Archive for April, 2010|Monthly archive page

‘TO SAVE THE EUROZONE: $1 TRILLION, EUROPEAN CENTRAL BANK REFORM, AND A NEW HEAD FOR THE IMF,’ by Peter Boone & Simon Johnson at baselinescenario .com.

In Uncategorized on April 30, 2010 at 08:57

To Save The Eurozone: $1 trillion, European Central Bank Reform, And A New Head for the IMF

Posted: 29 Apr 2010 03:43 AM PDT

By Peter Boone and Simon Johnson

When Mr. Trichet (head of the European Central Bank, ECB) and Mr.  Strauss-Kahn (head of the International Monetary Fund, IMF) rushed to Berlin this week to meet Prime Minister Angela Merkel and the German parliament, the moment was eerily reminiscent of September 2008 – when Hank Paulson stormed up to the US Congress, demanding for $700bn in relief for the largest US banks.  Remember the aftermath of that debacle: despite the Treasury argument that this would be enough, much more money was eventually needed, and Mr. Paulson left office a few months later under a cloud.

The problem this time is bigger.  It is not only about banks, it is about the essence of the eurozone, and the political survival of all the public figures responsible.  If Mr. Trichet and Mr. Strauss-Kahn were honest, they would admit to Ms. Merkel “we messed up – more than a decade ago, when we were governor of the Banque de France and French finance minister, respectively”.  These two founders of the European unity dream helped set rules for the eurozone which, by their nature, have caused small flaws to turn into great dangers.

The underlying problem is the rule for printing money:  in the eurozone, any government can finance itself by issuing bonds directly (or indirectly) to commercial banks, and then having those banks “repo” them (i.e., borrow using these bonds as collateral) at the ECB in return for fresh euros.  The commercial banks make a profit because the ECB charges them very little for those loans, while the governments get the money – and can thus finance larger budget deficits.  The problem is that eventually that government has to pay back its debt or, more modestly, at least stabilize its public debt levels.

This same structure directly distorts the incentives of commercial banks:  they have a backstop at the ECB, which is the “lender of last resort”; and the ECB and European Union (EU) put a great deal of pressure on each nation to bail out commercial banks in trouble.  When a country joins the eurozone, its banks win access to a large amount of cheap financing, along with the expectation they will be bailed out when they make mistakes.  This, in turn, enables the banks to greatly expand their balance sheets, ploughing into domestic real estate, overseas expansion, or crazy junk products issued by Goldman Sachs.  Just think of Ireland and Spain, where the banks took on massive loans that are now sinking the country.

Given the eurozone provides easy access to cheap money, it is no wonder that many more nations want to join.  No wonder also that it blew up.  Nations with profligate governments or weak financial systems had a bonanza.  They essentially borrowed funds from the less profligate elsewhere in the eurozone, backed by the ECB.  The Germans were relatively austere; the periphery enjoyed the boom.   But now we have moved past the boom, and someone in Greece, Portugal, Spain, Ireland and perhaps Italy has to repay something – or at least stop borrowing without constraint.  So Mr. Trichet and Mr. Strauss-Kahn go, cap in hand, to ask Germany for further assistance.

There are three possible scenarios.  First, the ECB may be allowed to really let loose with “liquidity” – and somehow buy up all the bonds of troubled eurozone nations.  But this is exactly the process that always and everywhere brings about high inflation.  The Germans would fight hard against such a policy, although it would prevent default.

Second, officials still hope that bond yields for weaker governments widen but then stabilize.  This is bad news for troubled eurozone countries, but they manage to avoid default.  The rest of the world grows by enough to pull up even the European “Club Med + Ireland”.  Call this the trickle down scenario or just a miracle.

Most likely, the situation is about to turn much worse and a third scenario unfolds.  The nightmare for Europe is not at this point about Greece or Portugal – it is all about Italian and Spanish bond yields.  This week those yields are rising quickly from low levels, while German yields are falling – so this spread is widening sharply.  The yields for Spain – for example – are rising because hitherto inattentive investors, who always thought these bonds were nearly as safe as cash, suddenly realize there are reasonable scenarios where those bonds could fall sharply in value or even possibly default.  Given that Spain has 20% unemployment, an uncompetitive exchange rate, a great deal of public debt, and a reported government deficit of 11.2 percent (compared with headline numbers for Greece at 13.6 percent and Portugal at 9.4 percent), everyone now asks:  Does a 5% yield on Spain’s ten year bonds justify the risk?  The market is increasingly taking the view that the answer is no, at least for now.  So, we can anticipate Spanish (and Italian) yields will keep rising.  In turn, this causes other asset prices to fall in those nations, thus worsening their banking systems, and hence leading to credit contraction and capital flight.  It is a dismal prognosis.

Then it gets worse.  As rates rise, traditional investors in euro zone bonds, which are pension funds and commercial banks, will refuse to take more.  There will be no buyers in the market and governments will not be able to roll over debts.  We saw the first glimpse of this on Tuesday, when both Spanish and Irish short term debt auctions virtually failed.  Once this happens more broadly, the problem will be too big for even Mr. Trichet or Ms. Merkel to solve.  The euro zone will be at risk of massive collapse.

If this awful but unfortunately plausible scenario comes about, there is a clear solution – unfortunately, it is also anathema to Mr. Trichet and Ms. Merkel, and thus unlikely to be discussed seriously until it is too late.  This is the standard package that comes to all emerging markets in crisis: a very sharp fall in the euro, restructuring of euro zone fiscal/monetary rules to make them compatible with financial stability, and massive external liquidity support – not because Europe has an external payments problem, but because this is the only way to provide credible budget support that softens the blow of the needed austerity programs.

