The Piano Tuner's Report

According to our piano tuner, these are hard times to be in the business of selling pianos. They are expensive, not exactly necessities, so no surprise there.

What is a surprise, is that he says these are good times for piano teachers and piano tuners. Compared to conventional retail therapy, a weekly piano lesson are apparently a mere pittance. And, in a tough economic climate, people turn inward and try to find a space that doesn't cost much to occupy. If you already own your piano, playing it fits the bill--it's much cheaper than a round of golf or a massage.

So, on his tuning appointment before mine, he tuned the piano of a guy who'd been told he was to be laid off and the end of the month. The guy said he wanted to get the piano tuned while he still had a paycheck, and, soon to be out of work, he figured he'd have plenty of time to play it.

At least it hasn't gotten to the point where people are trying to raise cash by selling their pianos. If that starts happening, the D word may be the right one to describe the economic climate.

Let's Do the Two Step

Face, a bad bank, ring fence, troubled asset relief purchase approach to resolving the insolvency of the financial services sector makes no sense, if it's a one step approach. But if there is a hidden agenda (or a multiphase strategy, to put it more politely), it may be a good first step.

Step one. Buy troubled assets at a fair price. A fair price is above the market clearing fire sale price, on the one hand, but it's below the mark to model carrying value of the 'asset' on the financial institution's balance sheet. In the presence of a willing buyer in volume at a fair price, the accounting justification for mark to model disappears, and all holders of like assets must mark them them to the 'fair price.'

Step two. Marking these assets to this price will blow enormous holes in the balance sheets of any number of financial institutions. It will result in portfolio losses for any number of pension funds, endowments, hedge funds, etc. These will be the inevitable consequences of the 'price discovery' process.

Step three. Manage the resulting insolvency of the regulated financial institutions. In a nutshell, de facto nationalization, but perhaps graded in to dismantle the side bets without bringing the edifice down. In other words, shut down the casino for good, or for a generation, at least, but preserve the utility like functions of the banking system that justify special relief for it in the first place.

Step four. Keep a weather eye out for systemic risk resulting from the stress on other institutional investors--CalPers, the Texas Teachers Retirement Fund and similar entities will have to be monitored, but it's not clear what, if any, assistance they will require.

Halo Slipping?

The tax problems of the Obama nominees may be a precursor of business as usual. Withdrawing the Richardson and the Daschle nominations raises two questions. One, was the issue one of bad vetting or bad judgment? Two, has the Democratic establishment under the Bush Administration been as tainted with venal habits as their Republican counterparts.

Probably, answers--to question one, both, to question two, yes.

Number Games

When is ten percent not ten percent?

There is a game that gets played when people start talking about peak-to-trough declines. It goes like this: Let's say that the nearest historical parallel to the performance of an asset class is a 50 percent decline, peak to trough, and that the asset class in question has declined 40 percent to date. To reach the 50% mark, what further decline is required?

If you said, 10%, you are right, but only if you are measuring off the peak price. The percentage decline from the current price required to get from 60% to 50% is closer to 16.7%. That's because to drop from 60 to 50 requires a drop of 10/60, or 1/6. A 10% decline from 60% would be a reduction of 6% to 54%. A 16.7% decline from 60% gets you to 50%.

So, it's a common mistake. But not one you'd expect the former chief economist of the IMF to make writing in The Wall Street Journal.

Another common mistake is to take a factoid and mangle it. Assume that it is true that 10% of the residential real estate mortgages in the United States is in default, delinquent or otherwise troubled. That does not mean that 10% of American households are in default, or even that 10% of American homeowners are in default (the home ownership statistic in America is around 2/3rds, and about a third of the homes that are owned are not mortgaged.

Enough of this.

How will America react

culturally and politically to relative decline in its economic strength and global political pre-eminence?

The world doesn't love us. Some of it fears us, some of it respects us, some of it has some lingering appreciation for past services rendered. A relatively small but growing sliver hates the United States and holds its people, its culture and its values in contempt. The last couple of years have, unfortunately, been kind to that sliver. But the vast majority of the global population is in a watching mode, waiting to see how all this unfolds for the good ole USA.

We do seem to be headed for a diminution. The last time this happened was in the 1970s, but that turned out to be a false dawn for the old Soviet Union. Despite the initiatives in Africa, and in part because of those in Afghanistan, efforts to exploit American weakness in a variety of global theatres failed more or less completely--less because of the skillfulness with which the U.S. government countered and more because the 'correlation of forces' about which Soviet strategists of the time blathered turned out to be illusory and the internal contradictions, not of capitalism, but of the Soviet Empire turned out to be mortal.

This time around, I don't see the Chinese reacting with the same eagerness and embarking on a self-destructive exercise in global over-reach. But I also don't see the United States in quite the distress, in terms of a military quagmire or economic morass, that we found ourselves in by the early 70s. The Iraq adventure has not come at the internal social cost incurred in Southeast Asia, and so far the economic is not as indescribably screwed up as it was by 1973--with price controls, inflation and alternate day gasoline rationing. Give our politicians time, and we may achieve a similar level of economic misery, and make no mistake, even if the internal political costs of Iraq are lower than those of Vietnam, there were be a price to be paid, in terms of international power, for mistakes in the Middle East.

It will be interesting to watch the take of the American public on all this as it unfolds. So far, we're not quite to the level of scapegoating--although public outrage at Wall Street compensation could easily evolve into that. And some scapegoating might be healthy, cathartic and cautionary.

New York--Detroit Redux?

Rudy Guiliani has pointed out an inconvenient truth.

The regional economy of the New York metropolitan area is driven by the bonus structure and bonus dollars of the financial services sector. Take away the excessive financial services sector compensation, and the place will start looking like it did back in the 1970s.

Stop and think about it. What drives an average Manhattan apartment price to around a million dollars? What makes five thousand dollars a month seem like a reasonable rent for a one bedroom apartment? Where does the money come from to pay all that private school tuition?

The antics of the new Guilded Age may have seemed pretty repugnant to those of us on the outside looking in, but there is no denying the trickle down effect. All those nannies, car service drivers, executive coaches, real estate agents and so one were indirectly feeding from the trough that was nourishing the managing directors and their kin. Take away the bonus, take away the personal trainer. This year, send the kids to camp to pass on renting in the Hamptons. Let's do something more adventurous (and cheaper). It's pretty safe to predict that there will be many fewer new kitchens, much more jewelry discretely on consignment, and an reduction in the size of expense account tabs.

Generally, the regions that have been ground zero for the economic impact of bad news have been peripheral, perhaps even remote. Detroit is a long way from either Coast. Back in the 80s, the Oil Patch was flyover territory. Today, in Southern California, the misery is centered in the Inland Empire, and a few delusional homeowners are still hoping that the Westside of LA will get a free pass in this mess (it won't).

Well, it looks like the residents of Manhattan, the tonier parts of the outer boroughs and the better suburbs are going to get to eat their own cooking for a change. I hope they like Spam.