Something happened to management culture decades ago and now being a Master of Business Administration, especially from Harvard, is rather on the nose. MBA, it's being said, can also stand for 'Mediocre but Arrogant', or 'Management by Accident'. Reporter, Stephen Crittenden.
Audio
Stephen Crittenden: As the unemployment queues grow and the bailouts continue, they're beginning to say that narcissists with Harvard MBAs killed Wall Street.
Hello from Stephen Crittenden, welcome to Background Briefing on ABC Radio National.
This week, we're taking a look at the business culture behind the financial meltdown and the kind of business education which shapes that culture.
This is a story that goes a lot further back than Lehman Brothers, or Fanny Mae and Freddy Mac, to the glory days when America's leading manufacturing companies were the envy of the world.
It's the story of how this great corporate heritage was squandered, and what this all has to do with the rise of a comparatively new social figure: the professional manager.
There's no doubt that American business has relied heavily on the Masters of Business Administration as a credential. Some say too heavily: 100,000 new MBAs pour out of American business schools each year, and more than 40% of them go into the financial services sector.
But now they're being called the Masters of Disaster. As you'll hear in this program, some of the leading critics of the MBA culture are actually business school professors who have been raising the alarm for some time.
The most prominent among them is Henry Mintzberg, Professor of Management Studies at McGill University in Montreal. He says there is no question that business schools like Harvard, Wharton, Stanford and MIT deserve a large part of the blame for creating and sustaining the business culture that caused the meltdown, because they have been promoting an utterly dysfunctional form of management practice for decades.
Henry Mintzberg: Look, my view is you cannot create a manager in a classroom, let alone a leader. You simply can't. Management is not a science, it's not a profession, it's a practice; you learn it by doing it. To claim that you're training people who are not managers to be managers, is a sham, pure and simple, it's a sham. You can't do it. You give completely the wrong impression and you send them out with an enormous amount of hubris which is, 'I can manage anything, even though I've never managed anything'.
Stephen Crittenden: In 1986, when Russell Ackoff, a pioneer of management education, retired as Professor at the Wharton Business School, he was asked what were the benefits of a business education. With savage irony he replied that there were three:
Ackoff Reading: The first was to equip students with a vocabulary that enabled them to talk with authority about subjects they did not understand. The second was to give students principles that would demonstrate their ability to withstand any amount of disconfirming evidence. The third was to give students a ticket of admission to a job where they could learn something about management.
Stephen Crittenden: Everyone we spoke to for this program was quick to point out that there are many very capable MBAs, and many good business schools offering sensible MBA courses.
But the number of failed CEOs with MBAs has not escaped notice. Stan O'Neill and John Thane at Merrill Lynch, Andy Hornby at HBOS, and the best-known of all, Enron's Jeff Skilling who's serving a 24-year jail sentence, and the former President of the United States, George W. Bush.
McGill University Professor Henry Mintzberg says what we call a financial crisis is really at its core a crisis of management, and not just a crisis of management, but a crisis of management culture.
Henry Mintzberg: It's a syndrome, it's a whole attitude. We've corrupted the whole practice of management, it's utterly, utterly corrupt from top to bottom; not everybody, but much too much of it is corrupt. It is a cultural problem. And by the way, it's largely an Anglo-Saxon problem I think. I think the worst of it is in the US, and second is the UK. I think Canada has been smarter. In England the UK for example, there's a long history not just of MBAs but of accountants running everything. In other words, what you had is a detachment of people who know the business from people who are running the business.
Stephen Crittenden: Another critic of the MBA is Harvard Business School Professor Rakesh Khurana. He says the business schools have been teaching some pretty anti-social theories which their graduates go away and put into practice.
For example, Rakesh Khurana says it was the business schools who were the source of the theory of shareholder maximisation. They originated the idea of using derivatives and credit swaps to manage risk, and the idea that managers are so fundamentally self-interested that they can't be trusted to do their jobs unless they're provided with huge stock options.
Rakesh Khurana.
Rakesh Khurana: What we taught were very simplified and not necessarily accurate models of human behaviour, that over time become self-fulfilling. And so there was this model that in fact by basically being self-interested to an extreme, that was the appropriate way to behave and act. And what that does over time, because this is not an innocent exercise, it actually over time because it is a professional school, comes to shape the identity of those individuals. That is, they begin to see themselves in those views. And one of the consequences of that is that if you look with respect to executive compensation for example, and the incentives around that, the view becomes that I actually have to be compensated to do the job I was hired for, and on top of that you have to bribe me with stock options to make sure I do that job. In no other occupation or profession is that part of the modus operandi.
Stephen Crittenden: This is also a story about how society educates its elites. Phillip Delves Broughton is a former Paris correspondent for Britain's Daily Telegraph. He recently took two years off to do an MBA at Harvard Business School - HBS - and he's just written a book about the experience. Here's the man himself, reading from his book.
Phillip Delves Broughton: A second year student rose to welcome us, and to reiterate the importance of values to our future in business. He told us that simply by getting into HBS, 'You've won'. From now on, it was all about how we decided to govern our lives. What he said would be repeated throughout my time at Harvard. Harvard Business School was a brand, as much as a school, and by attending, we were associating ourselves with one of the greatest brands in business. We were now part of an elite, and we should get used to it. I struggled with this idea. It seemed so arrogant on the part of the school, and somehow demeaning to those of us who had just arrived. Regardless of who we were when we arrived, or what we might learn or become over the next two years, simply by being accepted by HBS, we had entered an über-class. It was Harvard Business School, not anything that came before it, that conferred the 'winner' tag on all of us.
Stephen Crittenden: Some defenders of business school education say the present financial meltdown has been caused by a few greedy and dishonest people, and that the problem can be fixed with more regulation. But Phillip Delves Broughton, speaking from New York, says it wasn't just a few people. It's a problem systemic to an entire management culture.
Phillip Delves Broughton: The big problem with the MBA culture is that it creates this elite group of people who are there by dint of nothing more than this qualification, which is useful, but little more than that. To say that it qualifies anyone to really do anything is absolutely false. And I also think it's fundamentally anti-democratic. One of the weirdest things about this country is you have enormous churn and entrepreneurialism, and you have a place like Harvard Business School that essentially says 'Once you get in, you're now part of an elite, almost regardless of what you do subsequently.' and it seems so antithetical to everything else in American culture. You see it in their behaviours, this sense of entitlement, the way these people take these golden parachutes. There is a sense that these people deserve more than their fair share because of who they are because they're this magnificent elite. And I think a little humility from these people would be very much appreciated, because it's been shown they haven't done a tremendous job.
Stephen Crittenden: Given all the risky behaviour we've seen with derivatives and toxic debt, Phillip Delves Broughton says it's ironic that in his experience, Harvard Business School seems to attract people who are actually risk averse, at least in relation to themselves and their own careers. He says unlike genuine entrepreneurs, they tend to be people who want fast-track careers, and by associating themselves with the powerful Harvard brand, what they're really doing is seeking to minimize risk in their own lives when they go after future opportunities.
Phillip Delves Broughton: Well it's always a big joke, essentially. You look at the great entrepreneurs in the world, the Bill Gates's, the Rupert Murdochs, the Kerry Packers, the guys who founded Google, Larry Page and Sergey Brin, not one of them went near a business school and yet they've built fortunes with companies that really have had a big impact on the way a lot of us live. So people who tend to go to business school I think are people who are trying to set themselves up for life in a certain way, they're grabbing onto an elite structure again, but they're not the great adventurers, they're not the buccaneers, they're not the people who are going to change the economic universe.
Stephen Crittenden: What about the atmosphere in the classroom at the Harvard Business School? In your book you paint a picture of a whole lot of pumped up, not necessarily very critical people, playing corporate games and elbowing each other out of the way, and you say that your wife, Margret, came to the conclusion pretty quickly, that they were a bunch of freaks.
Phillip Delves Broughton: Well you know, I think there's two things at play here. One is, I'm British, I was a journalist for ten years. You don't get a more cynical profession than Fleet Street. And so you take that, and put that in a terribly earnest environment. It's an American environment and I'm a great fan of America, but again, it can be jarring if you come from a more Anglo-Saxon, English, Australian, whatever it is, where people aren't so accepting of corporate game-playing. You know, in England, you start a corporate game, everyone is rolling eyes, saying, 'Oh Christ, do we have to do this?' I quote a friend of mine, a Chinese woman who just got driven crazy because at Harvard Uni, you're in these classes of 90, and every class is essentially everyone putting their hands up, there are no lectures, it's all case studies. You look at a business situation then you discuss it. So an enormous premium is placed on your ability to stick your hand up in front of 90 people and make a point. So for a Chinese woman, she just said, 'Why on earth is my ability to fill air space with just blather, matter?' What matters in Chinese business is your ability to get things done. The last thing they want is these kind of chest-bumping meetings. And I think again, if you're not from the American business culture, you can look at this and just find it nonsensical. Why does it matter if you're good at meetings? Why does it matter if you have an ability to B.S? And these things seem to be prized.
more
31 March 2009
Taken for the Ride of Our Life
by Doug Wakefield and Ben Hill, Best Minds, Inc. | March 30, 2009
In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency ‘that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.
Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.
Although Mr. Zhou did not mention the US dollar, the essay gave a pointed critique of the current dollar-dominated monetary system.
‘The outbreak of the [current] crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system,’ Mr. Zhou wrote.
http://www.financialsense.com/fsu/editorials/wakefield/2009/0330.html
To replace the current system, Mr. Zhou suggested expanding the role of Special Drawing Rights, which were introduced by the IMF in 1969 to support the Bretton Woods fixed exchange rate regime but became less relevant once that collapsed in the 1970s.
Mr. Zhou said the proposal would require, ‘extraordinary political vision and courage’ and acknowledged a debt to John Maynard Keynes, who made a similar suggestion in the 1940s.”
And, perhaps this is the direction that was intended all along. If you’re unfamiliar with the idea that John Maynard Keynes proposed in the 1940s, let me take you back to that era, when the world was still reeling from another world crisis and currencies were far off the radar screen of most individuals. On page 481 of, A History of Money and Banking in the United States, Dr. Murray Rothbard notes:
“While the [US] White Plan envisioned a substantial amount of inflation to provide greater currency liquidity, the British responded with a Keynes Plan that was far more inflationary. By this time, Lord Keynes had abandoned economic and monetary nationalism for Britain under severe American pressure, and his aim was to salvage as much domestic inflation and cheap money for Britain as he could possibly induce America to accept. The Keynes Plan envisioned an International Clearing Union (ICU), which, in return for agreeing to stable exchange rates between currencies and the abandonment of exchange control, provided a huge loan to its members of $26 billion. The Keynes Plan, moreover, called for a new international monetary unit, the ‘bancor,’ which could be issued by the ICU in such large amounts as to provide almost unchecked room for inflation, even in a country with a large deficit in its balance of payments.”
And, Geithner is open to China’s suggestion. On March 26th 2009, a Chinese news source, the People’s Daily Online, noted:
“Meanwhile, Timothy Geithner, speaking at the Council on Foreign Relations in Washington on Wednesday, said that the U.S. is ‘open’ to China's proposal.”
‘I haven't read the governor's proposal. He's a very thoughtful, very careful distinguished central banker. I generally find him sensible on every issue,’ Geithner said, saying that however his interpretation of the proposal was to increase the use of International Monetary Fund's special drawing rights (SDRs) – shares in the body held by its members – while not creating a new currency in the literal sense.
‘We're actually quite open to that suggestion – you should see it as rather evolutionary rather building on the current architecture rather than moving us to global monetary union,’ he said.
‘The only thing concrete I saw was expanding the use of the (SDRs),’ Geithner said. ‘Anything he's thinking about deserves some consideration.’
The continued use of the dollar as a reserve currency, Geithner added, ‘depends on how effective we are in the United States...at getting our fiscal system back to the point where people judge it as sustainable over time.’”
Though we discuss the behind the scenes aspects of these maneuvers in more detail in the closing pages of our November 2008 issue of The Investor’s Mind, “The Power of…the Few,” we will briefly touch on SDRs in the IMF’s own words:
“The Special Drawing Right (SDR) was created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system.
After the collapse of the Bretton Woods system in 1973, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar. The U.S. dollar-value of the SDR is posted daily on the IMF's website.”
As we read the IMF’s website further, we learn that the IMF has been trying to expand the amount of SDRs in circulation for years. The only thing the IMF needs to do so is a “yes” vote from the US on an IMF amendment. In the same issue of The Investor’s Mind, we quote George Soros’ October 28th 2008 article in the Financial Times, where Soros states, “The financial crisis is spinning out of control. It is time to start thinking about creating special drawing rights or some other form of international reserves on a large scale, but that is subject to American veto.”
On April 2nd 2009, the G20 will meet in London to discuss the largest expansion of lending powers of the IMF in world history. Both Japan and the United States have indicated that they will loan the IMF up to $100 billion, while the EU has stated that they will loan the IMF €75 billion.
While the UK has not agreed to an amount to loan to the IMF, as of this release, their financial stress indicates that they are having severe problems of their own right now. On March 25th 2009, a Bloomberg article titled, UK Bond Auction Fails for the First Time since 2002, reports:
“The UK failed to find enough buyers for 1.75 billion pounds ($US 2.55 billion) of bonds for the first time in almost seven years as debt investors repudiated Prime Minister Gordon Brown’s plan to stem the worst economic crisis in three decades.”
While most individuals refuse to believe that we have arrived at this juncture, any good contrarian looks to history to get their bearings. An expansion of a central currency will shift power away from independent countries and towards the global powers that be. And though, in light of the US’s profligacy, this may sound like a good idea to many, there is ample evidence to suggest that we were led to this point for a reason. Joan Veon, founder of the Women’s International Media Group, shows us that the “Public-Private Partnership” has been around since at least 1996 and talks about the history of such arrangements.
“I first heard the term Public-Private Partnership (PPP) when I attended the June 1996 United Nations Habitat II conference in Istanbul Turkey. The first time I read the conference’s Programme of Action, I missed it completely. After I returned from Istanbul, I went back over the document and was shocked at its prominence. I spent six months trying to figure out what it was and I even conducted several interviews with people at the U.N. and other agencies.
A Public-Private Partnership is exactly what it says it is. First, it is a partnership that is business arrangement, and it is for profit…Historically, such deals were considered glaring conflicts of interest, and as such, not in the best interest of the people…When you marry government and business, all existing rules of law and government change as the checks and balances of our Constitution no longer pertain…The door is open for anything – politically, socially, and economically. Plunder is tyranny.” (The United Nations Global Straightjacket (1999) Joan Veon, pp83-86)
So if you have recently been swept into euphoria of this explosive rally of the last few weeks, and haven’t spent a great deal of time studying the history of money and politics, now is the time to start asking a great many skeptical questions. History suggests that the second quarter of 2009 could be among the most important periods in financial history.
In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency ‘that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.
Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.
Although Mr. Zhou did not mention the US dollar, the essay gave a pointed critique of the current dollar-dominated monetary system.
‘The outbreak of the [current] crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system,’ Mr. Zhou wrote.
http://www.financialsense.com/fsu/editorials/wakefield/2009/0330.html
To replace the current system, Mr. Zhou suggested expanding the role of Special Drawing Rights, which were introduced by the IMF in 1969 to support the Bretton Woods fixed exchange rate regime but became less relevant once that collapsed in the 1970s.
Mr. Zhou said the proposal would require, ‘extraordinary political vision and courage’ and acknowledged a debt to John Maynard Keynes, who made a similar suggestion in the 1940s.”
