Afraid of Another Financial Crisis? Watch the Banks

Financial crises like we had in 2008 before the Great Recession, and earlier in the 1930's before the Great Depression, are the triggers for big, long lasting economic downturns that require painfully long times from which to recover.  They differ from ordinary economic recessions (i.e., two quarters of negative economic growth), which generally don't last more than a couple of years and are usually followed by good levels of growth.  Financial crises are caused by liquidity shortages in the financial system.  When major banks and other financial institutions cannot obtain ready access to loans, especially short term loans, the financial system can teeter, and in worst case scenarios, collapse. 

Recent news articles report that European banks are under stress because of the decline in oil prices (http://www.cnbc.com/2016/02/08/european-banks-face-major-cash-crunch.html), and because of low interest rates and legal costs, as well as oil prices (http://money.cnn.com/2016/02/05/investing/bank-stocks-worse-than-oil/index.html?iid=EL).  Things got so shaky today that Deutsche Bank, Germany's largest, felt compelled to put out a statement reassuring shareholders about its financial condition.  http://www.reuters.com/article/us-deutsche-bank-stocks-idUSKCN0VI1WI.  If Europe's major banks begin to encounter liquidity shortfalls, we could have a problem.  If not addressed properly, it could be a big problem.

Europe's big banks are in general not as well capitalized as America's big banks, so it's not surprising that the Europeans might encounter turbulence sooner.  But if Europe's big banks teeter, America's big banks will, because of the interconnections between all major banks worldwide, at least feel pretty nauseated.  Of course, in such a scenario, the European Central Bank and U.S. Federal Reserve will mount up and ride to the rescue.  But not even the Brobdingnagian bailouts of 2008 prevented the Great Recession.

If the financial system stays sound, the slowdown in China and the other BRICS may cause a recession, but probably not a catastrophe.  But if the financial system dives into the septic tank, as it did in 2008, then we can expect a stinky mess.  So watch the banks.

The EU Bubble

Today's kerfluffle in the stock markets over the debt default of an entity affiliated with Portugal's largest bank reminds us that if there is a financial bubble anywhere, it's in EU sovereign and bank debt.  EU sovereign debt and the debt of EU banks have become almost synonymous.  That's because they are linked by a problematic circularity.  EU banks have invested heavily in EU sovereign debt.  EU nations, in turn, have pretty much become the guarantors of the debts of their banks.  Thus, the banks borrow to invest in sovereign debt, and the sovereigns in turn guarantee the banks' debt that funds the sovereigns.  It's rather clever, as long as nothing goes wrong.

However, one could note that EU banks and sovereign nations appear to be burdened with each others' liabilities, and that the guarantees of EU nations accordingly have limited efficacy.  Given that the EU and its banks, in toto, can be reasonably described as overleveraged, this circularity can become a circular firing squad if there is a run on a major EU bank or an EU sovereign member nation.  This is particularly so since no EU nation can issue its own currency and pay its or its banks' debts with printed money.

Of course, the European Central Bank has in recent years made a show of pointing to shining armor it could don and white horses it could mount to ride to the rescue if there is another European financial crisis.  And it has adopted accommodative, money printing-like maneuvers when the going got tough (like letting EU banks use sovereign debt as collateral for borrowings at the ECB without any discounting of their face value).  If the dustup across the pond is limited to Portugal, the ECB should be able to find one way or another to keep the cookie from crumbling.  But if other EU nations, particularly larger ones like France, begin to waver, the EU financial bubble could burst in a nasty way.  The economic consequences could be bad.  Given the growing extremism in Europe, the political consequences could be worse.

There are some asset classes in the U.S. that may be getting bubbly.  Many Internet stocks are suspect. Housing except for the $1 million and up price range seems to be struggling.  In addition, small cap stocks haven't been doing well recently and may turn out to be a bubble bursting.  But it's unlikely that the frothiness of these asset classes could re-trigger the Great Recession.   On the other hand, if the EU sovereign nations can't keep their banking systems on an even keel, then all bets are off. 

Why You Should Invest Like the Smart Money

One characteristic of the investing strategies of the wealthy is to diversify.  Stocks, bonds, money markets, real estate, alternative investments, collectibles, precious metals, jewelry, and so on are frequently found in the portfolios of the high net worth crowd.  Diversifying is a way to win no matter what's going on with asset values, and the wealthy want to stay wealthy.

The 99% should do no different, and recent market activity illustrates why.  Bond values have improbably risen in recent weeks, while stocks are stuck in a trading range right about where they started the year.  Gold and silver went up earlier this year, but have slid back.  Real estate ended 2013 with a roaring comeback, but now seems to have stalled out in many markets.  International markets have delinked, with Asian markets generally falling over the past six months, while European markets have moved up slightly (Ukraine crisis notwithstanding).  It would not have been easy to predict this mix of events.  Indeed, it's rare to find financial analysts who predict much of anything right.  Few predicted the 2007-08 financial crisis.  Few predicted the 30% jump in stocks in 2013.  Few predicted that bonds would rise this year.

The investing patterns of the smart money reveal that the smart move is to diversify.  Don't look for a quick buck.  You'll probably get a quick loss.  Don't look to hit a home run with a single investment.  The financial press may glamorize the few who manage to do that, but generally pays little attention to the many who fail.  Don't try to predict the unpredictable.  There are rare situations, like 2008-09, when all asset classes seem to be falling in value.  That's what can happen when vast amounts of debt and other leverage enter the financial system in one-sided bets dependent on rising asset values.  When that debt begins to lose value, the assets it was used to buy are at serious risk.  But more typical is what we have today--a lot of uncertainty, but some of the uncertainty is about the upside and some about the downside.  Most of the time, diversification is the best way to play your cards. 

And if you're still unhappy about your net worth, save more.  Whether the markets are doing well or badly, adding to your pool of capital will pay off in the long run.

How To Stop the Too Big From Failing

Congress, and financial regulators in America and other nations, have struggled endlessly with the problem of financial institutions too big to fail.  Capital requirements have been increased, and regulation has been tightened (somewhat--much of the implementation of the Dodd Frank Act remains unfinished).  But the problem remains.

There is a simple way to seriously reduce the possibility of another taxpayer-funded bailout.  If a financial institution needs a government bailout, force the CEO, COO and CFO, and the members of the Board of Directors, to pay to the government the value of their entire compensation for the preceding five years.  This would include salary, bonuses, stock options, restricted stock, fees, country club memberships, company cars, and all other perks and compensation.  This payment would be required without regard to whether or not the executive officer or director was proven to have participated in any wrongdoing or neglect.  It wouldn't be a penalty for misconduct.  It would be an incentive to avoid sticking the government with the costs of mismanagement.

