Wrestling Alligators, Draining Swamps: Economic Policy, Politics and Partisans

The Economy, Policy and Politics:

Wrestling the Crisis Alligators By Dave Livingston. Dave is a management consultant with almost 30 years of experience with analyzing complex business problems and developing solutions and new businesses. He blogs on public affairs at his blog Parts, Systems, Structures and Outcomes (http://llinlithgow.com/PtW/ ) where he attempts to apply that toolkit to current affairs and public policy.

Introduction

2009 was the year we narrowly avoided an economic collapse into a second Great Depression and managed instead to turn it into a Great Recession. While the Economy has stopped its freefall we came very close to the edge of the abyss. The Economy is beginning to recover thru the combined effects of fiscal and monetary policy but joblessness is still higher than at any time since the Great Depression and will take years to begin growing again. Unfortunately the long-term prospects are rather poor, with a weak and jobless recovery and relatively high unemployment and poor job creation throughout the rest of the decade. Unfortunately the things necessary for our survival also became political footballs with strong opposition more on the basis of ideology than on a sound understanding. We try to dig deeper into the crisis, the fiscal policies and the strategic outlook to debunk many of the myths that became headlines and political attacks. A key component of the crisis was malfeasant behavior on the part of the Financial Industry where short-term profits were gained at the risk of long-term damage. To prevent a future occurance we need to re-think the role and function of the Industry and re-formulate the legislative and regulatory regime under which it operates. But political sausage-making is an ugly business at its best and the influence of special interests has rallied behind reducing and slowing down reform, despite its being in the best interests of the country and the industry. Combined with partisan political interests industry lobbying has made the scope and extent of reform more challenging than it should have otherwise been. On the other hand there was so much going on that there was little time, energy or attention to spare but 2010 promises to be the year of a multi-year effort. An effort that has already seen reasonable draft legislation in both Houses as well as the initiation of the Financial Crisis Inquiry Commission (FCIC), or Pecora II. When you take it all together we’re facing a very tough decade of weak growth with no bubbles to hide behind. Here we lay out some of the ins and outs of the crisis, its aftermath, government policy, the efforts at regulatory reform and dive into the longer-term outlook. We face three major challenges, sequentially:

1. The need to get the economy back on a sound footing where growth reaches takeoff velocity and becomes self-sustaining.

2. The need to de-leverage the economies because growth in the last two decades was built on excess debt accumulation by consumers, and even businesses.

3. The need to return to being a nation of savers, instead of a nation of spenders who direct those savings into productive investments that are the real, long-lasting source of growth and jobs.

The jury is out whether or not partisan politics, the influence of interest groups and the will of the voters will enable us to meet these challenges. But one way or another we will be living with the results for a long time to come.

Economy, Policy and Politics: Navigating the Hurricane + Tsunami

of 30

Table of Contents

1. Miracles on Pennsylvania Ave: Make it So, No. 1! 3

2. The Chinese Goldsmith, Finance and the Next Big Fight 7

3. Banks Hate Banks, Voters Hate Banks: Hear the People Singing! 10

4. The Beginnings of a Great Debate: People Singing, Politicians Making Sausage13

5. The Sine Qua Non: Economy, Stimulus and Outlook 16

6. Change is Necessary: Current Course and Speed = ROCKS! 21

7. Pecora 2 Hearings, Malfeasances, Your Future & Cusp Points 27


of 30

February 16, 2009

Miracles on Pennsylvania Ave: Make it So, No. 1! The big news from the last couple of weeks, at least domestically, is that we've succeeded in crafting and passing the largest peacetime suite of economics legislation in our history (the Stimulus Package plus the next round of TARP) with more to come as the other two legs of a 4-legged stool. Those being a Housing rescue package and a re-formulation of Financial Industry regulation. We also learned that the ME is not the only place where intransigent adherence to provably wrong shibboleths of policy, position and belief are rampant. Nonetheless the package is un-surpassed for size, scope, force and timeliness and as such gets a B+ on economics, an A- on politics and an A for pragmatic and realistic policy-making craftsmanship, admittedly grading on a curve. What do we mean by all that?

Economic Policy to Date

First, make absolutely no mistake about it. This package is absolutely essential to saving the economy. We're in a very serious situation where the liklihood of a more pronounced downturn followed by a decade or better of Japanese Malaise is entirely possible. Further, the economy is unlikely to recover on it's own because the normal, organic self-correction mechanisms are broken. People and companies are, were and will be continuing to pull in their horns as the situation deteriorates; government is the ONLY possible source of the spending necessary to salvage things. Second, in a short-term view the notion that OMG it's spending is just utter and absolute nonsense, that in fact is the whole point. It doesn't matter if gov't employees steal everything and go to Vegas - it's still stimulative. Third, there are real tradeoffs between tax cuts (which are fast but don't give you much bang, direct spending which gives you a much better multiplier but is slower and investment, e.g. infrastructure, where you get the most bang but is much slower and complex. For example investment in new energy sources doesn't do much good if you haven't the power grid to move the new power. Fourth, given the spending if you can use some of it to both get high multipliers AND lay the foundations of down payments in future improvements in the economy that's smart policy-making. Finally, this is a large, very complex under-taking for which the implementation mechanisms are lacking; as a result there's only so much spending you can do in certain timeframes and you need to build up your capabilities. You also need to get support and buyin. Taken all together the package is a very well-crafted balance among all these competing requirements, let alone in the time and with the ideological oppositions it faced. We've gone into some of this before (First Things: Financial Crisis, Economy and Barry) but if you'd like some more details try these more "technical" discussions (State of the World: Crisis Metastasis, Strains and Fault Line,Economy vs Earnings Cage Match: Outlook, Business Performance & Realities ???,Time, and Past to Play Bizzball: Economy to Business


of 30

Performance).

Let No. 1 Speak for Himself

If you don't entirely grasp the size and complexity of the package check out the accompanying graphic from the WaPo which shows how it's balanced across the major components and how those components break down across the various Departments and areas as well as across time. And if you think pulling that off in the timeframe with that good a design was an accident, or that all the talking heads echo-chamber discussions of how badly things were done is accurate here are some excerpts from the recent AFOne Chicago flight of an on-record interview with the President, again from the WaPo. Obama Interview Transcript 1. Almost to an economist, there was a consensus that we needed a large stimulus package not as the silver bullet to solve our economic problems, but as a necessary component to solving our economic problems, and in terms of scope, that we were going to need something between $600 billion and $1.3 trillion. That was the range that was presented to us. There also was consensus among economists that the best approach to spending that much money and getting the stimulus out of it was to diversify a little bit, so have a tax cut component -- there was a generally strong feeling that tax cuts targeted at people who were most likely to spend would have the biggest impact; a state fiscal relief component, or a countercyclical spending component, so everything from -- food stamps to unemployment insurance -- again, stuff that would be spent out quickly and, in some cases, help prevent a worsening of layoffs and a spiral downward. And then a third component of infrastructure. Now, each of these components had pluses and minuses. For example, tax cuts, you can get them out quick, but the general view is that you don’t necessarily see a dollar of spending by consumers for every tax cut they receive. Infrastructure, you get probably the biggest multiplier effect -- for every dollar you spend you might get $1.5 worth of demand


