The Financial Crisis (5)

At the beginning of the first Clinton administration, the President's tax and spending proposals drew an extremely negative reaction from the bond market. Mr. Clinton revised his budget and one of his principal political advisers, James Carville, was moved to say:

"I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

After a long period of somnolence, the bond markets are awake and have turned on Greece. Regardless of the proposed EU and IMF bailout, the Greek government will, within the next three years, likely default on some, if not all, of its debts. Naturally, such a default is being described as a restructuring but that merely attempts to disguise what is really going to happen.

Many banks, governments, hedge funds, bond funds and individuals are going to lose a lot of money.

Next to suffer will be the other so-called members of the PIIGS group: Portugal, Ireland, Italy and Spain. Only Ireland has taken significant actions to address its debt problem but it remains to be seen if those will be sufficient.

So far the USA has escaped the bond market's ire. That this should be so is something of a mystery. Specially as there currently seems to be exactly zero political will to address deficits that stretch from here to eternity.

Those who believe that we can continue to live beyond our means are living in an hallucination that will - sooner rather than later - become a nightmare. When the bond market turns on us, there will be three alternatives and all are equally unacceptable. We can raise taxes and cut spending to such an extent that we endure a severe recession - possibly even a repeat of the Great Depression, we can default on our debts, or we can print so much money that the resulting inflation will reduce the debt to a pittance in real terms. Countries that have defaulted have seen serious reductions in living standards while Weimar Germany and Zimbabwe both followed the path of hyper-inflation with even uglier consequences.

If we wait until the crisis, we will suffer a greatly reduced standard of living while watching China become the leading political and military power in the world.

There is still time to act but delay will only, and inevitably, lead to disaster.

As election season approaches, we must express our willingness to accept the hard policy changes that will be required. That includes voting against weak kneed politicians who pander to our very understandable desires to put off - for just a little longer, please - the foul tasting medicine that we must take to cure our current economic problems.

The use of this phrase, frequently written by Winston Churchill, is appropriate: "action this day."

More on Arizona

The issue of illegal immigration is almost entirely about jobs.

Americans no longer want to do the back breaking work of picking fruit and vegetables, packing meat, unskilled construction work or landscaping - to name only a few. At least, they don't want those jobs at the wages that employers, driven by relentless pressure for cheap goods and services, are willing to pay.

Hence a plethora of jobs for illegal aliens. Without demand for their cheap labor, however, these migrants will go home.

Here are two possible solutions.

First, even though the Federal Government actively regulates business, the States have greater powers. In particular, they have the power to issue Certificates of Incorporation and of Registration as a Foreign (that is incorporated in different State) Corporation. One of those is necessary to do business in every State of the Union.

States, then, have ample opportunity to cancel the corporate status of entities that are found to have hired or contracted with, whether deliberately or negligently, illegal aliens who do not have the right work in the USA.

If Corporation risked being put out of business as a result of hiring illegal aliens, they would be much less likely to do so and that should materially reduce the availability of jobs for illegal immigrants. True, a shortage of labor would increase its cost but that is the nature of a free market.

A second alternative is for the Federal Government (it is preferable to have a national policy) to make it a criminal offense for an employee of a corporation to hire, knowingly or negligently, an illegal alien. A minimum sentence of at least one year in jail - no parole, no suspended sentence, no work release, no halfway house, no "country club" minimum security jail - would also go far to reduce demand.

Then add a 'The Buck Stops Here' provision to the law which would provide for jailing the Chief Executive Officer in the case of generalized and widespread violations. Such a provision would likely put an immediate stop to almost all unlawful employment.

Since politicians seem to be in thrall to large corporations, and the political contributions of their executives, the chances of any such reform are not high. Add the screams from consumers, who who will have to pay more for the goods and services that are supplied by businesses where illegal immigrants are widely employed, and the chances of effective reform drop to near zero.

The need is for politicians with courage who will dare to stand up to corporations and short sighted consumers. Right now, nothing is happening at the Federal level but, in Arizona, our liberties are under threat from would be authoritarians, who don't believe that the Fourth Amendment is necessary - or useful, and who seem to have forgotten why America was founded.

