The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Our earlier commentary (The Left Right Paradigm is Over: Its You vs. Corporations) reminded me of this political cartoon:

As a follow up to our weekly FDIC bank closing charts, the WSJ has an article with accompanying interactive graphic (below) showing the progress of bank closings over the past 2 years.

They note that since WaMu fell, 279 lenders have collapsed; where the closings are concentrated was somewhat unexpected:

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click for interactive graphic

courtesy of WSJ

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This is a static version that also shows the distribution of failures:
click for larger map

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Source:
Banks Keep Failing, No End in Sight
RANDALL SMITH And ROBIN SIDEL
WSJ, SEPTEMBER 27, 2010
http://online.wsj.com/article/SB10001424052748704760704575516272337762044.html

Ron Griess of of The Chart Store directs our attention to this particular chart (below).

If you want to know why indicators using any form of advance/decline data do not work as well as they used to in the past, perhaps this chart might provide some clues.

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click for larger chart

Source:
Animal Spirits … Activate! Form of … a Stampeding Bull Market
Aaron Task
Yahoo Tech Ticker, Sept 27, 2010
http://finance.yahoo.com/tech-ticker/animal-spirits-…-activate!-form-of-…-a-stampeding-bull-market-535453.html

Every generation or so, a major secular shift takes place that shakes up the existing paradigm. It happens in industry, finance, literature, sports, manufacturing, technology, entertainment, travel, communication, etc.

I would like to discuss the paradigm shift that is occurring in politics.

For a long time, American politics has been defined by a Left/Right dynamic. It was Liberals versus Conservatives on a variety of issues. Pro-Life versus Pro-Choice, Tax Cuts vs. More Spending, Pro-War vs Peaceniks, Environmental Protections vs. Economic Growth, Pro-Union vs. Union-Free, Gay Marriage vs. Family Values, School Choice vs. Public Schools, Regulation vs. Free Markets.

The new dynamic, however, has moved past the old Left Right paradigm. We now live in an era defined by increasing Corporate influence and authority over the individual. These two “interest groups” – I can barely suppress snorting derisively over that phrase – have been on a headlong collision course for decades, which came to a head with the financial collapse and bailouts. Where there is massive concentrations of wealth and influence, there will be abuse of power.  The Individual has been supplanted in the political process nearly entirely by corporate money, legislative influence, campaign contributions, even free speech rights.

This may not be a brilliant insight, but it is surely an overlooked one. It is now an Individual vs. Corporate debate – and the Humans are losing.

Consider:

• Many of the regulations that govern energy and banking sector were written by Corporations;

• The biggest influence on legislative votes is often Corporate Lobbying;

• Corporate ability to extend copyright far beyond what original protections amounts to a taking of public works for private corporate usage;

• PAC and campaign finance by Corporations has supplanted individual donations to elections;

• The individuals’ right to seek redress in court has been under attack for decades, limiting their options.

• DRM and content protection undercuts the individual’s ability to use purchased content as they see fit;

• Patent protections are continually weakened. Deep pocketed corporations can usurp inventions almost at will;

• The Supreme Court has ruled that Corporations have Free Speech rights equivalent to people; (So much for original intent!)

None of these are Democrat/Republican conflicts, but rather, are corporate vs. individual issues.

For those of you who are stuck in the old Left/Right debate, you are missing the bigger picture. Consider this about the Bailouts: It was a right-winger who bailed out all of the big banks, Fannie Mae, and AIG in the first place; then his left winger successor continued to pour more money into the fire pit.

What difference did the Left/Right dynamic make? Almost none whatsoever.

How about government spending? The past two presidents are regarded as representative of the Left Right paradigm – yet they each spent excessively, sponsored unfunded tax cuts, plowed money into military adventures and ran enormous deficits. Does Left Right really make a difference when it comes to deficits and fiscal responsibility? (Apparently not).

