Splash! Safe landing for the economy, but too much was lost

Sullenberger pulled off the ultimate soft landing

As 2009 comes to a close I had this funny thought: Pain and suffering are market neutral. The market goes up, the market goes down and the pain and suffering continue.

I think of this as I stare down the data of 2009: The “V-shaped” recovery is here (see graphics below) — at least for now — and the stock market is up 20%, surging 60% from the March lows. The investment banks that nearly brought down the global economy are racking up both record profits and record bonus pools.

With so much good news, why are so many so glum?

Oh, we’re not glum the way we were in November 2008 or even last March. The nation feels glum the way a lost child feels knocking around the house, unclear which way to go or what to do. Or glum, the way one feels after a death. Change is in the air, and it doesn’t feel the least bit comfortable. In theory, The Great Recession should usher in The Great Recovery. Instead, 2010 looks, at best, like The Great Blah.The wind in our collective sail has faltered because in retrospect the bailouts have shattered our notion of fairness. And this is a country that accepts differences in wealth — so long as things feel fair. You work hard and are smart and lucky? Congrats on your millions, even your billions.

The bailouts have smashed our sense of ourselves as a nation in charge. The vision was an illusion lead by Alan Greenspan and a host of enablers; Bill Clinton, Robert Rubin, Phil Gramm, Barney Frank and all the other lawmakers and economists who thought they could engineer society (100% home ownership!) and the economy (low rates forever; no failures) without any negative consequences. Greenspan and his denizens appeared to have believed that they were Captain Chesley Sullenberger at the helm of an Airbus A320, capable of a soft landing no matter where. But what the ideologues in Washington and New York failed to realize is that even a soft landing is far from painless. Sullenberger saved the passengers but the aircraft was lost; now the bureaucrats saved the aircraft but crippled the passengers.

We look back, and still wonder: How could it have happened — not just the greatest bubble in economic history but the response? And the survivors! Key players who were responsible for many of the threads leading to the great market crack-up are flourishing. You won’t find them on the unemployment line. White House economic advisor Larry Summers, Treasury Secretary Tim Geithner, OCC chief John Dugan (recently profiled in an amazing piece in The Nation), Congressman Barney Frank, and NY attorney general Andrew Cuomo (former HUD give-’em-all-loans secretary). You have to wonder how the geniuses behind the Fannie Mae and Freddie Mac implosion performed so scandalously while one private firm (Enterprise Community Investment) devoted to low-income housing has fared so brilliantly, even during the darkest day of the economic breakdown.

And then there were the bailouts, an astonishingly slap-dash, even naive affair by Wall Street standards that left taxpayers with just the bill and not much more. We saved GM while castigating the world for contributing to climate warming. How about putting all those billions into building public transportation? Why subsidize something that symbolizes our dependence on oil? No vision whatsoever.

What is left behind is gnawing resentment between the haves and have-nots. And a series of tiresome articles about bonuses and benefits — a distraction in what some have tallied to be a $17 trillion bailout. Isn’t the whole point of capitalism that people can get rich? Isn’t that supposed to be an incentive? I don’t care if the bankers make more money than Midas himself. This is America. Anyone can do anything. A poor kid can become a billionaire — but his investors get rich with him. A man raised by his grandmother can become President, and we are all the richer.

But it’s New Year’s eve, so I’ll hit the pause button on this rant to consider the  V-shaped recovery, which everyone had been longing for. In this economic scenario, the economy comes roaring back from its lows. In an L-shaped recovery, which everyone feared, we just hobble along the bottom. In 2010, I expect the V-shape could continue, but we, as a nation, will feel like we are in an L-shaped scenario because the recovery will help relatively few people and because of the state of our national debt.

So here’s a roundup of a few data points that support the V-shaped recovery outlook:

First, the “activity index” from the Chicago Fed:

You see the “V” shape on the far right in the graphic? Business fell off a cliff and while still not in an expansionary mode is clawing it’s way back to Square One. In fact, according to the Chicago Federal explainer, this graph shows a classic pattern of recovery after a recession.

Next, existing home sales (via Calculated Risk):

The extension of the first-time buyer tax credit has given an extra boost to November home sales, but the ‘V’-shape is unavoidably visible.

Next, the Philadelphia Fed’s Coincident indicator (again, via Calculated Risk):

A majority of states show increasing activity for the first time since the Great Recession began.

