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Tuesday, September 30, 2008

Another open letter to legislators

We are all tired.

Truly.

No matter how much you like roller coaster rides, at some point one gets dizzy, then one gets sick, and one can get so sick one never wants to go on another roller coaster ride ever - seriously, ever.

The analysts say today's market rally was due to:

1) "correction" from over-selling (translation: people panicked too much the day before)

2) hope - from more promises (thankfully guarded) from legislators - that a bailout would be coming and they did hear the markets, and did seem to see that the markets were "in poverty" (maybe the markets were singing after all)

3) talk that the FDIC was going to ask Congress to increase the insurance limits from $100,000 to $250,000. Great news. A higher level of savings are safe. Fabulous for confidence. Markets like predictability; markets like the prospects of people having more money to invest in it. Markets think its going to happen. People think its going to happen. This will be an incredibly expensive disappointment if it does not happen.

4) the SEC provided "clarifications" on the fair value accounting. Let me oversimplify this so I don't lose the non-business non-accounting readers.
  • Companies like to make more money, not less.
  • There is a very rigid rule related to assets that made companies less profitable - some say unfairly so but at least it did so consistently. So its like saying - You house is worth $5 because the "markets" say it is worth $5 when you paid at least $20.
  • Companies had to be less profitable by the same rule.
  • This rigid rule when applied to complex exotic financial instruments based on people's mortgages has proved to be quite problematic (to be nice), so the SEC issued a "clarification" which is equivalent to relaxing the rule without saying so.
  • This means companies can make more money.
  • The market rallied on the prospects of less rigidity and the potential to be more profitable.
  • Sound's pretty good so far BUT in an environment of complete distrust, where everybody has a different perspective and "judgment", this is just making it more difficult for people to determine if the value is "fair" - which is the point. But, it did make the market excited - even if it is just for a day.
But let's move on. I am personally delighted to hear Senators will vote tomorrow night on some bailout bill and I want to make a plea:

I had the privilege to serve as a Senator. In the normal course of the legislative process, the Senators (in the Upper House) receive the bill after it has been passed by Members of Parliament (in the Lower House). Senators are the last review before any bill becomes signed into law. We knew the weight of the responsibility on our shoulders. Our focus was substance, substance, substance; even if sometimes our speeches reflected partisan views. There is nothing wrong with partisan views - they are a natural part of a democratic system and a democratic system is what we have until we change it. Senators were extremely proud of the fact that we in the Upper House did things, let's say - differently. It was rare for us to engage in vitriolic banter. Any one who did would quickly be chided "You are NOT in the Lower House".

So Senators, on both sides of the aisle, especially since you are taking the infrequently used step of initiating legislation, please inject some sanity and civility into this process:

Wall Street is not the only one on the line.
Main Street is not the only one on the line.
The American economy is not the only one on the line.
The American people are not the only ones on the line.
Democracy itself has been and remains on the line
.

Monday, September 29, 2008

"Ah wah mek dem a gwan so"?

Today's post is a little "Bob Marley 101". If you are befuddled by the title, it is a famous line from a Bob Marley song. "Ah wah mek dem a gwan so" means "What is making them behave like that?"

What happened today?

To continue my song and CD analogy - the singers claimed yesterday to have a song (we even heard the leadership of both sides singing a bit of it) but they went to the recording studio this morning and couldn’t get the song recorded. Why? Because the Republicans decided that they did not like one of the voices (Nancy Pelosi). It was an expensive way to be offended. Back to my analogy: Studio time costs money, and the song - any song - has to be recorded before it can make some money. Until you get a CD recorded, you are just racking up costs. What kind of costs? $1.2 trillion in market value was lost today for a $700 billion bailout bill - the "CD" with some kind of return. Somebody adding 2+2 and getting 4 yet? Kind of expensive to not like a speech. As I read in one of today's papers - the vote is on the bill, not a speech.

What caused today’s historic unprecedented 777 point drop in the Dow?

Disappointment and lack of confidence – both sides said they would do it, and then the Republicans reneged on their promise. Again, Republicans said:”yes I will”, and then no, they didn’t. What happened to “gentleman’s agreements”? What happened to “my word is my bond”? Do the Republicans appreciate the magnitude of a problem that a lack of trust in a Government causes, especially when political representatives display a lack of trust in their own Administration? Evidently not, since they consistently destroy any credibility they have with their own people and the world.

My two cents:

Respectfully, if the leadership did not think the bill was going to pass, people should have said nothing. Markets operate on information, confidence and trust, and they felt they had been made a promise. The $1.2 trillion 777 point drop is the result of a broken promise plain and simple. It represents uncertainty. And people are afraid when they do not know what to expect.