What does it mean when we can no longer distinguish between the actions of the left and the right? If that dynamic no longer accurately distinguishes what occurs, why are so many of our policy debates framed in Left/Right terms?

In many ways, American society is increasingly less married to this dynamic: Party Affiliation continues to fall, approval of Congress is at record lows, and voter participation hovers at very low rates.

There is some pushback already taking place against the concentration of corporate power: Mainstream corporate media has been increasingly replaced with user created content – YouTube and Blogs are increasingly important to news consumers (especially younger users). Independent voters are an increasingly larger share of the US electorate. And I suspect that much of the pushback against the Elizabeth Warren’s concept of a Financial Consumer Protection Agency plays directly into this Corporate vs. Individual fight.

But the battle lines between the two groups have barely been drawn. I expect this fight will define American politics over the next decade.

Keynes vs Hayek? Friedman vs Krugman? Those are the wrong intellectual debates. Its you vs. Tony Hayward, BP CEO, You vs. Lloyd Blankfein, Goldman Sachs CEO. And you are losing . . .

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This short commentary was conceived not to be an exhaustive research, but rather, to stimulate debate. There are many more examples and discussions we can have about this, and I hope readers do so in comments.

But my bottom line is this:  If you see the world in terms of Left & Right, you really aren’t seeing the world at all . . .

The tug of war between a lackluster economic recovery on one side and the Fed’s printing press on the other and its influence on stock market action will get another influence this week and again, its Washington, DC abetted. On Wednesday, the House is expected to vote on the Currency Reform for Fair Trade Act, aka, punish China for pegging their currency to the US$, notwithstanding that other countries do the same and even though China’s export figures are inflated because they only add a small amount to the finished product exported. I don’t know what the appetite of this bill is in the Senate to see whether it gains any traction past the House but any possibility of passage would be a disaster for our relations with China in my opinion. Moody’s downgraded the unguaranteed debt of Anglo Irish ahead of this week’s release of more details of the cost of its bailout. Straight out of the movie ‘Groundhog Day,’ Japan wants another stimulus package.

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THE ROAD NOT TAKEN

Investment letter – September 16, 2010

In the two years since Lehman Brothers was allowed to fail, there have been numerous books on the causes of the financial crisis. The housing boom and subsequent collapse is understandably at the epicenter of most of the books. Depending on the political persuasion of the author, the emphasis is that conservatives or liberals deserve more blame for the following reasons. What typically follows is a narrative of political bias. The fact is that both views have it partially right. However, at the end of the day, what is more important is that a number of contributing factors are worse now, than before the crisis.

Consider the following, which are presented in no order of significance, or intended to be inclusive of all the contributing factors. A number of institutions were so large and integral to the global financial system, central banks and governments around the world had no choice but to intervene and bail them out, since they were too big to fail. The solution applied to this problem by policy makers has been to make them even bigger. And there are no plans to break them up in the future. Instead, banks will be required to increase their reserves until 2019. This will work until the next batch of financial wise guys figure out a way to circumvent the rules. This is a bit like adding more bandages to the wound, rather than stitching up the wound. If a bank is poorly managed, it should be allowed to fail. Period.

Some have said the Federal Reserve held rates too low for too long in 2002 and 2003. Others point to a lack of oversight exercised by the Fed, as ads touting loans of 125% of a home’s value in 2004 failed to sound any alarm bells inside the FOMC. Now we have the Fed holding rates under .25% for an extended period because, in reality, they don’t have a choice. I have no idea how the Federal Reserve is going to delicately extricate itself from keeping rates so low. As the Fed does eventually raise short term rates, the debt burden of an already debt burdened consumer and federal government will increase. This will make balancing the Federal budget more difficult, and surely lead to politics playing a role in the Fed’s decision making. The scary thought is that I don’t think the Fed knows how they will accomplish this daunting task.