The liquidity support involved would be large:  if we assume that roughly three years of sovereign debt repayments should be fully backed – and it takes that kind of commitment to break such negative sentiment – then approximately $1 trillion would be needed to backstop Greece, Portugal, Spain and Italy.  It may be that more funds are eventually needed – but in any case, the amounts would be less than the total reserves of China.  These amounts would also be reduced as the euro falls; it could be heading back to well under $1 per euro, which is where it stood one decade ago.

External financial support would only make sense if combined with key structural reforms, including an end to the repo window at the ECB.  As former UBS banker Al Breach recently argued, the ECB could instead issue bonds to all nations which would then be used subsequently for monetary operations – every central needs a way to add or subtract liquidity from the financial system.  These bonds would need to be backed by a small “euro zone” tax, thus making the ECB more like other central banks around the world.  It would no longer accept bonds of “regional governments” in the union as collateral, and instead would buy and sell “eurozone” bonds.  These new eurozone bonds would also offer a way for governments to roll over some of their existing debts.

If the eurozone does need this package, it cannot be managed under a “business as usual” model.  The funds would need to come from the G20, and extremely tough decisions over fiscal and monetary policy need to be handled in a fair and reasonable manner.  Someone needs to be in charge on behalf of Europe (would this be the European Commission, or Ms. Merkel and the German government?) and someone needs to represent the G20.

By far the most natural G20 partner to manage this process is – despite all its baggage – the IMF, but there’s a serious problem.  Mr. Strauss-Kahn, the current head of the IMF today, very much wants to become the next President of France.  There is no way for the G20 to provide funding that he would guide – he has an obvious and unavoidable conflict of interest, and no incentive to make the tough decisions today that are required to sort out the euro zone.

Mr. Strauss-Kahn should resign and a respected financial leader of a relatively independent country should take charge at the IMF.  One potential choice would be Mark Carney, the current Governor of the Bank of Canada.   Or, if the G20 agrees – finally – that it is time to phase out the leading role of the G7 (which has not done well of late), Montek Ahluwalia of India would be an outstanding candidate.



In Uncategorized on April 28, 2010 at 12:39









‘WEAKNESS BEGETS WEAKNESS:FROM BANKS TO SOVEREIGNS TO BANKS, ‘ by Eric Sprott & David Franklin at John Maudlin’s ‘Investors Insight.’

In Uncategorized on April 27, 2010 at 09:31

Weakness Begets Weakness: from Banks to Sovereigns to Banks

By: Eric Sprott & David Franklin

Sprott Asset Management

The Greek debt situation has been an interesting case study for students of the sovereign bond markets. If there’s a lesson to be learned from Greece’s experience thus far it’s that sovereign bailouts are far more complicated than bank bailouts. They require more sophisticated negotiations and proposals and involve an extra layer of diplomacy that makes them especially difficult to accomplish. As we write this, the European Union has recently announced new lending terms to support the Greek government, with great efforts made to assure the markets that these new terms do not constitute a ‘bailout’. The problem with the Greek situation is that an actual bailout would involve an almost impossible coordination among all the major powers within the EU. It would require the unanimous pre-approval of all the EU heads of state. It would involve the European Commission, the European Central Bank and the International Monetary Fund (IMF) all visiting Greece to perform financial assessments. And finally, it would involve at least seven EU countries affirming support through parliamentary votes – all of this before a single euro is spent.

A true bailout involves an almost impossible number of hurdles that essentially guarantee nothing will happen until all other avenues of rescue are exhausted. However, judging by the recent increase in yields on 10-year Greek bonds, Greece may soon need more than a loan package proposal to solve its fiscal problems.

One aspect of the Greek situation that has been obscured by all the recent political wrangling is the crisis’ impact on the Greek banks. Although the banks were supposed to be rock solid after all the government-injected capital they received (not to mention zero-percent interest rates and generous lending terms from the European Central Bank), data shows that Greek bank deposits have fallen 8.4 billion euros, or 3.6 percent, in two months since December 2009. With no restraints on capital flows within the European Union, Greek savers are free to transfer their assets elsewhere. Given that bank deposit guarantees in Greece are the responsibility of the national government rather than the European Central Bank, we suspect Greek citizens are pulling money out of their banks because they question their government’s ability to honour its domestic deposit guarantees. We envision Greek depositors asking themselves how a government that can’t raise enough money to stay solvent can then turn around and guarantee their bank deposits? It’s a fair question to ask.

The Greek bank stocks have been thoroughly punished throughout the crisis. Chart A plots an index consisting of the four largest Greek bank stocks and shows an average decline of 47% since November 2009. The deposit withdrawals from these banks have been so damaging to their respective balance sheets (remember bank leverage?) that the Greek banks have asked to borrow 17 billion euros left over from a 28 billion euro support program launched in 2008.3 You see the connection here? Greece experienced a financial crisis, followed by a sovereign crisis, followed by another financial crisis. There is no doubt that the Greek crisis has helped drive the gold spot price to its recent all time high in euros. Gold is a prudent asset to own in times of crisis, and it’s possible that a portion of the Greek deposit withdrawals were reinvested into the precious metal. The fact remains, however, that if the Greek government cannot stem the outflows of deposits soon, the EU will have no other choice but to undertake a real sovereign bailout with all its bells, whistles and arduous protocols.