Is this ideology again?

Now, again – the Republicans befuddle me. This is now the SECOND internal revolt in front of the whole world in real time. Is this the ideology problem again that I mentioned in an earlier post? Let's look at a few words from Bob Marley who said:

“Today they say that we are free,
Only to be chained in poverty.
Good God, I think it's illiteracy;
It's only a machine that makes money.”

Well, if the markets would sing, that’s the song they would be singing today. Republicans tell us it’s all about the “free market”, right? Well the “free market” is chained in poverty, and frankly, it is only a machine that makes money.

Why do we care about the market being in “poverty”? When the markets are poor, people become poorer.

Let me spell this out:

1) Companies operate on credit. Credit comes from the “markets”. When markets are “in poverty”, they cannot provide credit, or when they do they make the terms very expensive. This makes companies “poorer" because of the cost of debt repayment, and it makes them have to make more expensive goods and services to sell to people to be able to afford to stay in business.

2) Poorer companies paying more for necessary credit - again, from the “market” - cannot afford to employ people so people may lose their sources of income – in other words, people become “poorer”

3) Poorer companies definitely cannot raise salaries so people can have more money to meet the rising costs of living – in other words, people become “poorer”

4) People have to spend the money they have on the more expensive goods and services I mentioned above, so people save less – putting less money in “the markets”. When they do put money in the “markets” and there are all these man-made shocks – caused by the Republican Administration and their internal revolts - the people lose their money - in other words, people become “poorer”

5) Goods and services are so expensive relative to salaries that people rely on credit to survive. Credit comes from the “markets”. If there is no credit, people cannot access it. If there is expensive credit, people become “poorer” trying to repay debts.

Free markets are the centerpiece of Republican ideology. Yet, when the markets are trying to be “unchained from poverty”, Republicans claim to be anti-Wall Street and pro-people. So let’s talk about people.

Again, Bob Marley said:
“Today they say that we are free,
Only to be chained in poverty.
Good God, I think it's illiteracy;
It's only a machine that makes money.”

Yes, its the same quote as above. But Bob Marley wrote this song to illustrate the plight of people – not markets. It is the people he sang about being "free" but "chained in poverty". The last time I looked, the Constitution started "We the People", not "We the Markets". So after all these cheap political points and the clinging to ideology, in order to prevent the people from dying of poverty, the Republican Government may just have to distribute $700 Billion to the people.

And that is the biggest irony of all - it would be the very Republicans who would have created the very thing - Socialism - they caused so much havoc trying to prevent with "Free Market Capitalism" ideology.

Sunday, September 28, 2008

Finally, a song ! Who will buy the CD?

Truth be told, today was iffy. More public declarations from the Republicans that, frankly, appeared like backpedaling after both sides came out so late last night with a "breakthrough".

Anyway, in my own small way of not aggravating the markets, I decided to save the blog until something more positive could be written. And now we have it.

The world got the new bill via the World Wide Web. Major progress. And the new bill is much better than the original 3 page draft.

Three press conferences later - first by the Democratic leadership in the Senate, then Rahm Emanuel (D), then the leadership of the House Republicans and somewhere in between no threats of veto from the President - Congress finally has a what I will call a "song". And by "song" I mean people (Members of Congress on both sides) are singing in tune (not all in agreement but sufficient to have harmony) and the some real lyrics (what they say, how they say it and the content of the bill). To be clear, I would not award a Grammy for songwriting but although we may not agree with every word, the fact is the language is less offensive. This is now a song that people - the markets, investors and taxpayers - may want to hear and may even like.

Here's the key question - how do you get people to actually buy the CD? Because implementation is really the key to the solution; the legislation is just the authority and the safeguards for action.

