Friday, October 29, 2010

Home and Away

Consider a country in another time and space. It is big and sprawling. It is too big and and too sprawling to be governed by a cadre, ruling class or oligarchy. It is a veritable nation-state of quasi-continental dimensions. In form it is a representative government, somewhere between a people's republic and a constitutional monarchy. But its political processes are as captured and as ossified as one might expect of an ancient, honored and imperial republic. Not a single party state by any means, but two parties jointly rule in a comfortable though occasionally unruly duopoly. This country still imagines itself as a Beacon on a Hill.

As might be expected, it has a political class and a financial elite. They are not exactly open, and not exactly closed. Porous is perhaps the best way to think of them. And much of the rest of the place is not particularly interested in joining either. There is also a cultural elite (several, in fact), various underclasses of varying hue and diverse origins, and all the complications and ramifications of several centuries of development as a civilization (all the while trying to imagine itself as a source of innovation and progress). For whatever reason, that bit is critical to its identity.

A few years ago, an economic crisis developed, mostly as a result of internal contradictions in organization, but in the aftermath of a some fairly miserable foreign adventures. And the situation had enough external aspects that it is possible, as most peoples are want to do, to blame the rest of the world for the current difficulties. As a result these people find themselves is a slow and tedious recovery without the instant return to happy prosperity that they believe is their due as the world's Beacon on a Hill and source of innovation and progress. That has soured the politics and the economy, and made them a bit more unruly, but so far had no greater ramifications.

In the throes of the economic crisis, that financial elite successfully held the political class hostage with a threat that boiled down, according to a domestic humorist, to 'save our banks or we'll kill your economy.' A reasonable number of the banks were saved, and since then the government has papered over (literally, printing gobs of the stuff) the inability of the banking systems to meet broad swaths of the mandate its social contract implies. In the process, interestingly, various agencies of the government have developed a set of procedures, capacities and competencies that significantly reduce the necessity for a financial services sector as presently constructed. But that has occurred almost by stealth, with virtually no public comment.

In the aftermath of the crisis, the political class was collectively enraged by the failure of the financial elite that it had just saved to 'stay bought.' This is entirely understandable. As a group the political class is premised on relationships rather than transactions. Relationships come in all varieties and strengths, but they are generally characterized by concepts of power, obligation, and nuanced flexibility through time. As a group, the financial elite is oriented towards transactions. Transactions come in equal variety, but they are generally one-off, creating no long term obligations, and the terms are set at the outset, lived up to, then renegotiated (or confirmed) before the next piece of business is done.

From the point of view of the financial elite, the political class were suckers. They didn't extract enough advantage at the outset of the transaction and so they sold their assistance too cheaply. To come back afterwards and expect to recut the deal is naive beyond words. Once past the crisis, the sensible thing to do, for the financial elite, was address the urgent rebuilding of their wealth--both at the institutional and the personal level. The public optics of that exercise would be manageable.

Fairness compels a distant observer to note that the first match of this series was fought in the home court of the financial elite. The political class was operating on the turf of the financial elite, for high stakes. The early innings moved at a fast moving pace, without time or space for reflection, compromise or error. When in its latter stages the political class attempted to collect for its assistance, it got stiffed (so did the public interest, but only a fool would expect optimal policy outcomes in a game played by these rules).

And there will be a rematch. It may come fairly soon. But it will not play out quickly. It will not play out on the home turf of the financial barons. It may not play out in public. And the result is not foreordained.

I have the sense that the opening volleys are being fired in this whole mortgage fiasco. The early efforts to quantify the impact are fairly amusing. We haven't even figured out how to characterize what's been going on. Is it a paperwork snafu caused by antiquated real estate filing requirements under state law? Is it the commission on an almost heroic scale of routine criminal acts of forgery and perjury for which bank charters should be surrendered and senior executives imprisoned. Is it a systems breakdown that with the commitment of organizational resources on a massive scale can be remediated. Is it the sort of back office failure of epic proportions that delivered the final blow to so many Wall Street brokerages of the Go-Go Years and required a regulatory reshaping of that landscape?

So damage assessment is way premature. How this plays not only will depend on what needs to happen to fix the problem that first brought it to light. It will depend on a variety of other agendas: internal agendas, public agendas, regulatory agendas, private agendas. And the battle lines aren't drawn yet, the roles haven't been defined. Look at the New York Fed--it is a regulator, customer, agent, plaintiff, etc., etc.