It would be nice if Arizona's politicians took heed of New Hampshire's motto:

Live Free or Die

Few of us think that uncontrolled illegal immigration is good for our country but our freedom must take priority. The ends do not justify the means.

Arizona and the American Gestapo

Immigration and border control, however mismanaged, are the responsibility of the Federal Government.

Notwithstanding that, Arizona Governor Jan Brewer (R) last week signed a bill passed by the Republican controlled State Legislature. Arizona law now requires police to question people about their immigration status if they have reasonable suspicion - not probable cause - to believe they they might be in the USA illegally. The crime, if they are here illegally, is criminal trespass in Arizona.

Needless to say the law is aimed at persons of Hispanic origin but, undoubtedly, to demonstrate that they are not engaged in racial profiling, police will find it prudent to pull over a reasonable number of blue eyed white people. That process already takes place at airports where TSA Screeners take aside eighty year old Great Grandmothers, with artificial hips and accompanied by small children, for intrusive pat downs.

"See, we're not profiling people who look like they might be from the Middle East"

Your correspondent is an immigrant - and proud of it. He is also an American citizen and proud of that but, in spite of having lived in America for over forty years, still speaks with a detectable foreign accent.

One of the freedoms of being an American is that we do not have to carry an Identity Card at all times. So, when I, an American citizen, am stopped by a member of the local Gestapo somewhere in Arizona, how do I prove that I am entitled to be here?

Why do I have to prove that I am a citizen. What happened to that quaint concept of 'innocent until proven guilty'? Where is the probably cause? To be detained by the police on the grounds of 'reasonable suspicion', particularly when the only basis is how a person looks or speaks, is hardly acceptable to a free people.

Papieren!

Jawohl, mein Herr.

Sieg Heil!

There is a resemblance to Nazi Germany that is not pleasant to contemplate.

Needless to say, as a matter of principle, your correspondent will not be going to Arizona until after this law is repealed or struck down by the courts.

Perhaps not even then.

The Financial Crisis (4)

Frank Borman was an Astronaut who commanded the Apollo 8 mission that orbited the moon in December 1968.

After his retirement in 1970, he was employed by Eastern Airlines, and subsequently served as Chairman and Chief Executive Officer from 1975 to 1986. After Eastern was sold to investor Frank Lorenzo in 1986, the airline subsequently filed for bankruptcy protection and was liquidated in 1991.

Mr. Borman knew what he was talking about when he said:

"Capitalism without bankruptcy is like Christianity without hell."

Those who are constructing new schemes to regulate Wall Street, as well those who make their livings there, would do well to remember Mr. Borman's simple insight.

Goldman Sachs and the SEC

It is not clear that the Securities and Exchange Commission (SEC) will prevail in the law suit that it recently filed against investment bank Goldman Sachs.

Certainly, if the case goes to trial, the SEC will need a lead attorney whose highest skill is to explain, in very simple terms, what Goldman Sachs actually did, why this is a civil fraud, and who was defrauded. All the while managing to prevent a majority of the jury from falling asleep within twenty minutes of arriving at the courthouse and taking their seats.

That will not be an easy task.

The twelve unfortunates, plus alternates, chosen for the Jury may be spared such an ordeal if Goldman settles. If there is a settlement, it will be because the disclosure of embarrassing and reputation destroying e-mails becomes too much for Goldman to endure. In that case the SEC will have won - but only by using blackmail rather than on the merits of the case.

Whether the SEC wins in court, or whether a settlement is reached, the SEC's actions appear to be a gross abuse of government power. There is no question that it is the job of governments to enforce the criminal laws. It is hard, however, to see the choice of a civil suit as anything other than a stratagem to avoid the requirement of criminal law that guilt be proved beyond a reasonable doubt.

If the buyers of the relevant financial instruments feel defrauded, let them sue. That they have not is highly suggestive: their reputations, too, would be on the line and their lawyers may well have reached the conclusion that the chances of winning, given their clients' stupidity and carelessness, are low.

None of the players had real assets in this game. All they did was to place very large bets on the direction that the value of certain real assets - owned by others - would take. One side wins, the other loses and the investment banker (casino operator) takes a fee for running the game.

