Saturday, April 18, 2009

Is Team Obama Clueless?

It is difficult not to be sympathetic to the observation that making policy (or managing an institution) is more difficult that usual when the consequences of decisions play out in so many unpredictable ways. In uncertain times, outcomes are harder to predict, so caution is the order of the day, and any undertaking must begin with an acknowledgement that success or failure will depend or more than just the ingenuity of the strategy or the efficacy of its execution.

That said, we are witnessing some decisions that appear to have been made with no consideration whatsover of their consequences. Not the second order effects, or the knock on consequences, but the basic cause and effect issues. I'm not sure if the Obama administration's stress testing of the major TARP recipients had its genesis in a speechwriter's desire for a good soundbite, a business as usual misunderstanding several layers down in the regulatory bureaucracy or a profound misread of just how interested a number of vocal constituencies would be in the outcome. But it appears to have been set in motion with no clear sense of what the outcome would be, almost as though the government is simply curious about the financial condition of the financial services sector.

These guys now appear to be floundering like students who haven't done any of the work and the mid-term is looming. Getting sick and rescheduling has already pushed back the deadline. But sooner or later, the results of setting the process in motion are going to come out. One way or the other.

And these guys have put themselves in the worst of all possible worlds. To the extent that institutions show healthy, the test itself will be damned as insufficiently rigorous. To the extent that weaker institutions are highlighted, the grounds are laid for an immediate culling of the herd. Perhaps that is a good thing, since it will facilitate the piecemeal dismantling of the financial services sector, which is necessary, but would be hard in a single pass. However, is difficult to believe that the stress tests are a blow in an ongoing campaign to dismantle the financial services sector, given the time, effort and treasure that is going into propping it up.

It's one thing to take a calculated risk and fail. It's quite another to make a move with no appreciation, not even of the risks involved, but of the dynamic you're set in motion. The ongoing saga of the stress tests appear to be a good example of the latter.

Friday, April 17, 2009

Republican Treason

This is slightly off topic for this blog.

What gives with the Grand Old Party? Yesterday, at some kind of staged right wing political event (a 'tea party') the Governor of Texas floated the idea that Texas just might secede from the Union. His trial balloon went over like a lead balloon and today he is busily backtracking. But he is on tape, just like the governor of Illinois trying to sell Barrack Obama's senate seat.

This isn't the first incident along these lines. Several years ago Sarah Palin was a speaker at the annual convention of the Alaskans for Independence movement. She got a free pass during the presidential campaign I suspect because she played the 'my husband made me do it' card (Todd Palin is the seccessionist family member, apparently he doesn't do the dishes, can't see Russia from his kitchen window, or fails to appreciate the concept of strength in numbers).

Palin and Perry are not trivial politicians. Two of the three most populous states in the country have Republican governors, and Perry is governor of one of them. Of course, Palin was the Republican vice presidential nominee in the last presidential campaign, as well as being the sitting governor of Alaska. What gives?

Now, treason has a highly technical definition in this country (unlike some places). For Perry and Palin, the two or more witnesses requirement is satisfied. I'd leave it others to decide whether travelling to and participating in an event promoting the dismemberment of the Union constituting an action aiding the enemies of the United States. FWIW, on the law, Perry might have the better defense, since Palin's Alaskan whackos are presumably serious and presumably plan their events to promote their purposes, while Perry just got carried away at a made-for-media right wing shennanigan.

Why is this getting any attention? I suspect it's an early warning sign of some fairly significant stresses the body politic is about to suffer. The issue of whether the United States are a single country was decided almost a century and a half ago (indeed, Texas was part of that failed succession). But what holds the country together today?

Since World War II, external pressures have played an important role--but now that the old Soviet Union has dismembered, despite the putative threat of militant Islam, those pressures are dialed way, way back. It is a common culture, set of values, and world view? While there continues to be general acceptance of the importance of the institutions of civil society, the rule of law, and a bland non-challenging secular mindset, the praise of diversity, exaltation of tolerance and confinement of religious issues to a private spiritual sphere of the individual citizen have privatised those previous commons.