And, perhaps this is the direction that was intended all along. If you’re unfamiliar with the idea that John Maynard Keynes proposed in the 1940s, let me take you back to that era, when the world was still reeling from another world crisis and currencies were far off the radar screen of most individuals. On page 481 of, A History of Money and Banking in the United States, Dr. Murray Rothbard notes:
“While the [US] White Plan envisioned a substantial amount of inflation to provide greater currency liquidity, the British responded with a Keynes Plan that was far more inflationary. By this time, Lord Keynes had abandoned economic and monetary nationalism for Britain under severe American pressure, and his aim was to salvage as much domestic inflation and cheap money for Britain as he could possibly induce America to accept. The Keynes Plan envisioned an International Clearing Union (ICU), which, in return for agreeing to stable exchange rates between currencies and the abandonment of exchange control, provided a huge loan to its members of $26 billion. The Keynes Plan, moreover, called for a new international monetary unit, the ‘bancor,’ which could be issued by the ICU in such large amounts as to provide almost unchecked room for inflation, even in a country with a large deficit in its balance of payments.”
And, Geithner is open to China’s suggestion. On March 26th 2009, a Chinese news source, the People’s Daily Online, noted:
“Meanwhile, Timothy Geithner, speaking at the Council on Foreign Relations in Washington on Wednesday, said that the U.S. is ‘open’ to China's proposal.”
‘I haven't read the governor's proposal. He's a very thoughtful, very careful distinguished central banker. I generally find him sensible on every issue,’ Geithner said, saying that however his interpretation of the proposal was to increase the use of International Monetary Fund's special drawing rights (SDRs) – shares in the body held by its members – while not creating a new currency in the literal sense.
‘We're actually quite open to that suggestion – you should see it as rather evolutionary rather building on the current architecture rather than moving us to global monetary union,’ he said.
‘The only thing concrete I saw was expanding the use of the (SDRs),’ Geithner said. ‘Anything he's thinking about deserves some consideration.’
The continued use of the dollar as a reserve currency, Geithner added, ‘depends on how effective we are in the United States...at getting our fiscal system back to the point where people judge it as sustainable over time.’”
Though we discuss the behind the scenes aspects of these maneuvers in more detail in the closing pages of our November 2008 issue of The Investor’s Mind, “The Power of…the Few,” we will briefly touch on SDRs in the IMF’s own words:
“The Special Drawing Right (SDR) was created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system.
After the collapse of the Bretton Woods system in 1973, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar. The U.S. dollar-value of the SDR is posted daily on the IMF's website.”
As we read the IMF’s website further, we learn that the IMF has been trying to expand the amount of SDRs in circulation for years. The only thing the IMF needs to do so is a “yes” vote from the US on an IMF amendment. In the same issue of The Investor’s Mind, we quote George Soros’ October 28th 2008 article in the Financial Times, where Soros states, “The financial crisis is spinning out of control. It is time to start thinking about creating special drawing rights or some other form of international reserves on a large scale, but that is subject to American veto.”
On April 2nd 2009, the G20 will meet in London to discuss the largest expansion of lending powers of the IMF in world history. Both Japan and the United States have indicated that they will loan the IMF up to $100 billion, while the EU has stated that they will loan the IMF €75 billion.
While the UK has not agreed to an amount to loan to the IMF, as of this release, their financial stress indicates that they are having severe problems of their own right now. On March 25th 2009, a Bloomberg article titled, UK Bond Auction Fails for the First Time since 2002, reports:
“The UK failed to find enough buyers for 1.75 billion pounds ($US 2.55 billion) of bonds for the first time in almost seven years as debt investors repudiated Prime Minister Gordon Brown’s plan to stem the worst economic crisis in three decades.”
While most individuals refuse to believe that we have arrived at this juncture, any good contrarian looks to history to get their bearings. An expansion of a central currency will shift power away from independent countries and towards the global powers that be. And though, in light of the US’s profligacy, this may sound like a good idea to many, there is ample evidence to suggest that we were led to this point for a reason. Joan Veon, founder of the Women’s International Media Group, shows us that the “Public-Private Partnership” has been around since at least 1996 and talks about the history of such arrangements.
“I first heard the term Public-Private Partnership (PPP) when I attended the June 1996 United Nations Habitat II conference in Istanbul Turkey. The first time I read the conference’s Programme of Action, I missed it completely. After I returned from Istanbul, I went back over the document and was shocked at its prominence. I spent six months trying to figure out what it was and I even conducted several interviews with people at the U.N. and other agencies.
A Public-Private Partnership is exactly what it says it is. First, it is a partnership that is business arrangement, and it is for profit…Historically, such deals were considered glaring conflicts of interest, and as such, not in the best interest of the people…When you marry government and business, all existing rules of law and government change as the checks and balances of our Constitution no longer pertain…The door is open for anything – politically, socially, and economically. Plunder is tyranny.” (The United Nations Global Straightjacket (1999) Joan Veon, pp83-86)
So if you have recently been swept into euphoria of this explosive rally of the last few weeks, and haven’t spent a great deal of time studying the history of money and politics, now is the time to start asking a great many skeptical questions. History suggests that the second quarter of 2009 could be among the most important periods in financial history.
Break the oligarchy ~ Brimlow on the takeover
NEW YORK (MarketWatch) -- Out of the mouths of ...? Two very fashionable non-financial magazines have just published powerful analyses of the current financial crisis. The implications are grim.
Although radically different in tone, both articles ( "The Big Takeover," by Matt Taibbi in the April 2 Rolling Stone, and "The Quiet Coup" by Simon Johnson in the May issue of Atlantic) reach remarkably similar conclusions.
As Taibbi puts it in his brilliant but unquotable-in-MarketWatch Gen X style: "People are [expletive deleted] about this financial crisis, and about this bailout, but they're not [expletive deleted] enough. The reality is that the worldwide economic meltdown and the bailout that followed were together a kind of revolution, a coup d'état. They cemented and formalized a political trend that has been snowballing for decades: the gradual takeover of the government by a small class of connected insiders, who used money to control elections, buy influence and systematically weaken financial regulations. The crisis was the coup de grâce: Given virtually free rein over the economy, these same insiders first wrecked the financial world, then cunningly granted themselves nearly unlimited emergency powers to clean up their own mess."
Paranoia? Taibbi supplies devastating detail about the way the subprime mortgage crisis metastasized through American International Group Inc.'s (AIG
) promiscuous use of "credit default swaps," the central role of Goldman
Sachs Group Inc. (GS
) , and the opaque nature of the consequent bailouts.
He quotes an unnamed Congressman: "I think basically if you knew [Bush Treasury Secretary] Hank Paulson, you got the money."
Still antsy? Well, the Atlantic magazine's Johnson is a professor at the Massachusetts Institute of Technology, former chief economist at the International Monetary Fund -- and a British immigrant! How much more respectable can you get?
Yet, comparing the U.S. crisis to previous developing-world crises, Johnson says: "The advice from the IMF on this front would again be simple: Break the oligarchy."
Both Taibbi and Johnson are obviously writing for liberal readers. Yet both make it clear that the catastrophe is bipartisan. What perhaps was the pivotal moment -- Commodity Futures Trading Commission Chair Brooksley Born's attempt to regulate credit default swaps -- was frustrated by Fed-head Alan Greenspan, SEC Chairman Arthur Levitt and Treasury officials Robert Rubin and Lawrence Summers in 1998, during the Clinton administration.
Of recent policy, Johnson writes in his Atlantic:
"But these various policies -- lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership -- had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector."
I'm happy to say this isn't news to MarketWatch readers. Edwin S. Rubenstein and I charted the financial sector's alarming elephantiasis last summer. ( See June 1, 2008, column.) The tacit China-US alliance was noted nearly five years ago. ( See John Brimelow's Nov. 22, 2004, commentary.)
Taibbi and Johnson imply the catastrophe is a failure of regulation.
Taibbi writes: "And all this happened at the end of eight straight years that America devoted to frantically chasing the shadow of a terrorist threat to no avail, eight years spent stopping every citizen at every airport to search every purse, bag, crotch and briefcase for juice boxes and explosive tubes of toothpaste. Yet in the end, our government had no mechanism for searching the balance sheets of companies that held life-or-death power over our society."
Obviously, regulation didn't work. But focusing on regulatory failure just means that government will find it politically safer to block all economic activity -- to make a desert and call it peace, as the historian Tacitus said of the Romans in Germany.
The deeper failure is in the metamarket -- the institutional framework without which markets can't function. For example, where were the auditors when AIG piled up $500 billion worth of CDS exposure?
Maybe derivatives were hard to track. But why didn't the auditors just qualify their opinion?
And how long has the manipulation of markets, which is now explicit policy, being going on? It was blatant in the peculiar decision to rescue Long Term Capital Management in 1998. ( See Sept. 29, 2008, column).
I repeat my call, which seems to have fallen on deaf ears, for a new Pujo Commission, which investigated the Panic of 1907. (And gave us the Federal Reserve, but that's another story.)
Although radically different in tone, both articles ( "The Big Takeover," by Matt Taibbi in the April 2 Rolling Stone, and "The Quiet Coup" by Simon Johnson in the May issue of Atlantic) reach remarkably similar conclusions.
As Taibbi puts it in his brilliant but unquotable-in-MarketWatch Gen X style: "People are [expletive deleted] about this financial crisis, and about this bailout, but they're not [expletive deleted] enough. The reality is that the worldwide economic meltdown and the bailout that followed were together a kind of revolution, a coup d'état. They cemented and formalized a political trend that has been snowballing for decades: the gradual takeover of the government by a small class of connected insiders, who used money to control elections, buy influence and systematically weaken financial regulations. The crisis was the coup de grâce: Given virtually free rein over the economy, these same insiders first wrecked the financial world, then cunningly granted themselves nearly unlimited emergency powers to clean up their own mess."
Paranoia? Taibbi supplies devastating detail about the way the subprime mortgage crisis metastasized through American International Group Inc.'s (AIG
) promiscuous use of "credit default swaps," the central role of Goldman
Sachs Group Inc. (GS
) , and the opaque nature of the consequent bailouts.
He quotes an unnamed Congressman: "I think basically if you knew [Bush Treasury Secretary] Hank Paulson, you got the money."
Still antsy? Well, the Atlantic magazine's Johnson is a professor at the Massachusetts Institute of Technology, former chief economist at the International Monetary Fund -- and a British immigrant! How much more respectable can you get?
Yet, comparing the U.S. crisis to previous developing-world crises, Johnson says: "The advice from the IMF on this front would again be simple: Break the oligarchy."
Both Taibbi and Johnson are obviously writing for liberal readers. Yet both make it clear that the catastrophe is bipartisan. What perhaps was the pivotal moment -- Commodity Futures Trading Commission Chair Brooksley Born's attempt to regulate credit default swaps -- was frustrated by Fed-head Alan Greenspan, SEC Chairman Arthur Levitt and Treasury officials Robert Rubin and Lawrence Summers in 1998, during the Clinton administration.
Of recent policy, Johnson writes in his Atlantic:
"But these various policies -- lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership -- had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector."
I'm happy to say this isn't news to MarketWatch readers. Edwin S. Rubenstein and I charted the financial sector's alarming elephantiasis last summer. ( See June 1, 2008, column.) The tacit China-US alliance was noted nearly five years ago. ( See John Brimelow's Nov. 22, 2004, commentary.)
Taibbi and Johnson imply the catastrophe is a failure of regulation.
Taibbi writes: "And all this happened at the end of eight straight years that America devoted to frantically chasing the shadow of a terrorist threat to no avail, eight years spent stopping every citizen at every airport to search every purse, bag, crotch and briefcase for juice boxes and explosive tubes of toothpaste. Yet in the end, our government had no mechanism for searching the balance sheets of companies that held life-or-death power over our society."
Obviously, regulation didn't work. But focusing on regulatory failure just means that government will find it politically safer to block all economic activity -- to make a desert and call it peace, as the historian Tacitus said of the Romans in Germany.
The deeper failure is in the metamarket -- the institutional framework without which markets can't function. For example, where were the auditors when AIG piled up $500 billion worth of CDS exposure?
Maybe derivatives were hard to track. But why didn't the auditors just qualify their opinion?
And how long has the manipulation of markets, which is now explicit policy, being going on? It was blatant in the peculiar decision to rescue Long Term Capital Management in 1998. ( See Sept. 29, 2008, column).
I repeat my call, which seems to have fallen on deaf ears, for a new Pujo Commission, which investigated the Panic of 1907. (And gave us the Federal Reserve, but that's another story.)
30 March 2009
Russia Supports Gold as Part of IMF SDR
MOSCOW, March 28 (Reuters) - Russia supports expanding the IMF's Special Drawing Rights (SDR) to include the rouble, the yuan and gold, but sees no chance of the G20 Summit accepting a new reserve currency, a Kremlin aide said on Saturday, agencies reported.
"It would be logical for the set of currencies (that make up the SDR) to be expanded, and it could include other currencies, including the rouble, the yuan and perhaps others," state RIA news agency reported the Kremlin's senior economic aide Arkady Dvorkovich as saying.
China this week caused a stir ahead of the April 2 Group of 20 meeting of rich and emerging economies when it suggested the world move towards greater use of the International Monetary Fund's Special Drawing Rights, created by the IMF in 1969 as an international reserve asset.
G20 leaders have made clear that for now the dollar's status as the dominant reserve unit remains, but the idea of creating a new reserve currency system based on SDRs has not entirely been knocked down.
Dvorkovich said he sees no chance of the G20 accepting a new reserve currency next month, but his comments suggest the issue will be in the spotlight at the meeting, where world leaders will discuss ways to combat the global economic crisis.
"We could also think about more effective use of gold and gold and forex reserves in this system," Dvorkovich said, RIA reported. For its part, he added, Russia would support the broad use of the rouble and the yuan as reserve currencies, Itar-Tass reported. (Reporting by Simon Shuster; editing by Sue Thomas)
http://www.reuters.com/article/marketsNews/idAFLS37648120090328?rpc=44
"It would be logical for the set of currencies (that make up the SDR) to be expanded, and it could include other currencies, including the rouble, the yuan and perhaps others," state RIA news agency reported the Kremlin's senior economic aide Arkady Dvorkovich as saying.
China this week caused a stir ahead of the April 2 Group of 20 meeting of rich and emerging economies when it suggested the world move towards greater use of the International Monetary Fund's Special Drawing Rights, created by the IMF in 1969 as an international reserve asset.
G20 leaders have made clear that for now the dollar's status as the dominant reserve unit remains, but the idea of creating a new reserve currency system based on SDRs has not entirely been knocked down.
Dvorkovich said he sees no chance of the G20 accepting a new reserve currency next month, but his comments suggest the issue will be in the spotlight at the meeting, where world leaders will discuss ways to combat the global economic crisis.
"We could also think about more effective use of gold and gold and forex reserves in this system," Dvorkovich said, RIA reported. For its part, he added, Russia would support the broad use of the rouble and the yuan as reserve currencies, Itar-Tass reported. (Reporting by Simon Shuster; editing by Sue Thomas)
http://www.reuters.com/article/marketsNews/idAFLS37648120090328?rpc=44
29 March 2009
Who's at risk for social and political unrest?
If things feel bad now, how much worse could they get?
In line with our previous risk reports (Heading for the Rocks and Shooting the Rapids), we have identified three macroeconomic scenarios for the evolution of the crisis that began in the US sub-prime mortgage market and is now reverberating throughout the world economy.
Scenario 1: Our central forecast (60% probability)
Government stimulus stabilises the global financial system and restores economic growth in leading developed markets during 2010, albeit at lower levels than in recent years. This scenario underpins our regular analysis and is not the subject of this report.