It’s a vicious spiral from financial crisis to sovereign debt crisis to banking crisis, and there is no reason it can’t spread to other European countries suffering from similar fiscal imbalances. With Spain and Portugal next in line with their own sovereign debt issues, we can expect depositors in these countries to make similar runs to the bank for their cash. “Guaranteed by Government” is truly beginning to lose its potency in this environment. The International Monetary Fund (IMF) seems to be preparing for such a scenario with its recent announcement of a tenfold increase in its emergency lending facility. The IMF’s New Arrangements to Borrow (NAB) facility is designed to prevent the “impairment of the international monetary system or to deal with an exceptional situation that poses a threat to the stability of that system.” The NAB facility has grown from US$50 billion to US$550 billion with the mere stroke of a pen. Does the IMF know something that the market doesn’t? Is this a pre-emptive measure to repel an attack by bond vigilantes’ on Europe’s fiscally-weakened countries?

Sovereign Debt

In our examination of the Greek situation this past month, we kept coming across various sovereign credit ratings. In an effort to better understand the Greek situation, we decided to look at how the ratings agencies generate their actual rankings and built our own model to determine a country’s credit risk.5 We used common metrics such as GDP per Capita, Government Budget Deficits, Gross Government and Contingent Liabilities, the inflation rate and incorporated a simple debt sustainability metric in order to generate our own sovereign ratings. What we discovered in the process was quite puzzling.

It should first be noted that the rating agencies are in the business of offering their ‘opinions’ about the creditworthiness of bonds that have been issued by various kinds of entities: corporations, governments, and (most recently) the packagers of mortgages and other debt obligations. These opinions come in the form of ‘ratings’ which are expressed in a letter grade. The best-known scale is that used by Standard & Poor’s (“S&P”) which uses AAA for the highest rated debt, and AA, A, BBB, BB, for debt of descending credit quality.

In our opinion, as they relate to sovereign debt, the ratings provided by the agencies are highly suspect. While these agencies claim to provide ratings that consider the business credit cycle, there appears to be very little forward-looking information actually factored into their credit models. In some cases, the agency ratings end up looking absurdly optimistic. This of course should come as no surprise – we all remember the subprime mortgages that were rated AAA that are now worth pennies on the dollar.

While there were some similarities in our rankings (for example, our model ascribed AAA ratings to the local currency debt of Australia, Canada, Finland, Sweden, New Zealand which matched the ratings given by S&P), we found some glaring inconsistencies in the rating results for less fiscally prudent countries that left us scratching our heads. A good example is South Africa. The agencies currently rate South Africa an A+ entity, while our model calculated a ‘BBB-‘ rating for its debt using our estimates. ‘BBB-‘ is the lowest ‘investment grade’ rating for local currency sovereign debt – one level above junk. We arrived at this rating without having factored in South Africa’s resource endowment. A significant contributor to South African GDP is derived from mining, particularly gold mining. While South Africa has been the largest producer of gold until very recently, their below-ground reserves have not been revised since 2001 when the country held 36,000 tonnes of gold (or about 40% of the global total). Recent stats from the United States Geological Survey (USGS) estimate that South Africa now has only 6,000 tonnes worth of economic gold reserves remaining. Further review by Chris Hartnady, a former associate professor at the University of Cape Town, using similar techniques to those of M. King Hubbert (the Peak Oil theorist), suggests that South Africa could have only half of the gold reserves estimated by the USGS.7 If these new estimates are correct, South Africa could have 90% less gold than claimed – and it’s not even factored into our BBB- rating! So what’s South African debt really worth? An ‘A+’ from the ratings agencies seems far too generous based on our cursory review of the country’s fundamentals.

The rating agencies’ ranking of the United States is even more disconnected from reality. To believe that the US sets the benchmark for sovereign debt credit ratings is preposterous. While we have written ad nauseam about the excessive debt issuance by the United States, we found a recent update written by United States Government Accountability Office (GAO) to be particularly instructive. The update noted the US’s budget deficit equivalent to 9.9% of GDP in 2009 – the largest 10 since 1945 – and stated that without significant policy changes the US government would soon face an “unsustainable growth in debt”.

This was not news to us. It goes on to state, however, that using reasonable assumptions, “roughly 93 cents of every dollar of federal revenue will be spent on the major entitlement programs and net interest costs by 2020.” This is news! In less than ten years, using reasonable assumptions, there will essentially be no money left to run the US government – 93% of all tax revenues the US government collects will go to pay social security, Medicare, Medicaid and the interest costs on their national debt. This implies no money left over for defense, homeland security, welfare, unemployment benefits, education or anything else we associate with the normal business of government. And the US government is rated AAA!?

The historian Niall Ferguson recently wrote that, “US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.” It’s hard not to agree given the foregoing statements by the GAO. The risk inherent to investors, of course, is what happens when the bond market begins to realize and react to this new level of risk. In a speech earlier this month, Jürgen Stark, who is a member of the board of the European Central Bank, stated, “We may already have entered into the next phase of the crisis: a sovereign debt crisis following on the financial and economic crisis.”

The activities of the IMF would confirm this statement. The question we must now ask ourselves is whether “backed by government” actually means anything anymore. In the depths of the 2008 crisis it was the governments that stepped in to provide a guarantee on financial assets. It was the governments that backed our savings accounts, money market funds, day-to-day business banking accounts, as well as debt issued by US banks. But what happens when confidence in the government guarantee begins to erode? We’ve seen what happened to Greece. Leverage inherent in the banking system elevated a bank run, equivalent to a mere 3.6 percent of deposits, into another full blown banking crisis. In our view it’s time for investors to acknowledge sovereign risk. The ratings agencies can opine all they want, but it seems clear to us that the only true AAA asset to protect your wealth is gold.

April 2010AGEMENT LP

John F. Mauldin

‘WILL GOLDMAN SACHS PROVE GREED IS GOD? , ‘ by Matt Taibbi in the Guardian.

