ith all the panic over a credit freeze and the climbing London Interbank Offered Rate (LIBOR), it seems increasingly clear that something is broken here. Not only is the shadow economy of investment banking threatening to bring down the real economy of labor, production, sales, and profit margin, it's now clear that the shadow economy is now the primary organism and the real economy merely survives to feed it. (A grisly picture, but it's starting to look that way.)
That's probably a result of lax regulation — old-fashioned greed isn't the culprit here so much as a get-rich-quick, quarterly horizon is — and maybe in the longer term it can be fixed. But for the last two weeks I knew there was something I'd read somewhere that was stuck in my mind from way back when. I've read a few analyses from the 40,000-foot view of how this financial crisis came about, but I was thinking of something I'd read that was more like the 40,000-year view. I finally found it:
"There is one bit of advice given to us by the ancient heathen Greeks, and by the Jews in the Old Testament, and by the great Christian teachers of the Middle Ages, which the modern economic system has completely disobeyed. All these people told us not to lend money at interest: and lending money at interest — what we call investment — is the basis of our whole system. Now it may not absolutely follow that we are wrong. Some people say that when Moses and Aristotle and the Christians agreed in forbidding interest (or "usury" as they called it), they could not foresee the joint stock company, and were only thinking of the private moneylender, and that, therefore, we need not bother about what they said. This is a question I cannot decide on. I am not an economist and I simply do not know whether the investment system is responsible for the state we are in or not. This is where we want the Christian economist. But I should not have been honest if I had not told you that three great civilizations had agreed (or so it seems at first sight) in condemning the very thing on which we have based our whole life."
— C.S. Lewis, Mere Christianity, 1952.
Yeah, that was what I was trying to remember. Thanks, Jack.
An interesting twist on this, where the meta-issues in our domestic policy meet the meta-issues in our foreign policy meet issues of faith, is the realization that, under Islam's Shariah law, charging interest is still illegal.
I'm not sure what the implications of that comparison are, and it certainly isn't a prescription for an economic rescue package that a majority of House members can vote to pass. But I find it an interesting commentary on this crisis from the perspective of religious history, nonetheless.
Markos has seven good points that should be addressed before any bailout is agreed to. Read, mark, inwardly digest.
T
his from the wayback machine seems priceless, given the news:
More recently, instruments that are more complex and less transparent--such as credit default swaps, collateralized debt obligations, and credit-linked notes—have been developed and their use has grown very rapidly in recent years. The result? Improved credit-risk management together with more and better risk-management tools appear to have significantly reduced loan concentrations in telecommunications and, indeed, other areas and the associated stress on banks and other financial institutions.
ongressional Democrats hold the cards in many ways on this. Paulson's objection to imposing CEO pay limits on takers of the bailout? Fine. They don't have to take the bailout. Don't like bankruptcy judges rewriting mortgage terms? Fine -- if the federal government owns those mortgages, the federal government becomes the other party to the mortgage, with the homeowner. It can do it without judges at all.
The Democrats' plans are mostly in line with each other, whether that's Chris Dodd's proposal, Barack Obama's four principles for any bailout, or Hillary Clinton's proposals (though several of hers don't seem to address the immediate crisis quite so well, but are all good mid-range proposals). All are related, all have good ideas — Obama was making these same points back in March, for example — and fortunately, Barney Frank and Chris Dodd seem to be on the same page here, so Nancy Pelosi and Harry Reid — and even Barack Obama — need to take their cues from them.
But beyond that, here's what the Congressional Democrats need to say to the Bush administration, including Henry Paulson: "You people and your approach got us into this mess, so now you'll take what we give you to fix it, and you'll like it. Or else, if you veto this, we're starting impeachment proceedings." Because, really, with the worst attack on American soil on their watch, a war we didn't need, gross violations of the Constitution and abuse of power, and now a meltdown of the financial sector, again on their watch, do we really need further evidence that Bush, Cheney and the whole crew headed up at 1600 Pennsylvania Avenue is anything other than incompetent, dishonest, lazy and unconstitutional? If these aren't "high crimes and misdemeanors" then what, pray tell, is?
ast week's financial sector meltdown certainly feels like a game changer to me. For one thing, capitalists are now on record as no longer believing in the power of the free market — or, rather, admitting it has an awesome power, greater than they expected, and therefore it needs some care and feeding — and tacitly admitting that needs to come with oversight.
The Tom Toles cartoon said it best. It showed a fireman, dressed sorta like Uncle Sam, pulling a Wall Street fatcat from a burning building, who is saying, "Wait! Let me go back and save my needlepoint 'Government isn't the solution, government is the problem' inspirational wall hanging."