Scenario 2: The main risk scenario (30% probability)
Stimulus fails, leading to continued asset price deflation and sustained contraction in the leading economies—a depression persisting for some years. The stubborn decline in global economic activity is punctuated by occasional rallies that are taken as signs of recovery, but these quickly fade as the underlying downward trend reasserts itself. The prominent role of governments in propping up banks and reviving domestic demand leads to strong political pressure for protectionism, effectively putting the process of globalisation into reverse.
Scenario 3: The alternative risk scenario (10% probability)
Failing confidence in the dollar leads to its collapse, and the search for alternative safe-havens proves fruitless.
Economic upheaval sharply raises the risk of social unrest and violent protest. A Political Instability Index covering 165 countries, developed for this report, highlights the countries particularly vulnerable to political instability as a result of economic distress. The results of the index are displayed in map form and in a ranking table in the centre pages, along with a brief methodology.
The political implications of the economic downturn, informed by the results of the Social and Political Unrest Index, are discussed at length in the second half of the report.
The full report, in both PDF and HTML format, is available online at www.eiu.com/special. The microsite includes a full methodology for the Political Instability Index, a complete ranking of results including a comparison with the results for 2007, and a large-format version of the map.
full report
In line with our previous risk reports (Heading for the Rocks and Shooting the Rapids), we have identified three macroeconomic scenarios for the evolution of the crisis that began in the US sub-prime mortgage market and is now reverberating throughout the world economy.
Scenario 1: Our central forecast (60% probability)
Government stimulus stabilises the global financial system and restores economic growth in leading developed markets during 2010, albeit at lower levels than in recent years. This scenario underpins our regular analysis and is not the subject of this report.
Scenario 2: The main risk scenario (30% probability)
Stimulus fails, leading to continued asset price deflation and sustained contraction in the leading economies—a depression persisting for some years. The stubborn decline in global economic activity is punctuated by occasional rallies that are taken as signs of recovery, but these quickly fade as the underlying downward trend reasserts itself. The prominent role of governments in propping up banks and reviving domestic demand leads to strong political pressure for protectionism, effectively putting the process of globalisation into reverse.
Scenario 3: The alternative risk scenario (10% probability)
Failing confidence in the dollar leads to its collapse, and the search for alternative safe-havens proves fruitless.
Economic upheaval sharply raises the risk of social unrest and violent protest. A Political Instability Index covering 165 countries, developed for this report, highlights the countries particularly vulnerable to political instability as a result of economic distress. The results of the index are displayed in map form and in a ranking table in the centre pages, along with a brief methodology.
The political implications of the economic downturn, informed by the results of the Social and Political Unrest Index, are discussed at length in the second half of the report.
The full report, in both PDF and HTML format, is available online at www.eiu.com/special. The microsite includes a full methodology for the Political Instability Index, a complete ranking of results including a comparison with the results for 2007, and a large-format version of the map.
full report
G20 'make or break', Soros says
Billionaire investor Gorge Soros has said the G20 summit will be a "make or break" event for the world's economy.
In a BBC interview, Mr Soros said the international financial system had collapsed because it was flawed and it had to be restructured.
Mr Soros say it may be the last chance to prevent a full-scale depression.
He said the G20 meeting had to come up with concrete solutions to help the developing world in particular, which had been been worst hit.
'Depression'
Mr Soros warned that any attempt to pull economies out of recession had to be done co-operatively.
He said: "The G20 meeting is make or break because unless they do something for developing world there will be serious collapse in that part of the world.
"I'm using phrase depression because unless we take the right measures we're liable to end up there.
If countries start doing it [engineering a new financial world order] bilaterally instead of multilaterally, the system will fall apart and we'll end up in depression."
He also said the rebuilding meant the previous economic system had to be scrapped.
The International financial system has collapsed and cannot be restored in its current form
George Soros
"I don't think we'll ever be back to where we came from. It should be recognised that the last 25 years were an aberration and we cannot go back there. We have to reconstruct the financial system from its foundations up."
Mr Soros said regulators and the financial sector shared the blame for the meltdown, as they "participated in this crazy boom built on false premises on the belief that markets are self-regulating and should be left alone".
Mr Soros also warned the UK economy was in a deep recession "which is going to be a lasting one".
He added: "The International financial system has collapsed and cannot be restored in its current form. It will have to be restructured because it was flawed and collapsed under its own weight."
In May last year, Mr Soros was interviewed by the BBC's business editor Robert Peston and said he was worried about the US and UK's ability to deal with the downturn because of their reliance on credit.
Mr Soros urged wealthy nations to give their allocations of the IMF's internal currency, called Special Drawing Rights, to poorer ones because developing countries were not in a position to bail out their own failing banks.
George Soros famously made his name - and $1bn - when he bet that sterling would have to withdraw from the European Exchange Rate Mechanism in 1992. He's also said to have accurately predicted and profited from the Asian financial crisis in 1997.
The 78-year-old Hungarian is one of the largest aid donors in Africa, having donated around $6bn to his favourite causes.
http://news.bbc.co.uk/2/hi/business/7970199.stm
In a BBC interview, Mr Soros said the international financial system had collapsed because it was flawed and it had to be restructured.
Mr Soros say it may be the last chance to prevent a full-scale depression.
He said the G20 meeting had to come up with concrete solutions to help the developing world in particular, which had been been worst hit.
'Depression'
Mr Soros warned that any attempt to pull economies out of recession had to be done co-operatively.
He said: "The G20 meeting is make or break because unless they do something for developing world there will be serious collapse in that part of the world.
"I'm using phrase depression because unless we take the right measures we're liable to end up there.
If countries start doing it [engineering a new financial world order] bilaterally instead of multilaterally, the system will fall apart and we'll end up in depression."
He also said the rebuilding meant the previous economic system had to be scrapped.
The International financial system has collapsed and cannot be restored in its current form
George Soros
"I don't think we'll ever be back to where we came from. It should be recognised that the last 25 years were an aberration and we cannot go back there. We have to reconstruct the financial system from its foundations up."
Mr Soros said regulators and the financial sector shared the blame for the meltdown, as they "participated in this crazy boom built on false premises on the belief that markets are self-regulating and should be left alone".
Mr Soros also warned the UK economy was in a deep recession "which is going to be a lasting one".
He added: "The International financial system has collapsed and cannot be restored in its current form. It will have to be restructured because it was flawed and collapsed under its own weight."
In May last year, Mr Soros was interviewed by the BBC's business editor Robert Peston and said he was worried about the US and UK's ability to deal with the downturn because of their reliance on credit.
Mr Soros urged wealthy nations to give their allocations of the IMF's internal currency, called Special Drawing Rights, to poorer ones because developing countries were not in a position to bail out their own failing banks.
George Soros famously made his name - and $1bn - when he bet that sterling would have to withdraw from the European Exchange Rate Mechanism in 1992. He's also said to have accurately predicted and profited from the Asian financial crisis in 1997.
The 78-year-old Hungarian is one of the largest aid donors in Africa, having donated around $6bn to his favourite causes.
http://news.bbc.co.uk/2/hi/business/7970199.stm
Wage Deflation Sets In ~ Mish
Wage deflation is setting in. Let's look at some anecdotal evidence.
The Times Plans Temporary Pay Cuts
March 26, 2009
Facing a steep drop in revenue, The New York Times Company plans to cut the pay of most employees by 5 percent for nine months, in return for 10 days’ leave, and will lay off 100 people and make other budget cuts, executives said on Thursday.
The company will make the pay cuts unilaterally for most nonunion employees, including top executives, in its corporate division, at the flagship Times newspaper and at The Boston Globe. The reductions will be in effect from April through December.
At The Times newspaper, the company will ask the Guild, which represents most newsroom employees, to accept the 5 percent cut and 10 days off voluntarily, and avoid possible layoffs. It is not clear how the moves will affect unionized employees at The Globe.
McClatchy to cut 1,600 jobs, lower salaries
March 9, 2009
Struggling newspaper publisher McClatchy, parent company of Charlotte's Observer, said Monday that it would cut 1,600 jobs and lower salaries across the company.
McClatchy (MNI), based in Sacramento, Calif., said the job cuts amount to about 15 percent of its work force. The company plans to begin laying off workers and restructuring operations by the end of the first quarter. The reductions will result from a combination of layoffs, attrition and outsourcing, the company said.
McClatchy said that its salary reductions would include a 15 percent cut in Pruitt’s base salary. In addition, other executive salaries will be hit with a 10 percent reduction, while board members will see a 13 percent decline in cash compensation, including retainers and meeting fees. Also, McClatchy will pay no bonuses to executive officers this year.
Gannett puts 15% pay cut on the table
March 12, 2009
The Indianapolis News Guild is sad to inform you that Gannett is now seeking to cut the pay of newsroom and building services employees by 15 percent. The lawyer for the company provided us with a one-page “supplemental” proposal this afternoon that he said would implement this uniform salary reduction either 1) at the time we reach a new contract with the company, or 2) at the time both sides reach an impasse and cease talks.
This was a disappointing move, given that we thought the company’s bargaining team was starting to embrace the concept of negotiating instead of dictating. In fact, we believe the company’s actions at the table today raise the specter of regressive and bad-faith bargaining.
Microsoft temps face 10 percent pay cut
February 26, 2009
The thousands of contractors who work at Microsoft through third-party agencies are facing pay cuts beginning Monday, as Microsoft continues to look for ways to cut costs.
Microsoft and its contracting agencies agreed to a 10 percent cut in the bill rate, impacting all temporary worker assignments. Several contract employees have said the reduction is being passed on to them in the form of a pay cut. One person said some agencies are seeking to pass deeper pay cuts onto their workers. Several contractors contacted The Seattle Times, asking for anonymity for fear that speaking out would jeopardize their jobs.
The 10 percent cut is for existing contracts. New contracts will have a 15 percent reduction in the rate.
The Oregonian Newspaper Takes Cost Cutting Measures
March 23, 2009
The Rocky Mountain Paper closed recently after 150 years in print. The Seattle Post Intelligencer can only be found on-line now. And Portland’s Willamette Week has instituted an 8 percent pay cut.
So the staff at The Oregonian knew cuts were coming.
Nobody from the Oregonian's management responded to a request for an interview. But in a letter to employees Publisher Fred Stickel said that the Oregonian lost “several million dollars” last year -- and doesn’t have enough income to cover expenses this year. Stickel says quote:
"The economic crisis has dramatically worsened the precarious financial situation facing the media industry, our Company, and many of our advertising customers."
To fix the problem he announced a 15 percent pay cut for himself and other top staff, and a five or 10 percent cut for other employees. Some part-time workers are also being laid-off, while other staff will be required to take four furlough days over the next few months.
'Spokesman-Review' to Freeze Wages, Seek Salary Cut
February 18, 2009
SPOKANE, Wash. The Spokesman-Review newspaper will freeze wages in 2009, and seek a 5 percent salary cut for all managers, non-union employees who earn more than $11 an hour, and, with their voluntary consent, all union employees.
Morris Communications to reduce worker wages
Wednesday, March 18, 2009
Morris Communications Co. announced today it will reduce employee wages by 5 to 10 percent effective April 1. The reductions will affect hourly and salaried employees.
Mr. Morris said the pay cuts are designed to preserve jobs in a difficult economic environment.
"The newspaper business is facing unprecedented challenges," Mr. Morris said in a news release. "Just yesterday, after 126 continuous years of publishing, the Seattle Post-Intelligencer printed its last edition. Other newspapers have sought protection from creditors in bankruptcy court, severely cut back on their publishing schedules or abandoned the business entirely.
ADN announces staff, pay cuts
March 19th, 2009
The Daily News will cut its work force and reduce wages as part of a major nationwide effort by its owner, the McClatchy Co., to cut $110 million in expenses to offset declining advertising revenue, Patrick Doyle, the newspaper's publisher, told employees in a letter Thursday.
This will be the third round of staff reductions at the newspaper in 10 months and is symptomatic of an industry-wide crisis threatening to sink newspapers across the country.
Staffing at the Daily News will drop by 45 people, or about 17 percent, through a combination of buyouts, layoffs and the elimination of vacant positions, Doyle said. Seven of the jobs eliminated were the result of new, more efficient production equipment.
The cuts will affect every department, from circulation to advertising, production and news.
The paper will also impose pay cuts ranging from 2.5 percent for lower-paid employees to 10 percent for the highest paid, Doyle said. Those making less than $25,000 a year will not see a reduction.
Koreans Take Pay Cuts to Stop Layoffs
March 3, 2009
Shinchang Electrics Co. offered union leaders a proposal that would reduce wages at the auto-parts company by 20% in exchange for no layoffs among its 810 workers this year. Eight days later, the union agreed.
The deal is one sign of the unusual way South Korea is grappling with the global economic crisis. Across the country, executives, salaried employees and hourly workers at companies from banks to shipbuilders are joining to slash wages and other costs with the goal of avoiding layoffs.
Singapore Press Reduces Pay, Halts Hiring Amid Slump
March 12 (Bloomberg) -- Singapore Press Holdings Ltd., the city-state’s largest newspaper publisher, will cut wages and bonuses of 3,000 employees and freeze hiring to reduce costs amid the island’s deepest recession.
The lower salaries will result in a 20 percent drop in the overall wage bill, the company said today in a statement to the Singapore exchange, without giving a figure for savings. Hiring has been halted and profit-related bonuses will drop, it said.
Singapore’s government has said the economy may contract as much as 10 percent this year, prompting companies to fire staff, cut pay and conserve cash. Singapore Airlines Ltd. has offered more than 14,000 workers the option of as much as two years of unpaid leave, the Straits Times reported on March 11.
“We need to bring our costs down in the face of a weaker advertising market and uncertain business environment,” SPH Chief Executive Officer Alan Chan said in the statement, which was released after the close of trade. “It is imperative that we prepare for a longer-than-expected downturn.”
HP to cut staff wages by 5% as print revenue drops
23 February 2009
HP has said it is to slash most of its employees' wages by 5% in a bid to combat declining revenues and reportedly save around 20,000 positions worldwide.
The cuts come as revenue within HP's Imaging and Printing Group dropped 19% to $6.0bn (£4.19bn) in the first quarter to 31 January 2009.
Supplies revenue in the group was down 7%, and commercial hardware revenue and consumer hardware revenue dropped 34% and 37%, respectively.
The manufacturer recorded a 33% dip in printer unit shipments and commercial printer hardware units were down 39%. Operating profit for the group was $1.1bn – equivalent to 18.5% of revenue.
Con-Way to cut employees' base wages by 5%
March 9, 2009
Con-way Inc. (CNW) said late Monday that it will cut base wages and salaries of executives and employees of Con-way Freight and Con-way Inc. by 5% and suspend certain 401(k) contributions in an effort to further reduce costs. The trucking company will also reduce the salaries of Chief Executive Douglas Stotlar and certain members of the senior leadership team by 10%. The measures, which are scheduled to be completed early in the second quarter, are expected to save the company between $100 million to $130 million in 2009. Con-Way had already cut 2,500 positions, suspended bonuses and reduced capital expenditure during the fourth quarter.
Sacramento Bee Staffers Approve Pay Cuts
March 6, 2009
Newspaper Guild members at The Sacramento Bee agreed Friday to take pay cuts of up to 6 percent to save jobs at the 152-year-old paper.
Members voted 65 percent to 35 percent to accept the deal, said Ed Fletcher, a reporter who heads the Guild's local at the Bee.
Even with the pay cuts, Bee managers plan to cut 34 of the 268 Guild-covered positions in the editorial and advertising departments. Another 19 jobs would have been in jeopardy if the union had rejected the pay cuts.
