Financial Crisis

As far as the financial crisis goes, Mr Paulson has been wrong about the crisis since it began and he is wrong now. It is not the end of western civilization as we know it, but the normal functioning of the economic cycle. There are always booms and busts in capitalist systems - does anyone remember the dot com boom and bust? This is just the busting of the housing boom in America with the added twist of the explosion of subprime mortgages and their securitizaton and spread all over the financial system. Paulson does not need $700 billion to buy all the toxic assets. Let the banks write them off and raise new capital. Paulson is just a drama queen and is trying grab more power for the US Treasury.

The lesson of the Great Depression as set forth by Friedman and Schwartz in their groundbreaking "Monetary History of the United States" is that the Federal Reserve made the depression worse by allowing the money supply to contract drastically as hundreds of banks went under in the 1930s. Applied to today's crisis, that would mean that the Fed should keep lending to banks by accepting any assets they have as collateral for loans. The Fed is already doing that.

We are already in a recession and the unemployment rate will probably hit 7% in the next year. Economic cycles are a fact of life and there is no way to avoid them. By trying to avoid the consequences of the dot com bust earlier in the decade, Greenspan's Fed flooded the system with liquidity. That created the conditions for the lending boom of this decade and the subprime debacle.

Punchdrunk Paulson

There is no rhyme or reason to all the interventions from Washington.
Why save AIG, and not Lehman Brothers?
Why give JPMorgan $29 billion to buy Bear Stearns?
All this is being done on an ad hoc basis with no overarching philosophy.
A Republican administration has presided over the most far reaching intervention in the financial markets since the Great Depression in the 1930s.
Why have they forgotten the lessons that Milton Friedman drew from the Great Depression? None of the Keynesian pump priming worked. The reason the Depression was so severe was that the Fed did not know what it was doing and destroyed 30% of money supply by liquidating foreclosed banks.
The lesson for this crisis is for the Fed to keep the system liquid by injecting Fed Funds and keeping money supply stable.
The attempt to buy mortgages in an RTC Part II is misguided - it does not allow the excesses to be cleared out, and it inflates federal government borrowing.

Is Barack Obama going to make it?

A Bad Bank Rescue

This piece from Sebastian Mallaby in the Washington Post is excellent on why the Paulson bailout is a bad idea.
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/20/AR2008092001059.html


A Bad Bank Rescue

By Sebastian Mallaby
Sunday, September 21, 2008; B07

With truly extraordinary speed, opinion has swung behind the radical idea that the government should commit hundreds of billions in taxpayer money to purchasing dud loans from banks that aren't actually insolvent. As recently as a week ago, no public official had even mentioned this option. Now the Treasury, the Fed and congressional leaders are promising its enactment within days. The scheme has gone from invisibility to inevitability in the blink of an eye. This is extremely dangerous.

The plan is being marketed under false pretenses. Supporters have invoked the shining success of the Resolution Trust Corporation as justification and precedent. But the RTC, which was created in 1989 to clean up the wreckage of the savings-and-loan crisis, bears little resemblance to what is being contemplated now. The RTC collected and eventually sold off loans made by thrifts that had gone bust. The administration proposes to buy up bad loans before the lenders go bust. This difference raises several questions.

The first is whether the bailout is necessary. In 1989, there was no choice. The federal government insured the thrifts, so when they failed, the feds were left holding their loans; the RTC's job was simply to get rid of them. But in buying bad loans before banks fail, the Bush administration would be signing up for a financial war of choice. It would spend billions of dollars on the theory that preemption will avert the mass destruction of banks. There are cheaper ways to stabilize the system.

In the 1980s, the government did not need a strategy to decide which bad loans to take over; it dealt with anything that fell into its lap as a result of a thrift bankruptcy. But under the current proposal, the government would go out and shop for bad loans. These come in all shapes and sizes, so the government would have to judge what type of loans it wants. They are illiquid, so it's hard to know how to value them. Bad loans are weighing down the financial system precisely because private-sector experts can't determine their worth. The government would have no better handle on the problem.

