Author Archives: sdiamond

Geithner and reality: keeping the deregulatory “counter-revolution” alive

For anyone who is interested here is a link to the testimony today of Treasury Secretary Geithner, who survived calls for his head this week with a little boost from the markets. Geithner is very busy these days making sure people think he is up to big things.

Don’t be fooled.

This package is aimed at defusing far more radical calls for restructuring the financial system in order to allow business lobbyists to carve up the reforms into tiny bite size pieces that can be easily digested.

If Geithner were serious about reform – well if he were serious he would not hold his job for long – but let’s assume we had the opportunity for serious reform, what would one have to confront?

The basic problem is that over the last several decades a conscious sophisticated effort begun by the United States Supreme Court under the leadership of Justice Louis Powell has slowly but effectively unraveled the regulatory framework put in place in the 1930s in the wake of the first global collapse of modern capitalism. The New Deal revolution, sealed after the war by a global labor-management consensus or social contract, was gradually undone on multiple levels.

Calling this counter-revolution “de-regulation” hardly does it justice. It was, in fact, the creation of an entirely new political economy, global in scope and massive in its complexity. It is, overwhelmingly, outside of the control of government much less the democratic polity.

Let’s take a single example: at the core of regulatory principles of the financial markets put in place in the 30s is the simple idea that if you sell a security such as stocks or bonds you must register that sale with the SEC including detailed information that must be provided to purchasers of the security prior to their decision to close the sale. The counter-revolution started by Justice Powell, however, made it acceptable to redefine the term “security” so that a wide range of new types of financial instruments were exempted from the registration requirements.

That, in turn, led to all sorts of investors being sold securities that they often did not understand. Examples abound: the collapse of Orange County, the Enron frauds, the crash of WorldCom and now the implosion of major investment banks, commercial banks, insurance companies and even government sponsored enterprises like Fannie and Freddie.

Thus, a simple proposal: if you want to begin the process of rebuilding a constructive and reliable means to channel our savings into productive investments that are socially useful, re-impose the basic requirements of our federal securities laws and require that sellers of these securities provide purchasers with the information they need to make an informed investment decision.

But as I said the de-regulation counter-revolution built an entirely new political economy. That political economy has been deeply damaged. But it has not sunk and so its beneficiaries will defend it. Geithner, of course, is their man in the Administration and once again today the market sent up a strong signal of support as they did on Monday when they realized that he was in trouble. They fear a turn to the left that might make their life a little too complicated.

So watch Geithner with interest – his role on the world stage right now is to defuse the possibility of genuine reform while maintaining the illusion of significant change. That produces a fascinating form of political theater.

The AIG Scandal – An Insurance Company that wants to be paid? Surprise, surprise…

I was interviewed on Oakland-based KTVU about the AIG scandal. You can watch it here.

A key point I was not able to work into the discussion: we need to keep in mind the larger picture here.

First, according to a must read profile of the AIG Financial Products unit in Rolling Stone, its 400 employees were paid some 3.5 billion dollars in salary and BONUSES over the last seven years, including $280 million to the group’s founder Joe Cassanno, a veteran of the junk bond fraud run by disgraced financier and now ex-con Michael Milken. And yet the US Treasury – led by Neel Kashkari – thought it essential to hand them $40 billion in new money last fall and only limit the bonuses paid to the top executives of the holding company, AIG parent, not AIG Financial Products!

Second, what value have these financial geniuses brought the US public for our $40 billion (followed by another $100 billion or so since, including a $30 billion line of credit a few weeks ago)? Instead of negotiating with their counter parties to whom they sold the Credit Default Swaps that were at the heart of the AIG-FP business model, they apparently just paid them off at 100 cents on the dollar!

Now, that’s the kind of insurance company I want.

“There Will Be Blood”

images-1I have not been a fan of popularizers like historian Niall Ferguson, but one has to admit that he puts his finger on the depth and complexity of the current crisis in this interview with a Canadian newspaper. He points out that the US is in a relatively privileged position because its currency and economy remain the central pillars of the world economy. But the crisis represents the end of globalization as we have known it since the end of the Cold War.