In Uncategorized on April 27, 2010 at 09:05

Will Goldman Sachs Prove Greed is God?

The investment bank’s cult of self-interest is on trial against the whole idea of civilization – the collective decision by all of us not to screw each other over even if we can

By Matt Taibbi

April 26, 2010 “The Guardian” – April 24, 2010 —  So Goldman Sachs, the world’s greatest and smuggest investment bank, has been sued for fraud by the American Securities and Exchange Commission. Legally, the case hangs on a technicality.

Morally, however, the Goldman Sachs case may turn into a final referendum on the greed-is-good ethos that conquered America sometime in the 80s – and in the years since has aped other horrifying American trends such as boybands and reality shows in spreading across the western world like a venereal disease.

When Britain and other countries were engulfed in the flood of defaults and derivative losses that emerged from the collapse of the American housing bubble two years ago, few people understood that the crash had its roots in the lunatic greed-centered objectivist religion, fostered back in the 50s and 60s by ponderous emigre novelist Ayn Rand.

While, outside of America, Russian-born Rand is probably best known for being the unfunniest person western civilisation has seen since maybe Goebbels or Jack the Ripper (63 out of 100 colobus monkeys recently forced to read Atlas Shrugged in a laboratory setting died of boredom-induced aneurysms), in America Rand is upheld as an intellectual giant of limitless wisdom. Here in the States, her ideas are roundly worshipped even by people who’ve never read her books oreven heard of her. The rightwing “Tea Party” movement is just one example of an entire demographic that has been inspired to mass protest by Rand without even knowing it.

Last summer I wrote a brutally negative article about Goldman Sachs for Rolling Stone magazine (I called the bank a “great vampire squid wrapped around the face of humanity”) that unexpectedly sparked a heated national debate. On one side of the debate were people like me, who believed that Goldman is little better than a criminal enterprise that earns its billions by bilking the market, the government, and even its own clients in a bewildering variety of complex financial scams.

On the other side of the debate were the people who argued Goldman wasn’t guilty of anything except being “too smart” and really, really good at making money. This side of the argument was based almost entirely on the Randian belief system, under which the leaders of Goldman Sachs appear not as the cheap swindlers they look like to me, but idealised heroes, the saviours of society.

In the Randian ethos, called objectivism, the only real morality is self-interest, and society is divided into groups who are efficiently self-interested (ie, the rich) and the “parasites” and “moochers” who wish to take their earnings through taxes, which are an unjust use of force in Randian politics. Rand believed government had virtually no natural role in society. She conceded that police were necessary, but was such a fervent believer in laissez-faire capitalism she refused to accept any need for economic regulation – which is a fancy way of saying we only need law enforcement for unsophisticated criminals.

Rand’s fingerprints are all over the recent Goldman story. The case in question involves a hedge fund financier, John Paulson, who went to Goldman with the idea of a synthetic derivative package pegged to risky American mortgages, for use in betting against the mortgage market. Paulson would short the package, called Abacus, and Goldman would then sell the deal to suckers who would be told it was a good bet for a long investment. The SEC’s contention is that Goldman committed a crime – a “failure to disclose” – when they failed to tell the suckers about the role played by the vulture betting against them on the other side of the deal.

Now, the instruments in question in this deal – collateralised debt obligations and credit default swaps – fall into the category of derivatives, which are virtually unregulated in the US thanks in large part to the effort of gremlinish former Federal Reserve chairman Alan Greenspan, who as a young man was close to Rand and remained a staunch Randian his whole life. In the late 90s, Greenspan lobbied hard for the passage of a law that came to be called the Commodity Futures Modernisation Act of 2000, a monster of a bill that among other things deregulated the sort of interest-rate swaps Goldman used in its now-infamous dealings with Greece.

Both the Paulson deal and the Greece deal were examples of Goldman making millions by bending over their own business partners. In the Paulson deal the suckers were European banks such as ABN-Amro and IKB, which were never told that the stuff Goldman was cheerfully selling to them was, in effect, designed to implode; in the Greece deal, Goldman hilariously used exotic swaps to help the country mask its financial problems, then turned right around and bet against the country by shorting Greece’s debt.

Now here’s the really weird thing. Confronted with the evidence of public outrage over these deals, the leaders of Goldman will often appear to be genuinely confused, scratching their heads and staring quizzically into the camera like they don’t know what you’re upset about. It’s not an act. There have been a lot of greedy financiers and banks in history, but what makes Goldman stand out is its truly bizarre cultist/religious belief in the rightness of what it does.

The point was driven home in England last year, when Goldman’s international adviser, sounding exactly like a character in Atlas Shrugged, told an audience at St Paul’s Cathedral that “The injunction of Jesus to love others as ourselves is an endorsement of self-interest”. A few weeks later, Goldman CEO Lloyd Blankfein told the Times that he was doing “God’s work”.

Even if he stands to make a buck at it, even your average used-car salesman won’t sell some working father a car with wobbly brakes, then buy life insurance policies on that customer and his kids. But this is done almost as a matter of routine in the financial services industry, where the attitude after the inevitable pileup would be that that family was dumb for getting into the car in the first place. Caveat emptor, dude!

People have to understand this Randian mindset is now ingrained in the American character. You have to live here to see it. There’s a hatred toward “moochers” and “parasites” – the Tea Party movement, which is mainly a bunch of pissed off suburban white people whining about minorities consuming social services, describes the battle as being between “water-carriers” and “water-drinkers”. And regulation of any kind is deeply resisted, even after a disaster as sweeping as the 2008 crash.