of 30

out there, but necessarily you can’t get all those infrastructure projects done within a two-year time frame and the start-ups may be longer. So our whole goal was to provide a framework for Congress that presented the best mix based on the best available information that we’d gotten. I raise this because I think that some of the critics ended up fastening on this pet project or this program that they suggested was not stimulative; in fact, it would be hard to find economists who would argue that the guts of the program, the core of what just passed the House and hopefully will pass the Senate while we’re in the air or shortly after we land is not pretty well designed to get the economy moving again. And one last point -- one last goal that we set out, and that was if we were going to spend this much money, our number one priority being to get jobs in place and to get the economy moving again, wouldn’t it also be helpful for us to make sure that we laid some made -- that we made an investment in longterm economic growth -- that we put a down payment on things that have been deferred for too long? 2. Now, in terms of what I’ve learned on the politics of it, I think what I’ve learned is that I’ve got a great team because we moved a very big piece of legislation through Congress in record time. And that was not easy to do. And I think the end product is not a hundred percent of what we would want, but it is a very good start on moving things forward. I made every effort to reach out to Republicans early to get their input and to get they buy-in. I think that there were some senators and House members who have a sincere philosophical difference with the idea of any government role in boosting demand in the economy. They don’t believe in Keynes and they’re still fighting FDR. And no matter what we did, said, whatever the process was, they just don’t agree that this is the best prescription. And I think we can disagree without being disagreeable on that front. I also think that there was a decision made that was political and tactical on their part where they said, you know what, if we can enforce conformity among our ranks then it will invigorate our base and will potentially give us some political advantage, either short term or long term. And whether that’s a smart strategy, I think you should ask them. The last point I would make, though, is that given the urgency of the situation right now, my consistent goal throughout this process is: Are we getting the most immediate, most effective relief possible to American families who are losing their jobs, losing their homes, losing their health care? I welcome Republican participation in that process, but ultimately I’m answerable to the American people. And my determination was to get it done, and I think that we’re going to get it done. 3. Look, I mean, the fact of the matter is, is that once a decision was made by the Republican leadership to have a party-line vote -- a decision that I think occurred before I met with them -- then I’m not sure that there was a whole host of things that we were going to do that was going to make a difference. But again, my bottom line was not how pretty the process was; my bottom line was am I getting help to people who need it. Going forward, each and every time we’ve got an initiative I’m going to go to both Democrats and Republicans and I’m going to say, here’s my best argument for why we need to do this. I want to listen to your counter-arguments; if you’ve got better ideas, present them. We will incorporate them into any plans that we make, and we are willing to compromise on certain issues that are important to one side or the other in order to get stuff done. There are 535 members of Congress; they’re not potted plants. Their job is to represent their constituents and they’ve got ideas, too. So I’m not interested in bulldozing them. On the other hand, I’m answerable to the American people in an emergency economy. And what I won’t do is to engage in Washington tit-for-tat politics and spend a lot of time worrying about those games to the detriment of getting programs in place that are going to help people. : Well, look, as I said, I don’t want to question the sincerity of some of the Republicans who opposed this plan. They just may have a different theory about how the economy works. Now, I have to say that given that they were running the show for a pretty long time prior to me getting there and that their theory was tested pretty thoroughly and it’s landed us in the situation where we’ve got over a trillion dollars’ worth of debt and the biggest economic crisis since the Great Depression, I think I have a better argument in terms of economic thinking. But, again, I don’t question their sincerity. I do think that over time, as we keep on reaching out, and as I think the American people express their view that we need to start actually doing something about jobs, housing, health care, education, and so forth, that there will be some counterveiling pressures to work in a more constructive way.


of 30

4.I don’t have a crystal ball, and I don’t think anybody does, but I think that you can imagine very easily a scenario in which we duplicate what happened in Japan in the ‘90s, where we paper over core problems in the banking system. Despite some efforts at stimulus, we never fully get private credit flowing again, and the economy contracts severely and then sort of limps along for a very long period of time. Keep in mind, though, that even in that scenario, Japan had an awful lot of foreign currency reserves, they had a surplus from a positive trade balance. And the United States was pulling a world economy along. In this situation you’ve got all the economies around the world, even including China, decelerating at a fairly rapid rate. So if what happened in Japan is duplicated here in the United States, there’s nobody else to help drive the engine of growth, you could end up seeing an even more protracted and prolonged worldwide contraction. And I think that would have a severe impact on our quality of life. Let me, first of all, emphasize that the recovery package was critical to help families right now. Unemployment insurance extensions, health care through a COBRA that’s affordable, some immediate job creation -- those are very important. That’s only one leg of the stool. As I said in my press conference, the second leg of the stool is getting credit flowing again. And what the first round of TARP accomplished was to avert potential -- I hate to use the word again, but potential catastrophe in the banking system. I mean, things could have melted down much worse. Because of a lack of clarity, consistency, transparency, what you didn’t see was a market rebound and credit moving the way it needs to. So the credit markets still are not functioning the way they should. Now, this is a hard problem, and that’s why I said, I think on Nightline the day that Tim Geithner spoke, there are certain market participants who think that there’s some painless, quick fix here. There isn’t. Because what happened was that you had banks making bets, leveraging $30 off of one dollar of subprime assets; that was duplicated throughout the system, and deleveraging, sort of working through all those bad debts is going to be really tough. Now, we started talking about this, by the way, in transition as well, and so along parallel tracks, even as we were working on getting the recovery package done, we were also talking about how do we get credit flowing to home owners; how do we make sure that we’re getting small businesses the resources they need; how do we make sure the banks trust each other in terms of lending, and even blue-chip companies are able to shed corporate debt, so they can make payroll and keep people working.

Bottomline Assessments

Think of this as the New Coke marketing paradigm - even if you screw up you gain because you've ranged and bracketed the opportunity. 1. Barry reached out to everybody and included major chunks in the plan strictly for compromise, that is the tax cuts, which we know are NOT that efficacious in this regime. 2. He and his team guided things in the background but rested the primary responsibility for Congress and let them do their thing. In both cases we learned they aren't up to the task, still thinking in old patterns and (especially the Rips) reverting to old posturings and shibboleths; the talk show appearances sounded just like Newt the Grinch's playbook from the mid-'90s on perjorative labeling to trigger the lizard brain. McCain did too. And btw it was the same rhetoric that lost the election for him. So what did Barry do so far...he 3. Kept his cool, didn't get trapped into we said/you said, and pointed out it takes time to change people's habits thought, especially when they're burned into the deepest levels of their lizard brains. 4. At the same time in the press conference and at Elkhart he fired several major warning shots that said he can't


of 30

afford to tolerate to much childish behavior before being forced to get out the leather strap. Chess master indeed. And playing not just for the Opening or to set up the Middle Game but begin to set up the positional game for the long-run. And AT THE SAME TIME taking a very long, patient and balanced view of how you work in the short-term but play to change the tone without getting trapped in the emotionalisms and posturings. Unlike almost everybody else in the game. We'll see in that short-run how the messaging and positioning works out - that one he may have lost by losing some of the skirmishes but this battle isn't over. Let along the campaign. In fact if you'd like a baseball analogy much of the critiscisms have been about the base-running and sliding while ignoring the hits, runs and errors, let alone the season or the balance of forces. As it happens less than 1% of the bill is characterizable as "Pork" but the Rips played the old pejoration labeling games invented by Newt the Grinch to go after Clinton that have since dominated political discord, oops, I mean discourse, in this country. For a prior dissection of Lizardbrain vs Substantive communications see this (Rope-a-Dope at Hofstra: Handicapping the Debate and Results) and then compare it to the Meet the Press vidclip. Better yet compare that vidclip to this book talk by psychologist Drew Westen and look for the labeling vs non-labeling appeals to the lizard-brain. IOHO they've made major strategic and tactical blunders for narrow partisan advantages that may in fact be cynically self-serving, with an admixture of sincere disagreements (despite all evidence to the contrary over almost thiry years of Supply Side debates). In any case listen to the posturings on some of the vidclips in the readings (of which there is a whole......le bunch covering the spectrums of political, policy and posturings concerns). Or check out this series that provides a window on how well they sold the PorkFest Messages. October 22, 2009

The Chinese Goldsmith, Finance and the Next Big Fight http://llinlithgow.com/PtW/2009/10/the_chinese_goldsmith_finance.html The last several months have seen partisan fight after partisan fight in Washington, often leaving us average citizens as innocent bystanders or even collateral damage, or so it seems to many people. Now we've been focused on the Healthcare Reform fight and the debate on Afghanistan. On the first there was some amazingly good news, the last committee passed a proposal out of the Baucus Committee to the rest of the Senate, though the day before the Insurance Industry published a report attacking the proposals that was so bad even the consultants who wrote it have disavowed it. On Afghanistan we by stand what we've been saying - it's a mess but if we walk away again it'll be worse. The big fight you may be missing is the one over Finance Industry Reform. It was back-burnered because of the urgency and importance of immediate business, e.g. saving the country from economic collapse, but is moving center stage. Like many of the stakeholders in HC Reform those in Finance have been fighting to water down the bill but in this case with less justification, if possible, more smoldering anger among the public and, with this week's announcements. The Industry argues that the last two quarters of monumental bonuses are right, proper, the way they do business, indicate a return to health and good for the economy and country. The country's mood is probably captured by the cartoon collage but just in case were wondering how angry people are check out this


of 30

video clip from Dylan Rattigan's Morning Meeting. The question is who's right? (http://www.msnbc.msn.com/id/31510813/#33414533 )