I have no doubt that the Republicans, as adept as they are at self- and other kinds of deception will choose to remember this crisis differently, and much will depend on what happens over the next two weeks or so. But I for most people the meltdown last week demonstrated, once and for all, that unbridled market forces, "the invisible hand of the market," cannot, by itself, bring about all the good things that we want — especially if that includes stability.
Although I have a standard disclaimer on my site that "My thoughts/opinions ≠ My employer's thoughts/opinions," I also rarely post about anything related to business or technology, so that disclaimer should be fairly obvious. But in this case, I'm going to wonder aloud about some financial and business principles that I should restate clearly are just my own musings, and not at all the opinions of my employer.
Perhaps even more importantly, I should add the warning that I understand the financial world just enough to be dangerous to myself, but don't have the capital behind me to be very dangerous to too many others. So chalk up my ignorant statements here to just that, ignorance.
But my basic, overall take is that the financial industry got completely divorced from reality. "Wall Street got drunk," as George W. Bush famously said when he thought all the cameras were off. Got drunk and started have hallucinations is more like it. This quote, from David Leonhardt's excellent piece "Bubblenomics" in this past Sunday's Week in Review section of the Times, sums it up perfectly:
Benjamin M. Friedman, author of "The Moral Consequences of Economic Growth," recalled that when he worked at Morgan Stanley in the early 1970s, the firm’s annual reports were filled with photographs of factories and other tangible businesses. More recently, Wall Street’s annual reports tend to highlight not the businesses that firms were advising so much as finance for the sake of finance, showing upward-sloping graphs and photographs of traders.
"I have the sense that in many of these firms," Mr. Friedman said, "the activity has become further and further divorced from actual economic activity."
Exactly. The actual banking system — where we deposit money in a bank for some small interest and banks make money by loaning it out to other people at higher interest — and the actual economy for that matter — the stuff of balance sheets and income statements — needs to be the primary means of wealth building for the country or, frankly, we're doomed.
I don't know if short-selling, for example, is a bad thing or a good thing. Or a morally neutral thing. I've heard people say that it provides liquidity in the market — increases what's out there to be bought and sold, in other words. And everyone points out that it was short sellers who first clued in that Enron's finances were a house of cards, and their selling Enron short led to deeper examinations of its financial health and ultimately, uncovered, the mess. That may be. But it's also investing merely as gambling. It allows you to sell a stock you don't yet own. If the price drops, you make money; if it goes up, you lose money. (Basically the opposite of going "long" as an investor.) But unlike going long — buying a stock because you expect its value to increase — short selling allows you to play the market with that stock but not own it until the transactions are totaled up.
Short selling is a headache for companies — who, admittedly, only want their stock to go up, even when it probably shouldn't. But my problem with it is that it further divorces the investment from the thing being invested in. It's like "Beginning Derivatives 101," with the "investment" merely being a prediction and a bet to make money on it. And that, I think, is the overall problem with our financial house today.
Another example: a lot companies don't pay dividends. Now, that alone wouldn't have saved us from this crisis, although a company that can't or won't pay the owners may not have all its ducks in a line, either. I know, I know: many companies, like Berkshire Hathaway, don't pay dividends, they reinvest the profits back into the company, and people who got in early there have made fortunes with the rise of their value of their stock. But at some level I have to ask: is there anything tangible connected to the ownership of the stock, or is it merely the perceived value that someone is willing to buy it for that makes it of value?
I know the answer to that. Gold has no intrinsic value, and yet we've still got survivalist whackjobs out there who want our currency tied to it. And the money that's been made (and now lost) in the stock market for so many people has not primarily come from dividend payouts, not by a long shot.
All of that is probably okay. As long as, theoretically, a payout could be made, or if we sold all the assets I'd get some small part of the proceeds, then that's as good as an actual dividend. And gold may not be "worth" any more than granite except because someone else says it is, but at least it's a thing. What worries me about what's happened to the financial system is that we've flopped the importance of the actual economy with a shadow economy of placing bets on the actual economy. We look at balance sheets and cash flows and buy stock in a company — even though there is absolutely no connection to the activities or even income of the company and the rise or fall of its stock.
Here's a modest proposal. But first, some background, again from that excellent article by Leonhardt:
The classic measure of whether the stock market is overvalued is the price-earnings ratio, which divides stock prices by annual corporate earnings. At the height of the bubble, in 2000, companies in the Standard & Poor’s 500 Index were trading at 36 times their average earnings over the previous five years. It was the highest valuation since at least the 1880s, according to the economist Robert Shiller.
By 2004, surprisingly enough, the ratio had dropped only to about 26, still higher than at any point since the 1930s. At the start of last year, it was still 26.
But after the market closed on Friday, the ratio was down to roughly 17, which happens to be about its post-World War II average. At least by this one measure, stocks are no longer blatantly overvalued.