In addition, Goldman appears to have rigged the roulette wheel (yes, it can be done), but even that was likely to have been disclosed in the prospectus. Were it not, a decent analyst should have been able to tease out the relevant information. More importantly, perhaps, no one forced the losers to place such unwise bets.

Goldman's actions appear slimy and unethical and the company undoubtedly deserves to be punished. If what they did is criminal, let criminal charges be filed: if what they did is civil fraud, let the losers sue, not the government. Otherwise, let the damage to Goldman's already tattered reputation take its own toll.

Those who lost money should have taken more care in their due diligence. Their analysis - or lack thereof - of the prospects for the American housing market, and the poor quality of mortgages supporting it, appears to have been entirely incompetent. Worse, they neglected the most basic principle of dealing with investment bankers:

READ THE FINE PRINT!

Your correspondent is unable to muster much sympathy for those who lost money as a result of their own stupidity and incompetence.

Enough said.

The Financial Crisis (3)

Up until sometime in the 1980s, Wall Street actually provided useful services to society:

• It gathered capital and provided it, in the form of debt (bonds) and equity, to new and growing businesses.
• It allowed those who had invested in the early stages of business to reap their just rewards by underwriting Initial Public Offerings.
• It gathered capital to lend to governments at all levels
• It provided advice and valuations when companies decided to engage in mergers and acquisitions.
• It facilitated the purchase of what is effectively 'price insurance' using uncomplicated and relatively easy to understand derivatives such as futures and options.
• It allowed investors to trade their holdings.

The financial sector's role was to act as an intermediary by facilitating transactions that had real economic value. For this service, they took a modest scrape - at least by modern standards - and relatively little risk. The financial sector acted as the grease that lubricated the real economy.

In the early 1980s things changed. Salomon Brothers was only the first of the major investment banks to change from being organized as a General Partnership, where the partners were liable for all of the company's obligations - without any limit, to becoming a corporation where shareholders could lose their entire investment - but no more than that. Managers, instead of owning the entire company and being liable for all its losses, now owned only a tiny part. In addition, since they could keep much of their wealth outside of the corporation, there was a safety net. The incentive to take enormous risks was irresistible because the worst that could happen was that they lost their jobs and their unexercised stock options.

Investment banks, instead of being middlemen, saw that the big money was to be made through proprietary trading - taking a position on which way the markets would move. Then they amplified the rewards (and the losses) with vast amounts of borrowed money.

The repeal of the Glass Steagall Act of 1933, which had separated deposit taking institutions (commercial banks) from investment banks, brought another major change. Investment banks, once solely conduits for capital flows, now performed that service only as a sideline while focusing on speculation for their own accounts. Commercial banks as well as Savings and Loans, neither group known for the quality of their management, joined the mob of speculators with the advantage of an explicit government guarantee in the form of deposit insurance provided by FDIC and FSLIC.

The relationship between management, shareholders and the taxpayer, became 'heads I (management) win, tails you (shareholders and taxpayers) lose'. The inevitable result was risky and dysfunctional behavior.

In an ideal world, big banks would be allowed to fail. Since, in 2008, the expected effects of major bank failures on the real economy of goods and services were so dire, the government - not unreasonably - felt that it had to intervene. The Wall Street bail out pleased few but arguably saved us from a catastrophic economic meltdown.

While your correspondent is reluctant to see another expansion of government power, a very good argument can be made that President Obama should act in the same sort of manner that President Theodore Roosevelt - a former Republican President of whom he thinks highly - did with respect to the industrial trusts. Break up the financial institutions that are too big to fail because too big to fail simply means too big.

Period.

Then provide suitable penalties for those that remain organized as corporations and certain benefits for those that are organized as General Partnerships. Couple that with a very modest limit on total compensation ($250,000 say) for those who are not Partners so free rides (heads I win, tails you lose) are no longer part of the game.

Let the senior executives put all of their net worth - and more - on the line and see whether they continue to take outrageous risks. If they do that, then there are no limits to how much they can make but, perhaps, the financial sector will return to its roots as a net contributor to society and our economy.