Owning a home is part of the American ‘dream’, especially since home prices have over time increased in value. The rating agencies were so convinced that home prices would never decline nationwide their risk models didn’t even include the possibility of a decline. Even as the ratio of median home prices to median incomes rose from 3 to 1 (between 1965 and 2000), to 4.6 to 1 in 2006, the rating agencies chose to ignore the obvious in lieu of collecting billions in fees. They continued to rubber stamp pools of mortgage backed securities AAA well into 2007, after the cracks in housing emerged. No surprise then that politicians would want to exert their influence on the GSE’s (Fannie Mae, Freddie Mac, and FHA) to make it possible for more lower income families to own a piece of the American dream. Prior to 2007, the GSE’s represented 45% of the home mortgage market. Now the GSE’s are behind 95% of all mortgage originations.

Although there had been banking panics in 1873, 1884, 1890, and 1893, the Panic of 1907 was the most severe, since it was centered in New York City. On October 24, 1907, the New York Stock Exchange would have closed had it not been for J.P. Morgan’s effort to raise $25 million from fellow bankers to provide much needed liquidity. This brush with disaster culminated in the establishment of the Federal Reserve in 1913. The common denominator in all of these panics was a run on banks, with depositors demanding their money. As simply explained by George Bailey in “It’s A Wonderful Life”, the banks didn’t have enough cash on hand, since they had lent the money so homes could be purchased and businesses could run. The primary purpose of the Federal Reserve was to inspire confidence so bank runs wouldn’t happen in the first place, and then, serve as the lender of last resort when they did occur. The Federal Reserve failed to provide enough liquidity in the early stages of the Great Depression and allowed the money supply to contract. This certainly deepened the 1930’s downturn, and ultimately led to the establishment of the Federal Deposit Insurance Corporation (FDIC) in 1933 with the passage of the Glass-Steagall Act.

Theoretically, the Federal Reserve is an independent central bank. However, since the Constitution gives Congress the power to coin money and set its value, the Federal Reserve must act in accordance with objectives set by Congress. In 1978, Congress passed the “Full Employment and Balanced Growth Act”, which mandated that the Fed establish a monetary policy that strives for full employment, growth in production, price stability, balance of trade, and balancing of the Federal Budget. The Act, which also known as the Humphrey-Hawkins bill, also explicitly states that the Federal government would rely primarily on private enterprise to achieve those goals. However, the Act expressly allows the government to create a ‘reservoir of public employment’, if private enterprises fall short.

The primary objective of the “Full Employment and Balanced Growth Act” has been to use a combination of fiscal and monetary policy to mitigate the natural ebb and flow of the business cycle. In the 25 years between 1957 and 1982 (300 months), there were 64 months that the economy was in recession. In the 25 years between 1982 and 2007 there were only two shallow recessions, which each lasted 8 months. On the surface, it certainly appears that the manipulation of fiscal and monetary policy had succeeded in taming the business cycle. In reality, the attempt to defeat the business cycle only succeeded in allowing far larger imbalances to develop. During the window of apparent success, between 1982 and 2007, total debt relative to GDP, mushroomed from $1.65 for each $1.00 of GDP in 1982, to $3.70 of debt for $1.00 of GDP in 2007.

Household debt as a percent of GDP rose from 44% in 1982 to 98% in 2007. Rather than allowing a recession to remove excesses and recalibrate the level of credit and debt relative to asset prices and GDP, the manipulation of fiscal and monetary policy only allowed the economy to inhale. As a result, we are now experiencing the Great Exhale. Although the Great Recession has ended, the Great Exhale has years to run. Unfortunately, policy makers are still using the same playbook that created so many imbalances. I have no idea whether the Great Exhale will end with a whimper or a bang. Neither outcome looks appealing. The one thing I am not doing is holding my breath in the expectation that policymakers will realize that all things oscillate in cycles, including the business cycle.