Any such proposal would, of course, provoke howls of outrage from financial institutions and their free-roaming packs of mouth-foaming running dog lobbyists.  Such a measure would be unfair if the officer or director hadn't been shown to have engaged in misconduct, it would be argued.  However, the SEC already has the legal authority to force a company's CEO and CFO to pay out all their compensation for the 12 months following the issuance of financial statements that are subsequently modified (in a form called a restatement)--see Section 304 of the Sarbanes-Oxley Act.  The SEC isn't required to show that the CEO and CFO did bad things.  They can be forced to make this payout simply because the original financial statements were wrong and needed to be restated.  The courts have upheld this authority.  There's nothing unfair about requiring senior executives to get important things right in the first instance.

Banks and other financial institutions might also object that they couldn't recruit the executive talent they need if this financial Sword of Damocles were to hang over their heads.  But, when we consider the geniuses at some financial institutions in the recent past who steered their firms right over cliffs and into government safety nets, this argument loses its persuasiveness.  Executive compensation arrangements at the too big to fail seem to incentivize risk-taking, even if it might entail unmanageable complexity.  There needs to be a disincentive--and a strong one.

The government has been criticized for not penalizing the high and mighty for the financial crisis of 2008.  Remember, however, that the statutes and regulations governing financial institutions are complex.  Proof of violations can be difficult.  A simple measure like a penalty of five year's compensation for a government bailout offers a way to nail the top dogs for signing a chit the taxpayers have to pay.

Knightmare in the Financial Markets

Knight Capital's announcement today that it lost $440 million yesterday (Wednesday, Aug. 1, 2012) when its trading system went haywire illustrates the potentially dramatic consequences of computerized trading. Details on exactly what happened remain scarce. But it appears that trading volume at Knight spiked for some 30 to 45 minutes at many strange prices. A large number of trades were cancelled. Broker-dealers that normally route orders to Knight have temporarily ceased to send it business until the air is cleared.

Knight opened for trading this morning, saying that it still complied with regulatory capital requirements. Nevertheless, its capital position is reportedly not pretty, and news stories indicate that it's seeking a capital infusion, plus an emergency loan from a major bank. Knight may not survive if it doesn't establish confidence among the broker-dealer community within a day or two.

And that's the really scary thing about the Knight debacle. It's conceivable that Knight could have been rendered immediately insolvent if its big trading glitch had lasted a bit longer, or had involved a somewhat larger number of transactions. Such an insolvency would have impacted Knight's counterparties, possibly imperiling them if their exposures to Knight were large enough. If these counterparties had become insolvent, the financial miasma could have spread and other firms knocked down like falling dominoes. All this, potentially, because of less than an hour's computerized trading gone haywire.

The risk of insolvency in such a situation could be heightened by the fact that other market participants might observe such a debacle in real time and pull their accounts before the trading day ended. This, were it to occur, would amount to a run on Knight. Now that the financial community knows that Knight (and perhaps its competitors) can become imperiled within an hour's time, they might be all the quicker to grab for their money first, and ask questions later. The quaint display of depositor anxiety so sentimentally portrayed in It's A Wonderful Life would be a mere box car compared to the Maserati of broker-dealer flight in our world of computerized trading.

Sadly, regulators would probably have little or no idea of what would be going on. The SEC recently adopted rules for a consolidated audit trail with a requirement to report trades to the agency. But the new rules call for next day reporting to the SEC. The agency wouldn't be able to track in real time what the cannoli was going on, and hence would be behind the curve as market participants cut and ran.

Of course, the Federal Reserve would jump in with bailout checks for one and all of the imperiled firms if a meltdown of the financial system loomed. But the availability of desperation-driven, last ditch bailouts offers little comfort. More than ever, market participants and regulators need to get a handle on computerized trading. The ability of computers to execute vast numbers of ridiculous trades without any constraint is really, truly, seriously dangerous. By all indications, the financial markets are now operating on a sudden death basis. That cannot end well.

J.P. Morgan's Big Problem

The baseline problem underlying J.P. Morgan's recently announced $2 billion loss on a credit default swap bet gone bad is that big banks face virtually all economic risks. Banking, as conducted by major money center banks, cuts across essentially all economic sectors, all lines of commerce, all financial instruments, and all asset classes. There are some exceptions. For example, big banks rarely dabble in penny stocks or business startups. And they tend to limit their exposure to junk bonds. But they directly or indirectly play in almost all sandboxes in the economy.

The essential conceit of contemporary financial engineering is that risk somehow can be controlled. It is believed that if you find a clever enough math whiz with an MBA from a sufficiently fancy school, s/he can fashion a derivative for any purpose that will magically (albeit for a fee) transport risk to a distant land from which it will never return. With such magical powers, one need not be prudent and limit exposure to risky assets. One need only have a smart enough financial engineer to fashion a seemingly appropriate hedge.

Derivatives can work, and work well, when the risk they're meant to mitigate is narrow and well-defined. For example, futures contracts for red winter wheat serve salutary purposes when appropriately used by farmers, grain companies and speculators.

But when derivatives are deployed to mitigate wide-ranging and vaguely defined risks, their limitations come into play. Press reports indicate that J.P. Morgan's management directed its chief investment office to mitigate the risks of economic deterioration in Europe. This, to say the least, is a rather large, complex and wide ranging problem. Things in Europe can go downhill for a variety of reasons, not all of which are easily defined or predicted. The murkier a situation, the more difficult it becomes to fashion appropriate hedges. And if the hedges aren't entirely appropriate, their imperfections may have be hedged in turn. Reports in the financial press indicate the mandate from J.P. Morgan's management seems to have morphed into a net position that bet on improved financial health for a number of major corporations. Such a bet wouldn't seem the intuitively obvious way to hedge against a downturn in Europe.

As with all financial firms, J.P. Morgan's most important asset is its reputation. Since the 2007-08 financial crisis, its reputation has been golden. J.P. Morgan avoided unduly large real estate risks. It bought Bear Stearns at the government's behest, quelling incipient panic in the financial system. Its earnings were relatively stable, compared to its competitors. While the latter downsized to ditch hinky assets and offload risk, J.P. Morgan became the largest bank in America.