Ferguson states:

“There will be blood, in the sense that a crisis of this magnitude is bound to increase political as well as economic [conflict]. It is bound to destabilize some countries. It will cause civil wars to break out, that have been dormant. It will topple governments that were moderate and bring in governments that are extreme. These things are pretty predictable. The question is whether the general destabilization, the return of, if you like, political risk, ultimately leads to something really big in the realm of geopolitics. That seems a less certain outcome.”

We’ll see.

Global slowdown hits China hard

For awhile some advocates of globalization contended that China and other developing countries were immune from the banking crisis hitting the US and other advanced economies. They argued a so-called “de-coupling” thesis which said that an independent growth dynamic was at work in what were once called “underdeveloped nations” and that they could ride out the storm.

Not.

Here is just a snippet of headlines from China in the past week or so, courtesy of Doug Noland at Prudent Bear:

February 2 – Bloomberg (Robert Hutton):  “Chinese Premier Wen Jiabao said the worldwide economic crisis shows ‘how dangerous a totally unregulated market can be.’ ‘It brings disastrous consequences,’ Wen said… ‘The main causes are for some economies, they have imbalances in their economic structure. For a long period of time they’ve had dual deficits, trade deficits and fiscal deficits.’”

February 4 – Bloomberg (Luo Jun):  “Chinese banks may have offered a record 1.2 trillion yuan ($175 billion) of new loans in January, the China Securities Journal reported… The four biggest state-owned banks completed 20% of their full-year target, with majority of the loans lent for railways, highways, electricity grids and the infrastructure, report said.”

February 3 – Bloomberg (Wang Ying):  “China’s oil refineries posted a loss of 149.3 billion yuan ($22 billion) in the first 11 months of last year because of higher raw material costs… China faced an energy shortage in the first half though supplies became ample in the second half as the economy slowed, the Ministry of Industry and Information Technology said…”

February 1 – Bloomberg (Dune Lawrence):  “China’s retail sales during the week- long Lunar New Year holiday climbed to 290 billion yuan ($42.4 billion), 14% higher than last year’s holiday period, the Ministry of Commerce reported yesterday.”

February 3 – Bloomberg (Chia-Peck Wong):  “Hong Kong’s home sales fell for a seventh month in January…  The number of residential units changing hands last month slumped 67% from January 2008…”

Our Ponzi Economy

Every spring I teach securities law to law students and until this year it has always felt somewhat odd to lecture about Ponzi schemes. After all, didn’t this kind of fraud disappear with childhood polio in America? 

We thought we had in the SEC and federal and state regulations the toughest legal regime in the world, worth its weight in a lower cost of capital to thousands of companies that sell their shares here and to millions of investors worldwide who park their cash in our financial markets.

As it turns out the concept of the Ponzi scheme is far from dated and, according to Pimco’s Bill Gross, it lies at the heart of understanding the current mess we are in. Gross is one of those commentators about whom it can credibly be said, when he speaks, you owe it to yourself to stop what you are doing and listen.

His argument is that the basics of a Ponzi scheme are what explain the explosion of fictitious capital that is now crashing down around us. The core operating principle of a Ponzi scheme is that the operators of the scheme 1) lure investors into an investment with promises of above market returns; and 2) because the funds they receive are not, in fact, invested in anything that can in fact generate those above average returns must lure in new investors to pay off the old investors.

About the nature of our credit driven economy today Gross writes:

Under the policy-endorsed cover of technology and somewhat faux increases in financial productivity, we became a nation that specialized in the making of paper instead of things, and it fell to Wall Street to invent ever more clever ways to securitize assets, and the job of Main Street to “equitize” or, in reality, to borrow more and more money off of them. What was not well recognized was that these policies were hollowing, self-destructive, and ultimately destined to be exposed for what they always were: Ponzi schemes, whose ultimate payoffs were dependent on the inclusion of more and more players and the production of more and more paper. Bernie Madoff? As with every financial and economic crisis, he will probably go down as this generation’s fall guy – the Samuel Insull, the Jeffrey Skilling, of 2008.