Here’s the coup de grace, gross domestic product, a measure of how we’re doing coast-to-coast — even including California!

You can see the V-shape emerging.

And just for those of you who would like to see an upside down V that signals good things — the declining number of jobless claims:

via Calculated Risk

This brings me back to the start of my post: pain and suffering are market neutral. This, of course, has always been true. It just feels so much more poignant now. What strikes me as particularly humorous this go-round is that in the ’00s, hedge fund managers sold “market neutral” strategies as a sure-fire method to avoid losing money in down or up markets. AIG Financial Products was so hedged that its fearless leader promised winnings no matter what. (Estimated minimum loss to taxpayers: $30 billion — remember the biggest bailout until 2008 cost taxpayers $1 billion with the demise of Continental Illinois in 1984.) The emails in the recent Washington Post story on the demise of AIG are amazing to read. One trader, puzzled by the implosion, complains that he isn’t getting his allotted high-fives.) Market neutral was one of the biggest flops on Wall Street, along with credit default swaps and securitized mortgages, and the triple-A seal of approval from the credit rating agencies.

And now as we look into 2010, investors ask whether the market rally is a true harbinger of The Great Recovery. Who better to ask than the famous hedge fund manager of the month? According to the Wall Street Journal, David Tepper foresaw it all — the “V” in recovery and the brightness of our future. This fearless manager had the backbone to invest in America, the tree that grows no matter what. David Tepper, hedge fund manager and brilliant strategist stood tall and bet that we wouldn’t lapse into a recession, as a result, raking in a cool $7 billion profit for his Appaloosa Fund.

But is that really what Tepper’s trading bets signal? A real belief in the hardiness of our oil-dependent, smoke-belching, Zombie-lovin’ economy? Or maybe he was just placing a bet on the spinelessness of the feds and their willingness to print and print and print more dinares for supplicant financial Amazons. I’ll grant Tepper has the cajones to follow his instincts. He’s one hell of a trader. But his instincts didn’t exactly point to a noble vision of American know-how leading to great economic success. No, his vision wouldn’t result in a wild rendition of “Ode to Joy.”  In his own words, Tepper says he was betting that the feds wouldn’t let the banks go under:

On Feb. 10 of this year, Mr. Tepper read that the Treasury Department was introducing the so-called Financial Stability Plan. It included a commitment by the government to inject capital into banks by buying their preferred stock, or shares that carry less chance of reward but also less risk than common stock.

At the time, investors worried that the government ultimately would have to nationalize big banks. U.S. officials said they had no intention of such a move, which could wipe out common shareholders, but investors were dubious.

The news from the Treasury Department struck Mr. Tepper as proof that the government would stand behind the banks. He directed his traders to begin buying bank stock and debt.

For the past decade, the feds have basically pursued a policy that enabled moral hazard. Why would Tepper believe that anything different would happen this time round?

So even as 2009 was shaping up to cap the worst decade for stock investors in nearly 200 years, Tepper’s Appaloosa Management is up 120%, after fees. On Twitter the traders soundly chastised all the lumpen-proletariat who missed out on one of the greatest market rallies. One commented that they held on to their bearish views “the way toddlers clutch  blanky.”

But one trader said to me that playing the rally doesn’t signal a long-term bullish Indeed, the Treasury curve, typically interpreted as the Grand Seer of the macroeconomy is sending mixed signals. The difference in yield between the two-year and 10-year note has now widened to 2.81 percentage points. The last time the yield curve looked this steep was 1992 or 2003, according to the Journal. And what do you know — that was just when we were emerging from recessions. It could be yet another harbinger of recovery. But this time round some are wondering whether the yield curve is signaling something else. It may be a measure of how much investors fear the mounting costs of the bailouts and the ambitious Obama agenda. This year alone, Treasury issued a record $2.1 trillion in new debt. The yield curve may be saying: Next year, the Fed won’t be buying debt to help repair the economy; it may actually be selling securities, depressing bond prices and raising interest rates. Yikes.

At the moment, our leaders are relying on a sea of liquidity, which is not unreasonable so long as it flows to where it’s truly needed; so long as it doesn’t offend our sense of fairness.  At the moment, bank lending is abysmal and non-financial companies are sitting on a hoard of cash. With some luck and skill, we can hand back the economy to entrepreneurs who create something more than financial instruments. That is where the future lies.