IBM Cuts Jobs as It Seeks Stimulus Money
March 25, 2009
Reports of deep job cuts at International Business Machines (IBM) come at a potentially delicate time for the company—just as it is hoping to secure money from the federal stimulus package. The company will lay off as many as 5,000 U.S. workers in its Global Business Services unit, transferring some of the work they performed to India, according to media reports.
Any job transfers IBM may make to India would occur at a sensitive time, as the recession deepens and as the U.S. unemployment rate climbs. Moreover, the company would be cutting high-skill positions domestically as it and others jockey for new business from the $787 billion stimulus package Congress enacted in February—primarily to help create U.S. jobs.
Currently, 29% of IBM's workforce is in the U.S., down from 35% in 2006. The fact that IBM has built up large workforces in such low-cost countries as India allows it to shift work abroad more easily, says Ron Hira, assistant professor of public policy at the Rochester Institute of Technology. He says the current economic climate allows IBM to position itself as one of many firms squeezed by the recession and forced into layoffs. IBM "can now blame the layoffs on the economy, masking the reality that it is offshoring high-wage, high-tech jobs to low-cost countries," says Hira.
But while offshoring has been on the rise for decades, the economics of the recession are creating a new political climate that makes such moves more controversial. That's because, as IBM and others continue global restructuring, they're working to secure pieces of the $787 billion stimulus measure enacted in February.
IBM is seeking a share of the $8 billion the U.S. plans to spend on high-speed rail and part of the $20 billion in the stimulus plan to digitize the U.S. health-care system. Palmisano was one of 13 executives who met with President Barack Obama in January in an appearance aimed at pressuring the House of Representatives to pass the economic stimulus bill. He joined the CEOs of Xerox (XRX), Motorola (MOT), and Google (GOOG).
Wage Deflation Tally
9 Publishers
IBM
Hewlett-Packard
Microsoft
Con-way Freight
Shinchang Electrics
Wage deflation is setting in like wildfire in the publishing industry. Technology and trucking are affected as well. Budget cuts in California and other states are affecting teachers. Rest assured this is not inflationary news.
http://globaleconomicanalysis.blogspot.com/2009/03/wage-deflation-sets-in.html
The Times Plans Temporary Pay Cuts
March 26, 2009
Facing a steep drop in revenue, The New York Times Company plans to cut the pay of most employees by 5 percent for nine months, in return for 10 days’ leave, and will lay off 100 people and make other budget cuts, executives said on Thursday.
The company will make the pay cuts unilaterally for most nonunion employees, including top executives, in its corporate division, at the flagship Times newspaper and at The Boston Globe. The reductions will be in effect from April through December.
At The Times newspaper, the company will ask the Guild, which represents most newsroom employees, to accept the 5 percent cut and 10 days off voluntarily, and avoid possible layoffs. It is not clear how the moves will affect unionized employees at The Globe.
McClatchy to cut 1,600 jobs, lower salaries
March 9, 2009
Struggling newspaper publisher McClatchy, parent company of Charlotte's Observer, said Monday that it would cut 1,600 jobs and lower salaries across the company.
McClatchy (MNI), based in Sacramento, Calif., said the job cuts amount to about 15 percent of its work force. The company plans to begin laying off workers and restructuring operations by the end of the first quarter. The reductions will result from a combination of layoffs, attrition and outsourcing, the company said.
McClatchy said that its salary reductions would include a 15 percent cut in Pruitt’s base salary. In addition, other executive salaries will be hit with a 10 percent reduction, while board members will see a 13 percent decline in cash compensation, including retainers and meeting fees. Also, McClatchy will pay no bonuses to executive officers this year.
Gannett puts 15% pay cut on the table
March 12, 2009
The Indianapolis News Guild is sad to inform you that Gannett is now seeking to cut the pay of newsroom and building services employees by 15 percent. The lawyer for the company provided us with a one-page “supplemental” proposal this afternoon that he said would implement this uniform salary reduction either 1) at the time we reach a new contract with the company, or 2) at the time both sides reach an impasse and cease talks.
This was a disappointing move, given that we thought the company’s bargaining team was starting to embrace the concept of negotiating instead of dictating. In fact, we believe the company’s actions at the table today raise the specter of regressive and bad-faith bargaining.
Microsoft temps face 10 percent pay cut
February 26, 2009
The thousands of contractors who work at Microsoft through third-party agencies are facing pay cuts beginning Monday, as Microsoft continues to look for ways to cut costs.
Microsoft and its contracting agencies agreed to a 10 percent cut in the bill rate, impacting all temporary worker assignments. Several contract employees have said the reduction is being passed on to them in the form of a pay cut. One person said some agencies are seeking to pass deeper pay cuts onto their workers. Several contractors contacted The Seattle Times, asking for anonymity for fear that speaking out would jeopardize their jobs.
The 10 percent cut is for existing contracts. New contracts will have a 15 percent reduction in the rate.
The Oregonian Newspaper Takes Cost Cutting Measures
March 23, 2009
The Rocky Mountain Paper closed recently after 150 years in print. The Seattle Post Intelligencer can only be found on-line now. And Portland’s Willamette Week has instituted an 8 percent pay cut.
So the staff at The Oregonian knew cuts were coming.
Nobody from the Oregonian's management responded to a request for an interview. But in a letter to employees Publisher Fred Stickel said that the Oregonian lost “several million dollars” last year -- and doesn’t have enough income to cover expenses this year. Stickel says quote:
"The economic crisis has dramatically worsened the precarious financial situation facing the media industry, our Company, and many of our advertising customers."
To fix the problem he announced a 15 percent pay cut for himself and other top staff, and a five or 10 percent cut for other employees. Some part-time workers are also being laid-off, while other staff will be required to take four furlough days over the next few months.
'Spokesman-Review' to Freeze Wages, Seek Salary Cut
February 18, 2009
SPOKANE, Wash. The Spokesman-Review newspaper will freeze wages in 2009, and seek a 5 percent salary cut for all managers, non-union employees who earn more than $11 an hour, and, with their voluntary consent, all union employees.
Morris Communications to reduce worker wages
Wednesday, March 18, 2009
Morris Communications Co. announced today it will reduce employee wages by 5 to 10 percent effective April 1. The reductions will affect hourly and salaried employees.
Mr. Morris said the pay cuts are designed to preserve jobs in a difficult economic environment.
"The newspaper business is facing unprecedented challenges," Mr. Morris said in a news release. "Just yesterday, after 126 continuous years of publishing, the Seattle Post-Intelligencer printed its last edition. Other newspapers have sought protection from creditors in bankruptcy court, severely cut back on their publishing schedules or abandoned the business entirely.
ADN announces staff, pay cuts
March 19th, 2009
The Daily News will cut its work force and reduce wages as part of a major nationwide effort by its owner, the McClatchy Co., to cut $110 million in expenses to offset declining advertising revenue, Patrick Doyle, the newspaper's publisher, told employees in a letter Thursday.
This will be the third round of staff reductions at the newspaper in 10 months and is symptomatic of an industry-wide crisis threatening to sink newspapers across the country.
Staffing at the Daily News will drop by 45 people, or about 17 percent, through a combination of buyouts, layoffs and the elimination of vacant positions, Doyle said. Seven of the jobs eliminated were the result of new, more efficient production equipment.
The cuts will affect every department, from circulation to advertising, production and news.
The paper will also impose pay cuts ranging from 2.5 percent for lower-paid employees to 10 percent for the highest paid, Doyle said. Those making less than $25,000 a year will not see a reduction.
Koreans Take Pay Cuts to Stop Layoffs
March 3, 2009
Shinchang Electrics Co. offered union leaders a proposal that would reduce wages at the auto-parts company by 20% in exchange for no layoffs among its 810 workers this year. Eight days later, the union agreed.
The deal is one sign of the unusual way South Korea is grappling with the global economic crisis. Across the country, executives, salaried employees and hourly workers at companies from banks to shipbuilders are joining to slash wages and other costs with the goal of avoiding layoffs.
Singapore Press Reduces Pay, Halts Hiring Amid Slump
March 12 (Bloomberg) -- Singapore Press Holdings Ltd., the city-state’s largest newspaper publisher, will cut wages and bonuses of 3,000 employees and freeze hiring to reduce costs amid the island’s deepest recession.
The lower salaries will result in a 20 percent drop in the overall wage bill, the company said today in a statement to the Singapore exchange, without giving a figure for savings. Hiring has been halted and profit-related bonuses will drop, it said.
Singapore’s government has said the economy may contract as much as 10 percent this year, prompting companies to fire staff, cut pay and conserve cash. Singapore Airlines Ltd. has offered more than 14,000 workers the option of as much as two years of unpaid leave, the Straits Times reported on March 11.
“We need to bring our costs down in the face of a weaker advertising market and uncertain business environment,” SPH Chief Executive Officer Alan Chan said in the statement, which was released after the close of trade. “It is imperative that we prepare for a longer-than-expected downturn.”
HP to cut staff wages by 5% as print revenue drops
23 February 2009
HP has said it is to slash most of its employees' wages by 5% in a bid to combat declining revenues and reportedly save around 20,000 positions worldwide.
The cuts come as revenue within HP's Imaging and Printing Group dropped 19% to $6.0bn (£4.19bn) in the first quarter to 31 January 2009.
Supplies revenue in the group was down 7%, and commercial hardware revenue and consumer hardware revenue dropped 34% and 37%, respectively.
The manufacturer recorded a 33% dip in printer unit shipments and commercial printer hardware units were down 39%. Operating profit for the group was $1.1bn – equivalent to 18.5% of revenue.
Con-Way to cut employees' base wages by 5%
March 9, 2009
Con-way Inc. (CNW) said late Monday that it will cut base wages and salaries of executives and employees of Con-way Freight and Con-way Inc. by 5% and suspend certain 401(k) contributions in an effort to further reduce costs. The trucking company will also reduce the salaries of Chief Executive Douglas Stotlar and certain members of the senior leadership team by 10%. The measures, which are scheduled to be completed early in the second quarter, are expected to save the company between $100 million to $130 million in 2009. Con-Way had already cut 2,500 positions, suspended bonuses and reduced capital expenditure during the fourth quarter.
Sacramento Bee Staffers Approve Pay Cuts
March 6, 2009
Newspaper Guild members at The Sacramento Bee agreed Friday to take pay cuts of up to 6 percent to save jobs at the 152-year-old paper.
Members voted 65 percent to 35 percent to accept the deal, said Ed Fletcher, a reporter who heads the Guild's local at the Bee.
Even with the pay cuts, Bee managers plan to cut 34 of the 268 Guild-covered positions in the editorial and advertising departments. Another 19 jobs would have been in jeopardy if the union had rejected the pay cuts.
IBM Cuts Jobs as It Seeks Stimulus Money
March 25, 2009
Reports of deep job cuts at International Business Machines (IBM) come at a potentially delicate time for the company—just as it is hoping to secure money from the federal stimulus package. The company will lay off as many as 5,000 U.S. workers in its Global Business Services unit, transferring some of the work they performed to India, according to media reports.
Any job transfers IBM may make to India would occur at a sensitive time, as the recession deepens and as the U.S. unemployment rate climbs. Moreover, the company would be cutting high-skill positions domestically as it and others jockey for new business from the $787 billion stimulus package Congress enacted in February—primarily to help create U.S. jobs.
Currently, 29% of IBM's workforce is in the U.S., down from 35% in 2006. The fact that IBM has built up large workforces in such low-cost countries as India allows it to shift work abroad more easily, says Ron Hira, assistant professor of public policy at the Rochester Institute of Technology. He says the current economic climate allows IBM to position itself as one of many firms squeezed by the recession and forced into layoffs. IBM "can now blame the layoffs on the economy, masking the reality that it is offshoring high-wage, high-tech jobs to low-cost countries," says Hira.
But while offshoring has been on the rise for decades, the economics of the recession are creating a new political climate that makes such moves more controversial. That's because, as IBM and others continue global restructuring, they're working to secure pieces of the $787 billion stimulus measure enacted in February.
IBM is seeking a share of the $8 billion the U.S. plans to spend on high-speed rail and part of the $20 billion in the stimulus plan to digitize the U.S. health-care system. Palmisano was one of 13 executives who met with President Barack Obama in January in an appearance aimed at pressuring the House of Representatives to pass the economic stimulus bill. He joined the CEOs of Xerox (XRX), Motorola (MOT), and Google (GOOG).
Wage Deflation Tally
9 Publishers
IBM
Hewlett-Packard
Microsoft
Con-way Freight
Shinchang Electrics
Wage deflation is setting in like wildfire in the publishing industry. Technology and trucking are affected as well. Budget cuts in California and other states are affecting teachers. Rest assured this is not inflationary news.
http://globaleconomicanalysis.blogspot.com/2009/03/wage-deflation-sets-in.html
28 March 2009
2009 Outlook: Commodities
2009 Outlook - Commodities
The first thing we must understand when viewing this sector is the fact that commodities and precious metals went through a 25-year SECULAR BEAR MARKET, which ended in a double bottom that was formed between 1998 and December 2001. Just in time, inventories and international shipping severely reduced the need to hold inventory. Every bit of excess capacity and stockpiles were virtually eliminated worldwide. I have created a MONTHLY chart of the continuous commodity index going back to the 1976 period to emphasize the period where anyone who tried to build a commodity business was ground to dust as every rally was false, and expansion of supply was punished in the marketplace from 1980 through 2001:
1976 1980 1984 1988 1992 1996 2000 2004 2008
Please notice how the BULL market has corrected a Fibonacci .619 of its move off the 1998-2001 lows, which implies that we have just witnessed the first wave up of a 20 to 25-year SECULAR BULL MARKET (and the first corrective wave down of the bull move), and when it turns higher and gives a buy signal, we are most probably staring at the next leg up in commodities directly ahead. The creation of commodity and energy supply is a long process, usually taking 5 to 10 years, and whatever capacity was being built up until the credit crisis began has now been shut down. So, very few new sources of commodities can be expected to emerge. Oil supplies are falling almost 10% a year; a rate faster than the rate of decline in demand.
After the relentless secular bear market and base building period, population growth and the emergence of the BRICS (Brazil, Russia, India, China), as G7 deindustrialization and new found capitalist economies based on Austrian economics, created rising incomes and middle classes in many formally impoverished regions. These societies are based on SAVINGS (as they know the government is good for nothing), producing more than you consume (as not to do so leads to personal demise), and the work ethic to provide a better future for their children. Wealth creation is alive and well in the emerging world. Once they learn to “smell the roses” of their success and consume more (as they are doing daily), these societies will become the wealthiest in the world as the wealth of the world continues to rotate from the Western developed economies to the emerging world. Any historian can tell you this long pattern of wealth rotation has been in place for centuries.
There are BILLIONS of people emerging into higher standards of living, and they live in the MOST economically competitive areas of the world. They are masters of providing “MORE FOR LESS” to their customers, and thus will be the provider of choice for income-constrained western consumers. The formerly Austrian G7 capitalist economies have evolved into quasi-socialist asset-backed economies, where wealth is an illusion of misstated inflation of assets (which we now see reverting back to the real, not nominal values.) They now live in de-industrialized shells of their former economies, incapable of producing more than they consume and creating the savings necessary for rising middle classes and capital investment, which is the seed corn of future wealth.
So the governments of the G7 have resorted to what all empires do as they reach the end of their histories: borrow and print money to support their spending since wealth creation no longer does so. Gold is at or near a new high against every FIAT currency in the world and that is no coincidence. It is a reflection of the declining purchasing power of the currencies in which it is denominated. Take a look at these charts of world currencies and gold (courtesy of Mike Hewitt and www.dollardaze.org ) since 1971, when Breton Woods II forever tore G7 currencies from gold and silver reserve backing:
Thank you, Mike. Notice there is only one currency which has not lost purchasing power and that is the oldest currency in the world: GOLD. As the MONEY printing in the G7 accelerates to underpin the governments and financial systems, you can expect commodities to REPRICE higher to reflect the lower purchasing power of whatever currency in which it is denominated, putting additional buying power in them as investors increasingly seek shelter from the printing presses.