But such golden reputations become a burden, because the market expected J.P. Morgan to remain golden. Given that big money center banks face virtually all economic risks, this becomes a harder and harder job as time passes. Skilled risk managers and corporate executives might be able to anticipate most risks most of the time. But no one can predict all risks all the time, and a financial institution facing the length and breadth of economic risks borne by major money center banks will stumble sooner or later. Indeed, the longer a bank's winning streak, the greater the chance the next quarter will be a bad one.

Management sitting on a winning streak will understandably want to keep the streak going. But they must consider whether or not they can. Not all risks can be hedged or managed. Much of the "hedging" that goes on in the financial markets consists of using apples to hedge oranges. The two sides of the hedge are not mirror images of each other, but approximations. If the approximations are pretty close, a well-capitalized firm can get by. But that "if" gets bigger and bigger as derivatives positions get larger and as some derivatives are used to hedge risk factors in other hedges (which may have been the case at J.P. Morgan). When risk managers and management fail to recognize that the magic doesn't work in all situations, they get a morass.

Recognizing one's limits is an ancient and highly effective means of risk management. Not taking a risk, or offloading it, eliminates the possibility that it will later bite your butt. Being the biggest bank doesn't necessarily mean that you're the best bank. Appreciate that derivatives are imperfect financial instruments, and because of their newness, their imperfections are imperfectly understood. Given the inability to comprehend all risks or hedge them, having a shipload of capital may be best way for a bank to safeguard its future.

Banks typically trade at comparatively low multiples of earnings per share. That's because of the plethora of risks financial firms typically face. The siren call of the derivatives market is that, for a fee, a bank can hedge its way out of problems instead of having to manage them. These sirens have claimed a number of victims since the 2007-08 financial crisis, and now they appear to have lured J.P. Morgan onto a rocky coast.

Dexia and MF Global Holdings: Canaries in the Financial Markets?

Financial market volatility as we've had in recent months inevitably takes a toll if it continues long enough. A few weeks ago, a large Belgian-French bank, Dexia, was bailed out and partially nationalized after sustaining heavy losses from the European sovereign debt crisis. This weekend, news services report that MF Global Holdings, a financial services firm, is on the ropes because of sizeable losses in proprietary holdings of European sovereign debt. MF Global and its advisers have reportedly been seeking to sell part or all of the firm, but no transaction appears imminent. This evening (Sunday, Oct. 30, 2011), we now learn that the firm has hired bankruptcy lawyers. http://www.marketwatch.com/story/mf-global-hires-bankruptcy-lawyers-wsj-2011-10-30?link=MW_home_latest_news, and http://www.reuters.com/article/2011/10/30/us-mfglobal-idUSTRE79R4YY20111030?feedType=RSS&feedName=topNews&rpc=71.

Because Dexia is a bank, its bailout was not a particular surprise. The EU could hardly allow a major bank to collapse at this moment of crisis, lest its entire financial system nosedive.

MF Global, however, isn't a bank and doesn't have a hovering government Sugar Daddy waiting to hand over a blank check. It brokers derivatives transactions, and its operations include the clearance and settlement of derivatives trades. It also trades for its own account. The firm reportedly held about $6.3 billion in hinky European sovereign debt, and disclosed a quarterly loss of $191.6 million on Oct. 25, 2011. Moody's and Fitch have lowered MF Global's credit rating to junk, which could disrupt its normal access to credit. Some brokerage customers have apparently been exiting, stage right. Press reports indicate that, to maintain liquidity, MF Global has drawn down two bank lines of credit. Its banks include Citigroup, Bank of America and J.P. Morgan Chase. That these big boys would allow MF Global to tap out its lines of credit indicates a difficult situation. One surmises that MF Global may be facing a potentially major run by customers and, with its banks' assistance, is doing whatever it can to buy time to find an acquirer.

MF Global hired three of the largest law firms in New York to assist in a possible bankruptcy: Skadden Arps Slate Meagher & Flom, Weil Gotshal & Manges, and Sullivan & Cromwell. Chances are it wouldn't hire firms of this size and stature unless something very big might happen very soon. These firms can, on a moment's notice, throw legions of lawyers onto a matter such as a bankruptcy of MF Global. The retention of such massive potential legal resources doesn't signal a bright near term future for MF Global.

What's unclear from news stories is the condition of MF Global's derivatives clearance and settlement operation. Such operations typically are protected by the capital of the settlement and clearance firm, which may also hold collateral from counterparties. A crucial question is whether losses from the proprietary trading could spill over into the brokerage operation and impair its ability to honor its brokerage and clearance and settlement obligations. If so, the value of an unknown quantity of derivatives transactions could be thrown into doubt. Were that to happen, a pathway for financial contagion could open up and spread outward into the larger financial system. If there is a potential for financial contagion to spread, expect the Federal Reserve to open the monetary floodgates.

The MF Global situation provides yet even one more reminder that we really need to implement a new regulatory regime for derivatives. The possibility that a derivatives broker, that provides clearance and settlement services, might put customers at risk from its proprietary transactions is simply unacceptable today. For many decades now, clearance and settlement in the stock markets have been legally insulated from proprietary trading, and separately capitalized. Mistakes and misjudgments at proprietary trading desks shouldn't be able to blindside clearance and settlement customers. The Dodd-Frank legislation provides a framework for making clearance and settlement in the derivatives market much more rigorous and secure. With all the volatility we've had, it's entirely possible that more financial firms beyond Dexia and MF Global are headed for the shoals. How many more canaries in the financial markets need to stop tweeting and fall over before we have reform?

The Politics of Powerlessness

The Iowa straw vote and Tim Pawlenty's sudden withdrawal from the race for the Republican presidential nomination starkly highlights the pervasive feeling of powerlessness that drives politics today. Michelle Bachmann and Ron Paul finished a close first and second, with Pawlenty a distant third. Bachmann and Paul appeal to the far right, tapping into the anger of those that feel unconnected to the mainstream of American society. Pawlenty was very much the traditional conservative that the power brokers of the Republican Party would like as their candidate. He got clobbered.

Others who fit the profile preferred by the Republican power structure--Mitt Romney, Jon Huntsman, Rick Santorum, and Rick Perry--either stayed out or did poorly. Romney's campaign dropped hints to the press that his absence from the straw vote was strategic. But in politics, avoiding losses isn't the way to get elected. Romney may have deftly ducked a left jab from the far right. But his deliberate decision to stay out of the straw vote seems to quietly acknowledge his lack of appeal to the most powerful force in politics today: those that feel dispossessed.