So allow me four quick tutorial suggestions:
  • Members of Congress should take "Markets 101" to understand how what one says, how one says it and the timing of what one says makes a world - literally - of difference. If Members of Congress understand the markets, then they can explain to their constituents 1) the size of the fire 2) where and how the gasoline is spread all over the country and 3) the apparant colossal "dam-burst" required to out the fire and prevent it from spreading. Whilst I recognize that legislators have to state their objections for the record during the vote, the markets may not necessarily see it that way. So brace for volatility the days there is voting since voting is televised.
  • Members of Congress should take "Strategy 101". This fire needs to go out quickly with the best implementation possible. Prevent another fire - speed up appropriate regulatory and accounting reform (in action, not just words). Investigate for arson after. Delegate the "woe is us" deliberations to the Historians. Gaining acceptance from the taxpayers may be tough, but when leaders complain, they are leading people to complain. How is that constructive? And after all the heated - and sometime vitriolic - rhetoric in the last few weeks, information overload is real, and the information is largely negative. Optimism may be the strongest global currency we will have for a very long time.
  • Bankers should brush up on "Bedside Manners 101". One cannot blame lenders when they are only part of the problem, and a small part. Believe it or not, people do understand that "paper" - otherwise known as some inventions of the financial engineers that used their personal mortgages - is a significant part of this problem. They draw the distinction between the mortgage and the "paper". And they cannot be held responsible for downturn in housing prices. They also know that lenders engaged in predatory lending. Now that is not to let borrowers who just do not meet their obligations for no good reason off the hook. But be real about the causes of this problem. Authenticity is a very important attribute of credible leadership. Furthermore, one also cannot blame the borrowers because one depends on them for deposits. Banking is based on confidence - and people do not like to be offended, or lied to.
That all said, at the end of the day this is all about people. And perhaps the best thing we can all do is brush up on "Communications 101". Within a few weeks, there is a general election, and the more people who can understand and relate to the problems they are grappling with daily, the more people can work constructively together to find workable solutions for all.

The new draft bill - initial comments

Just a few initial thoughts:

This is much better than the 3 Page Paulson bill, but there are still some areas for improvement, in my humble opinion:
  • Positive: There are stated provisions with some "shall" language for taxpayer benefit. There are very good provisions, including repayment of the public debt
  • Negative: There are many more "may" provisions with regard to the taxpayer
  • Positive: There are layers of oversight and transparency - reports to Congress, a Board for oversight, GAO study, Inspector General, posting of transactions on the web etc.
  • Negative: Maybe I missed it, but there does not seem to be a definitive mechanism to require Paulson to do anything more than listen. Yes, he has to report and make his actions transparent, but it appears that he still calls the shots. And the Board has all the people who were in positions of responsibility all along and there was limited oversight - to be diplomatic
  • Positive: There is a call for a study for accounting and regulatory reform
  • Negative: The study for regulatory reform is due by April 2009. The study - not the action. So what happens in between? No need to overregulate. But a "study" and, most importantly, some action, respectfully, needs to come before April 2009 or the US will have to live by the rules set by the rest of the world if it is to participate in global economy. There is universal agreement for urgent action on national and global regulatory reform.
  • Big Negative: "without limitation" remains in the language, and there are provisions for "guarantees" which are contingent liabilities.
  • Reality: You can bet that no matter what the language is companies with highly paid brilliant attorneys have more resources to make this legislation work for them, rather than the country. No legislation is perfect; no implementation is perfect - this is better than the Paulson bill, but its not "the best". There is no such thing as "the best", but the legislation needs to make sure it does not allow for implementation to be hampered either by too many restrictions on power, or too much allowance of power. There is a delicate balance to be struck. Law cannot be "undone" without another legislative amendment.
  • Bottom line: In an ideal world, this would really benefit from a public private sector commitment to the stability of the markets and the revival of the economy, i.e. for everyone to act in the national interest. But at least this proposed legislation is not silent on taxpayer benefit which really, I think, was the most important thing for justifying spending taxpayer funds.

Saturday, September 27, 2008

Make or Break

Tonight's announcement of a tentative agreement - "a breakthrough" - and the visible positive cues in tone and body language - is a welcome development.

However, the markets really, I humbly submit, cannot handle any more "roller coasters". If all the leadership in Congress did not believe there was a genuine tentative agreement then silence is literally golden. Again, why do we care about markets? Because all the people that these lawmakers represent have their savings and investments tied up in them. So, part of the lawmakers responsibility is to act responsibly with respect to the markets.

There is an expression I am so fond of: "You are trespassing on my patience". And I suspect if the markets could talk, that's what they would say. Confidence and credibility are very low, for good reason.

So, my two cents here:
  • Having made this announcement, no matter what, I repeat - no matter what - find a way to work out the details - constructively
  • Then vote as quickly - but responsibly - as you possibly can.
  • Do not come back with another "the deal fell apart", "there was really no deal" "we are not talking". The markets have already heard those messages - they do not like them.
  • Threats to "veto" are not helpful, to be diplomatic
  • If the US really wants to build credibility and confidence, it would be the BEST signal for every single person to vote for the new bill. This is not the time to score cheap points. If someone really cannot live with it, no person should have to vote against his or her conscience. But people need to understand the magnitude of what is riding on the ability of the US to restore confidence in the US governance system and prospects for the financial markets and economy - not only as a leader in the global economy, but even as a participant in the global economy. The world is watching every move, and fortunately still waiting - but it won't wait forever.