Post De-regulation: Finance Industry, Debt and the Economy

There's no question that a properly functioning Finance Industry is necessary for a growing economy and contributes to long-run growth and prosperity. Neil Ferguson covers millenia of history in addressing that in his PBS Special "The Ascent of Money". We'll rest the strategic case there and focus instead on the narrower one of is our finance industry functioning properly? In particular has it contributed to our wealth and prosperity at an acceptable cost to society, that is are we getting a return for our money? :)! The graphic starts to speak directly to that with the top part showing recent changes in debt among several sectors (NB: all this worry about excess government borrowing is mis-placed, btw; right now it's simply absorbing all the excess sloshing around as everybody else de-leverages and is likely to do so for years). The bottom part of the chart is the really interesting part. On the left you can see ordinary businesses continuing a gradual growth of their borrowing while the Finance Industry, ex-post mid-80s de-regulation, securitzation and financial engineering wizardry, shooting for the money...oops, we mean moon. Similarly consumers got completely carried away as well, again beginning with the widespread availability of cheap consumer and credit card debt. Judging from these charts the net impact of the last three decades of de-regulation was to load down everybody in the economy with loads and loads of debt. Which sustained the explosion in consumer demand that fueled worldwide economic growth. As the US consumer pulls back, de-leverages and re-builds their balance sheets we're facing a fundamental change in the underlying economic structure we've been dealing with.

Finance Industry, Debt and Bonuses

So what did the Industry do with all that debt? Well judging by this chart, again from the WSJ, it looks like what it did was pay itself bonuses from the profits from loading up the rest of us with debt. Just to draw the points home Wall St. compensation before WW2 was significantly higher than compensation in the rest of the economy and then went thru a huge equalizing drop. Then, after de-regulation, it sky-rocketed back to the mooney until it exceeded the relative levels seen during the 20s and 30s! So much for the argument that high bonuses are innate in the Industry or contribute to the overall health and well-being of the economy. We won't go thru the charts or arguments but will mention that prior to de-regulation and bonuses excesses the US enjoyed


of 30

both its highest rates of saving and its highest rates of economic growth. We'll also add that the last couple of years have seen an enormous destruction of wealth for the average citizen. In the readings you'll find very extensive links and excerpts to a huge inventory of readings that examine the business performance of the Industry, economic policy and the state of the economy. Let's summarize the findings so far, inclusive of those readings: 1. The Industry argues that bonuses are a natural part of the way it does business but not only is that not true but ALL the profits in the last two quarters were the result of proprietary trading, i.e. speculating on their own account. That'd be o.k. if it were their own money at risk but actually, between bailouts, Fed guarantees and bond purchases, etc. it's our money and our risk but their profits and bonuses. 2. While efficient and effective finance is important we think we've also shown that an industry built on leverage, securitization and financial engineering has created a situation that has over-loaded the economy with debt and hampered growth. So much for the "social value" argument. 3. The "encumbrances" on the rest of us are part of the problem but then again the Industry almost destoyed itself; in other words by blindly and apparently mindlessly pursuing excess risks they didn't understand they destroyed the last decade's worth of what turned out to be paper profits inside the industry. In other words as businesses they performed abysmally. 4. Finally, and obviously of course, they almost brought down the entire economy and destroyed Western Civilization. Just in case you hadn't noticed! :).

Helmet Laws, Adult Supervision and Re-regulation

Peter Drucker tells us a business has three main purposes - it should:

1) create value for society, 2) create an effective work environment that makes people effective and 3) it should contribute to the health of society.

He further breaks down the last point into three major points about organizational social responsibility by arguing that any organization should also

a) do no harm, b) act to correct harms innate in its activities and c) support the correction of society's problems because no organization can be successful in an un-

healthy society. How would you judge the Finance Industry on those criteria? Based on the points we've summarized above and document extensively in the readings? People argued that seat belt or helmet laws are an unwarranted interference in private decision-making. We confess to having similar notions ourselves but then we thought about it. When some idiot goes ripping down the road without a helmet and crashes society is put to the problem of cleaning up the mess, treating the idiot and taking care of the innocent victims. This kind of external damage is why we end up with helmet laws. The President and his administration have been inviting the Industry since taking office to act responsibly and this last


of 30

weekend many senior members of the Administration made appearances on the Sunday news shows to repeat and re-iterate the appeal. Not to mention the President's speech to Wall St. several weeks ago. We'd suggest that when you've got the President and many senior members of Congress mad at you you're making a major mistake. When it turns out your case for arguing with them is beyond wrong you're in a world of hurt. Yet the Industry continues to appear tone-deaf where these issue are concerned. If you don't think he's serious we suggest you listen to the CSpan vidclip (http://www.c-span.org/Watch/Media/2009/10/09/Economy/R/24155/Pres+Obama+Pushes+Regulatory+Reform.aspx )....not just the words but the tone and body language. For Mr. Cool we'd suggest he's more than a little irate.

The Chinese Goldsmith vs the Special Interests

Mancur Olson in his book The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities about how special interest groups eventually seize control of the levers of power and begin acting in their own narrow interest and sacrificing the good of society tells an interesting story from the end of the last Chinese Imperial Dynasty. In seems an innovative goldsmith tried to introduce modern wire-drawing equipment from the West that would have enormously improved the productivity of his apprentices, let him make a lot more jewelry and sell it at much cheaper prices. The end result? His fellow goldsmiths found this change all together too threatening to their iron ricebowls and put him to death using the "Death of a Thousand Cuts"! Now in this case who's the innovator and who's protecting their iron rice bowls? An exercise for the reader with, we hope, an obvious answer. We'll leave you with a final hint...again channeling Herr Drucker. When an Industry refuses to correct a major problem it leaves society no choice but to step in and fix it, even when the fix is not ideal. He further adds that its a fundamental management responsibility to anticipate these problems and fix them before society is forced to. To otherwise is deeply irresponsible. And your judgment? October 28, 2009

Banks Hate Banks, Voters Hate Banks: Hear the People Singing!

http://llinlithgow.com/PtW/2009/10/banks_hate_banks_voters_hate_b.html We're going to stick with Financial Reform for a while because so much has happened in the last week, and even more importantly, because it's such an important, even critical, issue. In some ways, though not all, Financial Reform is the single most important domestic policy challenge after stimulating the economy. Healthcare Reform as well as Education, Energy and Innovation are probably more important in the long-run but to get there we need to have a healthy, reliable and effective Finance Industry. Setting aside the natural anger that almost all of us feel about the last two years, which should be counter-balanced by the fact that we all rode the gravy train for the last three decades, we've concluded that the policy and business cases for not reforming Finance do NOT hold up, and in fact are


of 30

completely contradicted by the facts and the economic history. But, like almost every other major policy initiative, we're now having to pay the Piper for that three decades party, before he comes to collect with claymore in hand. Take a few minutes to listen to this BNN clip (http://watch.bnn.ca/market-morning/october-2009/market-morning-october-27-2009/#clip228128%20 )from the founder of a Canadian securities firm who sounds about like the rest of us on the banks, but starts with discussing his recent trip to Afghanistan and the level of public dedication displayed as well as the level of progress. Then close the loop....what a compare and contrast between the Financiers and those troops. You might also want to check out Andrew Sorkin on Charlie Rose (go to the site, go to the archives and scroll down) and this recent PBS Special on Brooksley Born and futures regulation. Among other things Sorkin uses a key phrase - "tone deaf". What's happening to the Industry is something that they refused to see coming because they figured it was business as usual. On that topic Ms. Born's history should give you a bit of the history involved.

