for the small and weak United States of the time, convinced the Pasha of Tripoli to negotiate a peace treaty with the Americans and eventually release Bainbridge and other American captives. Today's remarkable rescue of Captain Richard Phillips is in keeping with the U.S. Navy's tradition in combating piracy.
Piracy, in purely financial terms, has had a minor impact on overall global commerce. That's why shipping companies and insurers pay ransoms rather than incur the increased cost of routing ships away from dangerous shipping lanes and arming sailors. But as the pirates have accumulated more loot, they've been able to buy better ships with more sophisticated equipment and more powerful weapons. With their armament thusly enhanced, they are able to seize larger and more valuable ships farther out at sea, increase their loot, and buy even more powerful ships and weapons. Piracy is becoming a bubble. The pirates' defeat today at the hands of the U.S. Navy won't be enough to pop the bubble. But it is heartening for a nation beset by recession, rising unemployment and a futile war in Iraq. The world is a better place when, at least once in a while, right prevails over wrong, the good guys win, and heroes get to ride happily off into the sunset.
Tuesday, April 7, 2009
Export Educational Opportunity
The recession is doing a lot of damage to the economy, much of it outside the financial sector that is now being so heavily subsidized by the government. Some parts of the economy won't fully recover. Automobile manufacturing is the most obvious example. Real estate construction is another. Investing in long term economic growth is essential as a way to replace these losses. Many of America's problems would become more manageable if long term economic growth is enhanced. Covering the cost of the ballooning federal debt, coping with the growing burdens of Social Security and Medicare, supporting the long term values of real estate and stocks--still the most crucial assets in retirement planning--and paying for the protection of the environment are some of the more obvious examples of problems that become less challenging if GDP growth rates rise.
Almost all of the federal government's bailout and stimulus measures are understandably focused on short term difficulties. If we don't fix short term problems like the banking crisis and the ongoing recession, prospects for the long term become dimmer. But the long term also becomes dimmer if we omit to make long term investments.
One of the best long term investments America could now make would be to export educational opportunity. We're not talking about American universities opening campuses overseas. We mean providing more opportunities for foreign students to study here. The United States has the best university system in the world. Not only is it superb--Nobel Prizes in the sciences go predominantly to faculty of American universities--but also very large, enrolling some 14 million students. There is plenty of space of for additional students, as enrollments are under pressure because of the weak economy and reduced availability of financial aid. Most importantly, foreign students can be among the best long term investments for the U.S. economy.
Something like half the startups in the Silicon Valley were founded by people who were born in another country. Sergey Brin and Jerry Yang, co-founders of Google and Yahoo, respectively, were both born in other nations. Many of the Silicon Valley's entrepreneurs first came to America to study, and then stayed because the opportunities were better than at home. Going farther back in time, foreign born engineers played important roles in the electronics revolution of the 1950s, which saw the development of the transistor (a key component in virtually every electronic device now made) and the computer. One, An Wang (no relation to this writer), helped design the structure of computer memories, and then went on to found Wang Laboratories.
America's role in the world economy will be mostly ideas-based in the future. Manufacturing, although still a critical sector, will decline relative to overall GDP. America's best economic opportunities will come from the production of high value goods and services, and we need brain power to create those products. By having foreign students study and stay here, we obtain some of the best and brightest from around the globe. Even though we're mired in recession right now, many foreign students will stay because America offers individual liberty and freedom in ways many and probably most other countries do not. They can cast off limitations in their home countries imposed by ethnicity, gender, religion, social stratum, and political beliefs, and like native born Americans recreate themselves. America is a nation of immigrants, and a flexible immigration policy is a gift that keeps on giving.
Of course, we can't simply open the borders, for both economic and security reasons. But ambition is the life force behind long term economic growth. Generosity in allowing foreigners to study and stay here channels into the United States ambition that would otherwise build the wealth of other countries.
Foreign students generally come up with the money for their educations on their own, with little aid from American sources. In that respect, they help to reduce the balance of payments deficit that the U.S. has with the rest of the world. We're not suggesting that the U.S. government provide support to foreign students, since they generally have powerful enough reasons and sufficient funding to come here anyway. However, the government should shape its immigration policies to give smart, well-educated foreigners greater opportunity to study here and then stay to work. Granted, foreigners applying for jobs here compete against native born Americans. But, from a longer term perspective, they enrich the nation as a whole. These people have, time and time again, proven immensely valuable to America. Over the long term, the most valuable capital is human capital, and America shouldn't shortchange itself.