Since their peak in 2006, home prices are down almost 30%, and mortgage rates are at multi-generational lows. Despite the increase in affordability, new home sales fell to their lowest level in July since 1963, when the Commerce Department began records. Sales of existing homes plunged in July to their lowest level since 1995. Some of this weakness can be attributed to the expiration of the first-time home buyers’ tax credit at the end of April, which clearly pulled sales forward. This is another example of policy makers attempting to affect the natural ebb and flow of supply and demand. New home sales and existing homes sales will likely rebound in coming months, as a sense of equilibrium is restored to the housing market. That said, housing will remain weak, as long as unemployment growth remains elusive, income growth is feeble, and lending standards require home buyers to make a down payment and prove their income.

Read the rest of this entry »

As if we need further evidence of the gross and willful malfeasance of Moody’s S&P’s and Fitch: The latest evidence of their criminally irresponsible behavior comes to us via the Financial Crisis Inquiry Commission.

This was not, as the narrative has been reconstructed, a case of good loans gone bad. Mere incompetence does not explain the ratings agency debacle. This was a Ford Pinto, a calculated attempt to maximize profits regardless fo the systemic damage it caused. So what if a few people had to burn to death in order to make our bonuses — bankrupting the global economy is merely a cost of doing business.

NYT excerpt:

“D. Keith Johnson, a former president of Clayton Holdings, a company that analyzed mortgage pools for the Wall Street firms that sold them, told the commission on Thursday that almost half the mortgages Clayton sampled from the beginning of 2006 through June 2007 failed to meet crucial quality benchmarks that banks had promised to investors.

Yet, Clayton found, Wall Street was placing many of the troubled loans into bundles known as mortgage securities. Mr. Johnson said he took this data to officials at Standard & Poor’s, Fitch Ratings and to the executive team at Moody’s Investors Service.”

The mortgage securtitizers hired independent analytical companies (like Clayton) to “sample loans and flag any that were problematic.” According to his testimony, Clayton found a large percentage of loans that failed various tests such as geographic diversity, the loan-to-value ratios, credit scores and incomes of borrowers. These findings appear to have veen routinely ignored by both the underwriters and the rating agencies.

It was a trust-but-verify approach — but without the verification that might reduce a lucrative business:

“According to testimony last week, from January 2006 to June 2007, Clayton reviewed 911,000 loans for 23 investment or commercial banks, including Citigroup, Deutsche Bank, Goldman Sachs, UBS, Merrill Lynch, Bear Stearns and Morgan Stanley.

The statistics provided by these samples, according to Mr. Johnson and Vicki Beal, a senior vice president at Clayton who also testified before the inquiry commission, indicated that only 54 percent of the loans met the lenders’ underwriting standards, regardless of how stringent or weak they were.

Some 28 percent of the loans sampled over the period were outright failures — that is, they were unable to meet numerous underwriting standards and did not have positive factors that compensated for their failings. And yet, 39 percent of these troubled loans still went into mortgage pools sold to investors during the period, Clayton’s figures showed.”

This was not a case of error or bad forecasting or poor execution. This was a reckless pursuit of profit by design. The risks, indeed probabilities of default were well known, and ignored.

If any group of firms deserve the Arthur Anderson fate of corporate execution for bring guilty of murderous behavior, it is the rating agencies. In my opinion, they should be put down like rabid dogs.

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UPDATE: October 13, 2010
Felix Salmon is (belatedly) on the case of bank liability, and having entire CDO/RMBS bundles put back to the banks.

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Source:
Raters Ignored Proof of Unsafe Loans, Panel Is Told
GRETCHEN MORGENSON
NYT, September 26, 2010
http://www.nytimes.com/2010/09/27/business/27ratings.html

How journalists are coping with a flood of information by borrowing data visualization techniques from computer scientists, researchers and artists.

Full Stanford University project info here.

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Journalism in the Age of Data from geoff mcghee on Vimeo.

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Hat tip Flowing Data

Another week, and you know what that means: FDIC Bank takeovers!

All charts courtesy of The Chart Store