The Vicious Cycle of Malfeasant Financial Engineering

The last post went into some length on why the business models are broken and why the case(s) for leaving the Industry un-regulated don't hold up as well as pointing to support from an interesting range of commentators, from Greenspan to Volcker to Mervyn King of the Bank of England. In the accompany graphic we've tried to summarize those arguments and put them into the context of the bigger economic picture. The top box summarizes the key economic policy goals that we must succeed at, no ifs, ands or buts, if we're going to stabilized the economy, get it growing again and re-create a healthy long-term outlook for us all. A healthy and product Financial sector is vital to all of them, but is key to #6 and IS #7! The righthand box summarizes several of the critical arguments we concluded the last post with on what a contributory organization has to do to be a constructive member of society. We are after all a large and complex society that would be unable to function without our large organizations. In other words effective organizations that make a positive contribution, are well-run and, at minimum, do no harm to society, are inescapable to our meeting those goals. How would you grade the Finance Industry on those topics (please feel free to review the last post again)? We'd offer up our grades but there's nothing below an F and somehow that seems inadequate for an Industry that almost collapsed Western Civilization. It also seems in adequate for an Industry that's taking advantage of public funds and support programs to create giant trading profits to pay bonuses when there's no demonstrable positive contribution. In fact we could even argue that paying those bonuses when, at minimum, they should be used to shore up the capital of the banks is essential. The lefthand box summarizes our findings from the last post, and all the readings excerpted there, on where the Industry has failed us. The bottomline is that an argument for bonuses because it's essential to an efficient and effective industry doesn't hold up very well.


of 30

The Economic Outlook

Martin Feldstein was recently interviewed on BNN, the Canadian Financial News network, about his take on the industry and regulation in two parts. Wrapped around his comments in part two are his comments on the state of the economy and the outlook, and he's not very sanguine. In fact he sees a weak recovery with serious downside risks for another downturn without government support. Now as it happens he's NOT as strong on controlling bonuses and risk-taking as we are but we'd argue that he hasn't looked at those issues as carefully as we have, or in much depth. In fact it'd be interesting to have him or his team at the NBER take a look at the issues. You can see Part 1 of his interview by clicking on the highlights. (http://watch.bnn.ca/headline/october-2009/headline-october-28-2009/#clip228671 ) In fact while you're at it here are some other BNN interviews that are directly and specifically relevant on the state of the economy, the challenges we've still got ahead of us and the Industry reaction to regulatory reform. Rather than leave you entirely in suspense it struck as fascinating and encouraging that the industry business experts also supported reform. The sooner the better, too!

Dallas Fed President Richard Fisher

The president of the U.S. Federal Reserve Bank of Dallas says he sees the beginnings of an "inventory correction" in the U.S. economy. But, Richard Fisher also says a recovery is going to be "tough slog". He spoke with BNN's Howard Green in this exclusive interview. Part 1 and Part 2

Reaction to Fed Statement on Compensation

The Obama administration's pay czar released a report calling for big cuts in executive pay at companies that have yet to repay TARP loans. Paul Bagnell reports and BNN speaks to Scott Talbot, senior VP, government relations, The Financial Services Roundtable.

The Optics of Executive Pay

BNN investigates executive pay with Christopher Chen, regulatory lead, executive compensation, Hay Group.

We trust from the opening clip to the Rose and PBS programs to our own arguments plus the BNN interviews and reporting we've made a sufficiently strong case for why this is critically important? Feel free to write your Congressman. In fact, please do! Just in case we haven't you'll find a rather extensive reading except collection after the jump that is at least worth skimming IOHO, starting with an excellent Jim Jubak column on how badly broken the banks are in their traditional lines of business and where they're making their profits. Plus some stories that back up the "Malfeasant" part of the title, readings on compensation and some more on the need for structural reform. The final section on the readings is on Capitalism and its future - we particularly recommend them here. It turns out we're fighting another Cold War here. Several years ago a Marine Archeology team explored Kublai Khan's "Divine Wind" fleet that invaded Japan in the 13thC. What they found is that many, if not most, of the ships were built to hugely sub-par standards. Partly because they were rushed but mostly because the Mandarins in charge grafted off the public funds for their own purses. Who says History doesn't repeat itself!


of 30

November 19, 2009

The Beginnings of a Great Debate: People Singing, Politicians Making Sausage

http://llinlithgow.com/PtW/2009/11/the_beginnings_of_a_great_deba.html Let's go back and pick our theme of Financial re-regulation. On the surface that may appear to be a real swerve from our discussions of, stress and self-management. Or even the first bookend on "change is hard". It's actually not. Now this is critically important in and of and for its own sake. But it's also a case in point. It actually points to the problems when self-delusions and hubris create gigantic problems. It also a perfect example of the problems with sausage-making in the policy and political factories. It should be fairly clear at this point that reform is necessary and justified. But as reform has wound its twisty path thru the factory the Industry has been fighting it tooth and nail. Normally all that, like all the other momentous changes we're collectively tackling has been more visible than usual so we get an inside view of the slaughtering and processing that would normally be well hidden. The question, tying both threads together, is what kind of sausage do you want? In other words this about change on the personal and social level.

The Warning: How We Got In This Mess

An interesting question is it not? Overall it turns out we all drank the koolaid, some much more than others and therefore more directly responsible. But a central cause was a widely shared belief that markets would govern themselves. An argument that ignores the vital role of law, a court system and police to enforce it. As well as rules and regulations that make markets possible. There is no market that has ever existed that didn't have some mechanism for defining the nature and quality of goods, how they can be exchanged or what the price-setting mechanisms are. And ways of adjudicating and resolving disputes. Whether it's buying groceries, getting a new car or house, something arcane like a wheat (or pig) futures contract. Or punishing the guilty and malfeasant - just ask Bernie Madoff or think back to Enron and Ken Lay or Worldcom and Bernie Ebbers. Not only did we all drink the koolaid and surf a wave of funny money to buy all those things we believed. Nonetheless when there are rules there are those who will focus on manipulating them to their own advantage rather than playing the game. And from time-to-time there are key players who try and make sure the game stays honest, fair and just. When the players spend more time on manipulation than trying to win economists call that a


of 30

rent-seeking society - in other words rule manipulations trying to create rents just like the old German River Barons put up their castles at bends in the river to force merchants and bargemen to pay tolls, or rent. In the late '90s when the players were really starting to play rules one person, Brooksley Born, took a shot at reforming the game and was shut down by the koolaid drinkers. With the widespread applause of the Industry and society ringing in their ears. PBS did a marvelous special on her and The Warning (http://video.pbs.org/video/1302794657/ ), which you click on the picture to watch. The web page is here.

No More Koolaid? Industry Reactions

Now everybody's sworn off Koolaid - well almost everybody. A few weeks back there was an Industry conference in NYC (SIFMA) where Charlie Rose interviewed Jaime Dimon. Mr. Dimon is one of the good guys inside the Industry in all this and he has a lot of wise and insightful things to say. BtW - Rose has changed the structure of his web site so the clicking on the clip takes you to it rather than the specific interview. You have to scroll the archives - in this case the online only specials. But it's really well worth your trouble, at least IOHO. (www.charlierose.com ) Perhaps the most interesting thing is Dimon acknowledges the problems and failures, recognizes the need for a massive regulatory overhaul, has some well thought out suggestions and comments and so forth. But at the end of the day there are some things he still finds too hard to swallow about some of the proposals on the table. And this is the best of the best - literally. If he's pushing back how're the lobbyists in the backroom doing? Especially now that they are really doing God's Work, at least according to Lloyd Blankfein of Goldman Sachs. You know them - the secret government who's profited the most from public money and support and is in the process of paying the biggest bonuses in a decade? A decade of widespread over-consumption of the Koolaid, where bonuses were outrageous? And now they're paying bigger ones?