A similar dynamic operates on the left. Union busting tactics in Wisconsin by recently elected Republican governor Scott Walker sparked an outpouring of liberal anger, weeks of demonstrations in Madison, and recall elections that weakened the Republican hold on the Wisconsin Senate. The demonstrators weren't powerful Democratic leeches sucking taxpayers dry. They were just moderate and middle income people trying desperately to hold onto their small portions of the national economic pie.

Middle class Americans are buffeted by enormous forces beyond their control. Wall Street created a financial crisis that threw the nation into a great recession. Workers are laid off through no fault of their own. They then lose their homes to foreclosure by human auto-pens. They see vast amounts of deficit spending by the federal government that doesn't seem to benefit them. Their children, raised to believe they could accomplish anything if they tried, now have little faith in the future. Both parents and children feel betrayed. A sovereign debt crisis in Europe that could wreck the international financial system, coinciding with an astonishingly inept process in Washington for raising the debt ceiling, knocks stocks down 15% in a few weeks. Daily volatility sweeps the financial markets, enriching firms whose computers trade in millionths of a second while trampling over Ma and Pa trying to patch up the holes in their 401(k) and IRA accounts. The homes they worked so hard to buy sink in value, but they still have to pay their debts in full with stagnating incomes.

The human survival instinct, normally well-concealed by the congeniality that prosperity allows, is the most powerful organic force on Earth. Humans have grown from a small number of short-lived hunter gatherers in Africa to a population of billions who control virtually every square mile of planet. When prosperity flags, and questions of survival begin to surface, adrenalin flows and emotions erupt. Many, many millions feel powerless against these gigantic forces beyond their control and see politics as the only outlet for their surging survival instincts. That is the force harnessed by Bachmann, Paul and the unions in Wisconsin. That is the force that will play a key role in the 2012 elections.

Paul won't win primaries; he has a track record in that respect. The mandarins of the Republican Party will quietly do everything they can to undermine Bachmann, in the belief that she might primaries, but can't win the general election. That belief is probably correct. The ghost of Barry Goldwater haunts the Republicans. A far right candidate is easy to demonize, and Democratic operatives are surely hoping that Bachmann will continue to fore check mainstream Republican candidates.

On the left, dissatisfaction with Barack Obama, now seen as too expedient a compromiser, has led to mutterings about a primary challenge. It's hard to see who would be a viable challenger. But in August 2007, few people considered Barack Obama a viable challenger to the presumed Democratic nominee, Hillary Clinton. So you never know. The ultimate in cool projected by Obama isn't the right teleprompter feed for this election cycle, and a more impassioned candidate may win over the Democratic left.

With the economy slowing and the chances of renewed recession rising, feelings of powerlessness will play an ever greater role in politics. Political doings in Washington could become even more unpredictable than they have been. And the stability of the financial markets, now determined by governmental action as much as the direction of the economy, is likely to suffer correspondingly.

Of course, voters' desperation and its political consequences would evaporate if the economy began to grow briskly. But what are the chances of that?

An Omen of Financial Stress?

Something strange is happening in the short end of the Treasury securities market. Treasuries maturing in about 1 month are yielding around 0.01%. Just a couple of weeks ago, yields were above 0.10%. Perhaps this may all seem like peanuts (and it is, if you have, say, $10,000 invested). But a yield of 0.01% was last seen during the dark days of the credit crunch in late 2008 and in 2009, when the world's banking system faced a funding crisis. Such a low yield signified that no one trusted anything except the obligations of the U.S. government; that investors didn't care about getting a return. They just want to keep their money safe. The recent 90% plus drop in the short end of the Treasury yield curve in less than two weeks may be a sign that something is rotten somewhere.

Economists and other fortune tellers are raising their estimates for growth next year. Stock prognosticators are full of holiday cheer, predicting rosy returns for stocks in 2011. Consumers may be loosening their purse strings a bit for this year's holiday season. Recent tax legislation will widen the deficit for next year, ensuring that the federal spending spigot won't slow down. All systems are go, it would seem. What's to get stressed about?

Euro Mess. The European response to the Euro bloc sovereign debt crisis, generously assessed, has been tentative and muddled. The only clear impact has been to transfer risk of loss to European taxpayers and give the can a hard kick down the road. The continued uncertainty makes the U.S. greenback look good by comparison (once again demonstrating that it's easy to lose faith in America, until you look at the rest of the world). If you're going to dump Euros for dollars, it makes sense to buy the short end of the Treasury yield curve, where you're not competing against the Fed's quantitative easing program.

One group of potentially nervous investors would be money market funds that hold commercial paper of banks in shaky Euro bloc nations, like Greece and Portugal. Amazingly, in spite of the money market fund credit crunch in 2008, many money market funds bought this foreign issued commercial paper. (One wonders what happened to prudence, but then again prudence is something isn't brought up in polite company.) Those money market funds now may be quietly easing out of Euro bloc bank commercial paper and shifting into Treasuries before year end, when they'd have to disclose their holdings to investors.

Muni Mess. The muni market has fallen, about 5% in the past month. That may not sound like much, but if you held munis and it was your 5%, you'd be peeved. The future for munis isn't pretty. The federally subsidized Build America Bonds program turns into a pumpkin at the end of this year, and there won't be a fairy godmother for it next year. That means states and municipalities will face the harsh winds of the muni market without a quick fix from Uncle Sam. Many financially troubled states are still struggling with their budget problems. To make things worse, questions over states' pension accounting could compel larger state contributions to employee pension funds. Muni investors with battered portfolio syndrome may be seeking a port in the growing storm and heading for the safety of Treasuries.

Bond Mess. The bond market has fallen since early November, when the Fed formally announced its quantitative easing program. Investors who bet that QE would extend the 30 year bull market in bonds may now suspect that this time, things really are different. Those that aren't ready for the quicksands of the stock market may be parking at the short end of the Treasury curve, waiting to see whither the winds blow.

It's unclear that any of this will push the financial system back into the septic tank. Any analysis of that question would require information about who's holding what exposures in the derivatives markets. (Query: are major banks holding the hot tamale because they took the wrong end of the wrong credit default swaps?) But those markets are as opaque as ever, notwithstanding the enactment of the Dodd-Frank financial reform legislation this past summer. All we know is that the short end of the Treasury yield curve is at 0.01%, and the last time that happened, canaries in the mine were gasping.