So here's my proposal, or call it a musing: What would be the downside of establishing price floors and ceilings for a stock based on its P/E ratio? Say (for the sake of the argument) a 5/1 floor and a 25/1 ceiling? That would leave the vast majority of stocks unaffected. Checking the Google Finance stock screener, I see that it lists 141 stocks (out of 3,606) with a P/E ratio of 5 or less — and 17 of those have a negative P/E ratio. So maybe something has to be in place to account for those, for whatever reason they're trading so low. On the other hand, it shows 855 stocks with P/E ratios above 25 (one solar-related company as high as 4900.) In fact, Google, the providers of the stock screener, show a current P/E of 28.27.
In theory, a high P/E ratio is investor's confidence that a firm will make a lot more money in the long run, hence making this stock of such value. But given the way we've changed "investing" into "gambling," it's now really only investor confidence that the price will keep going up, and the "E" part of the equation be damned, or at least ignored.
If we had a floor and ceiling on P/E ratios, I don't know what the impact would be, to be honest. Nor what the correct such floors and ceilings should be: 0 and 30? -5 and 40? The stock market would be far less exciting, I'm sure. There'd be a whole lot less volume traded. IPOs would have to be rethought and reconfigured.
Or make it a further ratio to volume, and let the companies themselves decide on an annual basis by a vote of shareholders? If you choose a -10 to 50 range for your P/E ratio, 24-hour trading volume for your stock is held at a smaller number than if you opt for a relatively tight 5 to 20 range. Once it hits its allowable number of trades on the exchange, trading on that stock is halted for the day.
Or maybe we don't worry about P/E ratios, but we worry about day traders and those turning the stock market into a casino. That would mean getting rid of short selling and, probably, also requiring that a stock be held for one bell closing before it can be sold. Or maybe we do both. Maybe we find a way to outlaw — or at least outlaw public companies — from tradiing in investments that are two, three, and five or more steps removed from actual things — real estate, shares in companies, metals, bonds, commodities, etc.
Obviously, I don't really know. And none of my goofy proposals around P/E ratios and trading volumes would have solved this particular problem. And do I know what the floor or ceiling rules for P/E ratios should be? Of course I don't. And the primary philosophical objection would be that "no one can know, so we should let the free market decide." Except, as we've seen now in the past few weeks, the free market doesn't know either. So — and here's the actual proposal — why don't we let democracy decide?
Or is that exactly how we got to this problem? I'm not sure. Fortunately, Barney Frank is far smarter about this stuff than I am. In the political realm of all this, I have to point out the difference between these two candidates, based on their remarks on the economy last Friday, September 19:
I found these two examples very enlightening. For one thing, one of them is laying out four principles that any bailout should include, but said he'd withhold details of any plan to keep from politicizing what was being worked out between the Treasury Secretary and the Congress. (Now that we've heard the details of Paulson's plan, all three pages of 'em, Obama could probably be allowed to let loose with his commentary on it, if he hasn't already.)
The other (that would be McCain) bounced all over the map, making up new regulatory agencies even while he complains about the number of regulatory agencies. And, as part of that, he thinks a good "generalist" regulatory agency would be far more effective than the "specialist" agencies. I guess, by that line of thinking, there's really no need for all those cabinet positions, either, is there? Let's have the Treasury Department manage our federal prosecutors, the Navy, public forests, and gun licenses. (Oh, wait: they actually did do that last one for decades, until the Department of Homeland Security was created in 2002.)
And he yet again yelled for the head of the head of the SEC, Christopher Cox — basically for no reason other than wanting to blame someone and look "mavericky."
But more importantly, look at how McCain took this opportunity to basically campaign against Obama, blaming him for the crisis (somehow). Obama, on the other hand, took this speech as an opportunity to say that he, John McCain, President Bush, and the Democrats and Republicans need to come together to come up with a workable plan to this financial crisis. And that was essentially the extent of his remarks about John McCain.
Now which of these two men exhibited leadership? Finally, are we seeing a trend here? The Bush Administration ignores a warning — "Bin Laden Determined to Attack Inside the U.S." — and Al Qaeda attacks the United States. George Bush then says the only way to address this crisis of vulnerability is to give his administration sweeping powers, and Congress must act immediately to provide those powers. From that we get the Patriot Act.
Then Saddam Hussein — who was provided financing, agriculture credits, dual-use technology, chemicals, weapons and intelligency by the Reagan and Bush I administrations — was deemed a growing threat following the US-Iraq war (see "yellowcake"), and George W. Bush again demanded sweeping powers, a blank check that would total hundreds of billions of dollars, and no oversight from Congress so he could prosecute a "preventive war" (see "Bush Doctrine").
Now we're facing the worst financial crisis in 80 years, brought on by the deregulating glee with which the Republican administrations of the past three decades treated matters economic and financial. And the solution is yet again to give the Bush Administration a blank check totaling hundreds of billions of dollars and refusal of any oversight (or it will ignore the oversight).