In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals. If the government bought the most from the sickest institutions, it would be slowing the healthy process in which strong players buy up the weak, delaying an eventual recovery. The haggling over which banks got to unload the most would drag on for months. So the hope that this "systematic" plan can be a near-term substitute for ad hoc AIG-style bailouts is illusory.

Within hours of the Treasury announcement Friday, economists had proposed preferable alternatives. Their core insight is that it is better to boost the banking system by increasing its capital than by reducing its loans. Given a fatter capital cushion, banks would have time to dispose of the bad loans in an orderly fashion. Taxpayers would be spared the experience of wandering into a bad-loan bazaar and being ripped off by every merchant.

Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles.

Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.

Congress and the administration may not like the sound of these ideas. Taking bad loans off the shoulders of the banks seems like a merciful rescue; ordering banks to raise capital or buying equity stakes in them sounds like big-government meddling. But we are in the midst of a crisis, and it shouldn't matter how things sound. The Treasury plan outlined on Friday involves vast risks to taxpayers, huge complexity and no guarantee of success. There are better ways forward.

smallaby@cfr.org

July 2007

Barack Obama is now at about 40% versus 44% for Hilary Clinton.
What, you may ask?
These are the odds on Intrade of either of them capturing the 2008 Democratic Presidential nomination.
Barack Obama is doing really well - he was at 28% only six weeks ago, and Hilary Clinton has not budged.
Barack Obama has now led Ms Clinton for two quarters in fund raising.
How long before the odds favor him?

alt="Price for 2008 Democratic Pres Nominee(Others on Request) at intrade.com"
title="Price for 2008 Democratic Pres Nominee(Others on Request) at intrade.com" border="0">

From Intrade

January 7, 2007

Editorial from New York Times

The Imperial Presidency 2.0

Observing President Bush in action lately, we have to wonder if he actually watched the election returns in November, or if he was just rerunning the 2002 vote on his TiVo.

That year, the White House used the fear of terrorism to scare American voters into cementing the Republican domination of Congress. Mr. Bush and Vice President Dick Cheney then embarked on an expansion of presidential power chilling both in its sweep and in the damage it did to the constitutional system of checks and balances.

In 2006, the voters sent Mr. Bush a powerful message that it was time to rein in his imperial ambitions. But we have yet to see any sign that Mr. Bush understands that — or even realizes that the Democrats are now in control of the Congress. Indeed, he seems to have interpreted his party’s drubbing as a mandate to keep pursuing his fantasy of victory in Iraq and to press ahead undaunted with his assault on civil liberties and the judicial system. Just before the Christmas break, the Justice Department served notice to Senator Patrick Leahy — the new chairman of the Judiciary Committee — that it intended to keep stonewalling Congressional inquiries into Mr. Bush’s inhumane and unconstitutional treatment of prisoners taken in anti-terrorist campaigns. It refused to hand over two documents, including one in which Mr. Bush authorized the Central Intelligence Agency to establish secret prisons beyond the reach of American law or international treaties. The other set forth the interrogation methods authorized in these prisons — which we now know ranged from abuse to outright torture.

Also last month, Mr. Bush issued another of his infamous “presidential signing statements,” which he has used scores of times to make clear he does not intend to respect the requirements of a particular law — in this case a little-noticed Postal Service bill. The statement suggested that Mr. Bush does not believe the government must obtain a court order before opening Americans’ first-class mail. It said the administration had the right to “conduct searches in exigent circumstances,” which include not only protecting lives, but also unspecified “foreign intelligence collection.”

The law is clear on this. A warrant is required to open Americans’ mail under a statute that was passed to stop just this sort of abuse using just this sort of pretext. But then again, the law is also clear on the need to obtain a warrant before intercepting Americans’ telephone calls and e-mail. Mr. Bush began openly defying that law after Sept. 11, 2001, authorizing the National Security Agency to eavesdrop without a court order on calls and e-mail between the United States and other countries.

