Wall Street bull—-

(FT) We are at the point of maximum confusion in the multi-year transition of the global economy, markets and policymaking. We have left the global growth regime that was driven primarily by debt-financed consumption in the US, but we have not as yet reached a position of more balanced, albeit anaemic, growth. Those who lack a robust anchoring framework, be they investors or policymakers, risk being misled and backtracking to outdated ways of thinking.

Multimedia: Banks still making billions using high-risk derivatives

The signs of inappropriate reversion are multiplying. Confusing temporary factors for sustainable ones, a growing number of analysts have extended the ongoing stimulus/inventory bounce to a V-like recovery next year and beyond. The momentum for meaningful financial reform is stalling in spite of clear evidence that financial activities have far outpaced the regulatory infrastructure. And some banks are returning to the bad habits that almost destroyed them.

FT  EDITOR’S CHOICE

Analysis: Wanted, a new model for markets - Sep-28

Video: The ‘black box’ lives on - Sep-28

Savers losing faith in banks - Sep-27

Analysis: Costly cogs, misfiring machine - Sep-27

Opinion: In defence of financial innovation - Sep-27

FT Series: The Future of Investing - Sep-28

Reversion to Mean

This reversion is intimately linked to the inadequacy of the anchoring analytical frameworks. Appropriate frameworks provide important protection against the short-termism that can contaminate markets and policymaking. By contrast, ill-designed frameworks can encourage short-term thinking, leading to market and policy overshoot on the way up and down.  Today’s lack of appropriate anchoring frameworks appears to be exacerbating short-termism. The issue goes well beyond the still-limited appreciation of the multi-year realignment of the global economy, which is gaining momentum. It also relates to tendencies well-documented by behavioural economists – such as framing the problem wrongly and refusing to question past approaches.

Given all this, we would be all well advised to follow the admonition of Mervyn King. Last month, the governor of the Bank of England stated bluntly: “It’s the level, stupid – it’s not the growth rates, it’s the levels that matter here.” Investors have not yet accepted his insight that the absolute levels of income, debt, wealth and unemployment, not just the rates of change, are what matters today. They need to, and soon.

Analysis of key levels in the global economy points to important deviations between desired and actual levels. The outlook for major countries will continue to be driven by the levels of key variables, not their rate of recovery. Consider four examples.

First, consumer indebtedness is still too high relative to income expectations and credit availability, particularly in the US and the UK. This inconsistency will hold back any sustainable bounce in the most important component of aggregate demand.

Second, some banks’ balance sheets are still too geared for the comfort of regulators or their own managers. This will inhibit them from lending to the real economy at a time when certain sectors (such as commercial real estate, but also residential housing) still require significant refinancing, and when consumers need time to work down their excessive debt loads.

Third, unemployment has risen well beyond expectations, and is likely to prove unusually protracted. It will take years for US unemployment to return to its natural rate, even after the natural rate shifted upwards. This will . . .

Read more here.

By Mohamed El-Erian writing for FT.  Published: September 28 2009

(NYT) WASHINGTON — The Federal Reserve and the Treasury are preparing broad new rules that would force banks to rein in practices that made multimillionaires out of many financial executives during the housing bubble, officials said.

The rules depart from the hands-off approach that dominated bank regulation for the last three decades, but are not as strict as proposals from some European leaders and suggestions from some members of Congress angered by the financial troubles of the last year.

Fed officials would give banks wide leeway in how they structure their rewards. They would not prohibit million-dollar pay packages or address issues of fairness. Rather, the rules are intended to restrict pay plans that encourage reckless behavior by rewarding only short-term gains.  And because the rules would be applied through the confidential bank examination process, it would be hard for consumers and investors to judge how strictly the rules were being applied.

The effort is also meant to be an alternative to proposals by some European leaders for specific limits on bonuses to financial executives, an idea opposed by the Obama administration. Officials from Europe and the Treasury are negotiating . . .   Read more here.

Fed Chief Ben Bernanke calls it: says U.S. recession likely over.

(NYT) WASHINGTON — The Federal Reserve chairman, Ben S. Bernanke, said Tuesday that it was “very likely” that the recession had ended although he cautioned that it could be months before unemployment rates dropped significantly. See FT.com report here.