Ideology? Is this for real?

I consider myself an independent thinker. I remember telling the journalist from the Economist when he interviewed me many years ago:

"I believe in education for all - does that make me a Communist? I believe in social services for all - does that make me a Socialist? I believe the private sector is the engine of growth - does that make me a Capitalist? I think that makes me none of the above."

Having said that,
is this really true what I am reading in the New York Times "Markets Can't Wait for Congress to Act":

"But it is also true that much of the opposition to the Paulson plan is purely ideological — there are Republicans who believe that the bailout plan is a step toward socialism. And it appears that they would rather see the economy go down the tubes than do something they find ideologically distasteful."

http://www.nytimes.com/2008/09/27/business/27nocera.html?pagewanted=1&8dpc
(Disclaimer: I do not support Paulson's original 3 page plan - it is not a solution as I have said many times before, it is just ripe to cause a bigger problem)

Did I read that right "ideologically distasteful"?

Respectfully, peoples lives are at stake. People cannot afford the economy to go down the tubes because of "ideology". If ideology buys gas, heating oil for winter, and food, then ideology just became more valuable than all the commodities combined.

_______

Just by way of background, I must admit that I am completely befuddled by the Republicans.


The Republican President and Administration propose a 3 page bill which is a blank check for $700B with unlimited, unquestioned, non-reviewable power. Other than doubts about whether it will work, no elected representative can make that law without being in dereliction of sworn duty. So that was just never going to be approved in that language.

But in the spirit of cooperation, and with acceptance of urgency, the Democrats and some Republicans work together - yes, constructively because I watched every second of the two days of hearings and they were surprisingly cooperative and constructive. Concessions were made.

The Republican President makes appearance after appearance on TV and on radio to convince the people. The Republican President and his VP summon the Presidential candidates and the leadership of Congress, all in front of the world trying to show urgency and unity

Then the House Republicans cause an internal revolution. Yes, the ruling party of the world's superpower has an internal revolt in the middle of a national and global financial and economic crisis on every cable news station broadcast all over the world on TV and the World Wide Web in real time.

The House Republicans say they have a new plan which traders (80% Republican it is reported) say cannot work. Paulson says it cannot work.

And here's the part beyond my comprehension - the House Republicans refuse to even come to the talks. The US financial sector and economy is in a crisis, and has been shocked by erratic actions of the Republican Government and then members of the Republican party refuse to talk. Am I missing something? "Representatives" represent people who have their savings and investments tied up in the markets. Markets do not like erratic behaviour. So these House Republicans have a responsibility to go and talk - and even object vociferously. But there is no excuse for not talking - its aggravating a fragile market.

So, after a financial shock which is aggravating a weak economy, the House Republicans cause a political shock which further aggravates the financial shock which further aggravates the weak economy.

And oh yes, remember that thing that the US said the rest of the world all had to have - and had to have their way - "or else" : globalization. Because of globalization, the WHOLE WORLD is reeling from these man made hurricanes, tsunamis, tornados, earthquakes, and volcanic eruptions all in one.

At some point we have got to get stability. My plan? I've already lined up a German tutor and looking for a Mandarin tutor. I'm just hoping that in the new financial world order, 2+2 is equal to 4.....because I kind of like that predictability.

Follow up comment - Posted on 9.25.08 on Facebook

Bloomberg's continuation on the ratings agencies.

http://www.bloomberg.com/apps/news?pid=20601109&sid=ax3vfya_Vtdo&

Some questions/comments on the Paulson bailout Plan - Posted 9.24.08 on Facebook

I am in favor of an urgent solution – not “any” plan that creates a bigger problem.

Questions/Comments:

1) Why is there a “need to encourage participation”? Is there a serious crisis or not? We are told the patient is about to have a heart attack. I buy that. We are told that we need a specialist. I buy that too. But am I really to accept that the specialist will not try to prevent his OWN heart attack? Because that IS the heart that is about to have a heart attack. He will not try to prevent his OWN heart attack unless the Congress forgets about some type of legislated taxpayer benefit and limits on executive compensation? Does anyone else find this very odd?