Inside the Factory: Reform Requirements and Outlook

At the same conference Rose also interviewed Tim Geithner who talked about all the things that need to be done as we re-think what's a safe industry and how we get there. There's probably no better sketch of what needs to be done and, from a strictly policy perspective, how we might get there. Larry Summers and the President have made similar speeches. We even commented before on the President's. The question of how the sausage is going to get made is a, shall we say, tad problematic. In the readings you'll find a collection of excerpts and links to some key readings that survey the situation, review the history and talk about the politics involved. Worth skimming at least. Now at the heart of the Industry's pushback is the argument that what they do is essential to the efficient and effective functioning of our economy, and therefore the health, well-being and prosperity of our society. In the longrun they're right - throughout history sound capital markets are essential (cf. Ferguson's "Ascent of Money" on PBS). The glitch is in that word sound.


of 30

Beginning the Great Debate

In previous posts plus some other investigations the business case, as it were, practices as usual and limited reform fail on five counts: 1) Financial Industry malfeasance almost destroyed the economy, brought on Great Depression 2.0 and might have collapsed Western Civilization. 2) The collective and cumulatively losses of the last couple of years wiped out most of the last decade’s profits, even though they were all funny money in the first place. In other words the Industry almost destroyed itself. It's in their own best interests since obviously they can't be allowed to play without adult referees.

• NB: the bonuses that the Industry started paying itself grew exponentially starting in the '80s, accelerated in the '90s and turned into a bubble in the '00s. And put compensation completely out of line. There is no evidence that those bonuses contributed positively to the health of society. In fact all the evidence is the other way.

3) Post de-regulation in the '80s we began almost three decades of wild indulgence in debt and over-consumption that loaded up the Industry, the consumer and business with leverage that we couldn't sustain. 4) That debt caused savings to drop to nothing and severely retarded investment and economic growth. 5) The lack of economic growth led to a relatively stagnant economy with poor job creation and flat to declining wages and benefits. And that, in turn, has led to an increasingly stratified society where the top 1% of earners, strangely enough somewhat concentrated in the Finance Industry, to garner all of the gains of the last three decades. When a society, historically, spends more effort on rent-seeking and power elites focus their careers on rule manipulation then it eventually succumbs to sclerosis and dies. Just ask the farmers and peasants who harvested all the wood on Easter Island and destroyed the ecology just to keep making giant statues for the Chiefs. We are not just debating Financial Reform but the kind of society we want, whether we can find it within ourselves to change and, indeed and not to get too dramatic, the future of Capitalism. Can we find the governance mechanisms that make it work and renew the most productive system mankind has ever come up with? Or we will choose to continue the descent into Collapse (cf. Jared Diamond)? A great debate indeed.


of 30

November 21, 2009

The Sine Qua Non: Economy, Stimulus and Outlook http://llinlithgow.com/PtW/2009/11/the_sine_qua_non_economy_stimu.html Sine Qua Non is Latin for that without which there is no other - a tag that had to be explained to me years ago but which has stuck with me as a useful description. Those old Romans were smart about a lot of things, weren't they? Well the Sine Qua Non of everything we'd like to do is the Economy and it's a very open question of how smart we'll be about it. To summarize we were saved from literal collapse last Fall, avoided the second wave of risk this last Spring and (likely) a lost decade and have turned the corner because of government monetary policy and spending programs. Make no mistake about it, absolutely none, the Fed and the Administration saved us from a near-run risk of disaster. We were staring into the Abyss and have moved quite a ways back from the edge. We still have a long way to go, the recovery will be weak and job creation will be poor (the jobless/jobloss recovery). Worse we're going to have deal with three decades of neglect, ideology and complacency to get growth. To get prosperity with rising wages, benefits, and long-term growth we need to re-base the economy while repairing its foundations. Almost all of the attacks and disagreements you have heard against those policies have been wrong-headed, proven wrong on the data to date, motivated by partisan political posturing, are self-serving and dangerous and grounded in ideological shibboleths that are dangerous to your health and well-being, as well as those of your children. That's it in a nutshell and if you understand it and believe it we're done, especially if you know why. And in strong language as well. The problem with economics is that it makes everybody's head hurt and they don't want to learn the basics. On the other hand the professionals don't make it easy, don't communicate well and get caught up in bright shiny things and their own narrow shibboleths. Plus they usually have no clue as to the practical policy and politics required to turn arm-waving into real world actions that work and are effective. So we're going to try and parse things thru chunk by chunk to try and help out with that. But if we don't get this right, and most of what you hear is crap, look out below.


of 30

State of the Economy

Let's start with where we're at in the business cycle. Most of the news coverage presents the data in ways that are hard to see and understand. But the economy moves in cycles where the control settings change but the patterns are consistent over decades, even centuries. The economy is like the ocean and moves in waves driven by deep currents. We look at it using the Year over Year percentage change (YoY%), which shows the redcurrant patterns very clearly. It also makes the trends, structure, relationships and turning points very clear as well. The top chart here is the core one and shows GDP compared to Consumption (PCE) an Employment. Notice how much deeper this downturn was but also notice that both GDP and PCE turned up this last quarter. Almost entirely because of the Stimulus programs. Also notice that Employment is still headed down. The next two charts stretch the time period back to 1960 so you can clearly see how GDP and Consumption and Employment move together. Looking at the GDP trend you an see where it went over the Abyss. Something you need to know is that real GDP growth needs to be above 3% to grow jobs, closer to 4-6% for a while followed by 3-4% to get the engine growing on a self-sustained basis (call it organic growth). Until we get the engine running on its own we need public spending programs.

Where's the Jobs: Employment vs. Growth

Employment growth hasn't turned around for two reasons. First, and foremost, it lags the general economy, usually by several quarters. Second, because we spent so much on Housing and other mis-allocations of capacity and the new jobs were created there, that the downturn has been worse because jobs are going to be shifted to other sectors. So there is a major cyclical problem combined with a significant structural problem. The third major problem, which explains why wages and benefits have done poorly for three decades, is that the long-term trend has slowed because we haven't invested enough in new capacity; nor have we come up with the new innovations and industries that would grow jobs on a major scale. That's largely because we loaded ourselves up with Debt and stopped Saving. It takes around 150K jobs/month to breakeven on population growth and productivity. For a healthy recovery we need to get way above breakeven to put people back to work, create new opportunities and and make up for


of 30

cumulative jobs losses. The last two recoveries have been jobless recoveries and we actually entered this downturn about -2 million jobs in the hole. Now are about -12 million in the hole. To get back to a long-term path of relatively high growth with increasing incomes and better opportunities for us and the next generation we need to fix all that. Which will be painful for quite a while. But the alternative is worse.

Understanding the Economy: Spending Patterns

There's a lot that always goes around talking lost this and simple fixes, most of which is wrong. And it's wrong often starting with the simplest things, which is what is the exact structure of the economy. That is what do we spend our money on and what's the structure of how we run the economy. This chart set is a start on re-grounding you in some of the facts - startled us when we first looked at, and we almost never hear any commentary that reflects the realities of how our economy is put together. The engine that drives everything else is Consumption, shown in the blue shades. Over this timeframe there haven't been any major structural shifts but going back to the '50s we've bought more services. Now it's by far the largest portion of Consumption. The accelerator that revs up the engine is business spending on equipment plus hiring. Neither of which happen unless there are good growth prospects. The late '80s Tech Bubble was driven by over-investment in Technology. What, literally, kept the wheels on the wagon this decade was the Housing ATM where people borrowed against the value of their Houses to fund consumption of all kinds. Talk about grasshoppers on a debt sugar-high! Another thing to notice is that Federal government spending is NOT the largest portion of total government spending, State and Local is. You really need to notice that non-Defense spending, the tiny little yellow slice, where all those conservative programs were going to create the new Nirvana is pretty darn small to base a trip to Heaven on.

Understanding the Economy: Industry Structure

Another little mis-apprehension you hear about is the death of Manufacturing. Well US Manufacturing still leads the world in total output and in productivity. And, while it remains a major part of the economy, there has been a shift to Services. The really big change though was a technology shift that enormously increased productivity while dropping the demand for labor. We built the economy on blue-collar jobs in Manufacturing that were well-paid enough to get workers into the Middle Class. That began to go away in the '60s. What goes with that by-the-way is that the US has always been the world leader in public education. The British noticed it in the early 1800's and it was the growth of the free public high-school in the early 1900's that created the educated labor force necessary for Industrialization and the growth we enjoyed thru the 1950s and into the early '60s. The lesson here is that we need to not only create new jobs thru another wave of Innovation but we need a whole new labor force


of 30

up to the challenges of those jobs. And a HS education as it's become won't cut it.