The temporary destruction of demand for commodities has been largely PRICED into commodity prices without disturbing the longer-term bull trend, caused by supply constraints which just recently began in 2001. You can count on the debasement of the G7 currencies to accelerate as investors and G7 currency holders increasingly shun buying paper that “melts in your hand and bank accounts” in favor of? The “Indirect Exchange” (as outlined by Ludwig von Mises) into the shelter provided by tangible assets, such as commodities, precious metals and raw materials. Look no further than the Chinese to see this in action, as they have embarked on a spending spree to rid themselves of the toxic G7 currencies and exchange them for tangibles of all stripes, including commodities.
In Conclusion: The G7 governments are at war with their citizens, only the citizens are largely unaware of it. Citizens have been dumbed down and the media spins the government line to dupe the public into believing that government is for them rather than against them in this period of time. The DARWINIAN struggle to survive and grow is now a showdown between the public sectors, government elites and special interests versus the private sectors and the public at large. As the governments increasingly DESTROY the ability to create wealth in the private sector, incomes have and will continue to collapse, as will tax receipts on the endless list of taxes and fees now imposed.
As these sources of income recede, the only options will be to borrow from future generations through treasury issuance to the central banks, aka “PRINTING THE MONEY”. Since there is this little timeless truth known by non-governmental economists as “there is no such thing as a free lunch”, we are headed toward the demise of the G7 financial systems. And of course, this does not include the FREE healthcare and new energy REGULATIONS and TAXES which they are about to impose.
On another note, FASBY 157, which mandates mark-to-market accounting, has succumbed to political pressure and has been eviscerated, effectively allowing the banks to misstate their assets values to models, rather than to market prices. So expect the losses to once again be HIDDEN from view and profits to appear when marked to model, i.e., lying with numbers with government approval. The profits are ILLUSIONS, courtesy of corrupt public serpents, banksters and now the accounting OVERSIGHT board. Insolvency is not cured with the stroke of a pen, it is fixed by NEW CAPITAL!
Look no further than recent LOUD outbursts by the G7’s largest creditors such as the Chinese, Russians, Indians and Brazilians, illustrating their dismay. They should, because when the debasement occurs, it is a theft of the purchasing power they store in G7 currencies and bonds. The rallies in stock indexes are nothing more than bounces in ongoing bear markets. Here is an analogue chart of the 4 biggest bear markets in history:
This is a powerful signpost of future price action. The only thing which may keep us from going to lows at the 3000 to 4000 level in the Dow is the rapidity of the monetary debasement process. Stocks are in many ways TANGIBLE investments and will re-price HIGHER to reflect the diminishing purchasing power of the currency in which they are priced. So the faster the G7 debases their currencies, the more buoyant NOMINAL prices will be. But don’t be fooled, they are declining in real terms “purchasing power” as this chart of the S&P 500 denominated in gold illustrates:
1980 1990 2000
Notice how the rally to new highs from 2002 to late 2007 DISAPPEARS when measured in REAL MONEY. That rally was an illusion of growth provided by FIAT currency and inflation. The true picture of the value of your stocks is displayed in this chart. If you look at bonds, the picture is WORSE…
I believe the recently unveiled public/private partnerships fail because the worth of the toxic assets is ZERO (this is what investors are willing to pay if not offered loans by the government and Fed), and after last week’s debacle in congress does anyone believe they can partner with the government and trust they will honor their agreements?
There is no way to avoid the unfolding, ultimately inflationary great depression because public servants are incapable of doing what is right for their constituents, rather than what is politically beneficial. But profits and opportunities will abound for the astute and informed investor. The abuse of the ability to issue debt and print money will be abused until such time that the financial, currency and banking systems collapse and are shunned by the world publics. Learn how to make money in up and down markets using absolute return alternative investments and seek the “indirect exchange” as outlined by Ludwig von Mises. So it is once again: Hi ho, Hi ho, off to the printing press they go; selling treasuries to create the money and sending you and your children the obligation to pay for it.
Charts and full article
The first thing we must understand when viewing this sector is the fact that commodities and precious metals went through a 25-year SECULAR BEAR MARKET, which ended in a double bottom that was formed between 1998 and December 2001. Just in time, inventories and international shipping severely reduced the need to hold inventory. Every bit of excess capacity and stockpiles were virtually eliminated worldwide. I have created a MONTHLY chart of the continuous commodity index going back to the 1976 period to emphasize the period where anyone who tried to build a commodity business was ground to dust as every rally was false, and expansion of supply was punished in the marketplace from 1980 through 2001:
1976 1980 1984 1988 1992 1996 2000 2004 2008
Please notice how the BULL market has corrected a Fibonacci .619 of its move off the 1998-2001 lows, which implies that we have just witnessed the first wave up of a 20 to 25-year SECULAR BULL MARKET (and the first corrective wave down of the bull move), and when it turns higher and gives a buy signal, we are most probably staring at the next leg up in commodities directly ahead. The creation of commodity and energy supply is a long process, usually taking 5 to 10 years, and whatever capacity was being built up until the credit crisis began has now been shut down. So, very few new sources of commodities can be expected to emerge. Oil supplies are falling almost 10% a year; a rate faster than the rate of decline in demand.
After the relentless secular bear market and base building period, population growth and the emergence of the BRICS (Brazil, Russia, India, China), as G7 deindustrialization and new found capitalist economies based on Austrian economics, created rising incomes and middle classes in many formally impoverished regions. These societies are based on SAVINGS (as they know the government is good for nothing), producing more than you consume (as not to do so leads to personal demise), and the work ethic to provide a better future for their children. Wealth creation is alive and well in the emerging world. Once they learn to “smell the roses” of their success and consume more (as they are doing daily), these societies will become the wealthiest in the world as the wealth of the world continues to rotate from the Western developed economies to the emerging world. Any historian can tell you this long pattern of wealth rotation has been in place for centuries.
There are BILLIONS of people emerging into higher standards of living, and they live in the MOST economically competitive areas of the world. They are masters of providing “MORE FOR LESS” to their customers, and thus will be the provider of choice for income-constrained western consumers. The formerly Austrian G7 capitalist economies have evolved into quasi-socialist asset-backed economies, where wealth is an illusion of misstated inflation of assets (which we now see reverting back to the real, not nominal values.) They now live in de-industrialized shells of their former economies, incapable of producing more than they consume and creating the savings necessary for rising middle classes and capital investment, which is the seed corn of future wealth.
So the governments of the G7 have resorted to what all empires do as they reach the end of their histories: borrow and print money to support their spending since wealth creation no longer does so. Gold is at or near a new high against every FIAT currency in the world and that is no coincidence. It is a reflection of the declining purchasing power of the currencies in which it is denominated. Take a look at these charts of world currencies and gold (courtesy of Mike Hewitt and www.dollardaze.org ) since 1971, when Breton Woods II forever tore G7 currencies from gold and silver reserve backing:
Thank you, Mike. Notice there is only one currency which has not lost purchasing power and that is the oldest currency in the world: GOLD. As the MONEY printing in the G7 accelerates to underpin the governments and financial systems, you can expect commodities to REPRICE higher to reflect the lower purchasing power of whatever currency in which it is denominated, putting additional buying power in them as investors increasingly seek shelter from the printing presses.
The temporary destruction of demand for commodities has been largely PRICED into commodity prices without disturbing the longer-term bull trend, caused by supply constraints which just recently began in 2001. You can count on the debasement of the G7 currencies to accelerate as investors and G7 currency holders increasingly shun buying paper that “melts in your hand and bank accounts” in favor of? The “Indirect Exchange” (as outlined by Ludwig von Mises) into the shelter provided by tangible assets, such as commodities, precious metals and raw materials. Look no further than the Chinese to see this in action, as they have embarked on a spending spree to rid themselves of the toxic G7 currencies and exchange them for tangibles of all stripes, including commodities.
In Conclusion: The G7 governments are at war with their citizens, only the citizens are largely unaware of it. Citizens have been dumbed down and the media spins the government line to dupe the public into believing that government is for them rather than against them in this period of time. The DARWINIAN struggle to survive and grow is now a showdown between the public sectors, government elites and special interests versus the private sectors and the public at large. As the governments increasingly DESTROY the ability to create wealth in the private sector, incomes have and will continue to collapse, as will tax receipts on the endless list of taxes and fees now imposed.
As these sources of income recede, the only options will be to borrow from future generations through treasury issuance to the central banks, aka “PRINTING THE MONEY”. Since there is this little timeless truth known by non-governmental economists as “there is no such thing as a free lunch”, we are headed toward the demise of the G7 financial systems. And of course, this does not include the FREE healthcare and new energy REGULATIONS and TAXES which they are about to impose.
On another note, FASBY 157, which mandates mark-to-market accounting, has succumbed to political pressure and has been eviscerated, effectively allowing the banks to misstate their assets values to models, rather than to market prices. So expect the losses to once again be HIDDEN from view and profits to appear when marked to model, i.e., lying with numbers with government approval. The profits are ILLUSIONS, courtesy of corrupt public serpents, banksters and now the accounting OVERSIGHT board. Insolvency is not cured with the stroke of a pen, it is fixed by NEW CAPITAL!
Look no further than recent LOUD outbursts by the G7’s largest creditors such as the Chinese, Russians, Indians and Brazilians, illustrating their dismay. They should, because when the debasement occurs, it is a theft of the purchasing power they store in G7 currencies and bonds. The rallies in stock indexes are nothing more than bounces in ongoing bear markets. Here is an analogue chart of the 4 biggest bear markets in history:
This is a powerful signpost of future price action. The only thing which may keep us from going to lows at the 3000 to 4000 level in the Dow is the rapidity of the monetary debasement process. Stocks are in many ways TANGIBLE investments and will re-price HIGHER to reflect the diminishing purchasing power of the currency in which they are priced. So the faster the G7 debases their currencies, the more buoyant NOMINAL prices will be. But don’t be fooled, they are declining in real terms “purchasing power” as this chart of the S&P 500 denominated in gold illustrates:
1980 1990 2000
Notice how the rally to new highs from 2002 to late 2007 DISAPPEARS when measured in REAL MONEY. That rally was an illusion of growth provided by FIAT currency and inflation. The true picture of the value of your stocks is displayed in this chart. If you look at bonds, the picture is WORSE…
I believe the recently unveiled public/private partnerships fail because the worth of the toxic assets is ZERO (this is what investors are willing to pay if not offered loans by the government and Fed), and after last week’s debacle in congress does anyone believe they can partner with the government and trust they will honor their agreements?
There is no way to avoid the unfolding, ultimately inflationary great depression because public servants are incapable of doing what is right for their constituents, rather than what is politically beneficial. But profits and opportunities will abound for the astute and informed investor. The abuse of the ability to issue debt and print money will be abused until such time that the financial, currency and banking systems collapse and are shunned by the world publics. Learn how to make money in up and down markets using absolute return alternative investments and seek the “indirect exchange” as outlined by Ludwig von Mises. So it is once again: Hi ho, Hi ho, off to the printing press they go; selling treasuries to create the money and sending you and your children the obligation to pay for it.
Charts and full article
The Quiet Coup
The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.
by Simon Johnson
One thing you learn rather quickly when working at the International Monetary Fund is that no one is ever very happy to see you. Typically, your “clients” come in only after private capital has abandoned them, after regional trading-bloc partners have been unable to throw a strong enough lifeline, after last-ditch attempts to borrow from powerful friends like China or the European Union have fallen through. You’re never at the top of anyone’s dance card.
The reason, of course, is that the IMF specializes in telling its clients what they don’t want to hear. I should know; I pressed painful changes on many foreign officials during my time there as chief economist in 2007 and 2008. And I felt the effects of IMF pressure, at least indirectly, when I worked with governments in Eastern Europe as they struggled after 1989, and with the private sector in Asia and Latin America during the crises of the late 1990s and early 2000s. Over that time, from every vantage point, I saw firsthand the steady flow of officials—from Ukraine, Russia, Thailand, Indonesia, South Korea, and elsewhere—trudging to the fund when circumstances were dire and all else had failed.
Every crisis is different, of course. Ukraine faced hyperinflation in 1994; Russia desperately needed help when its short-term-debt rollover scheme exploded in the summer of 1998; the Indonesian rupiah plunged in 1997, nearly leveling the corporate economy; that same year, South Korea’s 30-year economic miracle ground to a halt when foreign banks suddenly refused to extend new credit.
But I must tell you, to IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out.
No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.
Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.
In Russia, for instance, the private sector is now in serious trouble because, over the past five years or so, it borrowed at least $490 billion from global banks and investors on the assumption that the country’s energy sector could support a permanent increase in consumption throughout the economy. As Russia’s oligarchs spent this capital, acquiring other companies and embarking on ambitious investment plans that generated jobs, their importance to the political elite increased. Growing political support meant better access to lucrative contracts, tax breaks, and subsidies. And foreign investors could not have been more pleased; all other things being equal, they prefer to lend money to people who have the implicit backing of their national governments, even if that backing gives off the faint whiff of corruption.
But inevitably, emerging-market oligarchs get carried away; they waste money and build massive business empires on a mountain of debt. Local banks, sometimes pressured by the government, become too willing to extend credit to the elite and to those who depend on them. Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms.
The downward spiral that follows is remarkably steep. Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s “public-private partnerships” are relabeled “crony capitalism.” With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.
Squeezing the oligarchs, though, is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Kremlin bailout technique—the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large.
Eventually, as the oligarchs in Putin’s Russia now realize, some within the elite have to lose out before recovery can begin. It’s a game of musical chairs: there just aren’t enough currency reserves to take care of everyone, and the government cannot afford to take over private-sector debt completely.
So the IMF staff looks into the eyes of the minister of finance and decides whether the government is serious yet. The fund will give even a country like Russia a loan eventually, but first it wants to make sure Prime Minister Putin is ready, willing, and able to be tough on some of his friends. If he is not ready to throw former pals to the wolves, the fund can wait. And when he is ready, the fund is happy to make helpful suggestions—particularly with regard to wresting control of the banking system from the hands of the most incompetent and avaricious “entrepreneurs.”
Of course, Putin’s ex-friends will fight back. They’ll mobilize allies, work the system, and put pressure on other parts of the government to get additional subsidies. In extreme cases, they’ll even try subversion—including calling up their contacts in the American foreign-policy establishment, as the Ukrainians did with some success in the late 1990s.
Many IMF programs “go off track” (a euphemism) precisely because the government can’t stay tough on erstwhile cronies, and the consequences are massive inflation or other disasters. A program “goes back on track” once the government prevails or powerful oligarchs sort out among themselves who will govern—and thus win or lose—under the IMF-supported plan. The real fight in Thailand and Indonesia in 1997 was about which powerful families would lose their banks. In Thailand, it was handled relatively smoothly. In Indonesia, it led to the fall of President Suharto and economic chaos.
From long years of experience, the IMF staff knows its program will succeed—stabilizing the economy and enabling growth—only if at least some of the powerful oligarchs who did so much to create the underlying problems take a hit. This is the problem of all emerging markets.
Becoming a Banana Republic
In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.
But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a “buck stops somewhere else” sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for “safety and soundness” were fast asleep at the wheel.
But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits—such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside.
The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.
Click the chart above for a larger view
Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.
The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent.