“Even though from a technical perspective the recession is very likely over at this point, it’s still going to feel like a very weak economy for some time as many people will still find that their job security and their employment status is not what they wish it was,” Mr. Bernanke said in response to a question about unemployment trends. “That’s a challenge for us and all policy makers going forward.”

The cautiously optimistic assessment came at the end of a speech at the Brookings Institution observing a year after a market crisis that was precipitated by the collapse of the investment bank Lehman Brothers.  Shortly before the speech, the Commerce Department reported that retail sales had surged in August as consumers swapped old cars for new ones under the “cash-for-clunkers” program. The increase, by a seasonally adjusted 2.7 percent rate over the previous month, widely surpassed analysts’ expectations and was the largest monthly increase since January 2006. Mr. Bernanke said the consensus of economic forecasters was for moderate economic growth for the remainder of this year and next, particularly as credit markets thaw, consumer confidence takes time to heal and the federal government begins to unwind spending and lending programs intended to mend the economy.

“The general view of forecasters is that growth in 2010 will be moderate, less than you might expect given the depth of the recession,” Mr. Bernanke said, because of several issues, including continuing financial and credit problems, deleveraging by households and the need to end the economic stimulus programs. All these elements will “make the 2010 recovery moderate, in particular not much faster than the underlying growth rate of the economy,” he added. Read more here.

President Obama addressing Wall St. executives at Federal Hall

“It is neither right nor responsible after you’ve recovered with the help of your government to shirk your obligation to the goal of wider recovery, a more stable system and a more broadly shared prosperity.”

Mon, 14 Sept - President Obama reinvigorated his administration’s effort to reform the financial regulatory system by taking his bare knuckled message directly to Wall Street.  Speaking at Federal Hall directly across the New York Stock Exchange and using the one year anniversary of the collapse of Lehman Brothers the president reminded prominent financial industry executives of their role and risk-taking behavior that led to a global economic melt-down.  And flexing some muscle in the face of recent positive economic trends and a robust +48% rebound in Market performance from the March lows, the president also reminded the audience of measures his administration took to pull the Markets and the economy from the brink of collapse.

 Interactive Media: How the Lords of Finance Shrank, then Recovered

Pulling no punches the president offered a sharp admonition that “there are some in the financial industry who are misreading this moment.” “Instead of learning the lessons of Lehman and the crisis from which we are still recovering,” he noted, “they are choosing to ignore them,” Mr. Obama said in a speech at Federal Hall in Lower Manhattan. They do so not just at their own peril, but at our nation’s.”

Instead of learning the lessons of Lehman and the crisis from which we are still recovering, they [on Wall Street] are choosing to ignore them…They do so not just at their own peril, but at our nation’s.”

Turning screws a little tighter, the president added “I want everybody here to hear my words,” Mr. Obama said. “We will not go back to the days of reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.”

The president shed no new light, nor offered any new proposals to his administration’s financial industry regulatory overhaul plan called the New Financial Foundations. But he did outline how his vision and his plan could prevent future systemic risk and financial system meltdowns.  The president also specifically touted the administration’s plans to increase capital adequacy requirements at big banks, plans to give the Federal Reserve new oversight powers to regulate systemic risks to the financial system, and plans to establish a new consumer-protection agency, which would have broad powers over retail finance products such as credit cards, home mortgages and other consumer loans.  Mr. Obama also urged banks to adopt changes before Congress acts by simplifying the language they use with consumers, overhauling their executive pay structures or allowing shareholders vote on bonuses. He vowed to press the G-20 for action on regulatory reform, and cautioned top executives not to squander public trust with huge year-end bonuses.

We will not go back to the days of reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.

Of particular note on the one-year anniversary of Lehman’s collapse, a Federal judge citing basic fairness principles rejected a proposed legal settlement between the SEC and Bank of America over $3.6Bn in executive bonuses. Judge Jed Rakoff wrote the settlement “does not comport with the most elementary notions of justice and morality.”

‘This settlement does not comport with the most elementary notions of justice and morality. “It is quite something else for the very management that is accused of having lied to its shareholders to determine how much of those victims’ money should be used to make the case against the management go away”’

The ruling directed both the agency and the bank to prepare for a possible trial that would begin no later than Feb. 1. The case involved $3.6 billion in bonuses that were paid by Merrill Lynch late last year, just as that firm was about to be merged with Bank of America. Neither company provided details of the bonuses to their shareholders, who voted on Dec. 5 to approve the merger. The judge focused much of his criticism on the fact that the fine in the case would be paid by the bank’s shareholders, who were the ones that were injured by the lack of disclosure. “It is quite something else for the very management that is accused of having lied to its shareholders to determine how much of those victims’ money should be used to make the case against the management go away,” the judge wrote.