This debate is going to be crystallised in the Goldman case. Much of America is going to reflexively insist that Goldman’s only crime was being smarter and better at making money than IKB and ABN-Amro, and that the intrusive, meddling government (in the American narrative, always the bad guy!) should get off Goldman’s Armani-clad back. Another side is going to argue that Goldman winning this case would be a rebuke to the whole idea of civilisation – which, after all, is really just a collective decision by all of us not to screw each other over even when we can. It’s an important moment in the history of modern global capitalism: whether or not to move forward into a world of greed without limits.

‘THEY’VE GOT IT: FIXES FOR THE FINANCIAL SYSTEM,’ by Sewell Chan & Binyamin Appelbaum in the N. Y. Times.

In Uncategorized on April 26, 2010 at 10:07

They’ve Got It: Fixes for the Financial System


Published: April 23, 2010

WASHINGTON — Congress is consumed by the proposed legislation to overhaul the financial system, with lawmakers clashing over the best ways to regulate derivatives, protect consumers and end taxpayer-supported bailouts.

Most proposals in the Senate bill supported by President Obama amount to variations on the current system of regulation.

But some scholars in finance, law and economics — perhaps less inhibited by practical considerations — see an opportunity to revolutionize the financial system. In books, papers and presentations, they have proposed an avalanche of ideas, some more outlandish than others. Here are a half-dozen; judge the merits for yourself.

End the Dollar’s Supremacy


The housing bubble was inflated with vast sums borrowed from the rest of the world. Joseph E. Stiglitz, a Nobel-winning economist at Columbia, says the United States should surrender some of its borrowing power by trying to end the use of the dollar as the primary international reserve currency.

The United States basically borrows money by printing dollars and selling them, in the form of Treasury securities, to China and other governments that hold those dollars in their financial reserves. The United States then uses the borrowed money to buy foreign goods. This system, Mr. Stiglitz says, has, in effect, made the United States the world’s largest recipient of foreign aid.

The inflow of foreign money also tends to create asset bubbles, such as the spike in housing prices, making the American economy much more vulnerable to disruption and crisis. If other nations no longer needed dollars, the United States would not be able to borrow money as easily. “Knowing that it would be more difficult to borrow might curb America’s profligacy,” Mr. Stiglitz writes in “Freefall: America, Free Markets and the Sinking of the World Economy” (W. W. Norton, 2010).

Give Bankruptcy a Chance


When Lehman Brothers went to bankruptcy court in September 2008 after the government refused to rescue it, credit markets froze. The authorities quickly caved in and bailed out a bunch of other companies.

Lehman’s disorderly collapse, conventional wisdom says, showed that bankruptcy courts could not handle huge financial failures, because they were too slow, lacked the expertise and were not designed to consider the intricate linkages that hold financial companies together.

The bills in Congress seek to design a federal “resolution authority” — a way to arrange the orderly liquidation of giant financial companies — modeled after the process the Federal Deposit Insurance Corporation uses to take over failed banks.

But Thomas H. Jackson, former president of the University of Rochester, says the panic was not caused by bankruptcy proceedings, but by letting Lehman fail in the first place. Under current law, parts of Lehman went through bankruptcy, while other subsidiaries could not.

Among other changes, he calls for amending bankruptcy laws to cover companies — retail banks, stock and commodity brokers and insurance companies — so that large, complex institutions could be fully dealt with in court. And regulators would be able to pull the trigger.

“There’s a lot to be said for a judicial process rather than a government agency process,” says Mr. Jackson, author of an essay in “Ending Government Bailouts as We Know Them” (Hoover Institution, 2009). The legal system is more predictable and transparent and better established.

Bonds Can Regulate Banks, Too


Many economists say that creditors, who determine how much banks can borrow and on what terms, are often better equipped than regulators to provide the market discipline that can keep banks from taking on too much risk.

Unlike stockholders, bondholders have little to gain when banks take on risk in the hope of reward. What they want is a steady stream of income and the repayment of their loan. Corporate bonds tend to be held by institutions like mutual funds, hedge funds and insurance companies that have the time and resources to monitor their debtors.

Robert C. Pozen, chairman of MFS Investment Management and author of “Too Big to Save? How to Fix the U.S. Financial System” (Wiley, 2010), wants to require banks to issue an existing kind of bond known as long-term subordinated debt. “Subordinated debt is bought by very sophisticated investors who insist on conditions like capital requirements and covenants to make sure that banks don’t take on too much risk,” he says.

Since their investment is not guaranteed and their time horizon is long term, such creditors have interests closely aligned with those of government regulators, says Mr. Pozen, who is also a lecturer at Harvard Business School.

In a 2000 report, the Fed studied requiring banks to hold subordinated debt, but the idea went nowhere. Banks don’t like it because such debt generally charges higher interest than other kinds of corporate bonds.

Compound Interest 101


A person borrows $100 at an annual interest rate of 20 percent. How long does it take that debt to double? About four years. What share of American adults can figure that out? About one in three, says Annamaria Lusardi, an economist at Dartmouth College.

Ms. Lusardi wants to add financial literacy to high school curriculums. A crisis sparked in part by the decisions of millions of Americans to take mortgage loans they could not afford has underscored her conviction that “lack of financial knowledge is alarmingly widespread.”

‘RALPH LAUREN: NEW IN AN OLD WORLD, ‘ by Suzy Menkes in the New York Times!!!!!!!!

In Uncategorized on April 25, 2010 at 14:16

Ralph Lauren: New in an Old World


Published: April 19, 2010

“You represent an America we like very much — you and Barack Obama are the American dream,” said Mr. Sarkozy, before pinning the Légion d’honneur medal on the pinstriped suit of the designer, who he said represented “beauty, democracy and quality of life” and whom he recognized for his philanthropic activities.