And just because the financiers won their home game, that doesn't give them any advantage when they play away. If the way they've run their operations in the past is any sign, Big D has never been a strong point on their side. And that's what will be needed. Nor have cohesion, class solidarity or anything else along the lines of cooperative, collective, united front activities been strong points. Their leadership are the alpha fish of a shark tank--cold, slimy, powerful, dangerous and stupid.

Furthermore, on the basis of their behavior since the crash, I think it is more likely that they will be hooked, netted and filleted. But time--lots of it--will tell.

Tuesday, October 26, 2010

Throwing in the Towel

Is this the beginning of the end,
for our old friend,
extend and pretend?

At least as far as the commercial and residential real estate markets and the continued viability of the financial services sector as presently constituted are concerned?

Consider the following seven data points/factoids/developments:

1. Over the summer the first time home buyer incentive program came to an end. There is no political appetite for resuming it.

2. All of the housing indexes are indicating a resumption in house price declines. Good news for home buyers, bad news for home owners and lenders.

3. Residential and commercial construction is dead. Still dead. Not yet undead. Making no contribution to the 'recovery,' such as the recovery is.

4. HAMP was a failure. And servicer footdragging/non-cooperation that contributed to that preceded the inevitable homeowner redefaults to come.

5. There is the nasty little problem of a huge slug of not-yet-written down second mortgage loans on the books of various TBTF financial institutions (arguably a reason for the footdragging mentioned in point 4?).

6. The commercial real estate market, which hasn't been supported with the kind of governmental effort that has distorted the residential market, has resumed its decline and continues to set new lows. A contributor to continuing weakness of bank balance sheets and a harbinger of the residential real estate market?

7. The foreclosure gate scandal is leading all kinds of revelations about how the originate-to-distribute business model has actually been functioning (perhaps since inception?).

And a bonus, freebie, consideration--18 months ago the feds required the major banks to prepare stress tests predicated on a pair of assumptions concerning the path of residential real estate prices and unemployment levels. House prices could drop slightly more than 15% from where they are today without dropping to the the price levels projected in that exercise for the base case. House prices would have to drop almost 25% before reaching the levels projected in the more adverse case for the stress tests.

All of this suggests that a strategy of 'let's just hold things together 'til things get better' may have exhausted its utility and that the the time may have come to actually address the problems.

Monday, October 25, 2010

G20 Meeting and the Lessons of Japan

The truth that was illuminated at the G20 meeting.

If you assess currency manipulation by the impact of policy on exchange rates rather than the announced intentions of policymakers, we are all manipulating our exchange rates.

Er, so let's change the paradigm?

The Lesson of Japanese Lost Decade.

In a world of globalized trade and free international capital flows, the effects of a Keynesian approach to economic stimulus at the nation state level will dissipate across the globe and cannot be effectively targeted within the geographical boundaries of a national economy actively participating in the international trade (probably either as an exporter or an importer). You simply turn your currency into a funding vehicle for the carry trade.

Anyone care to speculate in the emerging markets using the dollar as a funding currency?

Sunday, October 24, 2010

Blood on the Knife

We need some blood on the knife.

That's my takeaway on the progress of the financial crisis so far. There is a public appetite for blood on the knife, and it hasn't been satiated. To put a finer point on it, the retributive aspect of justice has been sacrificed to the pragmatic interest in keeping the wheels on the system. It's time to shift gears.

There is an inchoate sense of rage that the people who made this mess, and profited handsomely from it, are getting off scot-free, leaving the rest of us to clean it up and pay for it. I think that's a big part of the Tea Party rage and will be the explanation for the midterm success of the Republicans (one of whom in Texas, my God, is calling for armed insurrection, claiming it is constitutionally permissible. Not since Edmund Ruffin of South Carolina in 1861 has such nonsense, oh, wait a minute, I forget Rick Perry of Texas about 18 months ago . . . )

I wish I could say that those in authority above us are too principled and committed to the rule of law to indulge such a taste. But I don't think so. The perp walks following Enron and the other scandals of a decade back suggest not. I think they are simply gutless, spineless and clueless.

It's time to throw some resources into criminal task forces. Now, there's a shovel ready project everybody can agree on.