Economic Outlook vs. Policy vs. Change

Let's try and explain what economic policy has done and is trying to do, and what the consequences are for the future. Particularly if we make the wrong choices. We'll use this set of conceptual charts to try and link several aspects of the economic cycle together with phases of the stimulus and budget programs. The really good news is that we managed to avert GD 2.0 (which is mis-scaled here - properly it'd blow thru the bottom of the chart using a log scale but you really don't want to know, or how close we came either). We did that with a combination of low interest rates, special purchase programs by the Fed and the bank bailouts. Despite all the pitchfork waving if any two government agencies deserve medals it's the Fed and Treasury. Politics and populists being what they are of course the cry went up and is going up to burn the witches. At least the peasants will feel better until we all starve to death. Now we're "deciding" whether the recovery will be L-shaped (drawn-out, no jobs, no growth) or U-shaped (weak, drawn-out, poor job creation, still loosing ground, low growth around 2.5% and no long-term prosperity). On the charts we're between the two curves and early; and on the policy chart (the middle one) transitioning from arrest and stimulate to stimulate and grow. We need more stimulus, which is in the plan and funded, to keep the engine turning over. But what happens then? If the stimulus fades out (think of this like the external starter for an airplane) without the engine catching on its own then we fade out and get a double-dip recession. Only if the engine catches and we get organic growth where businesses start hiring again do we get that U-shaped recovery. This really and truly a policy-driven economy. If/when/we hope that happens we still face those long-term problems we've been neglecting for decades. Assuming we get over the self-sustaining barrier we're still facing a decade of 2.5% growth (which is in fact the official and many other forecasts). If you thought this last decade was miserable, or if your memory extends back to the '70s just wait. It could be even more fund. If and only if we make the deep structural changes do we re-base ourselves and get back on a higher growth path.


of 30

Change Is Really Hard: Taking Next Steps

Now you're going to hear at least somebody raise the Deficit and Tax Cut questions, both of which we've discussed in depth before so we won't triple on already long post. Briefly Tax Cuts were part of the package but were, as expected, temporary, largely ineffective and put into savings. They were included as a bi-partisan gesture and also because their low impact was offset by speed while the more difficult programs were ramped up. NB: all of this is collected in the Economy archives. We'll also note that in the readings, among a lot of other stuff backing all of this is up, are some selected materials from Bruce Bartlett, Jack Kemp's economic staffer and one of the principal architects of the legislation of the Reagan Revolution. What's interesting is that the Prophet agrees with this entirely, much to utter chagrin of the current crop of Republicans. This chart, which we built almost four years ago but is based on things that have known and discussed in policy circles for decades, captures some major policy choices and the steps. When you believe in magic quick fix answers and go for the easy layup you get unintended consequences that come back to haunt you. You have to ask the next question and the next - so what happens then? In other words what's the initial impact, early reactions, delayed consequences, longer-term impacts and structural changes. We chose quick fixes whose longer-term impacts and structural consequences we're living with now. In other words THEN is NOW, change is hard, as ye sow so shall ye reap and the harvest is in.

Partisan Gamesmanship:

A short excerpt pointing to a short daily commentary by a Northern Trust economist has been added to the readings. Frankly we found it stunning because it calls out two very conservative Rep. Congressmen who published a WSJ oped piece repeating the old ideological shibboleths. Not so much technically - though it's good to seem someone of this stature speaking up instead of just ourselves. You have to stop and think about the context. NT manages money for the wealthy, has one of the best and most respected economics groups in the world who's track record is impeccable and such folks never comment on politics. NEVER. To add more fat to the fire we found it thru a bloggining buddy (Prier du Pleiss of Investment Postcards) who runs money in South Africa. The bottomline here is that partisan gamesmanship set us very badly for the crisis, almost collapsed the emergency rescue efforts last Fall thru sheer idiocy, has hampered recovery efforts all along the way and thretens the recovery. And all based on provably wrong ideas, analysis, data and constructs - and we do mean PROVABLY. To throw oxygenated high-octane gas on the fire Stan Collander of Capital Gains and Games takes the same non compos mentas to task for their manipulation of deficit fears, following an earlier piece by Bruce Bartlett (the economic staffer to Jack Kemp who was the principal architect of Reagan's reforms) on Republican deficit hypocrisies. Take it for what it's worth but these people are competent, informed, sophisticated, experienced, non-partisan and scared. Our take is that we're crossing a cusp point where this kind of self-serving politics is dangerous.


of 30

December 17, 2009

Change is Necessary: Current Course and Speed = ROCKS! http://llinlithgow.com/PtW/2009/12/change_is_necessary_current_co.html We're going to follow along with the "change is hard" theme by a semi-wonkish dissection of why it's necessary, including a look back at the history, how we got here and what's next. But the bottomline is that the last two posts inventoried the changes that are necessary (and their scope and scale) and why it's so hard to change, given we're working in a sausage-factory. But, remember, somebody buys the sausage - and that's you! At the end of the day we weren't concerned about making our lives, those of families and friends and the world around us better this would all be irrelevant. Instead we could focus on having a good time. The problem is when you wake up the next morning and the party of the last three+ decades is over and it's time to deal with the hangover (always an extremely painful process in our experience). The bottomline is that America has become an increasingly stratified society where the rewards for growth and progress go to fewer and fewer people. That's not (just) an issue of social justice because it's people's commitment to the strong and working society that's required. Which means, in turn, that they have to believe that society treats them fairly and with justice. The fundamental social contract in America is that if you work hard, play by the rules and help out your neighbors you can get ahead and make life better for your family, now and in the future. These days people are more than seriously questioning that - just ask your neighbors the next time you're having a beer or three.

Jobs, Jobs, Jobs: It's All About the Jobs

Everything we want to do in live ultimately rests on the ability to earn a decent living - a fair day's pay for an honest day's work. That was always our core belief and, we think, most peoples. What the chart above shows you is that's no longer entirely true. Underneath all this is the bedrock requirement for a growing economy that creates good jobs for everybody who wants to work that is fairly paid and qualified (those are all critically important caveats). That's the day-to-day translation of the social contract and what allowed us to build the society we have. The good news in all this btw is that we can get there again. The bad is that it'll take time,


of 30

hard work, discipline, being willing to give up things to get ahead and the death of the "instant gratification" culture. O.K. - here's we get a little wonkish, or worse. Sorry but it's necessary. These charts capture the last five decades of job creation. We've had flat periods before but this is the first time that we've had more than a decade where new private jobs created is zero! No jobs, no income, no pay raise, no gifts for the kids at Xmas, no....well you get the picture. The top chart set is the result of this one - poor job creation (again for which people are qualified) means that the few who have the right skills (or connections truth be told) are the ones the economy values. What created the modern middle class was the huge surge in good-paying jobs in industries where a h.s. education was good enough. This time last century a H.S. education was about like a graduate degree now. We need to do it again.

Please Mr. Obama, Make it Go Away

The last post inventoried the roster of major policy issues and where we're at on them. The funny thing is that in any of the last 3-4 administrations any line item would have been the central concern. Now we have double baker's dozen or more. On which we are making progress, believe it or not (and it's incumbent on you to do your home work and test our arguments). The President has spent a lot of political capital getting thru each of these barriers yet we're in better shape than you'd expect and much better than we deserve. Check out these poll results from the latest WSJ/NBC poll. Overall the Prez's popularity has declined, some of which you'd expect and some of which is because he didn't magically manage to fix all these problems instantly. When you start with euphoria based on illusion the only way to go is for the bubble to pop. When you go look at the original poll some of what struck us is how reasonable some of the feedback is, e.g. Afghanistan has more support than you'd have thought. The other thing of course is the expectations gap but what's also interesting is how well respected the President is. Maybe there's a bit of realism there after all. A key finding though is how dis-enchanted folks are with a gridlocked Congress playing partisan politics. They're your representatives folks - and they're doing what their constituents asked for. This comes back to you doorstep, in other words. In particular we'll point out the Republicans have fought every single item, gone straight-line party votes, proposed no alternatives and tried to sell their opposition as idealism. A friend constantly accuses of dissing those who disagree. Maybe. On the other hand good intentions and sincerity describes a lot of villains who thought they were doing the right thing. Now that's NOT an accusation we're leveling but on the acid test of proposing their own alternatives and working for compromise the Rips fail three tests: no proposals, strict partyline votes (nobody's that cohesive thru analysis, strictly politics) and emotional


of 30

appeals to the hindbrain (otherwise known as selling to the fear, death panels anyone). The real problem is that on the whole that's a fair summary of each policy issue.