There really wasn't any question before last week, but last week will add at least another two decades (to the at least five decades we were already guaranteed) to any kind of historical reassessment of George W. Bush:
om made a good observation tonight: You know how they turned on the Large Hadron Collider last week in Switzerland, but people are worried it will create tiny black holes that will start sucking things into them, and they'll grow larger and larger? So who would have thought that it would have started with U.S. financial firms? Stephen Hawking, please call your office.
Today's financial news is pretty scary, and could get much scarier. It's one thing to have a Dow meltdown or a Black Monday. But when it's the actual financial firms that loan money to, fund, invest, broker, insure, collateralize, etc., all the other companies on the stock market, what happens then? Or, more to the point, what happens next?
Can someone ask John McCain if he still wants to privatize Social Security? He's pretty firmly on record for wanting to do so, but perhaps he'd like to rethink that.
'm sure many Republicans are happy to be back to normal "us versus them" politics. It seems the convention -- and Sarah Palin's nomination as VP in particular -- has energized the people who felt they otherwise would need to sit this party out, having brought us eight years of failure, incompetence, and -- not that they objected to this one -- deep partisanship. The whole point of the culture wars is to play the "us versus them" game.
Their whole approach since the convention has been to lie, only to be cheered on further by the people who like to win elections, rather than govern.
This has been the case since the 2000 election, but it's appearing in its purist form yet so far. The reason is simple: far more than than any other election in my memory, the Republican candidates are on the wrong side of the electorate on almost every issue. So they have nothing to run on except personal attacks and personal narratives.
And it works. We really are a divided country, and becoming more so with this election. I've written about this before, when I said there are two kinds of people in the world: those who think "clarity" is the same things as "truth" -- and those who think there are more than two kinds of people in the world.
It gets even simpler than that, however. Because a lot of voters basically just want to vote for someone who will go on the offensive. They misinterpret attacks, even (or especially) lies and distortions, as "leadership." They see McCain as willing to fight dirty and think: that's the kind of leadership I want to vote for.
That's what a slim majority voted for in 2004 and what slim minority voted for in 2000. One wouldn't have thought it possible based on the 2000 primaries, but given the McCain claims that Obama wanted to teach kindergarteners about sex or called Sarah Palin a pig, I have to say that this time around, McCain has managed to out-Bush Bush. Giving a new understanding to the tag line "more of the same." At this point, it's looking like "much more."
Despite the latest, post-RNC convention bounce for McCain, I'm still hopeful. For one thing, I think this year voters may be more willing to vote based on the issues rather than the distraction tactics of the Republicans. And I think there's still a lot more energy behind voting for Obama than there is for voting for McCain, Sarah Palin's nomination notwithstanding.
And I think McCain has been such a heinous liar of late -- approaching the levels of the less official but no less welcomed e-mail and rumor campaigns that are so patently false (faith; citizenship; raising taxes...) -- that a lot of people will wake up and decide not to elect another administration in the same mold as the one we've had for the past seven-plus years. But on that I'm obviously being hopeful, not predictive.
Two anecdotal bits of evidence added to my hope, however. For one, this article from August that Obama is outpacing McCain 6-to-1 in campaign contributions from currently deployed troops. That could change, become closer, even flop -- but it certainly implies something going on among military families. Especially when you consider that the Disabled American Vets gave Obama a 92% rating for voting with them, but gave McCain only 28%. Or that the Vietnam Vets of America also gave Obama a 92%, but gave McCain a 37%. And the Iraq and Afghanistan Vets of America gave McCain a rating of "D" but gave Obama a B-plus. Or why the same contributions analysis shows Obama with $335,536 from 859 service personnel (deployed or not), whereas McCain had only $280,513 from 558 such personnel. The point of the number or amount of contributions is far less important than what it may say about what active duty members are saying to their families, in-laws, and friends, who in turn influence others around them.
And then there was this I found out myself. In looking through the FEC data for donations this political cycle from the ZIP code in Oklahoma I grew up in (mostly upper middle class, mostly white, safely Republican, and did I mention it's in Oklahoma?), I found that through July, there was more money given to Democratic candidates than Republican candidates (Democrats: $81,178 vs. Republicans $72,586). More importantly, Obama recieved $46,300 in donations in this ZIP code from 52 people, whereas McCain received only $41,768 from 30 people. (As a proof point, Hillary Clinton received $30,945 from 39 people.)
These (military contributions and donations from a Republican Oklahoma ZIP code) are just two examples, and only reflect data through July. But as I say, they give me hope.
McCain's chief economic policy advisor admits he was wrong earlier, and now says that Obama's economic plan amounts to a tax cut for most Americans, not a tax increase.
Is Bush using Obama's approach to catching bin Laden for a October surprise in support of McCain?