These aren't easy questions. Almost makes me wish for the good old days of 2006. Back then, leading Republicans refrained from treasonous sentiments, and satisfied themselves with insider trading (Senate Majority Leader Bill Frist), playing political bagman (House Majority Leader Tom Delay) and molesting teenage boys ((House Whip Thomas Foley).

Thursday, April 16, 2009

Six Factoids: Oregon v. China

I live in Oregon, but I pay attention to what's going on in China because, well, because it seems like a good idea.

Here are three little Oregon tidbits in the last week or so.

1. Citing inability to obtain construction financing, the developer of a 32 story downtown Portland office building abruptly halted construction on the project last Friday. Right now the building-to-be is a hole in the ground with the foundation poured behind Nordstrom's and next to the Fox Tower (primo location). I'm sure there is more to the story than has been made public, and the blather about redesign and resumption of construction in 2010 is just that.

2. The Oregon unemployment rate shot up to over 12% in March, probably the highest in the nation, according to the state official making the announcement. The increase in unemployment was attributed to previously non-working people entering the job market, rather than job losses. In other words, there is some movement between U-6 and U-3. That movement is probably the most important aspect of the factoid.

3. When it adjourned several months ago the State Legislature announced with great fanfare a program to create 3000 new jobs immediately. Last week the state agency responsible for tracking such things reported that 16 new jobs had been created. Congrats to the 16 lucky winners!

Meanwhile, across the Pacific pond--

1. China has become the world's largest domestic auto market, selling more than a million cars a month. This is probably temporary because the U.S. auto market runs a good deal higher than that before it crashed, and should again assuming we get back to something resuming 'normal', but China's new status is a comment on the effectiveness of their stimulus efforts.

2. Chinese banks are attaining the lending objectives established by the central authorities--in other words, credit creation has resumed in China. They are probably making a lot of bad loans, but the stimulative purpose of the credit creation is being achieved with a speed that the developed world is having trouble matching. This is a bit of a head scratcher, because it calls into question some of the premises of how our own financial sector is organized and why it is coddled.

3. The Chinese central government is busily telling its public that their economic fate is dependent on what happens in China, not elsewhere in the world. They appear to be making a concerted effort to get that message out as broadly and persuasively as possible. This is important for a couple of reasons--it suggests they expecting further export deterioration, they want to prepare their public for massive forex losses and for the time being they are eschewing the strategy of blaming their country's problems on the foreign demons. The first is a no-brainer, the second is simply prudent, and we should all be grateful for the last.

Okay, annetdotal evidence is a lousy substitute for reasoning and analysis. But, sometimes it's worth paying attention to what's going on around you. Otherwise you get blindsided, drift off into irrelevance, and miss out on a great deal of life's daily entertainment.

Wednesday, April 15, 2009

Fear Greed and all that follows

Right now we are watching a conflict blossom between the financial elite in this country and the political class. This is kind of fun because for the last generation the political class has turned itself into the handmaiden of the political elite (a handmaiden being a euphemism for an Emperor's Club escort), and the financial elite has come to regard the political class with all the trust and respect an Emperor's Club escort gets from her john.

Now, the financial elite collectively has a world view that would have fear and greed serving as the emotional yin and yang driving human behavior. And God knows there is room for the intrusion of behavioral sciences into economic analysis, and it is finally beginning as an offset to the quantative approach so mainstream today. (Fear and greed is just a simplified and bastardized summation of the consideration of behaviorial aspects of market performance and those who worship at the altar of Keynes may prefer the term animal spirits.)

But there is more to the world that fear and greed. Enter the political classes, an intrinsically messier group of people than the financial elite. Traditionally these guys have had their own simplistic yin and yang of the levers of power--the carrot and the stick. The donkey carries his load--feed him a carrot, the mule balks--smack him with the stick. It's roughly as sophisticated as the fear and greed analysis of market movements, and every bit as useful.

The Emperor's Club escorts are still operating on their johns' terms. They are thinking in terms of fear and greed. They need a dose of the old paradigm shift. As the freed slave told ole' Massah, 'de bottom rail on top now.'