Almost all of the federal government's bailout and stimulus measures are understandably focused on short term difficulties. If we don't fix short term problems like the banking crisis and the ongoing recession, prospects for the long term become dimmer. But the long term also becomes dimmer if we omit to make long term investments.
One of the best long term investments America could now make would be to export educational opportunity. We're not talking about American universities opening campuses overseas. We mean providing more opportunities for foreign students to study here. The United States has the best university system in the world. Not only is it superb--Nobel Prizes in the sciences go predominantly to faculty of American universities--but also very large, enrolling some 14 million students. There is plenty of space of for additional students, as enrollments are under pressure because of the weak economy and reduced availability of financial aid. Most importantly, foreign students can be among the best long term investments for the U.S. economy.
Something like half the startups in the Silicon Valley were founded by people who were born in another country. Sergey Brin and Jerry Yang, co-founders of Google and Yahoo, respectively, were both born in other nations. Many of the Silicon Valley's entrepreneurs first came to America to study, and then stayed because the opportunities were better than at home. Going farther back in time, foreign born engineers played important roles in the electronics revolution of the 1950s, which saw the development of the transistor (a key component in virtually every electronic device now made) and the computer. One, An Wang (no relation to this writer), helped design the structure of computer memories, and then went on to found Wang Laboratories.
America's role in the world economy will be mostly ideas-based in the future. Manufacturing, although still a critical sector, will decline relative to overall GDP. America's best economic opportunities will come from the production of high value goods and services, and we need brain power to create those products. By having foreign students study and stay here, we obtain some of the best and brightest from around the globe. Even though we're mired in recession right now, many foreign students will stay because America offers individual liberty and freedom in ways many and probably most other countries do not. They can cast off limitations in their home countries imposed by ethnicity, gender, religion, social stratum, and political beliefs, and like native born Americans recreate themselves. America is a nation of immigrants, and a flexible immigration policy is a gift that keeps on giving.
Of course, we can't simply open the borders, for both economic and security reasons. But ambition is the life force behind long term economic growth. Generosity in allowing foreigners to study and stay here channels into the United States ambition that would otherwise build the wealth of other countries.
Foreign students generally come up with the money for their educations on their own, with little aid from American sources. In that respect, they help to reduce the balance of payments deficit that the U.S. has with the rest of the world. We're not suggesting that the U.S. government provide support to foreign students, since they generally have powerful enough reasons and sufficient funding to come here anyway. However, the government should shape its immigration policies to give smart, well-educated foreigners greater opportunity to study here and then stay to work. Granted, foreigners applying for jobs here compete against native born Americans. But, from a longer term perspective, they enrich the nation as a whole. These people have, time and time again, proven immensely valuable to America. Over the long term, the most valuable capital is human capital, and America shouldn't shortchange itself.
Sunday, April 5, 2009
Now, the United States of Enron?
The Washington Post reported on Saturday, April 4, 2009, that, for some bank bailout measures, the federal government is using a funding mechanism that harks back to the Enron scandal, in order to circumvent legal limits on executive compensation and the requirement for a government equity stake in the bailed out institution. Specifically, the government is setting up intermediate entities, called special purpose entities, that would stand between the government and the banks and other private interests participating in the bailouts. The government would fund the SPEs with capital and loans, while private investors would provide an additional amount of capital. Because government money would directly flow to the SPEs, instead of the banks or other firms being bailed out, the limits on executive compensation and the requirement for taxpayer equity would supposedly not apply to the latter, even though they are the real beneficiaries of the bailouts.
If the term special purpose entity rings a bell, it’s probably from something you read about Enron, which ensured that SPEs will live in infamy as devices for concealing risky investments and providing extra, undisclosed compensation to executives. SPEs acquired added notoriety when it turned out they had been used to hold all manner of dicey mortgage-backed securities and derivatives offloaded by banks that wanted to disavow those assets. The irony of the federal government using scandalized investment vehicles for bailouts is so obvious it hardly needs to be mentioned.