Mr. Lauren opened a historic town house store, restored to its original gilded and frescoed glory, on Paris’s Left Bank last week. It has a “Ralph’s” restaurant across a cobbled courtyard in the former stables.

The iconic designer compared Mr. Sarkozy to Mr. Obama and reminisced about how on his first trip to Paris he had to stroke the Arc de Triomphe to believe he was really in the City of Light.

Mr. Lauren, who turned 70 last year (his kids gave him a motorcycle as a gift), brought his entire extended family, including staff who had shared the journey to build his $5 billion empire.

Ricky Lauren, his wife of 42 years, told guests how she had rolled up her sleeves to teach the restaurant chef how to make “Hole in the Middle,” a calorie-filled concoction of fried bread and eggs. Meanwhile the dinner at the American Embassy was a formal affair with long tables lined with crimson roses in silver bowls.

Hubert de Givenchy praised the four-year restoration of the store, from digging out a Roman well and skulls in the cellars to re-gilding the upstairs boiserie.

“He saved the building for France,” Mr. de Givenchy said.

Other designers supporting Mr. Lauren included Alber Elbaz of Lanvin, Karl Lagerfeld, and Sonia and Nathalie Rykiel.

In his speech, Ambassador Charles Rivkin said that Senator Hillary Clinton had sent a personal letter underscoring Mr. Lauren’s ongoing work for his cancer charity and for refurbishing the American heritage.

The previous night’s event, with a menu offering hamburgers with beef from Mr. Lauren’s ranch, drew a star-studded crowd, including the French actors Anouk Aimée, Isabelle Huppert, Vincent Perez and Gérard Depardieu.

“I like Ralph Lauren because he has built this empire very discreetly over a long period: he has taken time — and the restoration is marvelous,” Mr. Depardieu said.

Guests clustered in the first floor fashion area, with its immaculately restored parquet floor, gilded cornices and Rococo tableaux, as a backdrop to the women’s clothes in denim blue.

“St. Germain blue,” the designer dubbed the color, referring to the store’s position on the Left Bank boulevard. The color also appeared on a crocodile bag exclusive to the store, selling at a cool €16,000, or $21,000, while a watch salon displayed tony timepieces.

The interconnecting rooms also carry Polo Ralph Lauren menswear, with vivid-colored sweaters and a whiff of a weekend in the Hamptons; while the Double RL denim collections nestle under the ancient beams in the attic area.

Mr. Sarkozy summed up Mr. Lauren’s fashion range when he talked about “the chic of New England, the Indians of Santa Fe and the glamour of Hollywood.”

Wearing his habitual garb of darned denim, worn cowboy boots, seasoned leather jacket and a “St. Germain” blue scarf, Mr. Lauren sat down to discuss his feelings.

“What a week!” the designer said. “I’m in love with Paris — everywhere you look my heart is high, and when I go into the store it feels so good. I was a little intimidated by Paris. I didn’t speak the language. But now I have three stores, it feels like I’m living here — I am much more at ease and comfortable.”

Like the designer’s tribute to Mr. Sarkozy, whose popularity slumped in recent elections, Mr. Lauren’s vision of Paris is picture-postcard perfect. Even he admits that “other than the swagger of a scarf,” fashion is now much more global than when he opened the first Paris Ralph Lauren store in 1986.

“In truth, I don’t know if I am American, English or French — the world is one,” the designer said. “But I felt that even though I am considered an American designer, in my mind I am connected to Europe. Europeans have a very fine taste level, quality and sophistication.”

“My clothes are not about fashion — it’s about timelessness. That’s how to continue to grow for 42 years. It’s about what I see and what I love. I believe in what my vision is: ageless and timeless, but contemporary. I want to be now: a new Old World.”

But what about the wired world, which is already challenging the need for bricks and mortar?

“This is more than a store; it is the biggest statement the company could make,” said David Lauren, just back from his father’s first visit to China. He sees the Web site — — which he has helped develop as a complement to the grand mansions. The company does not break out e-commerce figures, but someone familiar with the figures said that it was well over $100 million.

There will be another big statement in New York this year, with a “new old” building constructed opposite the existing mansion on Madison Avenue.

“And all this is the very beginning,” was Mr. Lauren’s take on the week’s events in France. “I don’t believe it’s the end.”

‘THE SICKENING ABUSE OF POWER AT THE HEART OF WALL STREET, ‘ by Simon Johnson at baselinescenario .com.

In Uncategorized on April 25, 2010 at 10:04

The Sickening Abuse Of Power At The Heart of Wall Street

Posted: 24 Apr 2010 12:02 PM PDT

By Simon Johnson, co-author of 13 Bankers

Here’s where we stand with regard to democratic discourse on the future our financial system: leading bankers will not come out to debate the issues in the open (despite being approached by reputable intermediaries after our polite challenge was issued) – sending instead their “astro turf” proxies to spread KGB-type disinformation.

Even Larry Summers, who has shifted publicly onto the side the angels (surprising and rather late, but welcome anyway), cannot – for whatever reason – bring himself to recognize the dangers inherent in our unstable and too-big-to-manage banks.  Or perhaps he is just generating excuses that will justify not bringing the Brown-Kaufman amendment to the floor of Senate?

So let’s take it up a notch.

I strongly recommend that the responsible congressional committees request and require all assistant secretaries at the US Treasury (and other relevant political appointees over whom they have jurisdiction) to appear before them early next week.

The question will be simple: Please share your calendar of meetings this weekend, and provide us with a complete accounting of people with whom you met and conversed formally and informally.

