Posts filed under “Think Tank”
Good Evening: U.S. stocks finished mixed Wednesday after a morning dip and afternoon rally both failed. Some less than cheery news from FedEx and some bank downgrades set the tone for the early weakness, while a successful test of the 200 day moving average by the S&P 500 helped prices rebound in the afternoon. And it is also quite possible that stocks were ready to bounce a bit after a few down days, but I’ll focus more on market direction tomorrow. Instead I will review President Obama’s proposal for changing the regulatory landscape of the financial industry. The issues that brought us the financial crisis are not small, but I wonder if some of the President’s many, many ideas on the subject are correctly sized in relation to the problem. More is not always better, especially when it comes to a complex industry like modern finance.
Stocks overseas were on the weak side overnight, extending a trend that began late last week. U.S. stock index futures were also a bit lower, though the news out of FedEx may have been a contributing factor (see below). FDX announced an earnings beat, but then went on to say the economy deteriorated during the most recent quarter and put an exclamation point on this observation by halving its earnings guidance for the current quarter. Since what is shipped by FDX is the very stuff that makes our economy go, hearing its management say — whether from 30,000 feet or on the ground — that the green shoots are not visibly sprouting gave many investors pause in the early going.
The economic data was not much of a factor, since the tame CPI figures reported today tell us little about the inflation risks down the road. So, too, with the current account deficit; it narrowed in Q1 due to factors that have already started to reverse (see below). The banks, however, were a story with a little more teeth this morning. In the final story you will find below, S&P downgraded 18 banks — despite all the stress test results and capital raises in recent weeks. It would have been an even bigger story had the ratings agencies not trashed their reputations in the 2003-2007 time frame.
Given this news flow, stocks could have been forgiven for opening 1% lower, but they instead opened nearly unchanged before declining by the aforementioned amount 90 minutes into the trading day. The S&P 500 even managed to penetrate its 200 day moving average for a brief spell before that index followed NASDAQ higher. After rallying until they were up approximately 1%, the major averages settled back to close mixed. Bonds were firm in the morning, but they also reversed to finish mixed. Yields on the short end fell a couple of bps, while those on the long end rose in equal measure. At least the dollar and commodities were fairly consistent, though. The former fell and stayed down, while the latter followed oil and precious metals higher for most of the session. The CRB index closed 0.4% higher.
I’ve written quite a bit about how the U.S. can more intelligently regulate our financial system. Back in May, I cited Barry Ritholtz’s suggestions for financial reform, which he posted in this article on his site, The Big Picture . In addition to Barry’s list, I proposed the following suggestions in a commentary posted later the same day (comment) . I then added these ideas to this growing laundry list on June 9 in this piece. The philosophy behind these proposals is to create a regulatory boundary fence inside which financial firms can then more or less freely operate. Detail-loving micromanagers need not apply for a position in this framework-oriented approach.
In response to all of the free advice available above and elsewhere, the Obama administration put forth in the Monday edition of the Washington Post the following preview of the President’s proposal. This early glimpse was heartening to the extent that it addressed many of the issues that Barry and I have written about. But, as always, the mischief of regulatory reform is in the details. President Obama’s actual proposal broadly follows the outline laid out by Mr. Geithner and Mr. Summers, but it goes quite a bit further — and, perhaps, too far (Obama’s Draft Proposal). Let me clearly state that I have yet to read every one of the 85 pages, but the pages I have read seem to indicate that when choosing between “smarter” regulation and simply “more” regulation, the President’s draft proposal seems to favor a “more regulation is better” approach.
The first piece of evidence I offer in support of my assertion of an unwelcome drift toward “more” as opposed to “smarter” regulation is the size of the proposal itself. “Change” mean many things, but 85 pages are more indicative of too much micromanagement rather than a statement of principals and intents to be debated during the legislative process. The blueprints for the type of “boundary fence” regulation I’ve often proposed would require a few pages; regulating the behavior of financial institutions while inside the boundaries is what takes so much explaining.
Another indication that the “more is better” philosophy of regulation might be transcendent in the President’s draft is an entire section (# 3) has as its goal to “protect consumers and investors from financial abuse”. Like 99% of the American population, I’m against financial abuse in all its forms, but it’s a fool’s errand to try to set up a vast infrastructure of rules to deal with it. The smarter approach would tell all investors and consumers to take responsibility themselves for any dealings to which they are a party. “Caveat emptor” would be my first, if inelegant, suggestion.
To those two simple words I would also offer ways for consumers and investors have easy access (800#, website, etc.) to both FINRA and the enforcement division of the SEC. FINRA could handle most of the brokerage-related complaints (think: my advisor did unauthorized trades in my account), and the SEC could handle the larger problems surrounding organizational practices (think: Stanford or Madoff). Both FINRA and the SEC already have the power to police, fine and/or prosecute perpetrators of financial misdeeds, so let’s just make it easy for folks to find help at these two regulatory bodies and then just ask the agencies to do their jobs.