But Madoff’s scheme has a host of culpable look-alikes and one has only to begin with the mortgage market to understand the similarities. Option ARMs or Pick-A-Pay home loans allowed homeowners to make monthly payments that were so small they did not even cover their interest charges. Two million mortgagees either chose or were sold this Ponzi/Madoff form of skullduggery, believing that home prices never go down and that shoppers never drop. One can add to this the trillions in home equity/second mortgage loans that extracted “savings” in order to promote current instead of future consumption, and one begins to realize that Bernie Madoff and  our cartoon’s Wimpy had company all these years. 

While no one but his closest family members will cry when Madoff is led off to federal prison in an orange jumpsuit, as he surely will the dilatory behavior of our failing SEC notwithstanding, it is Gross’ point that he is only a slightly misshapen example of the entire period in which we have been living.

This argument is not a complete explanation of the crisis. That would require an understanding of the underlying changes in productivity that have helped make very large swathes of our economy socially worthless thus feeding the need to keep fictitious credit afloat lest entire chunks of the economy collapse. Such is the nature of late capitalism. But Gross puts his finger on the dynamic within that machinery that finds a way to keep paper claims to wealth floating like a massive hot potato from investor to investor, from country to country, from year to year.

And now it is the state itself, Gross believes, that must enter the picture to reflate the collapsing world of credit. That is Gross’ blindspot – he is looking, desperately, for a way out. Like all great traders, when he speaks you should listen but you should also understand that he is “talking his book” – his only fiduciary obligation is to his clients, who invest in the credit instruments he finds for them. Thus, he hopes the Government can spend its way through this crisis. He may be right, but it is a big bet.

DVD sales plunge, is the Biz in for a shake up?

A sobering reminder of the precarious nature of business models in the entertainment comes today from Bloomberg.

They report a 32% drop in DVD shipments in the 4th quarter. While the Studios multi-billion dollar gravy train is not disappearing, its form is shifting rapidly and it is less clear how the Hollywood-based companies can capture a share of the revenues being generated in other parts of the distribution chain.

For example, the rental market for DVDs remains strong as Netflix revenue surged 19% in the same 4th quarter.

But that means Netflix is doing well it does not mean the studios prosper. What’s good for Netflix is good for Netflix.

There are fears that the overall value of a film project will have to be heavily discounted now to reflect a disappearance of after market distribution.

As the article reports: 

Films are valued based on projected sales over 10 to 15 years, from theatrical release through DVD sales, cable television and TV broadcasts outside the U.S., said David A. Davis, managing partner of Arpeggio Partners LLC, a Santa Monica, California-based consultant to movie studios. Studio estimates of these cash flows may prove optimistic if DVD sales continue to deteriorate, according to [Sanford Bernstein analysy Michael] Nathanson.

While the onslaught of new media has struck fear in the hearts of many in the industry, that sector will clearly loom as more and more important in the coming decade.

Will the real Che Guevara please stand up?

mv5bmti2mzi3mzu2ml5bml5banbnxkftztcwntc2ndkxmg_v1_sx94_sy140_1In light of the new movie about Che Guevara, I am reposting something I originally blogged on in 2004 when Motorcycle Diaries came out:

The hundreds of thousands of people who will see the film version of Che Guevara’s Motorcycle Diaries can be forgiven for thinking that “Che” was the embodiment of compassion for the downtrodden of Latin America.

The movie is without a doubt a strikingly beautiful film and tells a moving story. And if you compare the young Che with his contemporaries in the United States – Jack Kerouac and Neal Cassidy in On the Road, for example – he certainly comes out ahead. But the Diaries have little to do with the real Che Guevara, at least not with Che as an adult.