The Wall Street–Washington Corridor
Of course, the U.S. is unique. And just as we have the world’s most advanced economy, military, and technology, we also have its most advanced oligarchy.
In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption—envelopes stuffed with $100 bills—is probably a sideshow today, Jack Abramoff notwithstanding.
Instead, the American financial industry gained political power by amassing a kind of cultural capital—a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America’s position in the world.
One channel of influence was, of course, the flow of individuals between Wall Street and Washington. Robert Rubin, once the co-chairman of Goldman Sachs, served in Washington as Treasury secretary under Clinton, and later became chairman of Citigroup’s executive committee. Henry Paulson, CEO of Goldman Sachs during the long boom, became Treasury secretary under George W.Bush. John Snow, Paulson’s predecessor, left to become chairman of Cerberus Capital Management, a large private-equity firm that also counts Dan Quayle among its executives. Alan Greenspan, after leaving the Federal Reserve, became a consultant to Pimco, perhaps the biggest player in international bond markets.
These personal connections were multiplied many times over at the lower levels of the past three presidential administrations, strengthening the ties between Washington and Wall Street. It has become something of a tradition for Goldman Sachs employees to go into public service after they leave the firm. The flow of Goldman alumni—including Jon Corzine, now the governor of New Jersey, along with Rubin and Paulson—not only placed people with Wall Street’s worldview in the halls of power; it also helped create an image of Goldman (inside the Beltway, at least) as an institution that was itself almost a form of public service.
Wall Street is a very seductive place, imbued with an air of power. Its executives truly believe that they control the levers that make the world go round. A civil servant from Washington invited into their conference rooms, even if just for a meeting, could be forgiven for falling under their sway. Throughout my time at the IMF, I was struck by the easy access of leading financiers to the highest U.S. government officials, and the interweaving of the two career tracks. I vividly remember a meeting in early 2008—attended by top policy makers from a handful of rich countries—at which the chair casually proclaimed, to the room’s general approval, that the best preparation for becoming a central-bank governor was to work first as an investment banker.
A whole generation of policy makers has been mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true. Alan Greenspan’s pronouncements in favor of unregulated financial markets are well known. Yet Greenspan was hardly alone. This is what Ben Bernanke, the man who succeeded him, said in 2006: “The management of market risk and credit risk has become increasingly sophisticated. … Banking organizations of all sizes have made substantial strides over the past two decades in their ability to measure and manage risks.”
Of course, this was mostly an illusion. Regulators, legislators, and academics almost all assumed that the managers of these banks knew what they were doing. In retrospect, they didn’t. AIG’s Financial Products division, for instance, made $2.5 billion in pretax profits in 2005, largely by selling underpriced insurance on complex, poorly understood securities. Often described as “picking up nickels in front of a steamroller,” this strategy is profitable in ordinary years, and catastrophic in bad ones. As of last fall, AIG had outstanding insurance on more than $400 billion in securities. To date, the U.S. government, in an effort to rescue the company, has committed about $180 billion in investments and loans to cover losses that AIG’s sophisticated risk modeling had said were virtually impossible.
Wall Street’s seductive power extended even (or especially) to finance and economics professors, historically confined to the cramped offices of universities and the pursuit of Nobel Prizes. As mathematical finance became more and more essential to practical finance, professors increasingly took positions as consultants or partners at financial institutions. Myron Scholes and Robert Merton, Nobel laureates both, were perhaps the most famous; they took board seats at the hedge fund Long-Term Capital Management in 1994, before the fund famously flamed out at the end of the decade. But many others beat similar paths. This migration gave the stamp of academic legitimacy (and the intimidating aura of intellectual rigor) to the burgeoning world of high finance.
As more and more of the rich made their money in finance, the cult of finance seeped into the culture at large. Works like Barbarians at the Gate, Wall Street, and Bonfire of the Vanities—all intended as cautionary tales—served only to increase Wall Street’s mystique. Michael Lewis noted in Portfolio last year that when he wrote Liar’s Poker, an insider’s account of the financial industry, in 1989, he had hoped the book might provoke outrage at Wall Street’s hubris and excess. Instead, he found himself “knee-deep in letters from students at Ohio State who wanted to know if I had any other secrets to share. … They’d read my book as a how-to manual.” Even Wall Street’s criminals, like Michael Milken and Ivan Boesky, became larger than life. In a society that celebrates the idea of making money, it was easy to infer that the interests of the financial sector were the same as the interests of the country—and that the winners in the financial sector knew better what was good for America than did the career civil servants in Washington. Faith in free financial markets grew into conventional wisdom—trumpeted on the editorial pages of The Wall Street Journal and on the floor of Congress.
From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies that is, in hindsight, astonishing:
• insistence on free movement of capital across borders;
• the repeal of Depression-era regulations separating commercial and investment banking;
• a congressional ban on the regulation of credit-default swaps;
• major increases in the amount of leverage allowed to investment banks;
• a light (dare I say invisible?) hand at the Securities and Exchange Commission in its regulatory enforcement;
• an international agreement to allow banks to measure their own riskiness;
• and an intentional failure to update regulations so as to keep up with the tremendous pace of financial innovation.
The mood that accompanied these measures in Washington seemed to swing between nonchalance and outright celebration: finance unleashed, it was thought, would continue to propel the economy to greater heights.
America’s Oligarchs and the Financial Crisis
The oligarchy and the government policies that aided it did not alone cause the financial crisis that exploded last year. Many other factors contributed, including excessive borrowing by households and lax lending standards out on the fringes of the financial world. But major commercial and investment banks—and the hedge funds that ran alongside them—were the big beneficiaries of the twin housing and equity-market bubbles of this decade, their profits fed by an ever-increasing volume of transactions founded on a relatively small base of actual physical assets. Each time a loan was sold, packaged, securitized, and resold, banks took their transaction fees, and the hedge funds buying those securities reaped ever-larger fees as their holdings grew.
Because everyone was getting richer, and the health of the national economy depended so heavily on growth in real estate and finance, no one in Washington had any incentive to question what was going on. Instead, Fed Chairman Greenspan and President Bush insisted metronomically that the economy was fundamentally sound and that the tremendous growth in complex securities and credit-default swaps was evidence of a healthy economy where risk was distributed safely.
In the summer of 2007, signs of strain started appearing. The boom had produced so much debt that even a small economic stumble could cause major problems, and rising delinquencies in subprime mortgages proved the stumbling block. Ever since, the financial sector and the federal government have been behaving exactly the way one would expect them to, in light of past emerging-market crises.
By now, the princes of the financial world have of course been stripped naked as leaders and strategists—at least in the eyes of most Americans. But as the months have rolled by, financial elites have continued to assume that their position as the economy’s favored children is safe, despite the wreckage they have caused.
Stanley O’Neal, the CEO of Merrill Lynch, pushed his firm heavily into the mortgage-backed-securities market at its peak in 2005 and 2006; in October 2007, he acknowledged, “The bottom line is, we—I—got it wrong by being overexposed to subprime, and we suffered as a result of impaired liquidity in that market. No one is more disappointed than I am in that result.” O’Neal took home a $14 million bonus in 2006; in 2007, he walked away from Merrill with a severance package worth $162 million, although it is presumably worth much less today.
In October, John Thain, Merrill Lynch’s final CEO, reportedly lobbied his board of directors for a bonus of $30 million or more, eventually reducing his demand to $10million in December; he withdrew the request, under a firestorm of protest, only after it was leaked to The Wall Street Journal. Merrill Lynch as a whole was no better: it moved its bonus payments, $4 billion in total, forward to December, presumably to avoid the possibility that they would be reduced by Bank of America, which would own Merrill beginning on January 1. Wall Street paid out $18 billion in year-end bonuses last year to its New York City employees, after the government disbursed $243 billion in emergency assistance to the financial sector.
In a financial panic, the government must respond with both speed and overwhelming force. The root problem is uncertainty—in our case, uncertainty about whether the major banks have sufficient assets to cover their liabilities. Half measures combined with wishful thinking and a wait-and-see attitude cannot overcome this uncertainty. And the longer the response takes, the longer the uncertainty will stymie the flow of credit, sap consumer confidence, and cripple the economy—ultimately making the problem much harder to solve. Yet the principal characteristics of the government’s response to the financial crisis have been delay, lack of transparency, and an unwillingness to upset the financial sector.
The response so far is perhaps best described as “policy by deal”: when a major financial institution gets into trouble, the Treasury Department and the Federal Reserve engineer a bailout over the weekend and announce on Monday that everything is fine. In March 2008, Bear Stearns was sold to JP Morgan Chase in what looked to many like a gift to JP Morgan. (Jamie Dimon, JP Morgan’s CEO, sits on the board of directors of the Federal Reserve Bank of New York, which, along with the Treasury Department, brokered the deal.) In September, we saw the sale of Merrill Lynch to Bank of America, the first bailout of AIG, and the takeover and immediate sale of Washington Mutual to JP Morgan—all of which were brokered by the government. In October, nine large banks were recapitalized on the same day behind closed doors in Washington. This, in turn, was followed by additional bailouts for Citigroup, AIG, Bank of America, Citigroup (again), and AIG (again).
Some of these deals may have been reasonable responses to the immediate situation. But it was never clear (and still isn’t) what combination of interests was being served, and how. Treasury and the Fed did not act according to any publicly articulated principles, but just worked out a transaction and claimed it was the best that could be done under the circumstances. This was late-night, backroom dealing, pure and simple.
Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here. In September 2008, Henry Paulson asked Congress for $700 billion to buy toxic assets from banks, with no strings attached and no judicial review of his purchase decisions. Many observers suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands—indeed, that is the only way that buying toxic assets would have helped anything. Perhaps because there was no way to make such a blatant subsidy politically acceptable, that plan was shelved.
Instead, the money was used to recapitalize banks, buying shares in them on terms that were grossly favorable to the banks themselves. As the crisis has deepened and financial institutions have needed more help, the government has gotten more and more creative in figuring out ways to provide banks with subsidies that are too complex for the general public to understand. The first AIG bailout, which was on relatively good terms for the taxpayer, was supplemented by three further bailouts whose terms were more AIG-friendly. The second Citigroup bailout and the Bank of America bailout included complex asset guarantees that provided the banks with insurance at below-market rates. The third Citigroup bailout, in late February, converted government-owned preferred stock to common stock at a price significantly higher than the market price—a subsidy that probably even most Wall Street Journal readers would miss on first reading. And the convertible preferred shares that the Treasury will buy under the new Financial Stability Plan give the conversion option (and thus the upside) to the banks, not the government.
This latest plan—which is likely to provide cheap loans to hedge funds and others so that they can buy distressed bank assets at relatively high prices—has been heavily influenced by the financial sector, and Treasury has made no secret of that. As Neel Kashkari, a senior Treasury official under both Henry Paulson and Tim Geithner (and a Goldman alum) told Congress in March, “We had received inbound unsolicited proposals from people in the private sector saying, ‘We have capital on the sidelines; we want to go after [distressed bank] assets.’” And the plan lets them do just that: “By marrying government capital—taxpayer capital—with private-sector capital and providing financing, you can enable those investors to then go after those assets at a price that makes sense for the investors and at a price that makes sense for the banks.” Kashkari didn’t mention anything about what makes sense for the third group involved: the taxpayers.
Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change. As an unnamed senior bank official said to The New York Times last fall, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.” But there’s the rub: the economy can’t recover until the banks are healthy and willing to lend.
The Way Out
Looking just at the financial crisis (and leaving aside some problems of the larger economy), we face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support.
Big banks, it seems, have only gained political strength since the crisis began. And this is not surprising. With the financial system so fragile, the damage that a major bank failure could cause—Lehman was small relative to Citigroup or Bank of America—is much greater than it would be during ordinary times. The banks have been exploiting this fear as they wring favorable deals out of Washington. Bank of America obtained its second bailout package (in January) after warning the government that it might not be able to go through with the acquisition of Merrill Lynch, a prospect that Treasury did not want to consider.
The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.
In some ways, of course, the government has already taken control of the banking system. It has essentially guaranteed the liabilities of the biggest banks, and it is their only plausible source of capital today. Meanwhile, the Federal Reserve has taken on a major role in providing credit to the economy—the function that the private banking sector is supposed to be performing, but isn’t. Yet there are limits to what the Fed can do on its own; consumers and businesses are still dependent on banks that lack the balance sheets and the incentives to make the loans the economy needs, and the government has no real control over who runs the banks, or over what they do.
At the root of the banks’ problems are the large losses they have undoubtedly taken on their securities and loan portfolios. But they don’t want to recognize the full extent of their losses, because that would likely expose them as insolvent. So they talk down the problem, and ask for handouts that aren’t enough to make them healthy (again, they can’t reveal the size of the handouts that would be necessary for that), but are enough to keep them upright a little longer. This behavior is corrosive: unhealthy banks either don’t lend (hoarding money to shore up reserves) or they make desperate gambles on high-risk loans and investments that could pay off big, but probably won’t pay off at all. In either case, the economy suffers further, and as it does, bank assets themselves continue to deteriorate—creating a highly destructive vicious cycle.
To break this cycle, the government must force the banks to acknowledge the scale of their problems. As the IMF understands (and as the U.S. government itself has insisted to multiple emerging-market countries in the past), the most direct way to do this is nationalization. Instead, Treasury is trying to negotiate bailouts bank by bank, and behaving as if the banks hold all the cards—contorting the terms of each deal to minimize government ownership while forswearing government influence over bank strategy or operations. Under these conditions, cleaning up bank balance sheets is impossible.
Nationalization would not imply permanent state ownership. The IMF’s advice would be, essentially: scale up the standard Federal Deposit Insurance Corporation process. An FDIC “intervention” is basically a government-managed bankruptcy procedure for banks. It would allow the government to wipe out bank shareholders, replace failed management, clean up the balance sheets, and then sell the banks back to the private sector. The main advantage is immediate recognition of the problem so that it can be solved before it grows worse.
The government needs to inspect the balance sheets and identify the banks that cannot survive a severe recession. These banks should face a choice: write down your assets to their true value and raise private capital within 30 days, or be taken over by the government. The government would write down the toxic assets of banks taken into receivership—recognizing reality—and transfer those assets to a separate government entity, which would attempt to salvage whatever value is possible for the taxpayer (as the Resolution Trust Corporation did after the savings-and-loan debacle of the 1980s). The rump banks—cleansed and able to lend safely, and hence trusted again by other lenders and investors—could then be sold off.
Cleaning up the megabanks will be complex. And it will be expensive for the taxpayer; according to the latest IMF numbers, the cleanup of the banking system would probably cost close to $1.5trillion (or 10percent of our GDP) in the long term. But only decisive government action—exposing the full extent of the financial rot and restoring some set of banks to publicly verifiable health—can cure the financial sector as a whole.
This may seem like strong medicine. But in fact, while necessary, it is insufficient. The second problem the U.S. faces—the power of the oligarchy—is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.
Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.
Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly—they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.
This may seem like a crude and arbitrary step, but it is the best way to limit the power of individual institutions in a sector that is essential to the economy as a whole. Of course, some people will complain about the “efficiency costs” of a more fragmented banking system, and these costs are real. But so are the costs when a bank that is too big to fail—a financial weapon of mass self-destruction—explodes. Anything that is too big to fail is too big to exist.
To ensure systematic bank breakup, and to prevent the eventual reemergence of dangerous behemoths, we also need to overhaul our antitrust legislation. Laws put in place more than 100years ago to combat industrial monopolies were not designed to address the problem we now face. The problem in the financial sector today is not that a given firm might have enough market share to influence prices; it is that one firm or a small set of interconnected firms, by failing, can bring down the economy. The Obama administration’s fiscal stimulus evokes FDR, but what we need to imitate here is Teddy Roosevelt’s trust-busting.