The Puzzling Prosecution of Sergey Aleynikov

On Thursday, February 11, 2010, the U.S. Attorney's Office in Manhattan announced the indictment of Sergey Aleynikov, a former employee of Goldman Sachs & Co., for allegedly stealing Goldman computer code used in high speed stock market trading. Aleynikov was accused of making an unauthorized transfer of proprietary trading software on the last day of his employment at Goldman, apparently with the idea that it could help him develop a high speed stock trading platform at another firm where he was shortly to begin working.

We don't want to prejudge Aleynikov. A judicial process is motion whereby his guilt or innocence will be established. Let's assume, hypothetically and for the purposes of discussion, that he engaged in the conduct alleged and that this conduct was criminal.

We have the United States government pursuing a former Goldman employee for supposedly stealing computer software in order to advance his career at a Goldman competitor. Goldman is one of the most profitable and powerful banks in the world. Its multiple billions of dollars of profits would allow it to pursue Aleynikov around the globe, sue him in any court of any nation, and seek to prohibit him from using the stolen computer code. To the extent that he or any firm that employed him improperly used Goldman's code, he and that employer could be held liable for damages and other monetary relief. If their conduct was particularly reprehensible, a federal court in the United States might order them to pay punitive damages to Goldman.

What is the public interest in the federal government trying to vindicate the intellectual property rights of a very large bank that is fully capable of hiring legions of lawyers to protect itself? With massive amounts of investment losses to public investors from the mortgage and credit crises of 2007-08, and the various collateral morasses, there is plenty of grist for the prosecutorial mill. Prosecuting white collar crimes takes a lot of resources, and the U.S. Attorney's Office in Manhattan isn't overflowing with personnel. The taxpayers have already spent trillions of dollars on bailouts and stimulus programs to deal with Wall Street's mistakes. It takes a great deal of highly refined reasoning to conclude that amidst the worst economic crisis since 1930s, taxpayer dollars are appropriately spent on protecting Goldman Sachs from one of its departing employees.

Federal prosecutors do not pursue every potential crime that comes to their attention. A former governor of New York who allegedly paid a call girl to transport herself across state lines in order to meet him for a liaison arguably had a federal criminal problem. But he evidently will not be prosecuted--and, frankly, we would not contend that he should be.

If Aleynikov is convicted and punished after legal proceedings conducted in accordance with law, it would be difficult to muster sympathy for him. He appears to be a highly intelligent individual who either did or should have understood the significance of his conduct, whatever it turns out to have been. Sympathy should go to the American taxpayer, who now must pay for a government prosecution that will do little or nothing to protect beleaguered individual investors, punish those persons responsible for the 2007-08 financial crisis, help the unemployed, or assist those without health insurance. Granted, the cost to the government of this prosecution will probably run in the hundreds of thousands of dollars, or a few million at the most. But consider the impact if the same dollars were spent prosecuting and convicting someone who knowingly foisted crappy mortgages onto investors in mortgage-backed investments? Cleaning up the mortgage-backed securities and derivatives markets could have billions of dollars of impact, much or most of which would flow to investors. That would be in the public interest.

Is the Federal Reserve's Free Ride Ending?

The announcement on Friday, Dec.4, that the unemployment rate had fallen slightly from 10.2 % to 10 % surprised many, and perhaps dismayed some at the Fed. At its Nov. 3-4, 2009 meeting, the Fed announced that it expected to keep the fed funds rate at "exceptionally low" levels for an "extended period" of time. That announcement helped to fuel stock and commodities prices for the month of November. But after Friday's announced unemployment drop, stocks closed with only a modest gain, gold fell 4%, oil fell a little over 1% and the 10-year Treasury note fell about 0.75% in value (with an increase in yield of about 10 basis points). The dollar rallied.

These market reactions were spurred by the implication that the Fed will have to raise interest rates sooner than it expected. An interest rate hike would strengthen the dollar, reduce the value of gold, and push bond yields higher (and bond prices lower). The price drop in oil--seemingly odd because a recovering economy would be expected to consume more oil--is a reflection of the asset bubbling spurred by the Fed's cheap money policies. The huge amounts of cash pumped by the Fed into the financial system pushed down the dollar, thereby making oil more valuable in dollar terms. If the Fed begins to pull back on its accommodation, thereby strengthening the dollar, oil prices in dollar terms would naturally abate.

The Fed's predictive powers have been demonstrably lacking. It failed to see the implications of the growth in the mid-2000s of looney mortgages (the kind given to people who couldn't repay), the misplaced risks and rewards of the securitization process (where Wall Street made monstrous amounts of money from doing deals--including excessively risky deals, recklessly stupid deals and irredeemably bad deals), the increasing opacity of the financial system's true condition caused by derivatives and then derivatives of derivatives, and finally the monumental blockheadedness of concentrating at AIG credit default swaps insuring hundreds of billions of dollars worth of mostly mortgage-related investments. One wonders whether the Fed has underestimated the pace of the economy's recovery.

On one level, we hope it has. Continuation of the Great Recession much longer could inflict lasting damage to consumers, workers, businesses and investors that might lead to the stagnation that has bedeviled Japan since its massive asset bubble burst in 1989-90. There, people seem to have lost faith in just about everything except the government. This was most recently demonstrated by the Japanese government's cancellation of plans to privatize its postal system (which is not only a mail carrier, but an enormous bank and insurance company). The U.S. government's greatly expanded role in the economy could easily become permanent if the private sector doesn't revive soon.

But a Christmas present in the form of improved economic performance could lead to volatility in the financial markets. A lot of players (they used to be called investors, but today long term investing is about as trendy as a large SUV) have borrowed dollars at cheap, short term rates, converted them into other currencies and invested in longer term plays denominated in other currencies. Or else they invested in oil or oil futures, betting that continued bottom of the barrel interest rates would push oil prices ever higher in dollar terms. Or they took heart from the Treasury securities market's improbable rally this year and the Fed's ongoing trillion dollar program to buy Treasuries and mortgage-backed securities, and used cheap borrowed money to purchase higher yielding long term securities they thought would be propped up by the Fed's massive money print. Or they jumped into the stock market with the hope that the Fed's gusher of liquidity would continue to push stocks higher, even after a 60% rally this year.

All this activity was premised on the Fed correctly foreseeing economic stagnation and keeping short term interest rates virtually at zero, as it publicly proclaimed. If the Fed again turns out to be wrong, and has to hike rates sooner than expected, a lot of free rides will end. The players who have borrowed short and invested long may well have to unwind their positions, learning the hard way that not matching the duration of your borrowings with the duration of your investments entails risk. That could lead to volatility in the financial markets. If the volatility begins to create systemic problems, the credit crunch could again rear its hideous head and banks may again become catatonic. Then we'd probably have the much feared double-dip recession.