See? My version of section # 3 alone would take only two paragraphs to explain, will cost next to nothing to implement, and will likely be more effective than any attempt to legislate even more “do’s” and “don’ts” than already exist. Sarbanes-Oxley is only one example of a confusing tangle of regs that has utterly failed to address the abuses it was intended to prevent. Conscientious objectors of the potentially higher staffing costs my idea might bring needn’t worry too much, since the extra funding the SEC might need could be found in eliminating certain departments (e.g. “Economic Analysis”).
Before anyone takes umbrage at what they may think is a political attack on the administration, let me say there is plenty to like about Mr. Obama’s proposal. I support 1) the overall approach to taking systemic risk into consideration instead of focusing only on individual institutions, 2) the imposition of leverage caps on these firms, 3) the move toward more transparency, 4) the desire to better coordinate the various regulatory bodies and their roles, 5) the attempt to finally rein in OTC derivatives, and 5) the goal of working toward international standards on all of the above. Done well, these changes will be quite welcome in that they will help lower the systemic risk embedded in our current system.
I’m less than enthralled, however, about 1) giving the Fed more power, 2) attempting to detail the ways we can now “protect” consumers and investors, 3) requiring hedge funds and “other pools of capital” to register with the SEC, and 4) skating past the moral hazard issues created by all the 2007-2009 bailouts. In short, Mr. Obama’s proposal is a start — one which I hope will emphasize intelligent attempts at regulation, but one I fear will end up just being more governmental ways to micromanage. This draft obviously will be subjected to considerable tinkering during the legislative process. Financial firms are huge campaign donors, especially in the Senate, so I’m guessing whatever our President eventually signs into law could be quite different than what he laid out today. Let’s hope Mr. Obama’s 85 pages of what looks like “more” get whittled down until we can proudly call them “smart”.
– Jack McHugh
Vincent Farrell, Jr. is Chief Investment Officer of Soleil Securities, a New York based investment management company. Over his long career on Wall Street, he has worked for numerous distinguished firms. Mr. Farrell graduated from Princeton University in 1969 and received his M.B.A. from the Iona College Graduate School of Business in 1972.
Household debt is “down” to 130% of disposable income. “Down” is a relative term. It was 134% recently. But it was half the current level as recently as the mid-1980′s. Total debt in the U.S. (all debt including the government) stands at about 360% of Gross Domestic Product. It was 155% in 1980. Another way to slice the debt overview is to look at non-financial debt (take the banks’ debt, etc. out) and that is 240% of GDP. The Euro zone is also at about that level and Japan is at something like 450% of GDP. But that economy has been down for a long time, so I take no comfort we are better off than that.
Let’s look at household debt for a moment. Disposable personal income is close enough to $11 trillion that we can use that as a number. If household debt were to retreat to, say, 100% of income, it would be a retrenchment of a good bit over $3 trillion. That would be one big bite out of consumer expenditures. I have no idea where this debt to income will or should go. Things tend to revert to the norm over time, and if we were in the 70% range in the 1980′s, I don’t think returning to 100% is a crazy view. If the savings rate were to return to its 70-year average of 9%, that would chip in almost $1 trillion a year. Savings might not go to pay off debt, but, from a total balance sheet overview, we could balance one against the other. If all else stayed equal (which of course it won’t), it would take several years to get back to 100%. Not a joyful prospect for a booming economy led by the consumer, but I don’t think any of us believe the consumer is going to be a driving force in any recovery.
What might be a driving force would be inventory restocking. I mentioned yesterday that Industrial Production was down again, which means there is no inventory build at all, and inventory liquidation instead. If final demand started to pick up, there would be a need to increase production quickly.
New York City has balanced its budget with the aid of Federal stimulus dollars. But the smoke and mirrors employed also revealed a rise in the sales tax and a reduction in the work force. How does the use of stimulus dollars in this sense stimulate? Taxes are up and employment down. I don’t get it. Only about $50 billion or so of the total stimulus package of $787 billion has been spent, and there is a lot of enthusiasm that, when the rest gets spent, the economy will prosper. But if it non-stimulates like this, we are in for a reassessment.