2) In legislation, language is critical. This is not a handshake agreement. This is law. And bad law can be infinitely worse than no law. It’s nice to see that Paulson now realizes he “wants and needs oversight”, therefore the language of 8 needs modification. Taxpayers funds cannot be spent without some kind of oversight, so this is no great concession, frankly. As for the rest of the legislation, there are other problems with the language. For example, in legislation, “is authorized” has a very specific meaning and there is a lot of “is authorized” attached to unlimited unquestioned non-reviewable power for Paulson. On the other hand, the legislation has language such as “consideration” – means to think about – for the taxpayer. That is even weaker than a “may” which means optional action. Where is the mention of a tangible benefit to the taxpayer in any kind of language in the legislation. If this is supposed to be a grant, then say so. But don’t try to convince everyone the taxpayer will benefit when there is no legislated type of benefit. There is nothing wrong with a difference of opinion in the “type of benefit”. But Congress must legislate a benefit of some kind with “shall” language, or it would be in complete dereliction of its sworn duty. Bankers know more than anyone that there is never something for nothing; and none of them would agree to that if it were their money. Some language like “the taxpayer SHALL receive all or part of the profit, and said profits SHALL be determined by audited financial statements” would be a start.

3) As for executive compensation, there is a problem beyond the offensive “optics”. First, at the levels these executives are used to there is disincentive to fix the problem quickly. Without compensation caps, Congress would be setting up a lucrative “bailout industry”. Second, the more money spent on salaries, the less money to unclog the financial system that Bernanke and Paulson are at pains to stress that needs as much money as it can get (therefore why they say tranches cannot work)

4) The unregulated complex exotic financial instruments are a significant contributor to this problem, to be diplomatic. Bailout or no bailout, this is a serious problem. The Credit Default Swaps (CDS) are only one type. CDS are an estimated $58 TRILLION market of instruments that most people do not understand, or can value, and as the SEC has said - finally – must be regulated and is ripe for fraud and manipulation (http://www.reuters.com/article/marketsNews/idUSN2332572720080923?sp=true) Even regulated, the market is too large, too interconnected causing a massive contagion risk which we are seeing in this domino effect.

Unless there are – simultaneously with the bailout - some restrictions on the creation of complex exotic financial instruments, and regulatory reform for the creation and trading of complex exotic financial instruments, Congress is handing over $700B to allow these same people who created a clogged mess with complex exotic financial instruments to financially engineer more complex exotic financial instruments in an unregulated environment. Is there not something wrong with what Congress is being asked to do? If you think that what Congress is being asked to do in its current form without any restrictions and regulations for these complex exotic financial instruments, start saving for the next bailout.

5) This bailout is silent on the ratings agencies. This is a serious omission. Ratings agencies are considered gospel to some, and there will be no global – I repeat, global – financial stability until something is done. If ratings agencies "like" something (an instrument, an institution, a country etc.), they make an announcement and people buy, buy, buy. They decide they don’t "like" something (again, an instrument, an institution, a country etc.) as much anymore,. they make an announcement and people sell, sell, sell or run to banks asking for their deposits (otherwise known as a run). It is an open debate that ratings agencies are not rated or have no oversight and this is a problem. There are many reasons this is a problem. The main one is that there is no transparency. No one really knows how they make decisions, and therefore they add a further element of unpredictability in a market starving for stability. If the objective is global stability in the short run, it will not happen if ratings agencies are not addressed in some constructive way. They serve an extremely useful purpose in principle. In a crisis, there needs to be a constructive concerted effort to restore confidence and stability in the markets - and the ratings agencies have to be a major part of that effort with considered actions. I urge everyone to read this : http://bloomberg.com/apps/news?pid=20601109&sid=ah839IWTLP9s&refer=news

6) Paulson keeps saying it’s his “hope” and “if the plan works as it should”? Has anyone considered just distributing $700B to taxpayers which will 1) improve the people's confidence 2) increase spending allowing companies to have more revenues 3) improve companies ability to pay taxes and keep people employed 4) allow people to stay in their homes and pay their debts? Now, that may be an extreme and I am not advocating that, but the point needs to be made - Paulson's plan is an expensive "hope" that what I have just described will happen and happen soon.

My two cents on the Paulson bailout plan - Posted 9.20.08 on Facebook

my two cents....

A plan must

1) give taxpayers tangible benefits,

2) be transparent,

3) be reviewable

A plan must not:

1) give anyone - especially Paulson - unlimited unquestioned power

2) have no safeguards. When you put money back into the system, and do not restrict exotic instruments that you have proved to be unable to regulate, and that have caused this problem, then you are asking taxpayers to fund yet another round of bailouts. Learn from your mistakes. You did not understand some of the instruments, or how large the market was or how much they were all interconnected thereby setting off a domino effect. Do not allow things you cannot monitor or regulate, especially when people are trying to recoup losses.