•

News accounts have also reminded us of the shameful state of American military prisons, where supposed terrorist suspects are kept without respect for civil or human rights, and on the basis of evidence so deeply tainted by abuse, hearsay or secrecy that it is essentially worthless.

Deborah Sontag wrote in The Times last week about the sorry excuse for a criminal case that the administration whipped up against Jose Padilla, who was once — but no longer is — accused of plotting to explode a radioactive “dirty bomb” in the United States. Mr. Padilla was held for two years without charges or access to a lawyer. Then, to avoid having the Supreme Court review Mr. Bush’s power grab, the administration dropped those accusations and charged Mr. Padilla in a criminal court on hazy counts of lending financial support to terrorists.

But just as the government abandoned the “dirty bomb” case against Mr. Padilla, it quietly charged an Ethiopian-born man, Binyam Mohamed, with conspiring with Mr. Padilla to commit that very crime. Unlike Mr. Padilla, Mr. Mohamed is not a United States citizen, so the administration threw him into Guantánamo. Now 28, he is still being held there as an “illegal enemy combatant” under the anti-constitutional military tribunals act that was rushed through the Republican-controlled Congress just before last November’s elections.

Mr. Mohamed was a target of another favorite Bush administration practice: “extraordinary rendition,” in which foreign citizens are snatched off the streets of their hometowns and secretly shipped to countries where they can be abused and tortured on behalf of the American government. Mr. Mohamed — whose name appears nowhere in either of the cases against Mr. Padilla — has said he was tortured in Morocco until he signed a confession that he conspired with Mr. Padilla. The Bush administration clearly has no intention of answering that claim, and plans to keep Mr. Mohamed in extralegal detention indefinitely.

•

The Democratic majority in Congress has a moral responsibility to address all these issues: fixing the profound flaws in the military tribunals act, restoring the rule of law over Mr. Bush’s rogue intelligence operations and restoring the balance of powers between Congress and the executive branch. So far, key Democrats, including Mr. Leahy and Senator Richard Durbin of Illinois, chairman of a new subcommittee on human rights, have said these issues are high priorities for them.

We would lend such efforts our enthusiastic backing and hope Mr. Leahy, Mr. Durbin and other Democratic leaders are not swayed by the absurd notion circulating in Washington that the Democrats should now “look ahead” rather than use their new majority to right the dangerous wrongs of the last six years of Mr. Bush’s one-party rule.

This is a false choice. Dealing with these issues is not about the past. The administration’s assault on some of the nation’s founding principles continues unabated. If the Democrats were to shirk their responsibility to stop it, that would make them no better than the Republicans who formed and enabled these policies in the first place.

Books on the American intervention in Iraq


Anderson, Jon Lee. The fall of Baghdad New York (State): Penguin Press, c2004.

Bremer, L. Paul and Malcolm McConnell. My year in Iraq : New York (State): Simon & Schuster, c2006.

Etherington, Mark. Revolt on the Tigris : New York (State): Cornell University Press, c2005.

Packer, George. The assassins' gate : England: Faber and Faber, c2006.

Ricks, Thomas E. Fiasco : New York (State): Penguin Press, c2006.

Riverbend. Baghdad burning II : New York (State): Feminist Press, 2006.

Riverbend. Baghdad burning : New York (State): Feminist Press at the City University of New York, c2005.

Rosen, Nir. In the belly of the green bird : New York (State): Free Press, c2006.

Wright, Lawrence. The looming tower : New York (State): Knopf, 2005, c2006.

For Dog Lovers, a Bigger Kennel

As Contrarians Have Lost Big,
Some Investors Learn New Tricks
In Harnessing Distressed Stocks

By E.S. BROWNING
December 26, 2006; Page C1

In this joyous holiday season, with so many stocks looking like winners, we examine this year's rarity: the lumps of coal.