I wish you all a prosperous and healthy 2010.

No ovation for this Obameration on Wall Street

Image via Wikipedia

I thumbed through my old edition of Wheelock’s Latin grammar this afternoon to see if I could find the correct conjugation for the verb ‘Obamere‘, which roughly translates as ‘to Obamerate,’ i.e., to deliver a speech full of eloquence and sleights of tongue; to leave the listener wondering — was it only fairy dust?

Today’s call to financial arms was the quintessential Obameration. As he stood in Federal Hall, site of the inauguration of George Washington, Obama was both heroic and elegiac: Fie! to the Wall Street bankers who needed taxpayer money; woe! to switch-and-bait mortgage lenders; shame! to the unnamed borrower who asked for more than he could truly manage (that’s you Edmund Andrews). Never again will the the United States of America allow so few to hurt so many. In other words, Obama had nothing to new to say. But I loved the structure of the speech and the omissions.

There was barely a ‘tsk, tsk’ to the regulators who missed it all. He urged almost every other player to take full responsibility for their actions (a very good thing), but in essence he said the regulators were largely to be pitied. And here is the heart of an Obameration, which allows our president to re-arrange the alphabet into words that soar so that if we blink, we miss the real import of his message: Those who were asleep during the years that bankers and borrowers amassed life-threatening amounts of risk shall gain more power. Here’s my favorite part of the speech (emphasis added):

…we’ve got to close the loopholes that were at the heart of the crisis. Where there were gaps in the rules, regulators lacked the authority to take action. Where there were overlaps, regulators often lacked accountability for inaction.  These weaknesses in oversight engendered systematic, and systemic, abuse.

Under existing rules, some companies can actually shop for the regulator of their choice – and others, like hedge funds, can operate outside of the regulatory system altogether. We’ve seen the development of financial instruments, like derivatives and credit default swaps, without anyone examining the risks or regulating all of the players. And we’ve seen lenders profit by providing loans to borrowers who they knew would never repay, because the lender offloaded the loan and the consequences to someone else. Those who refuse to game the system are at a disadvantage.

Let’s take a closer look at just this section of the speech:

Regulators lacked the authority to take action. That is a myth of the first order. The real issue is something known as ‘regulator capture’– the people entrusted to police Wall Street operated like minions. Think SEC and Bernie Madoff and you get a pretty good picture of what was really going on in the last decade. The power the regulators had they didn’t use. The regulators who urged more vigilance and greater independence from Wall Street — FDIC chair Sheila Bair and Brooksley Born —  weren’t even in attendance.

Regulators often lacked accountability for inaction. I wonder if this quick little slap made White House economics advisor Larry Summers and US Treasury Secretary Tim Geithner — who were invited to the speech — squirm. I believe that would be the former president of  the New York Federal Reserve who somehow said in his confirmation hearings that he wasn’t actually a regulator; Summers, of course, was part of the Clinton Administration urging critical changes that enabled many of today’s problems.

And others, like hedge funds, can operate outside of the regulatory system. Excuse me, but I don’t recall anyone bailing out any hedge funds — except for Long Term Capital Management during the Russian ruble crisis ten years ago. This line resonated for a bit on Twitter.

And we’ve seen lenders profit by providing loans to borrowers who they knew would never repay. Now that’s what I call a segue: from powerless regulators who clearly would have done something if they had only been able to see the forest for the trees (as Obama later explains was the real problem) to hedge funds (which the White House now needs to invest in toxic assets) to sleazy mortgage lenders.

And there, you have it, dear readers, the Obameration.

For those of you interested in true regulatory reform, I refer you to another speech also delivered today by Jeff Lacker, president of the Federal Reserve Bank of Richmond (h/t @bobbrinker). It take s a much more serious look at the real roots of the market blow-up and offers suggestions that won’t be popular.

Also of greater note today is an interview on CNBC with Rep. Barney Frank. I wondered if the White House crowd wasn’t ticked with Frank, who actually said something worth noting ahead of today’s Obameration. He asserted that Congress has got to do something to de-fang the credit rating agencies, lead players in the market mess. The agencies, of course, didn’t merit mention in today’s Obameration (and no one from the three biggies were in attendance to hear the speech in person); and so far, they’ve avoided any slap-down in power from the SEC. But who knows, maybe change is really afoot.

Avete atque valete.