3) provide more than absolutely necessary relief to institutions who created these now "troubled assets". The relief is to stabilize the markets. The relief is to provide confidence in financial institutions. The relief is to get the financial gears working again smoothly instead of coming to a grinding halt. The objectives are the lives and livelihoods of the people and the broader economy. Making financial institutions super profitable and their executives rich beyond belief are not the objectives.

--------------------------
---------------
Here is Paulson's proposed plan

http://www.nytimes.com/2008/09/21/business/21draftcnd.html?_r=1&adxnnl=1&oref=slogin&ref=business&adxnnlx=1221927070-7EjZ7ydQ%20eE23rVd2mc/Bg
----------------------------------------

Here are my questions :

(the numbers refer to the sections of the plan)

2a. Define and list all "mortgage-related assets".

2a. Only Paulson determines terms and conditions when he's spending taxpayer's funds? I don't think so

2b. "without limitation"? When has unlimited power ever been the right move?

2b1) who gets hired? how much are they paid? are the same people who caused this benefiting

2b2)contracts with the same people who caused this?

2b3)the same financial institutions who caused this?

2b4)does Paulson have the supervisory capacity?

2b5)who reviews the regulations?

3) "consideration" is not good enough

4) "within 3 months" - sooner. "semi-annual" reviews are not sufficient for 700B of taxpayers funds...monthly or week

5a) what rights?

5c) he can sell, but not set the rules for the sale

6)Does "at any one time" mean its more than 700B?

7)"expenses shall be deemed appropriate"....huh?

8)"non-reviewable by any court of law or administrative agency"? If he wants immunity, then you all sort that out - the decisions must be reviewed.

And oh yes, Where is the benefit to the taxpayers?

Follow up comment - Posted on 9.19.08 on Facebook

A few more thoughts on the upcoming legislation:

1) Sunset clauses are prudent for hurriedly drafted legislation for special circumstances. First, it forces legislators to consider if they are doing the right thing Second, it forces legislation to come to an end, and therefore if you feel the measures are desirable - after the dust has settled, and people are calmer, and markets stabilize - then come back and debate the matter again.

2) Sunset clauses are especially important when there is "broadening of powers"......broadening of powers may now be necessary but make sure there are safeguards to prevent abuse of power. We don't need anymore government induced shocks, or poorly planned bailouts.

Open Letter to Legislators and Regulators (in any country) - Posted 9.18 on Facebook

A few thoughts......

1. Take the past as a given – let the historians debate it. Understand the past to guide the solutions, but don’t lament it….it is gone. There’s no time to complain about it right now. Focus on the present and the future.

2. Remember that the interest of the people – the general population - is paramount. The financial sector does not exist for itself – no offense to all the executives who may believe that it does. It exists to provide capital for the real economy – so businesses can access capital to grow and provide jobs. It exists so people can deposit their money, save and make investments, and by doing so, people provide capital for the real economy. It exists so people can access short term credit (now increasingly used to try to afford to live in the absence of rising salaries), and long term credit to buy a home, a car etc. If people have no money, they cannot provide funds to banks. If people have money and have no confidence, the banks won’t get any money to provide capital. No capital, no growth, no jobs, no savings, no capital etc. etc. etc.….a vicious cycle.

3. If you don’t know what you are doing, pretend you do until you can find a replacement that does and then step aside. Confidence rules!

a. So far there have been piecemeal solutions, and forceful statements only to be followed by reversals. You cannot possibly know everything in a global interconnected economy. No one believes that you do know everything, and now everyone believes you do not know what you are doing, or understand the problem. When the prospect of a plan was announced today, the market rallied.

b. Right now, banks don’t trust each other, people don’t trust the banks and no one trusts the regulators. It is very serious when people do not have confidence in the markets. It is an absolute and complete catastrophe if people do not have confidence in the regulators, the regulatory system and the decision making process for government intervention. Any recovery plan must have the restoration of confidence - with tangible measures - as the priority.

4. Never ever act precipitously in public. It is never prudent to cause panic. It is never prudent to create a government induced shock to the system:

a. Do not summon the regulated – in front of the whole world - and expect them to solve their problems in a weekend. The markets are too complex, too globalized. 48 hours is not enough time with the very best of intentions.

b. Do not bring the companies together and then not expect them to act in the best interest of their shareholders over the weekend, and when the markets open. You have provided them with a lot of information they did not have before, and the market does not have. And you have stated that there will be no more government funds for bailouts. That may be good for the taxpayers in terms of a bailout, but the types of interventions, actions and your words have been disastrous to the taxpayers’ savings, job security, potential for access to credit etc. Do regulators not expect the regulated to hoard funds? Well, it happened and is happening – so have a plan to deal with it before markets open on Monday, not Wednesday.