Perhaps less apparent, but more troubling, is the governmental weakness it reveals. The administration is seeking capital from the private sector because it does not feel it can go back to Congress for more bailout funds. Wall Streeters can smell weakness the way sharks can smell blood, and have exploited the administration’s weakness to get dispensation to keep doing business as usual for compensation as usual. This sets a dangerous precedent. Increased regulation of financial institutions is in the offing. Will the administration allow banks to continue business as usual through off-balance sheet techniques that circumvent its own increased regulatory oversight?
Congress strengthens Wall Street’s negotiating leverage by engaging in UHF quality histrionics on C-Span instead of a thoughtful review of the problems and issues. Its basement level standing with the public will seep lower than sump pumps can go if it needlessly weakens the president at a time of crisis.
Even if we assume the administration’s SPE structures are legally permitted, they are too clever by half. Once taxpayers realize that the administration has gone out of its way to allow Wall Streeters to eat their cake and have it, too, they will begin to lose faith in their newly elected president.
President Obama has an abundance of political capital at the moment. The electorate trusts him regardless of what fat guys on conservative talk radio say. His toxic asset purchase program might fail. Strong banks could take advantage of it to offload their problem children, and then raise more capital from the private sector. Weak banks might instead take advantage of the FASB’s new, relaxed approach to asset valuation and paint a glowing picture of themselves while actually remaining zombies. The financial crisis could continue largely unabated. Something much more direct, like temporary nationalization of banks, may well be necessary. The president should be prepared to step forward and take the lead on measures like nationalization, and weakening his standing now with potentially controversial SPE structures will only make the ultimate resolution harder.
If the term special purpose entity rings a bell, it’s probably from something you read about Enron, which ensured that SPEs will live in infamy as devices for concealing risky investments and providing extra, undisclosed compensation to executives. SPEs acquired added notoriety when it turned out they had been used to hold all manner of dicey mortgage-backed securities and derivatives offloaded by banks that wanted to disavow those assets. The irony of the federal government using scandalized investment vehicles for bailouts is so obvious it hardly needs to be mentioned.
Perhaps less apparent, but more troubling, is the governmental weakness it reveals. The administration is seeking capital from the private sector because it does not feel it can go back to Congress for more bailout funds. Wall Streeters can smell weakness the way sharks can smell blood, and have exploited the administration’s weakness to get dispensation to keep doing business as usual for compensation as usual. This sets a dangerous precedent. Increased regulation of financial institutions is in the offing. Will the administration allow banks to continue business as usual through off-balance sheet techniques that circumvent its own increased regulatory oversight?
Congress strengthens Wall Street’s negotiating leverage by engaging in UHF quality histrionics on C-Span instead of a thoughtful review of the problems and issues. Its basement level standing with the public will seep lower than sump pumps can go if it needlessly weakens the president at a time of crisis.
Even if we assume the administration’s SPE structures are legally permitted, they are too clever by half. Once taxpayers realize that the administration has gone out of its way to allow Wall Streeters to eat their cake and have it, too, they will begin to lose faith in their newly elected president.
President Obama has an abundance of political capital at the moment. The electorate trusts him regardless of what fat guys on conservative talk radio say. His toxic asset purchase program might fail. Strong banks could take advantage of it to offload their problem children, and then raise more capital from the private sector. Weak banks might instead take advantage of the FASB’s new, relaxed approach to asset valuation and paint a glowing picture of themselves while actually remaining zombies. The financial crisis could continue largely unabated. Something much more direct, like temporary nationalization of banks, may well be necessary. The president should be prepared to step forward and take the lead on measures like nationalization, and weakening his standing now with potentially controversial SPE structures will only make the ultimate resolution harder.
Thursday, April 2, 2009
The Meaning of Fair Value Accounting
On September 15, 2006, the Financial Accounting Standards Board (the body responsible for establishing corporate accounting rules for the U.S. stock markets) adopted Statement 157, a set of rules concerning the determination of the "fair" value of an asset. This is the rule that governs the way many assets are valued, including the financial instruments that have turned toxic in the last two years. That day, the Dow Jones Industrial Average closed at 11,560.77, up 33.38 from the previous day. It achieved an intraday high of 11,661.38, or 133.99 above the previous day's close. By all indications, the stock market approved of Statement 157's impact on fair value accounting.
Today, under severe pressure from various members of Congress from both parties, the FASB issued interpretive guidance that appeared to give financial institutions more flexibility in the way they applied the fair value rules. In effect, banks were given greater latitude to avoid writedowns on assets not traded in active markets, including many toxic assets. The Dow closed at 7978.08, up 216.48. It reached an intraday high of 8,075.73, or 314.13 above the previous day's close. By all indications, the stock market approved of the rolling back of the stringency of fair value rules.