The Fed meets again on Dec. 15 and 16, 2009. Don't expect any rate hikes then. But the Fed may be compelled by continuing good news to modify its promise (that's how financial markets players have been viewing it) of ultra low interest rates. If it does, the speculators in the financial markets might have to make painful adjustments (as they probably already are).

Even as the Fed for the past year has given banks and other financial market participants a virtually free ride on borrowed money, it's gotten a free ride in terms of monetary easing. With banks making almost no new loans and pulling back existing credit, no amount of Fed accommodation seemed to have any impact on consumer prices. The Fed could keeping shoving printed money off its loading dock and not pay the price of monetary policy gone wild.

But the law of unintended consequences always lies in wait to ambush federal economic policy. The Fed didn't intend for its monetary easing to stimulate asset speculation here and abroad, even though it should have been sensitized to that risk by its role in the pumping up the real estate bubble. Chairman Bernanke's pledge of greater transparency of the Fed's thinking is a good idea. But when the Fed starts to play that most dangerous game--publicly predicting the future course of the economy and interest rates--it had damn well better be right. Or the rest of us will pay the price.

The Strange Pricing of Money

Strangely enough, the economies of the United States and all other major countries rest on prices set by the government. Market forces establish most prices. Governments--specifically, central banks--set the price of money.

The price of money is usually seen as the interest rate paid for loans. In general, central banks set short term interest rates for loans they make to banks, and for interbank loans (i.e., loans between banks). The Federal Reserve in the United States does this primarily through its discount rate, and the fed funds target rate. In addition, the Federal Reserve has gone farther than usual during the current economic crisis by purchasing large quantities of Treasury securities and mortgage-backed securities in order to hold down long term interest rates.

Federally prescribed interest rates are tools for combating economic problems. As the economy nosedives, the Fed lowers interest rates in order to soften the impact of the plunge and foster recovery. When inflation flares, the Fed raises interest rates in order to dampen pricing pressures.

It goes without saying that political considerations affect the government's pricing of money. In order to stave off a depression, the Fed last year reduced its fed funds target to a range of 0 to 0.25%, about as low as you can go. The European Central Bank, created against the backdrop of the German hyperinflation of the 1920s and the political extremism it fueled, focuses primarily on keeping prices stable, and was less aggressive on cutting rates.

Market forces seem to have little to do with government pricing of money. Commercial and consumer loan markets set the price of individual and corporate creditworthiness, with recognition (most of the time) that not everyone will repay a loan. But the price of money itself is set by governments to advance governmental goals.

How does the government know what price for money is right? Without the interaction of supply and demand to settle upon an equilibrium, can the government establish a price level that allocates resources efficiently? Or will it set a price that is politically expedient but not economically sound?

The pure time value of money, without considering credit risk, inflation or other factors, is believed to be somewhere around 3%. At the beginning of 2001, the fed funds rate was targeted by the Federal Reserve at 6%. Inflation in 2000 was 3.4% (as measured by the CPI-U), so a 6% fed funds target rate pretty much squared with the natural time value of money. But as the tech stock bubble collapsed, and then the 9/11/01 bombings took place, the Fed went whole hog for stimulus, lowering the fed funds target to 1.75% by the end of 2001. It didn't stop there, reducing the fed funds rate to 1.25% late in 2002 and to 1% in June 2003. Inflation averaged just under 2% per year from 2001 to 2003. When inflation is added to the 3% pure time value of money, one would have expected a free market to offer interest rates of around 5%. So the government's pricing of money was, in effect, negative. It shouldn't be surprising that everyone in the country with a pulse and a signature wanted a mortgage loan, regardless of their ability to pay. Giveaways attract interest. And this giveaway pumped up a big bubble in the housing and credit markets. We know the rest of the story.

Today, inflation in the last year is just barely negative, and the fed funds target rate is just barely positive. So another government sponsored giveaway is in progress. The Fed's purpose--revival of the economy--is salutory. But market forces, even when ignored or disrupted, have a way of coming back at you. A shipload of stimulus/accommodation/bailout money is funneling overseas via the carry trade to revive commodities prices and the economies of other nations. Fed governors seem to believe asset bubbles to be theoretical and not to be found in the wild. Foreign officials have already expressed concern over ongoing dollar-driven asset bubbles. Add to this continuing questions about how mere green shoots could support a 60% stock market rally in the last eight months, and the specter of asset bubbles grows.

Other cheap federal money sits on bank balance sheets, waiting to offset likely writedowns for yet more real estate lending losses. Scant portions of federal money have reached the real economy.

With so little federal money reaching the real economy, the question arises whether today the Fed's pricing of money allocates resources efficiently and spurs productive economic activity. GDP is growing again. But that's to a large degree because the federal government portion of GDP is growing. Take away this statistical effect, and the picture is less rosy. The government can always pump up GDP statistics by borrowing or printing more money. But with unemployment rising, there is a serious question how much good it's actually doing.

It would seem that for the second time this decade, the Fed has mispriced money. The first time, it produced gross distortions in the real estate and credit markets. There are signs it's producing more distortions now. Realistically, no modern industrialized economy can exist without fiat money (i.e., government issued currency). Complex economies require enormous amounts of exchange to circulate, and there isn't enough gold, silver and copper in the world to accommodate the need. But when the government misprices its currency, bad things will happen. Market forces, one way or another, will clear. It took them a while during the recent real estate and credit boom to bust, but bust they did and how. The Fed's stated intention of keeping short term interest rates at zero for the foreseeable, extended future is coming dangerously close to violating the law of unintended consequences.

Is the Federal Government Tempted by Moral Hazard?

The British government recently announced that it is thinking of breaking up the big British banks in order to avoid having institutions that are too big to fail. The U.S. government, by contrast, contemplates maintaining its de facto too-big-to-fail policy and building regulatory reform around it.

The British approach has the beauty of simplicity and the sensibility of placing limits. Smaller institutions, with effective controls over the amount of leverage and derivatives exposure they can take on, would be less likely to blow up counterparties. They would probably be less complex, engaging in fewer types of activities, and would therefore be easier to regulate. The system as a whole would be healthier. British taxpayers would sleep better.

In America, however, size and complexity remain. Regulators mostly believe that they can effectively oversee the behemoths they in part helped to create through mergers they strongly encouraged of failing firms with stronger ones. Perhaps they've also been subtly influenced by the industry's belief that size confers competitive advantages.