Natural Disasters

The recent very powerful earthquakes in Haiti, Chile and Tibet demonstrate the power of nature to disrupt human activities. Hurricanes, tsunamis and ordinary seasonal flooding take their toll as well.

A more interesting natural event is the relatively modest eruption of the Unpronounceable Name (Eyjafjallajokul) volcano in Iceland. While flooding and toxic ash falls are a local problem for Icelanders, there would have been little further impact on the world of fifty years ago.

Today, however, our societies and economies rely heavily on the widespread availability of inexpensive air freight and passenger transportation.

The eruption has spread a wind driven cloud of volcanic ash across the British Isles and Northern Europe. Since airborne volcanic ash can cause significant damage to jet engines, including in-flight shutdowns, the result is an indefinite suspension of air travel from the rest of the world as well as within Northern Europe.

The last time that the [Unpronounceable Name] volcano erupted was in 1821. Then, the eruptions continued for two years. If that happens again, the damage to the world economy will be significant - all because we have come to rely excessively on one technology - air transport - without considering the possibility of failure or having a back up solution.

The immediate personal consequences resulting from travellers trapped far from home, or being forced to cancel important trips, are significant but, in the greater scheme of things, essentially trivial. In the medium term, the economic consequences, including damage to tourism, could be severe enough to initiate the second half of a double dip recession.

Airlines, already in poor financial condition, are losing money at an ever increasing rate. Although European companies operating trains and long distance buses will benefit - at least in the short term, they are unlikely to increase capacity on a permanent basis. Companies that own large cruise ships might divert them to provide trans-Atlantic passenger service but substituting a five day voyage for an eight hour flight results in a major loss of productivity. It will also impose significant additional direct costs to travelers.

Alternative solutions, as always, are expensive and the consequences, while unknown in detail, will certainly be serious.

Mother Nature 1 Human Technology 0

Again!

Worth thinking about

Too often, modern America seems to be a society which flip flops between zero tolerance and a total unwillingness to hold people responsible for any of their actions.

This morning, at Washington National Airport, your correspondent ran across a High School Orchestra returning home to Palm Beach, Florida. The members were wearing t-shirts and on the back was written a thought that every person, who wishes to strike a proper balance in his life, should keep in a place of high visibility:

"To miss a note is insignificant, to play without passion is inexcusable."

The author was Ludwig van Beethoven.

It seems that the senior music teacher at this High School understands what life should be about: good is important, passion and enjoyment are critical. Kids who learn such a lesson are likely to turn out better than average.

For your correspondent, that encounter made for a better than average start to the day.

Head Scratcher (5)

Stephen Fincher would like to be elected to the U.S. House of Representative from Tennessee's 8th Congressional District. Mr. Fincher claims to be a Republican so he is running in that party's primary to be held on August 5th.

Mr. Fincher believes in lower taxes and smaller government which is the normal position for a Republican. His desire for smaller government, however, does not include any sacrifice on his own part: last year he received roughly $200,000 in farm subsidies. Such substantial payments hardly put him into the category of the mythical 'family farmer' so beloved of politicians competing to waste taxpayer money. Instead, Mr. Fincher ranks as just another recipient of corporate welfare, like the Wall Street firms that he supports.

The head scratcher is that Mr. Fincher can claim to be a small government Republican while simultaneously having his snout, and all four feet, planted firmly in the public trough. Better, perhaps to describe him as a right wing socialist who demands that the Federal Government stay out of his hair but becomes incensed if his subsidy check is threatened by budget cuts.

Hypocrisy 1 Taxpayers 0

Perhaps, if we are lucky, the voters will see Mr. Fincher for what he really is but even that will not stop his raid on the taxpayers' wallets.

Public Speaking

Politicians and other public figures have many regrettable characteristics. One of the worst is an excessive fondness for the sound of their own voices.

They would do well to take a lesson from the late President Franklin Delano Roosevelt:

“The key to a good speech? Three things. Be clear. Be brief. Be seated.”

Enough said.

The Financial Crisis (2)

Yesterday, the Financial Industry Inquiry Commission heard testimony from former Citibank CEO Chuck Prince and former CitiBank Director and "Executive Without Portfolio" Robert Rubin.