c. Do not ask weakened financial institutions to bail out their peers “or else”. This is a communist principle being imposed in a capitalist system – it will not work. Further, these companies all have regulatory obligations in other jurisdictions…..can they really just do what they want to bailout another company. Unless the authorities across the world all have some blanket agreement, I think the answer to that is no. And if there is some blanket agreement, I would love to see it since authorities in every country are obligated to act in the best interest of its own citizens. That would be the first time the whole world ever agreed on anything.

d. Do not make hard and fast rules about bailouts – everything is a “case by case” basis in a globalized economy reeling from the sub-prime crisis. Hard and fast proclamations send a very bad signal. There are better ways to communicate the same thing. Discourage bailouts, but don’t make people panic.

e. Do not allow shares to trade freely when there is massive – I repeat, massive - information asymmetry in the markets. Small investors and pensioners who are all taxpayers will always be the first to get burned. And please, at the very minimum enforce the existing rules!

f. Always watch your words. The markets are hanging on every syllable.

5. Consider the implications of your actions and put in mitigation measures, such as:

a. In the case in point, why wasn't an announcement made last SUNDAY that the SEC will have no mercy, and zero tolerance? Where was the statement to traders – “Do what is legal or else”? Christopher Cox should have at least tried that. Some people may actually have believed him. Today’s rally started with the FSA's decisive temporary ban and was aided by Cuomo's announcement of an investigation into illegal practices. You can always remove the ban, but SEC inaction is clearly not the answer.

b. Have a comprehensive plan with your counterpart regulators in all the major economies of the world – central banks and those that have jurisdiction over their stock markets.

i. That plan must have examined various scenarios. Lots of people do scenario planning as a profession. Wasn’t there any scenario planning to see what would happen? Didn’t anyone expect banks would have difficulty raising capital? Didn’t anyone expect investors to panic, and raiders to raid? Didn’t anyone expect shareholders to run for cover – the markets are down, the regulators keep coming up with plans that hammer them, the regulators don’t seem to know what they are doing, and where are the safeguards to protect them? $169B has moved from money markets in the last week. Is that shocking to the regulators? The market soared on talk of an actual plan. Just think it through carefully.

ii. Be careful of precedent. Precedent is part of what got the markets into this problem when there are no guidelines for bailouts. Bear Sterns somehow qualified, Fannie and Freddie too (but at the expense of shareholders - who are taxpayers, as well as pension and mutual funds who hold and invest taxpayers savings and are themselves taxpayers), but not Lehman which may be fine but then why not tell them that from day 1, and then not AIG, then OK AIG (again, at the expense of shareholders - who are taxpayers, as well as pension and mutual funds who hold and invest taxpayers savings and are themselves taxpayers), and likely the survival of AIG itself. Have guiding principles.

c. Keep in constant contact with your counterpart regulators and be prepared to act

6. Do not change the rules of the game unless you have very good reason and tell people what that reason is

a. There has only been one consistent position – the shareholders are expected to get burned. Paulson effectively did so and more importantly, said so with Fannie, Freddie, and AIG. The SEC has been deafeningly silent except to state – yesterday - the willingness to enforce existing rules. If the regulators have declared war on shareholders, then why not eliminate it as an asset class? Why allow people to be paid in shares? Investments should be based on a risk/reward determination. But if the authorities can change the risk and the reward without any rules, then how does one make that decision? It is highly unfair to encourage people to buy shares – i.e. own a piece of the company in expectation of a return in dividends and or capital gain – and then eliminate all hope of a return, as well as the amount invested to purchase the shares. What are you expecting rational shareholders to do? It cannot be rational to hold shares when you appear to be dealing with an “anti-shareholders” Government. Are the regulators really surprised at the massive capital flight to gold?

b. When you demonstrate a willingness to change the rules without explanation or consultation, here’s what else that gets affected (not meant to be an exhaustive list):

i. No one wants to lend your country money – where is the guarantee or rules to ensure it will be repaid. See http://ap.google.com/article/ALeqM5jv4hPN5qQykjJbz5T-S6Zn89N-_AD938P03O1

ii. No one wants to provide Foreign Direct Investment – you know that “thing” that provides jobs and growth. FDI is the first to suffer when Governments are prone to changing the rules. 5.3 million jobs were due to FDI in the US in 2006 and contribute $17.8B in taxes in 2002 http://www.state.gov/r/pa/prs/ps/2006/63041.htm

7. Stop allowing companies to create and sell and trade complex financial instruments that you – as the regulator - do not 1) understand 2) have the time to follow on a second by second basis. If you can’t monitor or regulate it, disallow it until you build the capability to regulate it. Companies exist to make money – not to make the markets stable. That’s why ordinary people buy shares – because they expect companies to make money. Market stability is the Governments’ responsibility.