The finance ministers and central bank governors of the world are in Washington this weekend for the spring meetings of the International Monetary Fund.  As is usual, the world’s megabanks are also in town in force, organizing big meetings and small dinners.

Through these meetings dutifully troop US treasury officials, providing in-depth and off-the-record briefings to investors.

Banks such as JP Morgan Chase and the other top tier financial players thus peddle influence, leverage their access, and generally show off.  They accumulate information from a host of official contacts and discern which way policymakers – their “good friends” – are leaning.

And what is the megabank whisper mill working on?  Ignore the “economic research” papers these banks put out; that is pure pantomime for clients-to-be-duped-later.  I’m talking about what they are telling the market – communicated in specific, personal conversations this weekend.

They are telling people that, based on their inside knowledge, Greece and potentially other eurozone countries will default on their debt.  Perhaps they are telling the truth and perhaps they are lying.  Most likely they are – as always – talking their book.

But the question is not the substance of their whisper campaign this weekend, it is the flow of information.  Have they received material non-public information from US government officials?  Show me the calendar of the top 10 treasury people involved, and then we can talk about whom to summon from the private sector to testify – under oath – about what they were told or not told.

There is no question that the megabanks derive great power and enormous profit from their web of official contacts.  We should reflect carefully on whether such private flows of information between governments and “too big to fail” banks are entirely suitable in today’s unstable financial world.

Large global banks make money, in part, through nontransparent manipulation of information – this is the heart of the SEC charges against Goldman Sachs.  But the problem is much broader: the Wall Street-Washington corridor is alive and well on its way to another crisis that will empower, enrich, and embolden insiders (public and private) while impoverishing the rest of us.

The big players on Wall Street are powerful like never before – and they use this power to press for information and favors from sympathetic (or scared) government officials.  The big banks also appear hell-bent on abusing that power.  One consequence will be further destabilizing global financial markets – watch carefully what happens to Greece, Portugal, Ireland, and Spain at the beginning of next week.

It is time for Congress to step in with a full investigation of the exact flow of information and advice between our major megabanks and key treasury officials.  Start by asking tough questions about exactly who exchanged what kind of specific, material, market-moving information with whom this weekend in Washington.

‘DON’T CALL IT POT IN THESE CIRCLES,’ by Jim Wilson in the N. Y. Times.

In Uncategorized on April 24, 2010 at 12:03

OAKLAND, Calif. — Like hip-hop, health food and snowboarding, marijuana is going corporate.

Jim Wilson/The New York Times

Varieties of medical marijuana were on view in a glass-covered display case at the Harborside Health Center.

As more and more states allow medical use of the drug, and California considers outright legalization, marijuana’s supporters are pushing hard to burnish the image of pot by franchising dispensaries and building brands; establishing consulting, lobbying and law firms; setting up trade shows and a seminar circuit; and constructing a range of other marijuana-related businesses.

Boosters say it is all part of a concerted effort to trade the drug’s trippy, hippie counterculture past for what they believe will inevitably be a more buttoned-up future.

“I don’t possess a Nehru jacket, I’ve never grown a goatee, I’ve never grown my hair past the nape of my neck,” Allen St. Pierre, the executive director of the National Organization for the Reform of Marijuana Laws said. “And I don’t like patchouli.”

Steve DeAngelo, the president of CannBe — a marketing, lobbying and consulting firm here — will not even use the word “marijuana.” Calling it pejorative, he prefers the scientific term “cannabis.”

“We want to make it safe, seemly and responsible,” Mr. DeAngelo said of marijuana.

That extends to his main dispensary and headquarters, the Harborside Health Center in Oakland, with its bright fluorescent lights, a clean, spare design, and a raft of other services including chiropractic care and yoga classes. On a recent Friday, the center was packed, with a line of about 50 people waiting as the workers behind the counter walked other customers through the various buds, brownies and baked goods that were for sale.

“If we can’t demonstrate professionalism and legitimacy, we’re never going to gain the trust of our citizens,” Mr. DeAngelo said. “And without that trust, we’re never going to get where we need to go.”

The ultimate destination, for many supporters, is legalization. Californians will decide in November if that is where they want to go, when they vote on a ballot measure that would legalize, tax and regulate marijuana.

Regardless of the outcome, CannBe says it expects to expand its business model nationwide to become what admirers say will be “the McDonald’s of marijuana.”

The for-profit company is made up of four proprietors of nonprofit dispensaries and their lawyer. Mr. DeAngelo calls them an “A-team of cannabis professionals.”

In late March, it helped lobby the City Council in San Jose, the nation’s 10th-largest city, to pass ordinances regulating dispensaries, a crucial step toward a legitimate industry. And last week at a cannabis conference in Rhode Island, Mr. DeAngelo was diversifying his product line, introducing a kind of “pot lite” with less psychoactive agents than regular marijuana and thus popular with what he calls “cannabis-naïve patients.”

John Lovell, a California lobbyist who represents two major police groups that oppose legalization, scoffed at the notion that marijuana proponents were cleaning up their act or gaining traction with the public, citing a recent decision by the Los Angeles City Council to sharply curtail the number of medical marijuana dispensaries there.

“They are a neighborhood blight,” he said. “Here you have dispensaries that have cash and dope. So, duh? Is it any surprise that they’ve been magnets for crime?”

But advocates call that characterization unfair and outdated.

“This is an emerging business opportunity, as it would be in any other area,” said Ethan Nadelmann, the founder and executive director of the Drug Policy Alliance, which favors legalization.

In California, dispensaries already employ all manner of business gimmicks to survive in an increasingly competitive market. West Coast Cannabis, a trade magazine, has dozens of advertisements for daily specials, free samples, home delivery, gift certificates, scientific testimonials, yoga classes, hypnotherapy, Reiki sessions, coupons, recipes and, of course — being California — free parking.