To describe their testimony as designed to obfuscate, rather than illuminate, would be charitable. Their attempts to claim that they did not understand the seriousness of the situation into which they had stumbled, without actually admitting incompetence - and therefore raising the question as to whether they should return a very large part of their compensation, would have been laughable were the situation not so dire.

Peggy Noonan (www.peggynoonan.com) is a former speechwriter for President Ronald Reagan who now writes a weekly column for the Wall Street Journal (www.wsj.com). Her descriptions of the roots of the financial crisis, and what honest executives should have said yesterday, are so good that they deserve to be repeated verbatim:

"Let's be real. This is what happened the past 10 years. You, for political reasons, both Republicans and Democrats, finagled the mortgage system so that people who make, like, zero dollars a year were given mortgages for $600,000 houses. You got to run around and crow about how under your watch everyone became a homeowner. You shook down the taxpayer and hoped for the best.

"Democrats did it because they thought it would make everyone Democrats: 'Look what I give you!' Republicans did it because they thought it would make everyone Republicans: 'I'm a homeowner, I've got a stake, don't raise my property taxes, get off my lawn!' And Wall Street? We went to town, baby. We bundled the mortgages and sold them to fools, or we held them, called them assets, and made believe everyone would pay their mortgage. As if we cared. We invented financial instruments so complicated no one, not even the people who sold them, understood what they were.

"You're finaglers and we're finaglers. I play for dollars, you play for votes. In our own ways we're all thieves. We would be called desperadoes if we weren't so boring, so utterly banal in our soft-jawed, full-jowled selfishness. If there were any justice, we'd be forced to duel, with the peasants of America holding our cloaks. Only we'd both make sure we missed, wouldn't we?"

About the only thing that Ms. Noonan did not address specifically is the disastrous structure of the Government Sponsored Enterprises - Fannie Mae, Freddie Mac, and too many others - that resulted in the privatization of profit and the socialization of loss. Socialism is bad enough but a government guaranteed hybrid is worse because it creates a culture of excessive risk taking based on one very simple premise: heads we (executives and shareholders) win, tails you (taxpayers) lose.

An essential part of capitalism is the freedom to fail. When for-profit companies become too large to fail, free enterprise is corrupted and capitalism, if not dying, becomes very very sick.

American Socialism (6)

In the 1930s, an intellectually honest argument could be made that the market, unassisted, would not provide electricity to rural areas within a reasonable period of time - if ever. In 1935, as part of the New Deal (see also effective economic stimulus), the Rural Electrification Administration (REA) was created to subsidize electrical service to rural and remote areas of the United States.

Similarly in 1934, the Telecommunications Act provided for subsidies, in the form of excess charges in urban areas, levied by monopoly provider AT&T, to make telephone service available in those same rural and remote areas.

Although the REA was - and still is - socialism at work, the program was initially successful and created real wealth in a manner that the market could not have done. It is also likely that near universal telephone service - at least prior the invention of the cellular phone - would never have been achieved without subsidies.

The real issue is why, seventy five years after their creation, when there are few parts of America lacking basic electricity supply or telephone service, the REA and the Universal Service Fund still exist to provide subsidized loans to commercial businesses and jobs for bureaucrats.

Perhaps America - supposedly the land of free enterprise - should take lessons from India, much of Africa, and other developing nations, where affordable, unsubsidized, cellular telephone service will soon be available almost everywhere.

The White Man's Burden

Last week, President Hamid Karzai of Afghanistan made it clear that the American presence in his country was becoming increasingly unwelcome. Iraqi Prime Minister Nuri Kamal al-Maliki's opinion does not differ by much.

Until the late 19th Century, America's wars were fought against the would be, actual, and former colonial powers (France and England) or for the acquisition (from Mexico and the Indian Nations) of sparsely populated land into which to expand. These wars were fought for the sole benefit of the United States.

The Spanish American War of 1898 was the nation's first imperial war and the first, aside from the Civil War, to include a strong altruistic motive. Following the Treaty of Paris, the United States become the temporary administrator of Cuba and acquired permanent colonial authority over well populated territories (Guam, Puerto Rico and the Philippines) ceded to it by Spain. No significant natural resources, or additional land into which to expand, were a part of the gain. Aside from the USA's acquisition of land for military bases (Guantanamo in Cuba and Subic Bay in the Philippines) the major beneficiaries of the war were the inhabitants of the countries freed from Spain.