The giveback of the June gains over the past few days in the S&P’s has been matched by the corporate credit markets where the CDS on the HY and IG index are back to the levels of late May. The action in the bank sector specifically is most interesting. On May 7th the results of…Read More
The higher than expected build in gasoline prices in today’s weekly DOE data is sending front month gasoline futures down 2.5%. This may result, in the next few days, in the very first decline in retail gasoline prices at the pump since April 28th, as measured by the daily AAA national unleaded gasoline price survey….Read More
The May CPI rose .1% headline, .2% less than expected but the core gain of .1% was right in line with forecasts. Headline CPI y/o/y fell 1.3%, the most since April 1950 and was .4% greater than expected. The core rate rose 1.8% y/o/y. In the CPI, food prices make up a larger portion than…Read More
Governor Kevin Warsh
At the Institute of International Bankers Annual Meeting, New York, New York
June 16, 2009
In a seminal essay delivered about 16 years ago, Senator Daniel Patrick Moynihan offered a striking view of the degradation of standards in society.1 He observed that deviancy–measured as increases in crime, broken homes, and mental illness–reached levels unimagined by earlier generations. As a means of coping with the onslaught, society often sought to define the problem away. The definition of customary behavior was expanded. Actions once considered deviant from acceptable standards became, almost immaculately, within bounds.2
Society moves on, as it were. Well-meaning efforts are periodically made to treat its failings. But if these efforts prove less than successful, citizens and policymakers alike tend to grow increasingly accustomed to the unfortunate statistics. Every bit the reformer throughout his decades of public service, Moynihan seemed reluctantly resigned to society’s construct: “In this sense, the agencies of control often seem to define their job as that of keeping deviance within bounds rather than that of obliterating it altogether.”3
Given the financial crisis, deep contraction in the real economy, and extraordinary fiscal and monetary responses, I cannot help but wonder what constitutes deviance in economic terms in 2009 and beyond. What level of real economic output and unemployment is expected and, more important, accepted? And what level of volatility constitutes the “new normal”?4 As I will discuss, we must be wary of macroeconomic policies that–in the name of stability– may have the effect of lowering trend growth and employment rates.
In Moynihan’s framework, will we in the official sector be accepting of periods of significant financial and economic distress, however infrequent? That is, will deviancy be defined down with the understanding that a rare crisis is the price for dynamic, robust economic growth? Or will the official sector say, “Never again–not on our watch,” and become less tolerant of deviations in economic and financial conditions? Under the mantle of reforming capitalism, will policymakers instead define deviancy up, and seek to guarantee stability in our economic affairs?
I suspect that, for a time, policymakers will be more attracted to this latter path. Stability is a fine goal, but it is not a final one. Long after panic conditions have ended, stability threatens to displace economic growth as the primary macroeconomic policy objective. But we must recognize that the singular pursuit of stability, however well intentioned, may end up making our economy less productive, less adaptive, and less self-correcting–and in so doing, less able to deliver on its alluring promise. This fate, however, does not have to be ours. The U.S. economy is capable, in my judgment, of delivering more.
The Growth Experiment5
This most recent boom and bust is not, as they say, our country’s first rodeo, but it may turn out to be the most consequential since World War II. And, here, I am not just talking about the near-term peak-to-trough changes in growth and employment levels, which are likely to prove significant.
Policymakers are revealing new policy preferences and prescriptions–fiscal policy, trade policy, regulatory policy, and monetary policy, chiefly among them. Long after the official recession ends, the choices being made may significantly alter the contour of the U.S. economy. The harder question that remains is whether these changes will prove beneficial.
From the mid-1980s through 2007, U.S. real gross domestic product (GDP) growth averaged more than 3 percent per year, and was less volatile than in previous decades. The average unemployment rate was less than 5-3/4 percent, a full percentage point less than in the previous 15 years. Most notable was the realized acceleration in labor productivity in the mid-1990s.
The bipartisan, pro-growth policies that predominated during this period contributed meaningfully to these gains. Tax and spending decisions generally sought to expand the economic pie. Trade policies were aimed at opening new markets to U.S. products and services, and removing barriers domestically. Regulatory policies permitted failure, and relied in equal parts on capital requirements, regulatory standards, and, no less important, market discipline. As a result, businesses were well positioned to adopt new efficiency-enhancing technologies and processes to excel in the pro-growth environment. These policies helped drive significant productivity gains, and remarkable U.S. and global prosperity.6
Volcker: Hedge funds don’t need to be regulated like banks. Keynote address by former Federal Reserve Chairman Paul A. Volcker to a meeting of the International Institute of Finance in Beijing, June 11: ~~~ Another important common concern is the “too big to fail” syndrome — the presumption that an institution is so large or…Read More
You know the concept of globalization is not some temporary phenomenon that got great press during the great global boom of 2003-2007 when the first ever BRIC summit happened today and world policy was discussed. To put into perspective, the cumulative GDP of Brazil, Russia, India and China is about $7 trillion, half the size…Read More
The predictions of the members of the Barron’s mid-year Roundtable discussion over the weekend were in agreement that the March lows of the stock markets would not be broken. This reminded me of one of the famous “Investment Rules” of Bob Farrell, legendary former chief stock market analyst at Merrill Lynch. Rule # 9 stated: “When all the experts and forecasts agree, something else is going to happen.”
Meanwhile, many stock markets yesterday registered their worst single-session percentage losses in a month. Commodities also faced heavy profit-taking, but government bonds rallied and the US dollar strengthened against a basket of currencies. “We could be seeing one of those occasional all-change signals in short-term trends,” said David Fuller (Fullermoney).
Richard Russell, veteran writer of the daily Dow Theory Letters, commented on Monday: “I’m of the opinion that this bear market rally is in the process of topping out. When a counter-trend rally tops out within an ongoing primary bear market, the odds are that the stock market will break to new lows during the period ahead. That means that the stock market will break below its March 9 lows in coming weeks. A violation of the March 9 lows would be a shocker to most investors, and it would be a forecast of an even worse economy coming up.”
Category: Think Tank