That movie has yet to be made.

While we wait, it might help to consider Che’s published views of the labor movement. In my Ph.D. dissertation on Nicararagua’s Sandinista revolution, I wrote a chapter which I link here that considered the ideas of Che about the role of workers and trade unions in a revolution and beyond and the influence those ideas had on Nicaragua’s fledgling Sandinista regime.

With the return of Che as an icon and the apparent staying power of the Sandinistas themselves (they recently won a huge victory in local elections in Nicaragua) this is not simply an historical or nostalgic exercise. (Note that the text was written in the early 90s which explains some of the grammar and references.)

Although I have not seen the new del Toro version of Che yet,  from all accounts it is no closer to the real Che than Motorcycle Diaries was.

Will The Real Che Guevara Please Stand Up?

What are these bankers thinking?

It appears that former Goldman Sachs executive John Thain forgot the lessons of teamwork and humility that were a part of the Goldman culture when he moved to Merrill Lynch. With the allegations that he spent $1.2 million on re-furbishing his personal office, he looks more like the felon Dennis Kozlowski of Tyco fame who once spent thousands of shareholders money on a dog-shaped umbrella stand!

With taxpayers spending hundreds of billions to rescue the banking system, outrage is surely justified.

But outrage is not policy….and it is policy that this crisis needs. It is becoming increasingly clear that we need to nationalize the banks to insure that the necessary reforms take place under the scrutiny of the public. In fact, that may be the only way to avoid the collapse of the system: if we try to buy the bad bank assets then it could cause a re-pricing downward of remaining assets. It also means the government gets the lemons while the banks keep the profitable assets.

Nationalization is only the first step – the second has to be a new system of governance including public trustees placed on the boards of our key banks so that we can insure that savings are allocated safely to those areas of the economy that need the money and can invest it wisely to create jobs and develop new useful technologies.

While discussion of nationalization has now surfaced in the pages of the Financial Times and today in the New York Times, one fears that the Geithner/Volker/Summers team will move too slowly to discard failed models.

Globalization in reverse? The China Price Hits Bottom

Brad Setser, partner to the better known Nouriel Roubini, notes that the hot money flow into China, to take advantage of an appreciating renminbi, is now moving into a sharp reversal.

This suggests a slow down in China. And it squares with my own pet hypothesis – that the current global financial meltdown is due to the fact that a bottom was reached in the “China Price” as Chinese workers started over the past few years to push back.
More on this later but here is a useful snippet from Setser:
Hot money is now flowing out of China. Here is one way of thinking of it: 

The trade surplus should have produced a $115 billion increase in China’s foreign assets. FDI inflows and interest income should combine to produce another $30-40 billion. The fall in the reserve requirement should have added another $50-55 billion (if not more) to China’s reserves. Sum it up and China’s reserves would have increased by about $200 billion in the absence of hot money flows. Instead they went up by about $50 billion. That implies that money is now flowing out of China as fast as it flowed in during the first part of 2008.

If this trend continues it will not only undermine the claims for the permanency of financial globalization, but will radically alter labor politics in the US where protectionism is on the rise and, of course, could have a politically cataclysmic effect on Chinese politics.

Brad Setser: Follow the Money

Fed induces crisis of legitimacy?

Stanford economist and former Fed member John Taylor nails the central dilemma presented by the Fed’s aggressive intervention into the financial crisis: legitimation. 
The viability of capitalism, which generates volatility and inequality as a matter of course, depends heavily on the notion of “consent by the governed.” Absent that revolution or chaos fill the vacuum. Taylor notes that the massive buy-in by the Fed has meant, whether intentional or not (certainly not), that the federal government is now making industrial policy choices. 
This is really no different than the “pick the winner” policies that are at the heart of the east Asian model. Thus, the Fed begs the question, who does the picking? 
Presumably the governed…but where are they in the process?

Fed has abandoned monetary policy, critic says
| Reuters