Several MSM sources provided excellent coverage of the speech which are outlined below.  In addition, you can find the full text of the speech here.

Web Resources:

Year later, economy poised for long recovery

The Obama Recovery Continues     

Obama Pushes Stricter Rules for Wall Street

Court Rejects Wall Street Bonus Settlement 

Powerful Wall Street Lobby Stalls Reforms 

U.S Taxpayers Earn $14 Billion Profit on Fed Bank Bail-out Loans

Ka-ching!!  According to reports in both the Financial Times of London, as well as the New York Times, the Federal Reserve has made a $14Bn profit on loan programs that have provided hundreds of billions of dollars in liquidity to the financial system since the start of the crisis two years ago, according to Fed officials. The internal estimate is based on the difference between the fees and interest on the lending facilities and the interest the Fed would have earned had it invested the funds in three-month Treasury bills. The central bank earned about $19bn in income from charging interest and fees to financial institutions and investors that tapped the new facilities to obtain much-needed funds during the turmoil. The interest the Fed would have earned by investing the same amount in T-bills was an estimated $5bn, leaving a $14bn gain since August 2007 for a handsome. The Fed assessment underlines the possibility that other central banks could make a profit on their crisis-fighting measures – at least before adjusting for the risk they assumed.

“The taxpayers want their money back and they want the government out of our banking system,”

Who's paying back..??

The profits, collected from eight of the biggest banks that have fully repaid their obligations to the government, come to about $4 billion, or the equivalent of about 15 percent annually, according to calculations compiled for The New York Times. These early returns are by no means a full accounting of the huge financial rescue undertaken by the federal government last year to stabilize teetering banks and other companies. The government still faces potentially huge long-term losses from its bailouts of the insurance giant American International Group, the mortgage finance companies Fannie Mae and Freddie Mac, and the automakers General Motors and Chrysler. The Treasury Department could also take a hit from its guarantees on billions of dollars of toxic mortgages. But the mere hint of bailout profits for the nearly year-old Troubled Asset Relief Program has been received as a welcome surprise. It has also spurred hopes that the government could soon get out of the banking business.

Credit Default Swap offering and structure

Profit of Doom

plan or your personal stock portfolio has tanked over the last two years or so, knows that it’s because of the global financial crisis. It was triggered by the collapse of the housing market in the United States and magnified worldwide by the sale of complicated investments – some, myself included, would say risky bets of the type found in casinos and betting parlors – that Warren Buffett warned about in March 2003, and once labeled these derivative products as ‘financial weapons of mass destruction.’

These instruments which used to be solely the province of “Bucket Shops” and for most of the 20^th century were illegal investment instruments are called credit derivatives or Credit Default Swaps (CDS). They were made legal in the 106^th Congress (2000-2001) by the financial industry lobby and complicit congressmen like former Texas Senator Phil Gramm and House Majority Leader Dick Armey (also from Texas) under their political party’s anti-government orthodoxy of “de-regulation.”  Today these instruments compose a $450 Trillion market – a veritable ticking financial WMD that can potentially wreck the entire global financial marketplace.

The reason I’m bringing all this up is because I saw an interesting segment this evening by 60 Minutes’ Steve Kroft, in which he walks viewers through the fundamentals of these financial WMDs called Credit Default Swaps (CDS) which were the derivative products underlying the near collapse of the global financial markets.  Ironically, these instruments are once again being structured and sold to investors as if . . . oh, what’s the point..??  Just check out the video.

Web Resources:

How to Understand the Derivatives Market

Congress Aims to Reform Derivative Markets

ECB Calls for More Transparency in Derivatives Market  

Americans in China

The New York Times featured an interesting article in today’s paper spotting a trend that more college graduates and corporate professionals are flocking to China in search of greener pasteurs for their careers. It’s thought-provoking and something even I might consider. . .

BEIJING — Shanghai and Beijing are becoming new lands of opportunity for recent American college graduates who face unemployment nearing double digits at home.