It will take a couple of months, and a few more cards will have to turn, but eventually, the political class, or at least some of the less bent over elements within it, will realize that carrots and sticks, not fear and greed are what are operative in the current environment. It would premature, at this point, to start publicly brandishing the stick. It would not be premature to discontinue the endless appeals to greed to get the financial elite to do what it needs to do to salvage its sorry situation. It would not be premature to stop denying the realities of which the public is properly fearful. It would be premature to begin privately reminding people of influence within the financial elite that the stick does exist and has been dusted off. (The best targets for such reminders might be board members, legal counsel, asset managers, anybody but the managements of the institutions themselves, who would find being cut out of the loop even more terrifying than hearing the news directly.) The pretense that this is a liquidity crisis and that we are all doomed if the banks fail is growing thin.

The banks have failed, we are not all doomed, or at least we are not dead yet. But we need to start preparing for the world to come, rather than trying to prop up what's already dead and resuscitate the zoombies.

Tuesday, April 14, 2009

Patience, Process and Pianos

"See it, solve it, fix it," is the modern day technocrat's translations of "veni, vidi, vici." There is a tendency to look at the mess in the financial services sector, take a look at the state of the general economy, do a down and dirty on just what that means for real estate values, credit card receivables and corporate credits, and reach the inarguable conclusion that the banks are currently insolvent, individually and collectively, that the passage of time is only going to make things worse, and that the only question is whether a few of the strongest ones will tumble into the abyss without government life support from their own stupidity or because of systemic issues of counterparty risk. But that question isn't very important from a systemic perspective--it amounts to debating the seamanship of the Somali pirates.

Having sized the situation up, then it is a simple matter of solving for 'x'--in this case a healthy prosperous private sector banking system meeting the needs of the general economy and providing plenty of post-public service enrichment opportunities to the political classes. Having seen it and solved it, fixing it comes next. This is the part most people aren't very good at. At least not the people who become consultants, venture capitalists, lawyers, professors, investment bankers, analysts, technocrats.

It should not be particularly difficult, assuming everyone involved understands on which side their bread is buttered, that the public is cut out of the process (I'm afraid that 'populist' and 'public' have the same Latin roots), and this inconvenient internet technology invented by the venture capitalist vice president Al Gore doesn't blow the lid off the sausage maker. Still, even without the internet, the sausage maker is perpetually gummed up. I guess everybody's too good and too smart to learn how to take it apart or get their hands dirty cleaning it.

I am as guilty of this as the next technocrat or policy wonk. To paraphrase T.S. Eliot, between the thought and the deed, between the word and the action, falls the shadow.

We are in the shadows now.

There is a dynamic at work that no one is commenting upon. Everyone is growing impatient. Those noted Republican populists Richard Shelby and John McCain are calling on the president to allow Citigroup and Bank of America to fail. Because he won't take decisive action, Obama's supporters to the left are muttering about regulatory capture and threatening to wash their hands of him on the grounds that he's sold out to Wall Street. As for the vaunted stress tests, some are contemptuous of them, some are confused by them, and many are bored with them.

I tend to think of the stress tests as a political fig leaf. Fig leaves can serve a purpose. Travelling through Italy last year, I saw a fair number of fig leaves. It was easy to think of them as rather silly, but they served their purpose. At least, when the choice was being made, instead of getting rid of a significant piece of sculpture and replacing it with something vapid and chaste, there was a minor debasement of a major work of art, which survived as a consequence.

Step back, and regard the current situation as an unfolding dynamic. At the end of the day, all of the major financial institutions in the country will have failed. The survivors will have been chosen by the government, capitalized by the government, and initially managed by the government. While they may continue the wear the colors of the gangs that destroyed them (the Stage Coach may well roll on, the house of Morgan may remain in the lexicon), they will be defined by and dictated to by regulatory authorities more focused on their meeting the needs of the general economy than their maximizing value for their shareholders (assuming they have any).

However, this is a result that is going to take time. Bluntly, the banks must first fail, and the financially elite utterly discredited, before the political will to reform the financial services sector will develop. Even then it will not develop unless the failure of the financial services sector has a sufficiently vicious impact on the public. No one in there right mind would wish for that latter. Unfortunately, if the current regime of technocrats (Bernacke, Paulson, Geithner, Summers, etc.) are correct, that vicious impact is inevitable if there is a systemic failure. So, they are in denial of the possibility of a systemic failure.