Consider the Economy and the Stimulus

Let's take the "simple" example of the Economy and the stimulus package which was wrong, should have more tax cuts in it and nothing else, hasn't worked and isn't creating jobs. Remember that's being said by the same people who this time last year voted down the financial rescue package that saved Western Civilization out of sincere adherence to their ideals - the fact that it served their own partisan interests and still does is entirely coincidental. Now we did a detailed pure look at the economy and the related policy just a bit ago (The Sine Qua Non: Economy, Stimulus and Outlook) and you might want to go back for a refresh. We "borrowed" this pair of charts from Nate Silver over at FiveThirtyEight:Politics Done Right. He starts by breaking up the initial pacakge into its pieces - you'll notice tax cuts were a big chunk of it. The problem is that tax cuts aren't very effective, they're just fast. Higher impacts comes from direct spending on making things but that takes longer and you can't exceed the ability of the government departments to manage the huge surge within existing staff and capabilities. On the whole, give or take 2-4% sausage-making fudging around the corners to get support (consider it the political tax for the speed and getting passed at all) {Think It's Been A Bad Year For The Federal Budget? Think Again.} this was a pretty darn well crafted package. True we haven't made up the ground in lost jobs and won't for a long time, but the situation ain't nowhere near loosing 3/4 of a million jobs/month either. Without the stimulus that's probably where we'd be. (Slapshot in Time: Economy Status and Appalling Military Metaphors). Now with all that level setting, hopefully evidence-based and reasonably well-argued, that's really about fixing the things that are leaking right now. Now we happen to think to get back to the kind of society we want we need to create 46 million jobs in the next decade and are likely to get 20 (Antipasto Appetizer, Bouillabaisse Main Course: Markets, Economy, Policy, Outlook). The BLS just said we're going to get 15. How do we fix that? Well we've actually been talking about that for a while now and it rather looks like the current policy agenda, again believe it or not. Put to put that in place it can't be business as usual and to fix that you need to understand where we're at, what it's cost us and how we got here.

Growth IS Jobs, Jobs are Wages, Wages Are Growth

Economic growth is what creates jobs. The top chart is more than a little wonkish but we wanted you to believe our arguments, or at least that we'd looked at it pretty hard. We need to grow jobs at 2.5%/year to breakeven and we need to get better than that to get that brave new world. You can read the requirements right off the chart - go to the vertical side, look up the number you want, run across to the red line and down to growth. If you do that you'll find that 4-5% growth is what we'd like. Oh lordy, would we like it. Remember, those aren't just numbers - it's who eats, who goes to college, who's kids get shoes. They may be just numbers but the lives behind them are really real.


of 30

Back in the '60s we sorta were getting those numbers and then the 70's caught up with us. We did a little better but not much in the 80's but it wasn't until the Tech Boom of the late 90's that we started gaining ground. All of which has been more than wiped away (again, look back: no new jobs in over a decade...OOPS!).

A Fair Day's Work, a Fair Day's Pay

Yeah, right. Now you tell one. This chart tells us the stories of real wages (after inflation) and personal income. Both went down in the 60s, crawled back in the 80's and started moving up again in the 90's. Then wages stalled and income get the crap beat out of it. But neither did very well - go back to the first chart on incomes. If jobs are poor and wages worse is it any surprise that incomes stalled out? In the 50's and 60's the distribution was kind of like a picket fence. Everybody got better together, roughly, give-or-take. From the '80s onward it got to be more and more like a stand of trees planted at different times (and to beat up with the analogy major differences in water, sunlight and fertilizer. Most of the fertilizer went to the tall trees).

Bring Out the Pitchforks: the Story of Profits

So where did the wages of sin, ahem, excuse us the returns from growth, go? Well on thing you might expect depending on which conspiracy theory you read last night is to evil corporations. A theory it turns out was not entirely far-fetched. If you deconstruct this pair there's plenty for discussion (economics is life, just in disguise). From 47-mid60's wages grew very nicely thank you and then went in the tank until they began stabilizing. But it wasn't profits, which also went down, it was capital investment (remember that was when safety regulation hit, we had two major oil shocks, women entered the labor force - in other words huge changes that need a lot of new stuff to make it work). But then this last decade wages really went into the crapper while profits soared. What happened there?


of 30

A Tale of Two Profits: Finance vs. the Rest of US!

Well now that's an interesting story indeed. It seems when you break it up into companies who make things and those who finance things the first set ran for decades behind the economy while the second set ran so far ahead of it was like power vs. horses. The doommongers may have a point - we quite making stuff and started financing it. Now you need to take a look at this decade where real company's profits went thru their own little mini-bubble because they weren't hiring or investment in equipment. Instead they were doing buybacks and buyouts, using some of that financing truth be told. But no company hires, builds plants or buys equipment unless they see future growth in demand. A no growth economy means you don't have to so you don't. Simple as that. The guys who made loans, funded your last vacation, gave you a credit card or traded on their own account on the other hand made money hand over fist. It turns out there really are some greedy capitalists out there who also seem to be tone-deaf to smoldering firestorms and the sound of pitchforks being sharpened. (Paying the Piper: Finance Industry, Performance, Value & Regulation,Beginning a Great Debate: People Singing, Politicians Making Sausage).

Debt, Debt, Debt and More Debt

But they sure didn't do it all by themselves. In fac the had the wholehearted cooperation of the rest of us. There's all sorts of talk about government debt running out of control these days that's not accurate, distorts the state of things (and the dire circumstances) and is selling to the hindbrain. In fact the Federal and State&Local governments (S&L) were the folks writing down their debt (here shown as multiples of GDP to scale it). Who really started running up their debt, beginning in the mid-80's, were Consumers (you) and Businesses (the people selling stuff to you). And the guys who just exploded were our favorite Financial types. Interestingly btw, if you read the charts, the biggest surges in Federal debt were under Reagan and Bush II. Our most conservative President's no less!


of 30

This chart is only try 2008 and private borrowing has dropped like a rock - which means that all the government is doing is taking up the slack, largely to get us out of this mess (though 90% of the debt is directly due to Bush's tax cuts and two wars). But Consumers were borrowing to a fare-the-well also (you can see the relative growth in the different sectors in this chart by clicking on thru). All of those mortgages, credit cards and vacation loans you know.

Paying the Danegeld

There's an old English saying to the effect that if you pay the Dane his gold he'll just want more. The alternative of course being having your villages destroyed but at some point you don't have any more gold. And oh what a price we've paid and oh what trouble we've created for ourselves by living for today on borrowed money. From this chart it looks to us that after the virtuous 60s where growth was higher we quit saving and that started impacting growth. It's really pretty simple - if you save then financial institutions, the right kind anyway, turn around and lend that to companies to invest in new plants and equipment. If they've made the right choices then they grow, and if there are enough of them, they grow the economy. Which means more jobs and higher wages. In other words by borrowing to party we cooked and ate the goose who laid the first batch of golden eggs. Which makes the remedy really simple and really...really....really hard. Start saving more and put it into productive investments. The problem with that "simple" remedy is that it's going to take us a long-time to rebuild our personal balance sheets and then start saving enough to start really growing again (remember 4% growth = 2.5% jobs). And that's where we need to get back to.