Money managers still want their ratings agencies: moral hazard lives

Image via Wikipedia

The Wall Street Journal laments today the weak stance the Obama regulatory overhaul took on the credit rating agencies. Indeed, on the really tough questions, the administration seems to have waffled. But the SEC may trump the Administration on this one — if it’s willing to battle opposition from an unexpected quarters:  money managers who depend on them.

First, a peek at the editorial page of the Journal:

If world-class lobbying could win a Stanley Cup, the credit-ratings caucus would be skating a victory lap this week. The Obama plan for financial re-regulation leaves unscathed this favored class of businesses whose fingerprints are all over the credit meltdown.

The government-anointed judges of risk at Standard & Poor’s, Moody’s and Fitch inflicted upon investors the AAA-rated subprime mortgage-backed security. They also inflicted upon the world’s nest eggs the even more opaque AAA-rated collateralized debt obligation (CDO). Without the ratings agency seal of approval — required by SEC, Federal Reserve and state regulation for many institutional investors — it would have been nearly impossible to market the structured financial products at the heart of the crisis. Yet Team Obama suggests only that regulators reduce the agencies’ favored role “wherever possible.”

via A Triple-A Punt – WSJ.com.

As I write, the SEC is debating final rule changes on the role the ratings agencies play in the financial industry. The rule to watch: 2a-7 of the Investment Company Act of 1940. That rule was inserted when money markets were a wild west — no one was sure what went into them. The rule required that money market managers invest only in top rated securities by anointed credited rating agencies, formally known as National Recognized Statistical Ratings Organizations.

Now the law of unintended consequences has kicked in. At the time, the regulators thoughts they were doing investors a favor. But instead they were setting them up because they didn’t realize the ratings agencies would behave so irresponsibly, handing out triple-A ratings to just about anything Wall Street sent their way (and also paid for).

Surprisingly, not only do the rating agencies oppose amending the rule to eliminate the role of NRSROs in the money market world but so are a number of investors: They don’t want to or have the means to do the credit rating work — in which case you could argue they should get out of the investing business. But why should they? If the ratings agencies mess up and then the money managers find themselves sitting on nuclear waste, no problem. Uncle Sam cleans it up.

It’s not clear that the SEC will have the political will to take away the feeding trough from the ratings agencies. If not, legislation is already started to bubble up. The question: just how many opportunities will policymakers miss to fix the ratings agencies?

Geithner, Summers said to envisage super-Fed from the start

Geithner whispers to Summers

The Washington Post offers a behind-the-scenes narrative on how regulatory reform was birthed at the White House.

Time and again, lawmakers, regulators and industry lobbyists pressed their concerns behind closed doors at the White House and the Treasury Department, according to participants.

Turf-conscious regulators opposed the idea to consolidate banking oversight agencies and took their appeal over the Treasury directly to the White House. Ultimately the administration spared all but one agency.

A few key lawmakers argued against merging the two federal agencies that oversee the stock and commodity markets. That did not happen.

Insurance companies fought over whether a national regulator should oversee them. The White House dropped the proposal.

But on those elements that mattered most to the administration, particularly expanding the powers of the Federal Reserve, Obama’s senior advisers were unyielding.

via Core Reforms Held Firm As Much Else Fell Away – washingtonpost.com.

The Federal Reserve, which sat idly by as Wall Street piled on enough leverage to blow up the global economy, is now the No. 1 policeman for too-big-to-fail institutions. And who was president of the NY Fed during this time: Treasury Secretary Timothy Geithner.

The Post makes clear just how strongly Geithner feels about the importantce of his former home:

On May 8, lobbyists representing many of the nation’s banks and hedge funds huddled with senior White House advisers in the Roosevelt Room, seeking to snuff out an administration plan to increase the Fed’s authority to regulate them, when Treasury Secretary Timothy F. Geithner stuck his head in the door.

Fresh from meeting with Obama, Geithner asked the lobbyists what they were up to. When they explained they preferred that a council of regulators, rather than the central bank, safeguard the financial markets, Geithner silenced the discussion with a string of obscenities, according to people who were present.

“I don’t believe in rule by committee,” he said.

The funny thing is, the markets did in essence end up with a council of regulators with a souped-up Federal Reserve. The funny thing is, banking analyst Richard Bove told Bloomberg News that no one needed any new powers: If the regulators had simply been doing their jobs for the past decades it’s unlikely we would be in the mess we’re in now.