It is liberating to say that there is a possibility, verging on inevitability, of a systemic failure, and to start thinking about what comes next. It then becomes possible to start considering steps to ameliorate that vicious impact (recognising its inevitability), and reform the financial services sector, rather than revolutionizing our current forms of economic organization.

I am currently, in my dotage, learning to play the piano. Playing the piano, for an adult, is an interesting discipline. A piece of music has a tempo, it proceeds on a beat. A sure way to muck it up is to hurry it up. It must be allowed to unfold at its own pace. You can't go fast through the easy parts and slow down when it gets hard. And, as you master the piece, you discover that it has a dynamic. To interpret the music, you have to be able to express the dynamic.

That's where we are in the reformation of the financial services sector.

Monday, April 13, 2009

Larry Summers?

Is Larry Summers going to be the Andrei Schliefer of the Obama Administration, or is he merely Henry Kissinger without the refined moral compass?

In any event, I doubt we'll ever hear about Larry Summer praying on his knees with a scotch-sodden Obama. Ultimately, Obama will go looking for siloviki.

A wonderful thing about the internet is that it makes footnotes and explanations less needed. Simply google or use wikipedia for 'Schliefer', 'siloviki' or, for that matter, 'Kissinger' or 'moral compass', depending on your age.

Sunday, April 12, 2009

Of Arabs and Arbs

The two words sound about the same in English spoken with a West Texas twang. Just ask the guys who ran El Paso Natural Gas into the ground back in the '80s.

The good news is that if you are still alive, your way of life will probably survive the current financial crisis. The bad news is that you may not survive the next one, which is coming, and if you do survive that one, there is another one coming after that.

I tend to look at the current situation as though it had two components--a severe recession in the general economy and a solvency crisis in the financial services sector. I'm in good company taking that view, but it's important to remember that the one affects the other--so that the recession was triggered by the financial services sector liquidity crisis, and the future solvency of the financial services sector is virtually certain to be impacted by deteriorating conditions in the general economy.

That said, let's statically assume that the stimulus package will 'work', bolstering the level of economic activity and buffering the worst of the recession's impact (without regard to the failure of the social safety net in the current environment). And let's assume that eventually one of the bailouts does the trick and we have a financial services sector in which, even if lending activity is non-existent, the comp committee is meeting again. In other words, the recent bear market rally correctly discounting an imminent mild improvement in short term economic conditions (I leave for you to decide whether that is merely a slowing or end of the deterioration or an actual improvement off the new base--nobody is realistically projecting a return to the glory days).

What does that success buy us? I think it buys us two things. First, it will give the feedback loop time to run from the general economy back into the financial services sector. Already weakened financial institutions will have to absorb the consequences of the recession (remember that the current capital crisis came out of the clear blue sky in a healthy general economy, this new event is much more typical). Of course, whether, even with government injections, the institutions can find the capital buffer to absorb that is a problem for another day (i.e., the next crisis).

The second thing that it buys us is time to deal with the issues the People's Bank of China has begun ventilating in articles and speeches by its personnel and on its website. In the most thought provoking thing I have read this month was Martin Wolfe's conjecture that these concerns will lie at the root of the next global financial crisis. Well, the premise there is that there will be another global financial crisis, and that it will come sooner rather than later. I think that's a sound premise. How it will be manifest--a currency crisis, a refunding crisis, inflationary pressures from monetizing the costs of the bailout--is a topic for the future.

The human mind is wired so that it vividly remembers major events, but memory tends to screen and obscure the details of the circumstances of those events and the mechanics by which they unfolded. There is a great deal of talk about the Great Depression and the 70s, but most of it omits the gritty fact that those Big Events were actually a series of smaller, cumulative crises that unfolded through time, frequently with the policies intended to address on crisis triggering the subsequent one. In neither of those situations did the internal dynamic of a market economy, as tweaked by the inputs of technocrats in positions of regulatory power, determine the more important outcomes.

As much as the economists are clutching to John Maynard Keynes and The General Theory, it might be time to recall The Dialectic of History, too.