There are several conclusions one can draw: (a) the stock market is wrong at least half the time; (b) the stock market has no idea what's going on; (c) the stock market is, at the moment, manic; and (d) the stock market didn't understand the full implications of the initial adoption of Statement 157, but now has a better understanding. The correct conclusion is all of the foregoing.
Statement 157 was adopted at a time of ballooning asset values. Few people anticipated the real estate downturn, credit crunch and grizzly bear market we have today. Those that did were regarded as freeze-dried food and bottled water stockpiling Chicken Littles. Accounting rules rarely come into controversy during good times because rising asset values allow a company to look good even if the rules are stringent.
But falling asset values have the potential to expose a multitude of sins. As the financial system and economy fell on hard times, banks began to cringe over the need to mark assets down. It's easier to blame an accounting rule than writing assets down and recapitalizing a crippled bank. No bank executive was ever fired for blaming an accounting rule; nor was one ever fired for using political influence to get an accounting rule relaxed.
It's unclear whether today's interpretive changes will have the positive impact that investors seem to expect. Citigroup has already announced that it won't change its accounting even with the FASB's new guidance. To the extent that banks use the new guidance to paint a rosier picture of themselves, they may only be delaying the pain if the real estate market and economy don't rebound fairly soon. Accounting rule changes don't improve a homeowner's chances of meeting the rising payments on an adjustable rate mortgage. A laid-off worker doesn't get any more cash with which to cover monthly payments if the FASB relaxes Statement 157. Smart investors won't invest new capital in a crippled bank just because the bank has taken advantage of liberalized accounting rules to freshen up its makeup. Indeed, doing so may heighten investor suspicions that the bank's assets have a serious mold problem.
The FASB's action today may help the stock market continue a near-term rise. But if you want to know if the market has truly bottomed out and that long term recovery has commenced, look beyond the pronouncements of accounting authorities.
Today, under severe pressure from various members of Congress from both parties, the FASB issued interpretive guidance that appeared to give financial institutions more flexibility in the way they applied the fair value rules. In effect, banks were given greater latitude to avoid writedowns on assets not traded in active markets, including many toxic assets. The Dow closed at 7978.08, up 216.48. It reached an intraday high of 8,075.73, or 314.13 above the previous day's close. By all indications, the stock market approved of the rolling back of the stringency of fair value rules.
There are several conclusions one can draw: (a) the stock market is wrong at least half the time; (b) the stock market has no idea what's going on; (c) the stock market is, at the moment, manic; and (d) the stock market didn't understand the full implications of the initial adoption of Statement 157, but now has a better understanding. The correct conclusion is all of the foregoing.
Statement 157 was adopted at a time of ballooning asset values. Few people anticipated the real estate downturn, credit crunch and grizzly bear market we have today. Those that did were regarded as freeze-dried food and bottled water stockpiling Chicken Littles. Accounting rules rarely come into controversy during good times because rising asset values allow a company to look good even if the rules are stringent.
But falling asset values have the potential to expose a multitude of sins. As the financial system and economy fell on hard times, banks began to cringe over the need to mark assets down. It's easier to blame an accounting rule than writing assets down and recapitalizing a crippled bank. No bank executive was ever fired for blaming an accounting rule; nor was one ever fired for using political influence to get an accounting rule relaxed.
It's unclear whether today's interpretive changes will have the positive impact that investors seem to expect. Citigroup has already announced that it won't change its accounting even with the FASB's new guidance. To the extent that banks use the new guidance to paint a rosier picture of themselves, they may only be delaying the pain if the real estate market and economy don't rebound fairly soon. Accounting rule changes don't improve a homeowner's chances of meeting the rising payments on an adjustable rate mortgage. A laid-off worker doesn't get any more cash with which to cover monthly payments if the FASB relaxes Statement 157. Smart investors won't invest new capital in a crippled bank just because the bank has taken advantage of liberalized accounting rules to freshen up its makeup. Indeed, doing so may heighten investor suspicions that the bank's assets have a serious mold problem.
The FASB's action today may help the stock market continue a near-term rise. But if you want to know if the market has truly bottomed out and that long term recovery has commenced, look beyond the pronouncements of accounting authorities.
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