Caps on executive compensation, while redolent of populism, might help restore the political balance of power and deter the emergence of a new oligarchy. Wall Street’s main attraction—to the people who work there and to the government officials who were only too happy to bask in its reflected glory—has been the astounding amount of money that could be made. Limiting that money would reduce the allure of the financial sector and make it more like any other industry.
Still, outright pay caps are clumsy, especially in the long run. And most money is now made in largely unregulated private hedge funds and private-equity firms, so lowering pay would be complicated. Regulation and taxation should be part of the solution. Over time, though, the largest part may involve more transparency and competition, which would bring financial-industry fees down. To those who say this would drive financial activities to other countries, we can now safely say: fine.
Two Paths
To paraphrase Joseph Schumpeter, the early-20th-century economist, everyone has elites; the important thing is to change them from time to time. If the U.S. were just another country, coming to the IMF with hat in hand, I might be fairly optimistic about its future. Most of the emerging-market crises that I’ve mentioned ended relatively quickly, and gave way, for the most part, to relatively strong recoveries. But this, alas, brings us to the limit of the analogy between the U.S. and emerging markets.
Emerging-market countries have only a precarious hold on wealth, and are weaklings globally. When they get into trouble, they quite literally run out of money—or at least out of foreign currency, without which they cannot survive. They must make difficult decisions; ultimately, aggressive action is baked into the cake. But the U.S., of course, is the world’s most powerful nation, rich beyond measure, and blessed with the exorbitant privilege of paying its foreign debts in its own currency, which it can print. As a result, it could very well stumble along for years—as Japan did during its lost decade—never summoning the courage to do what it needs to do, and never really recovering. A clean break with the past—involving the takeover and cleanup of major banks—hardly looks like a sure thing right now. Certainly no one at the IMF can force it.
In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign.
Boris Fyodorov, the late finance minister of Russia, struggled for much of the past 20 years against oligarchs, corruption, and abuse of authority in all its forms. He liked to say that confusion and chaos were very much in the interests of the powerful—letting them take things, legally and illegally, with impunity. When inflation is high, who can say what a piece of property is really worth? When the credit system is supported by byzantine government arrangements and backroom deals, how do you know that you aren’t being fleeced?
Our future could be one in which continued tumult feeds the looting of the financial system, and we talk more and more about exactly how our oligarchs became bandits and how the economy just can’t seem to get into gear.
The second scenario begins more bleakly, and might end that way too. But it does provide at least some hope that we’ll be shaken out of our torpor. It goes like this: the global economy continues to deteriorate, the banking system in east-central Europe collapses, and—because eastern Europe’s banks are mostly owned by western European banks—justifiable fears of government insolvency spread throughout the Continent. Creditors take further hits and confidence falls further. The Asian economies that export manufactured goods are devastated, and the commodity producers in Latin America and Africa are not much better off. A dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees. The baseline growth rates used in the administration’s current budget are increasingly seen as unrealistic, and the rosy “stress scenario” that the U.S. Treasury is currently using to evaluate banks’ balance sheets becomes a source of great embarrassment.
Under this kind of pressure, and faced with the prospect of a national and global collapse, minds may become more concentrated.
The conventional wisdom among the elite is still that the current slump “cannot be as bad as the Great Depression.” This view is wrong. What we face now could, in fact, be worse than the Great Depression—because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances. If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. Let us hope it is not then too late.
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by Simon Johnson
One thing you learn rather quickly when working at the International Monetary Fund is that no one is ever very happy to see you. Typically, your “clients” come in only after private capital has abandoned them, after regional trading-bloc partners have been unable to throw a strong enough lifeline, after last-ditch attempts to borrow from powerful friends like China or the European Union have fallen through. You’re never at the top of anyone’s dance card.
The reason, of course, is that the IMF specializes in telling its clients what they don’t want to hear. I should know; I pressed painful changes on many foreign officials during my time there as chief economist in 2007 and 2008. And I felt the effects of IMF pressure, at least indirectly, when I worked with governments in Eastern Europe as they struggled after 1989, and with the private sector in Asia and Latin America during the crises of the late 1990s and early 2000s. Over that time, from every vantage point, I saw firsthand the steady flow of officials—from Ukraine, Russia, Thailand, Indonesia, South Korea, and elsewhere—trudging to the fund when circumstances were dire and all else had failed.
Every crisis is different, of course. Ukraine faced hyperinflation in 1994; Russia desperately needed help when its short-term-debt rollover scheme exploded in the summer of 1998; the Indonesian rupiah plunged in 1997, nearly leveling the corporate economy; that same year, South Korea’s 30-year economic miracle ground to a halt when foreign banks suddenly refused to extend new credit.
But I must tell you, to IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out.
No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.
Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.
In Russia, for instance, the private sector is now in serious trouble because, over the past five years or so, it borrowed at least $490 billion from global banks and investors on the assumption that the country’s energy sector could support a permanent increase in consumption throughout the economy. As Russia’s oligarchs spent this capital, acquiring other companies and embarking on ambitious investment plans that generated jobs, their importance to the political elite increased. Growing political support meant better access to lucrative contracts, tax breaks, and subsidies. And foreign investors could not have been more pleased; all other things being equal, they prefer to lend money to people who have the implicit backing of their national governments, even if that backing gives off the faint whiff of corruption.
But inevitably, emerging-market oligarchs get carried away; they waste money and build massive business empires on a mountain of debt. Local banks, sometimes pressured by the government, become too willing to extend credit to the elite and to those who depend on them. Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms.
The downward spiral that follows is remarkably steep. Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s “public-private partnerships” are relabeled “crony capitalism.” With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.
Squeezing the oligarchs, though, is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Kremlin bailout technique—the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large.
Eventually, as the oligarchs in Putin’s Russia now realize, some within the elite have to lose out before recovery can begin. It’s a game of musical chairs: there just aren’t enough currency reserves to take care of everyone, and the government cannot afford to take over private-sector debt completely.
So the IMF staff looks into the eyes of the minister of finance and decides whether the government is serious yet. The fund will give even a country like Russia a loan eventually, but first it wants to make sure Prime Minister Putin is ready, willing, and able to be tough on some of his friends. If he is not ready to throw former pals to the wolves, the fund can wait. And when he is ready, the fund is happy to make helpful suggestions—particularly with regard to wresting control of the banking system from the hands of the most incompetent and avaricious “entrepreneurs.”
Of course, Putin’s ex-friends will fight back. They’ll mobilize allies, work the system, and put pressure on other parts of the government to get additional subsidies. In extreme cases, they’ll even try subversion—including calling up their contacts in the American foreign-policy establishment, as the Ukrainians did with some success in the late 1990s.
Many IMF programs “go off track” (a euphemism) precisely because the government can’t stay tough on erstwhile cronies, and the consequences are massive inflation or other disasters. A program “goes back on track” once the government prevails or powerful oligarchs sort out among themselves who will govern—and thus win or lose—under the IMF-supported plan. The real fight in Thailand and Indonesia in 1997 was about which powerful families would lose their banks. In Thailand, it was handled relatively smoothly. In Indonesia, it led to the fall of President Suharto and economic chaos.
From long years of experience, the IMF staff knows its program will succeed—stabilizing the economy and enabling growth—only if at least some of the powerful oligarchs who did so much to create the underlying problems take a hit. This is the problem of all emerging markets.
Becoming a Banana Republic
In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.
But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a “buck stops somewhere else” sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for “safety and soundness” were fast asleep at the wheel.
But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits—such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside.
The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.
Click the chart above for a larger view
Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.
The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent.
The Wall Street–Washington Corridor
Of course, the U.S. is unique. And just as we have the world’s most advanced economy, military, and technology, we also have its most advanced oligarchy.
In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption—envelopes stuffed with $100 bills—is probably a sideshow today, Jack Abramoff notwithstanding.
Instead, the American financial industry gained political power by amassing a kind of cultural capital—a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America’s position in the world.
One channel of influence was, of course, the flow of individuals between Wall Street and Washington. Robert Rubin, once the co-chairman of Goldman Sachs, served in Washington as Treasury secretary under Clinton, and later became chairman of Citigroup’s executive committee. Henry Paulson, CEO of Goldman Sachs during the long boom, became Treasury secretary under George W.Bush. John Snow, Paulson’s predecessor, left to become chairman of Cerberus Capital Management, a large private-equity firm that also counts Dan Quayle among its executives. Alan Greenspan, after leaving the Federal Reserve, became a consultant to Pimco, perhaps the biggest player in international bond markets.
These personal connections were multiplied many times over at the lower levels of the past three presidential administrations, strengthening the ties between Washington and Wall Street. It has become something of a tradition for Goldman Sachs employees to go into public service after they leave the firm. The flow of Goldman alumni—including Jon Corzine, now the governor of New Jersey, along with Rubin and Paulson—not only placed people with Wall Street’s worldview in the halls of power; it also helped create an image of Goldman (inside the Beltway, at least) as an institution that was itself almost a form of public service.
Wall Street is a very seductive place, imbued with an air of power. Its executives truly believe that they control the levers that make the world go round. A civil servant from Washington invited into their conference rooms, even if just for a meeting, could be forgiven for falling under their sway. Throughout my time at the IMF, I was struck by the easy access of leading financiers to the highest U.S. government officials, and the interweaving of the two career tracks. I vividly remember a meeting in early 2008—attended by top policy makers from a handful of rich countries—at which the chair casually proclaimed, to the room’s general approval, that the best preparation for becoming a central-bank governor was to work first as an investment banker.
A whole generation of policy makers has been mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true. Alan Greenspan’s pronouncements in favor of unregulated financial markets are well known. Yet Greenspan was hardly alone. This is what Ben Bernanke, the man who succeeded him, said in 2006: “The management of market risk and credit risk has become increasingly sophisticated. … Banking organizations of all sizes have made substantial strides over the past two decades in their ability to measure and manage risks.”
Of course, this was mostly an illusion. Regulators, legislators, and academics almost all assumed that the managers of these banks knew what they were doing. In retrospect, they didn’t. AIG’s Financial Products division, for instance, made $2.5 billion in pretax profits in 2005, largely by selling underpriced insurance on complex, poorly understood securities. Often described as “picking up nickels in front of a steamroller,” this strategy is profitable in ordinary years, and catastrophic in bad ones. As of last fall, AIG had outstanding insurance on more than $400 billion in securities. To date, the U.S. government, in an effort to rescue the company, has committed about $180 billion in investments and loans to cover losses that AIG’s sophisticated risk modeling had said were virtually impossible.
Wall Street’s seductive power extended even (or especially) to finance and economics professors, historically confined to the cramped offices of universities and the pursuit of Nobel Prizes. As mathematical finance became more and more essential to practical finance, professors increasingly took positions as consultants or partners at financial institutions. Myron Scholes and Robert Merton, Nobel laureates both, were perhaps the most famous; they took board seats at the hedge fund Long-Term Capital Management in 1994, before the fund famously flamed out at the end of the decade. But many others beat similar paths. This migration gave the stamp of academic legitimacy (and the intimidating aura of intellectual rigor) to the burgeoning world of high finance.
As more and more of the rich made their money in finance, the cult of finance seeped into the culture at large. Works like Barbarians at the Gate, Wall Street, and Bonfire of the Vanities—all intended as cautionary tales—served only to increase Wall Street’s mystique. Michael Lewis noted in Portfolio last year that when he wrote Liar’s Poker, an insider’s account of the financial industry, in 1989, he had hoped the book might provoke outrage at Wall Street’s hubris and excess. Instead, he found himself “knee-deep in letters from students at Ohio State who wanted to know if I had any other secrets to share. … They’d read my book as a how-to manual.” Even Wall Street’s criminals, like Michael Milken and Ivan Boesky, became larger than life. In a society that celebrates the idea of making money, it was easy to infer that the interests of the financial sector were the same as the interests of the country—and that the winners in the financial sector knew better what was good for America than did the career civil servants in Washington. Faith in free financial markets grew into conventional wisdom—trumpeted on the editorial pages of The Wall Street Journal and on the floor of Congress.
From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies that is, in hindsight, astonishing:
• insistence on free movement of capital across borders;
• the repeal of Depression-era regulations separating commercial and investment banking;
• a congressional ban on the regulation of credit-default swaps;
• major increases in the amount of leverage allowed to investment banks;
• a light (dare I say invisible?) hand at the Securities and Exchange Commission in its regulatory enforcement;
• an international agreement to allow banks to measure their own riskiness;
• and an intentional failure to update regulations so as to keep up with the tremendous pace of financial innovation.
The mood that accompanied these measures in Washington seemed to swing between nonchalance and outright celebration: finance unleashed, it was thought, would continue to propel the economy to greater heights.
America’s Oligarchs and the Financial Crisis
The oligarchy and the government policies that aided it did not alone cause the financial crisis that exploded last year. Many other factors contributed, including excessive borrowing by households and lax lending standards out on the fringes of the financial world. But major commercial and investment banks—and the hedge funds that ran alongside them—were the big beneficiaries of the twin housing and equity-market bubbles of this decade, their profits fed by an ever-increasing volume of transactions founded on a relatively small base of actual physical assets. Each time a loan was sold, packaged, securitized, and resold, banks took their transaction fees, and the hedge funds buying those securities reaped ever-larger fees as their holdings grew.
Because everyone was getting richer, and the health of the national economy depended so heavily on growth in real estate and finance, no one in Washington had any incentive to question what was going on. Instead, Fed Chairman Greenspan and President Bush insisted metronomically that the economy was fundamentally sound and that the tremendous growth in complex securities and credit-default swaps was evidence of a healthy economy where risk was distributed safely.
In the summer of 2007, signs of strain started appearing. The boom had produced so much debt that even a small economic stumble could cause major problems, and rising delinquencies in subprime mortgages proved the stumbling block. Ever since, the financial sector and the federal government have been behaving exactly the way one would expect them to, in light of past emerging-market crises.
By now, the princes of the financial world have of course been stripped naked as leaders and strategists—at least in the eyes of most Americans. But as the months have rolled by, financial elites have continued to assume that their position as the economy’s favored children is safe, despite the wreckage they have caused.
Stanley O’Neal, the CEO of Merrill Lynch, pushed his firm heavily into the mortgage-backed-securities market at its peak in 2005 and 2006; in October 2007, he acknowledged, “The bottom line is, we—I—got it wrong by being overexposed to subprime, and we suffered as a result of impaired liquidity in that market. No one is more disappointed than I am in that result.” O’Neal took home a $14 million bonus in 2006; in 2007, he walked away from Merrill with a severance package worth $162 million, although it is presumably worth much less today.
In October, John Thain, Merrill Lynch’s final CEO, reportedly lobbied his board of directors for a bonus of $30 million or more, eventually reducing his demand to $10million in December; he withdrew the request, under a firestorm of protest, only after it was leaked to The Wall Street Journal. Merrill Lynch as a whole was no better: it moved its bonus payments, $4 billion in total, forward to December, presumably to avoid the possibility that they would be reduced by Bank of America, which would own Merrill beginning on January 1. Wall Street paid out $18 billion in year-end bonuses last year to its New York City employees, after the government disbursed $243 billion in emergency assistance to the financial sector.
In a financial panic, the government must respond with both speed and overwhelming force. The root problem is uncertainty—in our case, uncertainty about whether the major banks have sufficient assets to cover their liabilities. Half measures combined with wishful thinking and a wait-and-see attitude cannot overcome this uncertainty. And the longer the response takes, the longer the uncertainty will stymie the flow of credit, sap consumer confidence, and cripple the economy—ultimately making the problem much harder to solve. Yet the principal characteristics of the government’s response to the financial crisis have been delay, lack of transparency, and an unwillingness to upset the financial sector.