Since then, all of America's major wars have been entered into for largely unselfish reasons. Although the United States has reaped benefits from some of these wars, the fundamental objectives were to protect the freedom of allies and trading partners as well as to reduce threats posed by hostile regimes.

The cost to the United States, after its acquisition of responsibility for the Philippines, was well described by Rudyard Kipling in a poem (Take Up the White Man's Burden) written in 1898:

Take up the White man's burden
Send forth the best ye breed
Go bind your sons to exile
To serve your captives' need;
To wait in heavy harness
On fluttered folk and wild
Your new-caught, sullen peoples,
Half devil and half child.

The entire poem http://tinyurl.com/yaf95hu should be required reading for any President, Secretary of State, Secretary of Defense or National Security Advisor who may be considering military action for any reason other than an invasion of our country.

That there may be good reasons to go to war is undeniable but the costs, particularly in the modern era, are extraordinarily high. Careful consideration of those costs against the often elusive benefits is mandatory.

While the 1st Gulf War war (1990 - 1991) seems to have met the test of reasonable benefits, your correspondent is not at all certain that the balance now favors us in either Afghanistan or Iraq. Assuming that it does not, out highest priority must be to extract ourselves from these swamps and rebuild our military capability. Only then, will we be able to make an effective response, if it is needed, to what seem like very real threats from North Korea and Iran.

Priestly Pedophilia (2)

In responding to criticism about the manner in which Bishops, Cardinals, and the Pope himself, have handled the problem of pedophile priests, the Roman Catholic Church and its defenders seem to have taken a lesson from what is said to be the CIA's unofficial motto:

Admit nothing, deny everything, make counter-accusations.

The Church might have served itself better by remembering and acting on an old cliche:

When you are in a hole, stop digging.

Enough said.

Priestly Pedophilia

There is a business and political lesson in the worldwide outrage over priestly pedophilia.

A few (we assume, and hope, that it is only a tiny minority compared to the many dedicated servants of the Church) rogue priests are a problem but one that could have been solved without major damage to the organization. It is not the crimes - heinous as they are - that are the biggest issue. Rather, it is denial, and the ensuing cover up, that causes the maximum damage to the reputation of a person or organization.

Many individuals and businesses have conspired to cover up problems and wrongdoing. President Richard Nixon was forced to resign his office after the House Judiciary Committee approved Articles of Impeachment following his attempted cover up of an accurately described 'third rate burglary' at the Watergate office building. In the corporate world, the tobacco industry destroyed its reputation by denying and covering up evidence - long known to its employees and management - of the dangers of smoking and of second hand smoke.

Notwithstanding the fact that the Roman Catholic Church has generally been a force for good - at least since the demise of such horrors as the Medici Popes and the Spanish Inquisition - it will take many years, perhaps centuries if Pope Benedict XVI does not address the issue in a direct and forthright manner, before its reputation is fully restored.

The world will hardly be a better place if the Roman Catholic Church turns inward and becomes dysfunctional because, by hiding from the truth, it manages to inflict more damage on itself than even the pedophile priests have inflicted on their victims.

Thoughts on Politics in a Very Partisan Environment

There are many difficult subjects still on the political agenda for this year.

As our politicians work through these issues, rather than taking a rigid ideological stance on the merits of government intervention - or avoidance thereof, they would do well to ponder, during the remainder of their Easter vacation, these words written in 1795 by Edmund Burke:

"… one of the finest problems in legislation, namely, to determine what the state ought to take upon itself to direct by the public wisdom, and what it ought to leave, with as little interference as possible, to individual exertion."

There are things that governments can, and should, do that markets cannot. So too, markets frequently excel where governments will fail. Then there are many situations where the proper balance between government and individual is far from clear.

To strike the correct balance is hard but failing to make the attempt is dereliction of duty. Open minds - and some of the humility expressed by Burke - if such still exist in the Congress of the United States, will raise the likelihood of success.

Your correspondent would like to be an optimist but is not planning to hold his breath!