Still, the results show just how little political will there is to de-Balkanize the regulatory system. It’s a big disappointment.

Photo via Getty

AIG gets a Compensation-Officer-in-Chief

When President Obama first began railing about bonuses on Wall Street, this time AIG, I immediately wondered: Is Iran no longer a nuclear threat?

The financial crisis is quickly showing the inexperience of Team Obama: Its members latch on to details and sideshows that stir big emotions — Big Bad Bonuses! Big Bad Rush Limbaugh! — but has yet to come up with a master plan that both Wall Street and Main Street can feel good about. Change is afoot without a roadmap.

The President slammed the values behind the AIG payday. But the AIG bonuses are not just a symbol of values gone awry — I can’t help but think that any normal person who contributed to a $40 billion loss would offer to return at least some of the bonus money! The bonus scheme and the dust-up are in many ways a crucible of the crisis we face: A concatenation of bad decision-making and leadership, from Wall Street to the White House, from Congress to Main Street.

The President, in his most recent rant and then re-cant on AIG bonuses, is not breaking this unfortunate chain. Mr. Cool nearly lost it, practically threatening to bring out the Marines to wrestle taxpayer money from a bunch of financial geeks (and insurance geeks, no less). Bringing the full power of the United States of America to bear on $450 million wasn’t the best idea in the Presidential tool kit — especially when grappling with a$1.7 trillion deficit. Now it turns out the Marines can’t subdue mercenaries wearing iron-clad contracts.

Obama should have left the entire matter to underlings; he diminishes his office and weakens his authority. The Washington Post asserts that the President has “dealt a sharp blow to his Administration” and will find it harder than ever to get Congress and the American people onboard with his ambitious agenda.

America elected a commander-in-chief, not a compensation-officer-in-chief. Saturday Night Live skewered the Administration focus on details brilliantly not long ago with a send-up of Treasury Secretary Timothy Geithner as a hapless telemarketer in search of a product.

Hey, brother, can you spare an idea?

This is a public relations nightmare. He is stirring up public anger, but to what end? Jimmy Carter fatally tried to show his empathy for the American hostages in Iran by refusing to leave the White House until they were freed. He looked weak and confused, shuffling around the Pennsylvania residence in his cardigan sweaters. Bill Clinton felt our pain, to the amusement of all. But strong leadership that stays above the fray is what Americans really want.

To that end, our new President has been trying out different personae, largely depending on his agenda. When he wanted to get his $787 billion stimulus bill passed, Obama presented a grim choice: deficits or doom. Once he had his bill in hand, his message changed — but the markets didn’t heed his new tune. The public and Wall Street are not as nimble as the President; sentiment can be like sediment — it sinks and settles. Not only were we still wading through his message of doom, but also through the disarray in Treasury.

And so, on the day Obama signed the stimulus bill on February 17, the Dow Jones Industrial Average sank 297 points to 7552.45. From there, the market lost 10.4% , falling to a 12-year low of 6,763 on March 2 — naturally, after AIG announced its stunning $61.7 billion fourth quarter loss. Obama’s sense of panic became palpable: The next day the President said at a news conference:  “…profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal if you’ve got a long-term perspective on it.”

The President became a value investor.

After the market began its four-day rally last week, Obama and his advisors went so far as to say that the economy’s fundamentals are strong (remember when he lambasted his opponent McCain for a similar assertion?). It’s true that it seems as if this President can work miracles. But really, in 50+ days can he take a financial mess of this proportion and go from doom to get-ready-for-a-boom? Indeed, even if they do think the worst is over, economists scoff at the growth projections in the new budget.

Obama has succeeded at making us mad, really mad. So let’s forget about those rosy projections in the budget and what that means for the deficit. It’s much more satisfying to get bent out of shape over something like AIG bonuses. And it’s ever so much more accessible than figuring out whether or not credit default swaps pose a mortal threat to our way of living.

The AIG story holds up a mirror to the American people, not just Wall Street. We’ve been living the life of Dorian Gray, a life of borrowed credit, of youth everlasting. At first the image made us smile; now we see the ugliness.

We want the old image back, or at least something better than what we have now. This is no time for the President to stir populist resentment or to micro-manage an insurance company. Now is a time for real leadership.

• Move Over Sarah Palin. It’s Geithner’s Turn on SNL (blogs.wsj.com)