Even those with limited or no knowledge of Chinese are heeding the call. They are lured by China’s surging economy, the lower cost of living and a chance to bypass some of the dues-paying that is common to first jobs in the United States.  “I’ve seen a surge of young people coming to work in China over the last few years,” said Jack Perkowski, founder of Asimco Technologies, one of the largest automotive parts companies in China.

“I didn’t know anything about China,” said Mr. Stephens, who worked on market research and program development. “People thought I was nuts to go not speaking the language, but I wanted to do something off the beaten track.”

Two years later, after stints in the nonprofit sector and at a large public relations firm in Beijing, he is highly proficient in Mandarin and works as a manager for XPD Media, a social media company based in Beijing that makes online games.

Jonathan Woetzel, a partner with McKinsey & Company in Shanghai who has lived in China since the mid-1980s, says that compared with just a few years ago, he was seeing more young Americans arriving in China to be part of an entrepreneurial boom. “There’s a lot of experimentation going on in China right now, particularly in the energy sphere, and when people are young they are willing to come and try something new,” he said

And the Chinese economy is more hospitable for both entrepreneurs and job seekers, with a gross domestic product that rose 7.9 percent in the most recent quarter compared with the period a year earlier. Unemployment in urban areas is 4.3 percent, according to government data. 

Read more here…

The US government is taking a clear stance against bonuses paid out by companies receiving bailout funds.

Question: What happens when an 80% shareholder of a company decides that the $165 million in bonuses contracted to employees prior to the purchase of shares are an abuse of the over $170 billion given in taxpayer bailout?

Answer: American International Group CEO, Edward Liddy, asks bonus recipients who received $100,000 or more to return at least half of the money back.

This recent chapter in the travails of the current U.S. economic crisis has become quite the controversy as it has exposed the underbelly of the federal bailout; how far can the government go in nationalizing companies before it inhibits stability and growth? A clear position from the government on the issue has begun to surface with the case of AIG, expressed quite poignantly by Massachusetts Representative and Chairman of the Financial Services Committee, Barney Frank, in a statement on CNN’s American Morning:

“The notion that we want to retain these people, that we want to pay the people who messed it up in the first place, so they don’t leave is just backwards to me… we [the government] own this company in effect, and we’re not asking that these bonuses be rescinded because we have lent money to the company, I believe we are saying as the owners of the company we do not think that we are paying bonuses or should have paid bonuses to people who made mistakes or are incompetent.”

For the complete 18 March interview with Barney Frank on American Morning, click here:

From the top, down we’re hearing the government express a relative degree of solidarity against what is being viewed by many as the misuse of bailout funds, including those vehemently against the most recent bailout’s amount of oversight. Representative Scott Garrett (R – NJ), a member of the Capital Markets Subcommittee, pointed questions toward those unhappy with AIG’s course of action, asking “What did you expect, and why weren’t you asking more questions before?” And given the sheer magnitude of monies spent by the federal government in national financial bailout, both sides of the debate are experiencing greater resistance as the government’s reach increases with the bailout’s price tag.

But just how far can the government go?

Rep. Barney Frank makes a very poignant distinction of note, later in the American Morning interview, when he mentions what is legislative vs. legal. In the case of AIG, Washington is first seeking legal action against AIG as everything from taxes on bonuses as high as 91% and lawsuits are on the table to subvert the use of funds as bonuses. New York Attorney General Andrew Cuomo even threatened the insurance company with subpoenas unless records of bonus information were revealed, using the 1921 Martin Act to gain convictions in investment related cases without proving criminal intent. (See NY’s Cuomo wins praise for pursuing AIG on bailout) And with 80% share of the company, the U.S. government is the majority shareholder and thereby has the legal voting rights on compensation packages, especially when dealing with the performance or underperformance of employees.

However, the true test of the AIG bonus fallout will be the impact of Liddy’s decision on corporate management by those companies also currently receiving federal aid. Many banks receiving funds from the original $350 billion bailout have begun to reconsider retaining these funds, citing the federal governments zealous and pliable exercise of legislative power. A 10 March New York Times article entitled “Some Banks, Feeling Chained, Want to Return Bailout Money”, found here, provides a good bit of insight into the conditions many of these institutions are wrestling with as they come to terms with the growing implications attached to this financial “lifesaver” being tossed by the federal government.