The response so far is perhaps best described as “policy by deal”: when a major financial institution gets into trouble, the Treasury Department and the Federal Reserve engineer a bailout over the weekend and announce on Monday that everything is fine. In March 2008, Bear Stearns was sold to JP Morgan Chase in what looked to many like a gift to JP Morgan. (Jamie Dimon, JP Morgan’s CEO, sits on the board of directors of the Federal Reserve Bank of New York, which, along with the Treasury Department, brokered the deal.) In September, we saw the sale of Merrill Lynch to Bank of America, the first bailout of AIG, and the takeover and immediate sale of Washington Mutual to JP Morgan—all of which were brokered by the government. In October, nine large banks were recapitalized on the same day behind closed doors in Washington. This, in turn, was followed by additional bailouts for Citigroup, AIG, Bank of America, Citigroup (again), and AIG (again).
Some of these deals may have been reasonable responses to the immediate situation. But it was never clear (and still isn’t) what combination of interests was being served, and how. Treasury and the Fed did not act according to any publicly articulated principles, but just worked out a transaction and claimed it was the best that could be done under the circumstances. This was late-night, backroom dealing, pure and simple.
Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here. In September 2008, Henry Paulson asked Congress for $700 billion to buy toxic assets from banks, with no strings attached and no judicial review of his purchase decisions. Many observers suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands—indeed, that is the only way that buying toxic assets would have helped anything. Perhaps because there was no way to make such a blatant subsidy politically acceptable, that plan was shelved.
Instead, the money was used to recapitalize banks, buying shares in them on terms that were grossly favorable to the banks themselves. As the crisis has deepened and financial institutions have needed more help, the government has gotten more and more creative in figuring out ways to provide banks with subsidies that are too complex for the general public to understand. The first AIG bailout, which was on relatively good terms for the taxpayer, was supplemented by three further bailouts whose terms were more AIG-friendly. The second Citigroup bailout and the Bank of America bailout included complex asset guarantees that provided the banks with insurance at below-market rates. The third Citigroup bailout, in late February, converted government-owned preferred stock to common stock at a price significantly higher than the market price—a subsidy that probably even most Wall Street Journal readers would miss on first reading. And the convertible preferred shares that the Treasury will buy under the new Financial Stability Plan give the conversion option (and thus the upside) to the banks, not the government.
This latest plan—which is likely to provide cheap loans to hedge funds and others so that they can buy distressed bank assets at relatively high prices—has been heavily influenced by the financial sector, and Treasury has made no secret of that. As Neel Kashkari, a senior Treasury official under both Henry Paulson and Tim Geithner (and a Goldman alum) told Congress in March, “We had received inbound unsolicited proposals from people in the private sector saying, ‘We have capital on the sidelines; we want to go after [distressed bank] assets.’” And the plan lets them do just that: “By marrying government capital—taxpayer capital—with private-sector capital and providing financing, you can enable those investors to then go after those assets at a price that makes sense for the investors and at a price that makes sense for the banks.” Kashkari didn’t mention anything about what makes sense for the third group involved: the taxpayers.
Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change. As an unnamed senior bank official said to The New York Times last fall, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.” But there’s the rub: the economy can’t recover until the banks are healthy and willing to lend.
The Way Out
Looking just at the financial crisis (and leaving aside some problems of the larger economy), we face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support.
Big banks, it seems, have only gained political strength since the crisis began. And this is not surprising. With the financial system so fragile, the damage that a major bank failure could cause—Lehman was small relative to Citigroup or Bank of America—is much greater than it would be during ordinary times. The banks have been exploiting this fear as they wring favorable deals out of Washington. Bank of America obtained its second bailout package (in January) after warning the government that it might not be able to go through with the acquisition of Merrill Lynch, a prospect that Treasury did not want to consider.
The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.
In some ways, of course, the government has already taken control of the banking system. It has essentially guaranteed the liabilities of the biggest banks, and it is their only plausible source of capital today. Meanwhile, the Federal Reserve has taken on a major role in providing credit to the economy—the function that the private banking sector is supposed to be performing, but isn’t. Yet there are limits to what the Fed can do on its own; consumers and businesses are still dependent on banks that lack the balance sheets and the incentives to make the loans the economy needs, and the government has no real control over who runs the banks, or over what they do.
At the root of the banks’ problems are the large losses they have undoubtedly taken on their securities and loan portfolios. But they don’t want to recognize the full extent of their losses, because that would likely expose them as insolvent. So they talk down the problem, and ask for handouts that aren’t enough to make them healthy (again, they can’t reveal the size of the handouts that would be necessary for that), but are enough to keep them upright a little longer. This behavior is corrosive: unhealthy banks either don’t lend (hoarding money to shore up reserves) or they make desperate gambles on high-risk loans and investments that could pay off big, but probably won’t pay off at all. In either case, the economy suffers further, and as it does, bank assets themselves continue to deteriorate—creating a highly destructive vicious cycle.
To break this cycle, the government must force the banks to acknowledge the scale of their problems. As the IMF understands (and as the U.S. government itself has insisted to multiple emerging-market countries in the past), the most direct way to do this is nationalization. Instead, Treasury is trying to negotiate bailouts bank by bank, and behaving as if the banks hold all the cards—contorting the terms of each deal to minimize government ownership while forswearing government influence over bank strategy or operations. Under these conditions, cleaning up bank balance sheets is impossible.
Nationalization would not imply permanent state ownership. The IMF’s advice would be, essentially: scale up the standard Federal Deposit Insurance Corporation process. An FDIC “intervention” is basically a government-managed bankruptcy procedure for banks. It would allow the government to wipe out bank shareholders, replace failed management, clean up the balance sheets, and then sell the banks back to the private sector. The main advantage is immediate recognition of the problem so that it can be solved before it grows worse.
The government needs to inspect the balance sheets and identify the banks that cannot survive a severe recession. These banks should face a choice: write down your assets to their true value and raise private capital within 30 days, or be taken over by the government. The government would write down the toxic assets of banks taken into receivership—recognizing reality—and transfer those assets to a separate government entity, which would attempt to salvage whatever value is possible for the taxpayer (as the Resolution Trust Corporation did after the savings-and-loan debacle of the 1980s). The rump banks—cleansed and able to lend safely, and hence trusted again by other lenders and investors—could then be sold off.
Cleaning up the megabanks will be complex. And it will be expensive for the taxpayer; according to the latest IMF numbers, the cleanup of the banking system would probably cost close to $1.5trillion (or 10percent of our GDP) in the long term. But only decisive government action—exposing the full extent of the financial rot and restoring some set of banks to publicly verifiable health—can cure the financial sector as a whole.
This may seem like strong medicine. But in fact, while necessary, it is insufficient. The second problem the U.S. faces—the power of the oligarchy—is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.
Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.
Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly—they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.
This may seem like a crude and arbitrary step, but it is the best way to limit the power of individual institutions in a sector that is essential to the economy as a whole. Of course, some people will complain about the “efficiency costs” of a more fragmented banking system, and these costs are real. But so are the costs when a bank that is too big to fail—a financial weapon of mass self-destruction—explodes. Anything that is too big to fail is too big to exist.
To ensure systematic bank breakup, and to prevent the eventual reemergence of dangerous behemoths, we also need to overhaul our antitrust legislation. Laws put in place more than 100years ago to combat industrial monopolies were not designed to address the problem we now face. The problem in the financial sector today is not that a given firm might have enough market share to influence prices; it is that one firm or a small set of interconnected firms, by failing, can bring down the economy. The Obama administration’s fiscal stimulus evokes FDR, but what we need to imitate here is Teddy Roosevelt’s trust-busting.
Caps on executive compensation, while redolent of populism, might help restore the political balance of power and deter the emergence of a new oligarchy. Wall Street’s main attraction—to the people who work there and to the government officials who were only too happy to bask in its reflected glory—has been the astounding amount of money that could be made. Limiting that money would reduce the allure of the financial sector and make it more like any other industry.
Still, outright pay caps are clumsy, especially in the long run. And most money is now made in largely unregulated private hedge funds and private-equity firms, so lowering pay would be complicated. Regulation and taxation should be part of the solution. Over time, though, the largest part may involve more transparency and competition, which would bring financial-industry fees down. To those who say this would drive financial activities to other countries, we can now safely say: fine.
Two Paths
To paraphrase Joseph Schumpeter, the early-20th-century economist, everyone has elites; the important thing is to change them from time to time. If the U.S. were just another country, coming to the IMF with hat in hand, I might be fairly optimistic about its future. Most of the emerging-market crises that I’ve mentioned ended relatively quickly, and gave way, for the most part, to relatively strong recoveries. But this, alas, brings us to the limit of the analogy between the U.S. and emerging markets.
Emerging-market countries have only a precarious hold on wealth, and are weaklings globally. When they get into trouble, they quite literally run out of money—or at least out of foreign currency, without which they cannot survive. They must make difficult decisions; ultimately, aggressive action is baked into the cake. But the U.S., of course, is the world’s most powerful nation, rich beyond measure, and blessed with the exorbitant privilege of paying its foreign debts in its own currency, which it can print. As a result, it could very well stumble along for years—as Japan did during its lost decade—never summoning the courage to do what it needs to do, and never really recovering. A clean break with the past—involving the takeover and cleanup of major banks—hardly looks like a sure thing right now. Certainly no one at the IMF can force it.
In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign.
Boris Fyodorov, the late finance minister of Russia, struggled for much of the past 20 years against oligarchs, corruption, and abuse of authority in all its forms. He liked to say that confusion and chaos were very much in the interests of the powerful—letting them take things, legally and illegally, with impunity. When inflation is high, who can say what a piece of property is really worth? When the credit system is supported by byzantine government arrangements and backroom deals, how do you know that you aren’t being fleeced?
Our future could be one in which continued tumult feeds the looting of the financial system, and we talk more and more about exactly how our oligarchs became bandits and how the economy just can’t seem to get into gear.
The second scenario begins more bleakly, and might end that way too. But it does provide at least some hope that we’ll be shaken out of our torpor. It goes like this: the global economy continues to deteriorate, the banking system in east-central Europe collapses, and—because eastern Europe’s banks are mostly owned by western European banks—justifiable fears of government insolvency spread throughout the Continent. Creditors take further hits and confidence falls further. The Asian economies that export manufactured goods are devastated, and the commodity producers in Latin America and Africa are not much better off. A dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees. The baseline growth rates used in the administration’s current budget are increasingly seen as unrealistic, and the rosy “stress scenario” that the U.S. Treasury is currently using to evaluate banks’ balance sheets becomes a source of great embarrassment.
Under this kind of pressure, and faced with the prospect of a national and global collapse, minds may become more concentrated.
The conventional wisdom among the elite is still that the current slump “cannot be as bad as the Great Depression.” This view is wrong. What we face now could, in fact, be worse than the Great Depression—because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances. If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. Let us hope it is not then too late.
Link
27 March 2009
Finanosaurs 1 Nation States 0 ~Global Guerrillas
widespread collapse in legitimacy
I mentioned at the time I wrote this brief, that viral violence targeting the barons of global finance was likely incoming (but that it wasn't here yet). Here's a small addition to that trend line (that builds on the thousands of death threats that have been received). In the UK, vandals hit the home of the former CEO of the Royal Bank of Scotland, 'Sir' Fred Goodwin (he and his family have already fled the country). Windows on the ground floor of the home and his Mercedes S600 were smashed. E-mails from a group claiming the attacks said,
We are angry that rich people, like him, are paying themselves a huge amount of money, and living in luxury, while ordinary people are made unemployed, destitute and homeless. This is a crime. Bank bosses should be jailed. This is just the beginning.
The Real Systemic Risk
This leads me to a broader topic. The real systemic risk we face isn't from a financial seizure. That risk is mild in comparison to the risk of a widespread collapse in legitimacy. Due to excesses (too many to name), legitimacy is rapidly draining from the global financial system and the networked groups that give it their primary loyalty (like Fred above). In recognition of this, nation-states should hold this system at arms length to limit damage to their own legitimacy. Given the constraints on resources faced by nation-states, a plan that would bulk up legitimacy would focus on reorganizing financial institutions (not bailing them out) and repairing the balance sheets of individual citizens (the only group in the chart to the left that is still loyal to nation-states). That isn't happening and the damage incurred from this mistake will be significant.
NOTE: The other thing that the inset chart tells us is that this crisis is due to debt, overreach, and insolvency. Until the US collectively writes/pays off $20 trillion plus in excess debt, not much will change. Transferring debt from financial firms to the government (as in the Paulson/Geithner plan), only accelerates the decline of nation-states relative to an already dominant global financial/economic system.
No the real problem is the US has been liquidating its human capital reserves.
Basically it threw the boomer generation away for some short-term gains in the financial centers and then tried to make up for it by importing people from other countries. Apparently the folks in power can ignore the fact that this was "treason" since no one apparently cares about such romantic notions anymore, and we can even ignore that it was "genocide" under the definition given by Lemkin, because that concept somehow doesn't seem to protect the Posterity of the Founders of the US.
No, the "real" issue is that the economic base has been wiped out and there is no fixing it because no one in power can even conceive, let alone admit the problem was incompetent human husbandry.
http://globalguerrillas.typepad.com/globalguerrillas/2009/03/journal-more-on-banksters.html
I mentioned at the time I wrote this brief, that viral violence targeting the barons of global finance was likely incoming (but that it wasn't here yet). Here's a small addition to that trend line (that builds on the thousands of death threats that have been received). In the UK, vandals hit the home of the former CEO of the Royal Bank of Scotland, 'Sir' Fred Goodwin (he and his family have already fled the country). Windows on the ground floor of the home and his Mercedes S600 were smashed. E-mails from a group claiming the attacks said,
We are angry that rich people, like him, are paying themselves a huge amount of money, and living in luxury, while ordinary people are made unemployed, destitute and homeless. This is a crime. Bank bosses should be jailed. This is just the beginning.
The Real Systemic Risk
This leads me to a broader topic. The real systemic risk we face isn't from a financial seizure. That risk is mild in comparison to the risk of a widespread collapse in legitimacy. Due to excesses (too many to name), legitimacy is rapidly draining from the global financial system and the networked groups that give it their primary loyalty (like Fred above). In recognition of this, nation-states should hold this system at arms length to limit damage to their own legitimacy. Given the constraints on resources faced by nation-states, a plan that would bulk up legitimacy would focus on reorganizing financial institutions (not bailing them out) and repairing the balance sheets of individual citizens (the only group in the chart to the left that is still loyal to nation-states). That isn't happening and the damage incurred from this mistake will be significant.
NOTE: The other thing that the inset chart tells us is that this crisis is due to debt, overreach, and insolvency. Until the US collectively writes/pays off $20 trillion plus in excess debt, not much will change. Transferring debt from financial firms to the government (as in the Paulson/Geithner plan), only accelerates the decline of nation-states relative to an already dominant global financial/economic system.
No the real problem is the US has been liquidating its human capital reserves.
Basically it threw the boomer generation away for some short-term gains in the financial centers and then tried to make up for it by importing people from other countries. Apparently the folks in power can ignore the fact that this was "treason" since no one apparently cares about such romantic notions anymore, and we can even ignore that it was "genocide" under the definition given by Lemkin, because that concept somehow doesn't seem to protect the Posterity of the Founders of the US.
No, the "real" issue is that the economic base has been wiped out and there is no fixing it because no one in power can even conceive, let alone admit the problem was incompetent human husbandry.
http://globalguerrillas.typepad.com/globalguerrillas/2009/03/journal-more-on-banksters.html
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