By almost any measure, true losers have been hard to find. Just four of the 30 stocks in the Dow Jones Industrial Average are down this year, compared to 16 last year.

As for the broader market, of 10 big industry groups tracked by Dow Jones Indexes, all 10 are comfortably up. Last year, three were down. The weakest industry groups this year are health care, up 5.4%, and technology, up 8.6%.

For one group of investors, this good cheer is unwelcome. Contrarian investors buy beaten-down stocks in hopes of a rebound. They use a host of systems and theories, some with folkloric names such as the Dogs of the Dow. With stocks so robust, what's a contrarian to do?

Some favor buying each year's weakest stocks, but that simple method has been disappointing -- especially if you are choosing from Dow stocks that are hardly down at all.

Even the 50 weakest stocks in the Standard & Poor's 500-stock index perform inconsistently. The 50 weakest from 2002, a year when stocks were hammered, rebounded 81% in 2003, according to research and money-management firm Birinyi Associates in Westport, Conn. But the 2003 losers trailed the index the next year, and the 2004 losers fell in 2005. The 2005 bunch are more or less matching the index.

What contrarians seek is a truly abandoned stock, one that is poised for a real rebound.

For that, they need one that investors have been fleeing for several years, in which the selling has run its course, says finance professor Werner De Bondt at Chicago's DePaul University, who has studied the phenomenon for the past 20 years. He recommends the 50 stocks that have fallen the hardest over the previous three to five years, and suggests using a broader universe than the S&P 500 in order to find real losers.

"But very few people have the emotional capability to implement such a strategy," Prof. De Bondt adds.

One reason: Some of the truly beaten-down companies will go bankrupt. And many investors have trouble holding on to their portfolios for the three to five years that Prof. De Bondt's studies call for. Some hedge funds -- sophisticated, loosely regulated investment pools -- do use a variation on his strategy, he says.

One way to avoid stocks that are headed for bankruptcy, Prof. De Bondt suggests, is to buy only after a stock shows signs of rebounding. You lose some of the initial pop, but you are less likely to buy a stock that is headed for the graveyard.

A similar approach is to buy stocks that have been removed from the S&P 500. Those that suffered that indignity this year are up 27% on average since removal, while those that were added to the index are up only 1% since joining, notes Paul Hickey of Birinyi Associates. (Of course, there is the risk that a stock removed from the S&P 500 will fall into bankruptcy, although that hasn't happened to this year's crop, Mr. Hickey says.)

Similar trends can be seen among stocks that are added to and removed from the Dow Jones Industrial Average.

The idea is that, by the time a stock is removed, it probably has been heavily sold, while those that are added generally are at the peak of popularity and overdue for a pullback. (In the short run, those that are removed normally fall farther as index funds sell them, while those that are added do the opposite. But that process ends after a few days.)

An even simpler system is to look among stocks that have fallen to very low dollar prices, says Richard Evans, of Richard L. Evans Investments in Flossmoor, Ill. He believes the system works especially well in December, because of tax-loss selling. Investors often sell losers at year's end in order to generate capital losses, to balance capital gains for tax purposes. That selling can depress prices artificially.

"These are valid turnaround opportunities," Mr. Evans says. He looks for such stocks that have been down for a while, and for which he can find a logical reason to expect a turnaround. At the moment, he likes some down-and-out computer-chip stocks and makers of optical fiber.

One of the oldest year-end techniques involves buying small stocks in December in hopes of a January rebound. Despite widespread publicity, this "January effect" still occurs, probably due to tax-loss selling, says business professor Mark Hirschey of the University of Kansas.

His research shows that, even though small stocks' January effect gained notice in 1976, it has continued to occur. His research shows that small stocks still rise 6% on average in that one month, compared with a 1% large-stock gain.