But the size advantage of America's big banks is meaningful only because the federal government backs them up. If there were no too-big-to-fail doctrine, the size of these institutions might frighten counterparties concerned about unseen exposures. The sheer complexity of the big banks on an operational level, something that not all their chief executives could master, would heighten counterparty fears of another AIG, where risks of its credit default swap operations weren't apparent to most market participants (and perhaps its executive management) until too late.

The U.S. government is able to back up America's big banks to a large degree because of the dollar's unique position among currencies as the world's reserve currency. Much and perhaps most of the world sees the dollar as a reservoir of value, and it's still used in international transactions far more than any other currency. In order to support the banking system, the U.S. government (primarily the Federal Reserve) has driven short term interest rates to zero while printing trillions of dollars. If any other country had taken these steps, its currency would have collapsed. But the dollar is special and the U.S. government can pull sh . . . stuff that no other government can pull.

That's a concern. On Halloween, when children have unusually easy access to candy, it's hardly surprising that they go on sugar binges. Wall Street banks were no different when they thought they could make money underwriting mortgage-backed securities based on loans to borrowers who had no verified income, employment, or assets, because they supposedly could pass the credit default risk onto investors. The banks, too, went on a binge--and we've all got a hangover from that one.

Federal officials are human, and it wouldn't be surprising if they've been tempted by the dollar's reserve status to push the edge of the envelope. The idea behind monetary and fiscal stimulus is that it triggers consumption and investment, which in turn spur more economic activity, which then pushes the virtuous circle farther along with new rounds of consumption and investment, etc. But the fiscal stimulus has been slow and spotty, and the monetary intervention seems to have put a lot of money in the big banks' reserves instead of being loaned out, or to have been sent overseas via the carry trade to stimulate the economies (or at least the investment assets) of foreign nations. The credit crunch hasn't gone away; it's simply shifted from Wall Street to Main Street.

Sugar binges ultimately have bad consequences, as do binges of poor mortgage underwriting. A federal monetary and fiscal binge isn't likely to be any different. If things fall apart, it's likely to have really, really bad consequences, because the U.S. government may have taken advantage of the dollar's reserve currency status to binge more merrily than a government that knew its limits.

The British learned prudence after World War II, when the United States deliberately displaced the pound sterling as the world's reserve currency with the dollar. The British government's 1992 attempt to intervene against hedge fund speculation in the pound was a dismal failure, reinforcing the lesson that currencies, like all other things economic, are subject to the laws of supply and demand. The U.S. government, triumphant after victories in World War II and the Cold War, acts as if the sun will never set on the all mighty greenback. The Fed, in its statement yesterday, continued to forecast zero interest rates over an extended period of time, in effect promising its print shop employees oodles of overtime pay for the foreseeable future. This enthusiastic wallowing in moral hazard is reminiscent of the British government's eagerness to borrow from America to pay for World War II. The Lend Lease Program, which gave the Brits multiple dollars for each dollar they actually repaid, was perhaps the biggest "wink and nod" ever in government-to-government lending. But that only ensured British insolvency at the end of the war, and when Britain asked for yet another loan after Japan's surrender, America's terms, in essence, probably accelerated the dissolution of the British empire. Britain had no choice but to agree (and repay this loan in full as well, with payment completed in 2006).

America's foreign creditors--China, Japan, oil producing nations and others--can do little in the near term about the federal government's profligacy other than preach and make subtle threats. They, indeed, have an interest in America's prosperity. But the more chits they hold, the more leverage they will have. At some point, they'll pull the plug on America, just as America pulled the plug on Britain. Not because of animosity--even today, Britain remains America's closest ally--but simply because it's in their interests to do so. America's system of national accounting doesn't very clearly balance assets against liabilities--indeed, it mostly focuses on national income (as measured by GDP) without much consideration of the costs, risks and liabilities connected with producing that income. There are no federal reserves to tide us over hard times (like many states' rainy day funds). We are in deep yogurt, but there is scant federal data revealing that problem.

The essential, unstated premise of federal economic policy today seems to be that by using the relatively painless process of printing money, we can get something for . . . well . . . basically, nothing. With the indulgence in moral hazard that the dollar's role as reserve currency allows, it's easy for the federal government, almost unconsciously, to reach this conclusion. The big banks on Wall Street now understand that they have to beware of the risks of moral hazard. If only this understanding extended to the government . . . because not every day can be Halloween.

The Obama Administration's Best Bet: Take the Common Sense Approach

The unifying theme in President George W. Bush's two terms was his wealth of self-assurance. He was certain he knew the answers. He stuck hard to the principles in which he believed. He had too much faith in the amen chorus with which he surrounded himself, and gave them too much free rein.

The cost was enormous. Year after year, casualties in Iraq grew while the war continued with no end in sight. Even as military expenditures rose sharply, taxes were dramatically cut with little thought seemingly given to the long term consequences. The federal deficit ballooned, but we were told to take comfort from the beneficial effects that would come from making the wealthy wealthier. The financial markets were provided with vast amounts of cheap credit, and given a deregulatory atmosphere in which to mainline it. Real estate was favored because, in defiance of economic reality, it supposedly would be the golden goose of legend, the asset that would never fall in value. Derivatives were given the Mother of all legal loopholes, which led to the stealth creation of a vast, multi-trillion dollar unregulated banking system that went unnoticed by regulators until it collapsed.

Absent from the picture was a decent measure of proportion, moderation, and common sense. Adherence to the administration's received truths took precedence over contact with reality. Apostates were banished and true believers drew closer together in the firmness of their beliefs.

The Bush Adminstration's rigidity was one of the main advantages Barack Obama had going into last fall's general election. The electorate had had its fill of closed-minded, inflexible wackiness that threw away lives and money. The voters wanted change.

They've gotten less than they might have hoped for. The Obama administration has generally followed the same approach in dealing with the financial and economic crises as their predecessors. There is momentary calm, but really big deficits loom and the real estate market's problems have been swept under the carpet instead of being resolved. Its health insurance reform proposal is being shouted down, with volume substituting for reason. The American war in Iraq is winding down (although the Iraqi war isn't). However, the American war in Afghanistan is ramping up, as is the American proxy war in Pakistan.

It's important for the Obama administration to take some big steps back from the extremes of the Bush administration's policies. That's what Barack Obama was elected to do. At the same time, it's important for him not to become caught up in new extremes. We need some common sense.