And if a clause giving shareholders (i.e. Uncle Sam) the right to vote on executive compensation packages wasn’t enough to make many of these executives nervous, House Representatives took charge on Thursday passing a bill to tax 90% of bonuses paid out since 1 January to AIG or any other company currently receiving more than $5 billion in federal aid. The Senate on the other hand has proposed a 35% tax on AIG bonuses and a 35% tax on the company; a bit milder of an alternative seeking to return a portion of taxpayer dollars toward other stimulus efforts.

From Main St. to Wall St. the argument continues on with each passing day. How will fairness and equality be delivered during this time of financial crisis. And as new theories and arguments about the best course of action will continue to develop, I’ll leave one in closing: Morton’s Fork.

Under the rule of Henry VII lived Lord Chancellor John Morton, who, in 1487, developed a policy of tax collection based in a two pronged argument: if a subject lived luxuriously he obviously had sufficient income to spare for the king, and if the subject lived frugally, he must have substantial savings from which he could afford to pay sufficient tax to the king. Dubbed Morton’s Fork, either choice of lifestyle for subjects under Henry VII’s rule painted an unfavorable conclusion, as no matter how one chose to live, he was still subject to an increased level of taxation.

As the federal government seeks economic stability and fairness, and Morton’s Fork is applied to companies decisions to choose bailout money or not, let’s hope that the windfall of increased government scrutiny over the use of funds doesn’t eclipse the bailout’s original intent: economic stimulus.

The FOMC today announced plans to buy $300B in treasuries and up to $750B in mortgage-backed securities, effectively agreeing to print a trillion dollars.

Well, we knew the money had to come from somewhere. When the federal government wants money, there are four places they can get it:

1) Take from other parts of the budget (Social security and military spending are the two big ticket items.)

Quite simply not going to happen. Both of the above are sacrosanct.

2) Increase taxes

Seems unlikely. This year’s budget included tax cuts for the middle class. The increased taxes for the rich seem unlikely to even make up the difference, since entrepreneurs are unlikely to be active in this economic climate, bonuses are way down, and big earners still have a variety of ways to shield their income. Raising taxes on an economy you’re trying to stimulate also sounds a lot like one step forward, one step back.

3) Borrowing money by selling treasuries

We’ve been doing this. But nobody in the world has the liquidity right now to support our enormous stimulus apparatus.

Printing money causes inflation, which nobody likes. Inflation can be looked at as a tax on savings, which doesn’t sound good. It’s also a tax on debt securities, which is even worse. Our foreign and domestic creditors, who have already funded quite a bit of our enormous bailout, are going to be understandably upset.

But the fact of the matter is, all of the other options are exhausted. If we’re going with a Keynesian solution, which the Obama administration as well as the plurality of academia seem committed to, then the cash has to come from somewhere. Overall, I think today’s news is frustrating, but inevitable.

At least the leprauchans won.

In a strange piece of spin, the New York Times says today that the financial crisis will wind up being good for China. It’s an unconvincing position to say the least. It’s true that, unlike the West, China has no trouble with currency exchange or stock markets, which are state regulated, or bank failure, because all of the banks are state owned. Or, to put it another way, the worst case scenario in the West is already the status quo in China.

The Chinese trade surplus is down almost 90%,  but apparently that’s ok, because the Chinese government is allowing their semi-private companies to shop more easily for foreign acquisitions. Foreign acquisitions at a time like this are a dubious proposition, and could just as easily wind up being deadweight losers as undervalued investments. Unemployment is down, wages are down, clothes are piling up in the factories, white collar workers are unemployed and may wind up a source of significan unrest. The Times says that this is “causing personal pain but reviving China’s advantage in labor costs.” I’m sure the laborers are pleased about that.

But! Unemployed laborers can now be part of a vocational retraining program to prepare China’s workers to better participate in the global economy. Call me a cynic, but that sort of language makes me think of the PRC’s last vocational training program.

Overall, it looks grim to me. China’s export dependence means that recovery will not happen there until it happens in the West. Their centralized economy is less agile at dealing with hardship, and the potential for social unrest is high. But on the bright side, maybe pressure from the unemployed will be able to achieve some liberalizing reform that was impossible during the good times.  Like Hu Jintao said, “Challenge and opportunity always come together — under certain conditions, one could be transformed into the other.”