8. Do not fool yourself that more regulation is the solution to this problem. It is not. Regulation needs to be coordinated and efficient. Yes, companies must disclose, but regulators have to understand what the companies are doing, and the interrelationships. Consistent and fair enforcement is critical. Over-regulation can only make it more difficult for people and companies to access credit which will further cripple the economy.

Just a word on Bailouts:

In principle, I do not support bailouts but I think this situation needs to be placed in the context.

What is the problem with bailouts? They are expensive to the taxpayer. However, if the bailout can prevent a complete catastrophe that will cause irreparable damage to the economy, then a bailout is perhaps necessary. I would argue that institutions that deal with the majority of housing and insurance - and materially affect the lives and livelihoods of the majority of the population - would qualify for bailouts. Let’s call that my ”litmus test”.

Now what have been the problems with THESE bailouts:

1) The authorities bailed out Bear Sterns. I am yet to be convinced that the situation with Bear Sterns was necessary. Where was the national or global catastrophe if one had not been provided? The bailout and the type of bailout only created a precedent and an incentive for other companies to seek a bailout rather than clean up their messes. Lehman has been in trouble for a long time – why wait until the 9th hour to publicly state that there would be no funds for Lehman? Didn’t anyone think the company, the economy, and the all possible investors expected that there would be some form of help after what happened with Bear Sterns? This is the problem with precedents.

2) The authorities did next to nothing while the situation became exacerbated at Fannie and Freddie, therefore the bill that taxpayers would have to pay went up daily

3) The authorities stepped in to Fannie and Freddie. If it is to save housing, then given the size and influence of Fannie and Freddie, this situation does pass my litmus test, in my humble opinion. However, the deal and what was said exacerbated the problem – for taxpayers. By emphasizing that the deal is not designed for shareholders and that shareholders are expected to share in the losses, it created a dangerous precedent. It meant that the government could step in without warning into any publicly traded company in a way that preferred shares and ordinary shares would mean nothing. This started the capital flight from those asset classes – as evidenced by the record declines in the stock indices, and the preferred stock index - and the volatility in the market. Was that the intention or should the statement have been more carefully worded? Why does that matter?

a. Because taxpayers have shares in Fannie and Freddie and other companies and all of a sudden shares are not so attractive

b. Because taxpayers have money in pension funds and mutual funds who are investors in Fannie and Freddie, and other companies

c. Because there are other publicly traded companies - that do meet the litmus test for bailouts - that must logically be impacted because they have shares in Fannie and Freddie, and because there is no longer confidence in shares as an asset class. One such company to suffer was AIG.

4) The handling of AIG was less than optimal – to be diplomatic. AIG’s was forced to raise capital in record time in a weakened and shocked financial market. Goldman and JP Morgan were asked to find money for AIG – from where? Public pronouncements were made by the authorities for no money for AIG. AIG Stock gets hammered. AIG asks the Fed for a loan – no, they are told. S&P downgrades AIG – how does one raise capital with a downgrade? Specifically, how does AIG find $75B in 24 hours as it is instructed? Then the Fed changes its mind with a relief package – great, except the terms are so onerous the company may not even survive that. So the authorities have increased the cost of the taxpayers’ bill.

The Government authorities must take some responsibility not only for a taxpayers’ bill, but, importantly, the size of it.

Let’s talk a bit more about taxpayers:

• these same taxpayers are struggling to hold on to their houses

• these same taxpayers need their insurance policies to be honored

• these same taxpayers are watching the little savings that they have being wiped out in front of their eyes as Pension Funds, Mutual Fund and their chosen investments all precipitously decline as a result of a government induced shock to the system (see 4)

• these same taxpayers are struggling to hold on to their jobs with companies that have to try to recover from the costs of this government induced shock (see 4)

• these same taxpayers are already struggling to try to afford increasingly expensive necessary goods and services - all of which are made more expensive when business that produce those goods and services cannot access capital, or face rising costs of capital as a result of this government induced shock (see 4)

Therefore, do not be surprised when taxpayers have no money to pay any taxes – further exacerbating the economic problems.

Finally, it can be fixed - and fixed quickly - but it takes a level of political will and cooperation never before seen. Are you all ready?
 
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Reasoning The Reasons by Deika Morrison is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.