For health insurance reform, let's institute the Great American Compromise. Like all industrialized nations, America spent much of the 20th Century coming to grips with the harshness of capitalism. While the free enterprise system is wonderful for innovation and economic growth, it spawns great inequality of wealth that triggers social unrest. Not all of the 20th Century solutions for this problem worked well (see history of Nazi Germany and the Soviet Union for illustrative examples). However, the American solution was to establish safety nets: unemployment compensation for wage earners innocently caught in economic downdrafts, Social Security to alleviate the poverty of the elderly and those unable to work, Medicare and Medicaid, and various welfare programs. The free enterprise system was largely left unchanged. People kept their private property, pursued their personally chosen careers, and in many cases vigorously exercised their Constitutional right to cuss out the government.

It's clear that those with good health insurance coverage don't want to give it up for the sake of health insurance reform. Nor should they have to. The biggest need is for a safety net--basic health insurance for those who can't find a private insurer. We already have such a system--it's called Medicare in some manifestations and Medicaid in others. These programs were created to provide health insurance for the elderly and poor, who would generally be uninsured anyway. Allowing other uninsured people to participate wouldn't be a terribly difficult modification. Their premiums could be adjusted for their ability to pay--a laid-off Wall Street millionaire would pay fair market rates while a laid-off furniture worker in North Carolina would get a break. Sidestep all the mouth-frothing about a National Health Service or single payer system. Just extend the safety net.

In Afghanistan and Pakistan, the U.S. and its allies are largely fighting members of just one ethic group, the Pashtun. The membership of the Taliban consists primarily of Pashtuns. They have successfully partitioned off part of Pakistan for their own country within a country, and give sanctuary to Al Queda in keeping with longstanding Pashtun traditions of hospitality and refuge for visitors in need. The United States has no strong interest in fighting the Taliban or other Pashtuns. They did not attack the World Trade Center or the Pentagon (the mostly Arab Al Queda did that). The U.S. should open channels of communication with the Taliban and other Pashtun groups, making it clear that harboring Al Queda will result in robust U.S. military action, but that peace is attainable if the house guests take a hike. It may seem implausible that the Taliban would make a deal with America. But the Shiites in Iraq did just that during the recent surge, and gave Al Queda the boot from their country. We should focus on destroying Al Queda, not fighting people who have not sought to fight with us.

The really big looming deficits stem from both the Bush administration's unwavering belief that they could get a free lunch--finance a tremendously expensive war in Iraq while sharply cutting taxes while increasing Medicare benefits (with Medicare D, the prescription drug program)--and the Obama administration's stimulus package. Since some 80% of government spending consists of entitlements like Social Security and Medicare, the government can't cut its way out of the fiscal mess. It will have to increase tax collections. That's just common sense. Letting the Bush tax cuts lapse would be a simple way of doing that--they're built into the Bush legislation anyway so nothing needs to be pushed through an increasingly rancorous Congress. But not fixing the alternative minimum tax would be a mistake. The alternative minimum tax is the stupidest tax in the Internal Revenue Code, taking back what the regular tax structure allows and hitting the middle class whom Barack Obama promised to protect against tax increases. The AMT has long ceased to serve its intended purpose and should be repealed or permanently adjusted way upward to hit only the wealthy (and kept upward with an automatic annual inflation adjustment, like the regular tax structure). Maybe more taxes will ultimately be needed. But let's start with the simple thing and let the Bush tax laws take their prescribed course.

In terms of financial and economic policy, the government has thus far dodged the difficult problems (like toxic bank assets, the festering illness that remains in the housing market and the spreading illness in commercial real estate) and softened their impact with the Federal Reserve's printing presses and stimulus legislation. But those problems haven't gone away, and with the real estate market likely to stagnate for years, they won't go away by themselves. These losses--cleverly pushed by Bush administration policies into President Obama's stewardship--will have to be booked eventually. That process is happening already, with each Friday afternoon's announcements of the past week's tally of failed banks. We're up to 84 failed banks for this year already, and many more collapses are expected. Real estate losses and losses from toxic assets will be booked one way or another. The only question is how and when. The banking system won't resume large scale lending while these zombie assets remain on its books. And the Federal Reserve can't keep printing money; indeed, it's trying to figure out how to get all those printed dollars back. Resolving these problems won't be simple. But common sense tells us that we can't avoid them indefinitely, and allowing them to fester may well make things worse in the long run. Green shoots can be overcome by noxious weeds.

One final common sense point. It's time for the administration to ignore the stock market. There is a fin de siecle quality to the market. Upwards of 40% of last week's trading on the New York Stock Exchange was in 4 financial stocks: Citigroup, Bank of America, Fannie Mae and Freddie Mac. There's nothing publicly known about these four companies that justifies this much attention. AIG stock is up some 250% for the month of August to date. That's even weirder, considering that there's no news about AIG, except that the new CEO has reportedly had some conversations with a former CEO, Hank Greenberg. Some rumors have it that Greenberg might be thinking of buying AIG back. But let's recall that the U.S. government, through the SEC, just settled an enforcement lawsuit against Greenberg, charging him with responsibility for improper accounting. He agreed (without admitting or denying wrongdoing) to pay $15 million. Do we really think that the U.S. government, which effectively owns AIG, would sell the company back to a guy it just punished? And then there's GM stock, which has traded all summer at a positive price. That's looney. The publicly traded GM stock is for ownership in the residual company that's going to be liquidated. The U.S. government bailed out, Fiat affiliated company that is making the Chevy Volt isn't traded publicly at all right now. The common stock of the residual company is worthless. But apparently not to numerous buyers in the stock market.

The market rally has become increasingly concentrated in a few large cap stocks. This brings to mind the halcyon days of late 1999 and early 2000, just before the big tech stock collapse. The market rally of those days also became increasingly concentrated in a few big stocks. If that handful of stocks stumbled, then the house would be revealed to be made of collapsing cards. They did, and it was.

Day trading is becoming fashionable again. That's always a bad sign, because the least knowledgeable and most inexperienced traders tend to jump in just before indexes nose dive. The fact that corporate insiders are now selling about 30 times as much of their own companies' stock as they buy (as opposed to an average of 7 times sales to buys) is another hint that the salad days will be short-lived. If the smartest money is selling heavily, what's the logic to buying?

Of course, all presidential administrations deny that their policies are affected by the stock market. But there hasn't been one yet that doesn't scrutinize market indexes. If the Obama administration fixates on stock market movements, it will find itself straitened into dysfunction or adopting policies that exacerbate problems instead of cure them. At some point, common sense dictates that governments can't stop lunacy snd shouldn't try.