Prof. Hirschey worries that small stocks in general might not benefit as much this January, because they have risen heavily in 2006. The small stocks that benefit most from the January effect are those that were sold in December, which is a relatively limited group this year, and which is the group he suspects will do best next month.

Prof. Hirschey has examined another once-popular system, called the Dogs of the Dow, and found it no better than buying the overall average.

The system calls for buying the five or 10 highest-yielding Dow stocks each year. The idea is that the high yield (dividend divided by price) often indicates a low price. Even if the doghouse stocks don't soar, the thinking goes, they at least pay good dividends.

The problem, Prof. Hirschey says, is that Dow stocks rarely fall deeply into disfavor, leaving them less room to rebound. Investment firms including Payden & Rygel, which once used versions of the Dogs of the Dow strategy, have stopped. And the system has proved inconsistent.

After a disappointing performance over the previous five years, the Dogs this year have risen more than 20%, well ahead of the overall average, which is up less than 16%. But Dow Dog General Motors, up 50% this year, still yields enough that it will be a Dog again next year. Some investors wonder whether it can deliver such brilliant gains for a second year in a row.

Neil Hennessy, whose Hennessy Funds in Novato, Calif., offers two funds based on the Dogs of the Dow, says fading interest in the system may mean that it won't be overused and might work better in the future. Anyhow, he says, buying high-yielding Dow stocks helps investors limit risk.

"Our philosophy is that it isn't what you make on the upside, it is what you don't lose on the downside," he says.

Write to E.S. Browning at jim.browning@wsj.com¹

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Kenya: No end to the corruption

Kenya No end to the problem
Nov 16th 2006 NAIROBI From The Economist print edition
Ever more reasons to worry about endemic corruption
THERE are few people left, even in Kenya, who dispute the fact that the country is one of the most corrupt in the world. Guesses about how much senior officials pinch from the public coffers range from $1 billion a year and up. But if that aspect of the country's corruption problem is well known, it is now doing other kinds of damage. For a rotten Kenya has also become an international security concern.
That was the message of Kim Howells, a Foreign Office minister from Britain, the former colonial master, on a visit to the country last week. In unusually frank terms, Mr Howells argued that because everyone, from Mombasa dockers to senior government officials, can be bought off, Kenya is “wide open” for drug cartels and terrorists. The cartels move large quantities of cocaine and heroin through Kenya and the drug money washing through Kenya's political bloodstream is making it even harder for honest ministers and civil servants to do their job.
Terrorism is another concern. Intelligence sources suggest that a few jihadists among the Somali Islamists in Mogadishu may be readying suicide attacks against targets in Kenya. Corruption certainly makes it easier for them to move between the two countries. Small bribes at remote border posts and larger bribes at Kenya's domestic airports are enough to make Somalis invisible to Kenya's security services. Corruption at the highest levels provides cover for stealing down the line. Some of the proceeds go on country club memberships and luxury cars. But far more is spent on political campaigns: rallies, paying off tribal elders, gangs to intimidate opposition supporters, and sometimes the voters themselves.
The present government was elected on an anti-corruption platform, but has done little to fulfil its promises. From the start, it borrowed money from many of the same individuals as the previous regime, and set about paying off debts with similar dodgy schemes. A few of these were laid bare by John Githongo, a government-appointed investigator who had to flee the country when his findings got too close to the top. His revelations did prompt two ministers to resign, but this week they were both reinstated. Some of the $300m or so involved in the scams has been returned to the treasury.
Donor countries are confining their aid to ever more strictly audited projects. Sir Edward Clay, an outspoken former British high commissioner to Kenya, says donors should be using their own laws more effectively against corrupt African officials. “Corruption is too far down the development agenda,” says Sir Edward. Kenya has made some progress. Mr Githongo and other brave whistle-blowers, after all, are Kenyans speaking for Kenya. But too many of them have had to flee abroad. Nor is there a single conviction in sight.