Your Grandparents Were Right

Which means some pretty fundamental changes in behavior for all of us together. Right now we're standing between the blades of the giant scissors of Debt vs. Savings. You grandparents were right - work hard, get a good job, don't spend more than you make and save....save...save. Better yet invest...invest...invest. And not in tanning booth salons either but in real stuff making real products that people really want to buy. The world we inherited was created by the people who lived their lives that way. Now it's up to us to get back to there. But this is actually good news - there are reasons for optimism. The only real requirement is that we all stop drinking the koolaid of easy answers, magic fixes and something for nothing and get back to the notion of a fair day's pay for a fair day's work.


of 30

As simple as that....as hard as that. But you'll decide, you really will. One way or another because not deciding is not an option. One way or another.

January 13, 2010

Pecora 2 Hearings, Malfeasances, Your Future & Cusp Points http://llinlithgow.com/bizzX/2010/01/pecora_2_hearings_malfeasancs.html The Financial Crisis Inquiry Commission (FCIC), or Pecora 2, kicked off its hearings this morning with quick statements from the chair and vice, testimony from the heads of 4 of 5 of the big banks, a second panel from several investment banker/analysts with strong criticisms and an afternoon panel from four banking/economic/housing experts. Frankly the hearings so far are stunning - intelligent, polite, informed, limited axe-grinding by the commissioners (with some exceptions), almost no ideology and a strong bi-partisan spirit of inquiry, digging into the data and understanding. In just today's hearings (which we intended to listen to only for the kickoff but ended up getting sucked into for the whole day mostly) we heard the entire crisis reviewed, most of the major root causes id'd and the last two years of back and forth raised, reviewed and either put too bed or confirmed. By and large the preliminary indicators are that our assessments align with the Commission's and the witnesses. Just to set the stage however we'll start you off with a recent show from Bill Moyer's Journal on PBS (http://video.pbs.org/video/1380851536 )where an editor and a report for Mother Jones discuss their findings for why there's been such a delay in moving forward with reform and how the Industry has influenced things. If you find your blood pressure rising that was and is the intent. Perhaps the most interesting thing was that all the big bankers started off, stayed with and finished up with Mea Culpas and fairly forthright discussions of what went wrong (the most intransigent and argumentative being Blankfein of GS, who more than got into it with the Chair).

Where We're At: Impacts and Current Status

Let's start with some charts taken from Mark Zandi, of Economy.com, testimony. Zandi by the way is well respected on both sides of the aisle, was an advisor to McCain and has a reputation for even-handedness. Starting in the UL corner he tell us that after a near-collapse that government intervention has stabilized the financial markets (under questioning he stated that the Stress Tests this last spring were THE major turning point). At the same time he also said that the markets are far from healthy, using (UR) the bond markets and the level of debt issuance as the critical indicator.


of 30

He then went on to point out that it was almost entirely the stimulus package that saved the economy per se from greater collapse and that many of the programs had large and beneficial effects, leading to an estimate of 4% GDP growth in Q4. Yet also worried that the as the impact fades the risks of a W-shaped outcome are serious and would recommend another $200B stimulus follow-on (again, this from a McCain advisor). He also pointed out that (LL) the labor markets were damaged and recovering poorly and would remain in trouble for a long time. Since all that lines up with everything we've been saying for months we thought it was profoundly insightful :)!

What Broke - the Analyst's Perspectives

Interestingly, despite differences in perspective (and one commissioner with an ideological axe to grind) all of the witnesses basically agreed to the same set of problems and breakdowns. Since one of them (Michael Mayo of Calyon Securities) was kind enough to provide charts to back up his diagnosis we borrowed a subset to create this composite. (all the exhibits can be downloaded from the FCIC's web site at www.fcic.gov). Starting in the UL corner he first pointed out that there was an explosion of securities in the 00's AND that the Asset/Equity ratios of the Banks and Securities firms exploded;i.e. they got themselves leveraged to a fare-thee-well (really interesting despite the roots lying in the 80s this didn't explode until this decade). Moving down the left column that much of that issuance moved from secure instruments to structured products and that this financial engineering drove a huge surge in fees. No self-interest here of course. Moving to the righthand column we see the concentration of this new issuance in real estate trading in one form or another, in which btw, consumers, et.al. were complicit as well - since consumer debt also exploded. The real money chart is the last in the lower r.h. corner - which tells you what happened to compensation in the Finance industry vs. the rest of the economy. So there you have it - graphic testimony to malfeasant greed run amok taking the innovative technology of securitization and metastasizing it this decade to drive fees, profits and bonuses. And, oh yeah, almost collapsing the world. Again - in so many words - everybody including Blankfein, Dimon, Mack and Moynihan (BAC), basically conceded all these points (and a good thing it was the new guy and not Lewis testifying).


of 30

The Long-term Strategic Impacts

So what are the long-term consequences? Well if you read our year/decade outlook on the economy, markets and business you've got one set of answers. But we'll go back to Mr. Zandi for his take - remember this is under oath btw. Well Mark sees it pretty much as we see it - though if anything he's even gloomier, though he put it more simply and clearly perhaps; and talked more about long-term debt and savings. Nonetheless coming from very different directions we ended up with identical conclusions. First off (UL) Consumers took a huge shot to their Net Worth that they will likely never recover and which will cause fundamental long-term damage. Which you can see in the Confidence charts (UR) for businesses and consumers - which despite improvement are still worse than at any time this data shows (NB: the spokesman for regional/community banks said something similar in his own words). The two really sad, scary and critically important factors are the long-term structural impacts. In the LR you can see the estimate of the long-term impact on GDP growth rates - we're going to be hamstrung for a long time. And in the LL you can what kind of debt financing problem we got saddled with and will take a long time to work out of. In the readings below we have a very long accumulation of excerpts leading up to the hearings, setting out the background, some diagnosis and recommended resolutions and the impacts. The Commission is chartered to take the year to to reach its conclusions but this will indeed be the year of re-regulation in several forms or the other.

The Hearings and the Assessment

There's been an enormous amount of criticism of the Administration and Congress for not moving faster on all this to quickly and magically fix it. Of course that's how we got into these problems and the original Pecora Commission didn't reach its end and see new legislation for almost four years. There was plenty else to do this year which should have and did preclude starting hearings on this matters. At the same time now people both have some perspectives and we've seen the Industry's true colors. All in all we don't think things could be better positioned for as good an investigation and re-think as we're ever likely to see. CSpan is carrying the hearings live and also putting them up on its web site. It's at least worth some of your time to listen to the openings (if the Chairman and Vice's statements are on this) but we felt encouraged from the get go, and more so as thing proceeded. (http://www.c-span.org/Watch/Media/2010/01/13/HP/R/28350/Financial+Crisis+Panel+Questions+Big+Bank+CEOs.aspx )


of 30

This is as qualified a group of public servants as you're likely to get, even considering the political process that brought them there. During the course of the hearings Zandi summarized the "root causes" in three points:

1) a worldwide excess of savings which created a sloshing surfeit of liquidity that drove down returns and caused people to go crazy looking for any advantage (something we remember saying a few times going back to '03). 2) the over-use and over-exploitation of securitization combined with absolutely terrible under-writing and diligence 3) and a failure of regulation.

He and several others added a fourth multiple times thruout today's hearings as the real root of the root - HUBRIS! But we'll add a fifth that is the Alpha and the Omega, the ultimate AUM (OM): the failure of corporate governance and performance management. In legal doctrine there is the notion of last clear chance to avert a disaster - well the people who had the first and last chances and who had the fiduciary duty to do so were the executives in charge. And the man who stepped up to that admission was Jaime Dimon, strongly seconded by John Mack. There were lots of factors, lots of mechanical breakdowns, a triumph of greed and some really terrible regulatory decisions. But the ultimate failure was a mangement failure - opting for malfeasant choices, in both the private and public senses, in the service of greed. Synthetic derivatives were merely the enabler, or one among many. The results of these hearings are going to frame your life and those of you descendents for decades, just as the originals did. And just as the failures of Financial leadership already have. Like we keep trying to say - the Industry as people keep trying to analyze it ain't coming back!

Wrestling Alligators, Draining Swamps: Economic Policy, Politics and Partisans

Documents

Transcript of Wrestling Alligators, Draining Swamps: Economic Policy, Politics and Partisans