There are also new schools and seminars that can be used as credit for required continuing education classes for doctors and lawyers.

That includes the Cannabis Law Institute, which was certified last month by the California state bar. It was co-founded by Omar Figueroa, a graduate of Yale University and Stanford law school, who is hosting a seminar in Sonoma County in June that promises to teach attendees about “this fascinating area of the law.”

Mr. Figueroa, who said he was voted “most likely to fail a Senate confirmation hearing” at Stanford, said he was earning a good living in marijuana law, but was in it for the experience. “My passion has always been cannabis,” he said. “It’s the world’s most interesting law job.”

But it is not just California. Business is also booming in Colorado, which has seen an explosion in the number of dispensaries in the last year. That rapid expansion has alarmed some authorities and sent legislators scrambling to pass new regulations, but has been a boon for law firms like Kumin Sommers L.L.P. in San Francisco, which has merged with Warren C. Edson, a lawyer in Denver representing about 300 Colorado dispensaries. Mr. Edson said many of his clients were curious about decidedly staid fields like workers’ compensation, tax withholding and occupational safety.

“There’s this real Al Capone fear that they’re going to get our guys, not on marijuana, but on something else,” Mr. Edson said, referring to how Capone was eventually charged with tax evasion rather than criminal activity.

The federal government continues to oppose any decriminalization of the drug. And while the Obama administration has signaled some leeway when it comes to medical marijuana, raids on dispensaries and growers by law enforcement agencies are still common — even in California, where the industry effectively began in 1996, with the passage of the landmark Proposition 215, which legalized medical marijuana.

Today, rules vary widely in the 14 states that allow medical marijuana, and a final vote on legalization is pending in the District of Columbia. Some states require sellers to prove nonprofit status — often as a collective or cooperative — and all states require that patients have a recommendation from a physician. But even those in favor of medical marijuana believe that the system is ripe for abuse or even unintentional lawbreaking.

“Almost all the dispensaries in California are illegal,” said William Panzer, an Oakland lawyer who helped draft Proposition 215. “They’re sole proprietorships, not collectives.”

Mr. Nadelmann’s organization, the Drug Policy Alliance, says it does not take a position on whether those who sell the drug should be nonprofit or not. But he added, “The key people involved are not becoming personally wealthy.”

‘GREECE, THE I.M.F. & WHAT COMES NEXT, ‘ by Peter Boone & Simon Johnson at baselinescenario .com.

In Uncategorized on April 24, 2010 at 11:06

Greece, The IMF, And What Comes Next

Posted: 23 Apr 2010 04:30 AM PDT

By Peter Boone and Simon Johnson

The latest developments from Europe – including Greece appealing for an IMF program today – may well be a watershed, but if so, it is not a good one.  The key event yesterday was that the yield on all the debt of weak eurozone governments widened while German yields fell.  The spreads show all you need to know: a very clear and large contagion risk.

The five year Portuguese yields rose from 3.84% to 4.26%.  The five year Spanish bonds rose from 2.89% to 3.03%, and the five year Irish bonds rose from 3.74% to 3.97%.  These are not minor moves for investment grade sovereign bond funds.  This kind of change means, for example (and roughly), you lose 0.5% on the value of a bond in one day.  These are bonds that just pay 3% per year – and one such day may be enough to cause “investment grade investors” to decide not to stay involved and not to come back for a long while.

If these bonds transition towards being held by “emerging market investors” (usually quite different people), and stronger European commercial banks decide to limit their exposure to the weaker government’s bonds, we could be in for quite a major increase in yields across the spectrum.

Emerging market investors look at these weaker eurozone bonds – compared to say Argentina with 10% yields – and think they represent unappealing reward for the risk.  Greek 5 year bonds rose to 9.4% yesterday from 8.1% the previous day.  This is still low for a country on the verge of default.

These higher government bond yields are also hitting banks.  No doubt there is a bank run on in Greece to some extent at the wholesale level.  This will spread to other banks in the region.  Since their marginal funding costs are tied to the creditworthiness of the sovereign, and since the collateral for these banks’ portfolios is tied to local property values and assets, these changes in sovereign yields will have a negative impact on banks’ balance sheets.

Irrespective of the next move – which lies this weekend with the International Monetary Fund and the ministers of finance meeting in Washington for the Fund’s spring meetings – this looks like the moment when the Greek problems really start to generate contagion across the eurozone region.  We’ll see rates on government debt trending higher, asset prices (such as real estate) falling even more, and renewed concern about banks on the European “periphery”.

What can the authorities do?  The only path is a new package of “liquidity assistance” for countries under pressure but not yet ready to call in the IMF.  The liquidity is available from the ECB – it can provide emergency loans to all the banks in the region to prevent bank runs from toppling them.  But there is also a solvency problem for the weaker countries now under pressure.

To return to solvency, the struggling eurozone countries will need funding for budget deficits and debt rollover for several years.  Governments will need to recapitalize their banks with new government-backed debt.  The best solution would be for the government to then sell their stakes to larger European banks with more creditworthy sovereigns.  SocGen Greece (with all its issues) would be a lot more attractive to Greek businessmen and depositors than National Bank of Greece at the end of all this.

And this is the heart of the problem:  Will Germany and other European nations be prepared to provide the large sums needed to refinance several peripheral nations?  Will these nations then take the painful austerity measures needed in the midst of recessions in order to get out of this?

When the problem was just Greece, the numbers were already large.  In our view, the Greek government needs 150bn euros over three years to be sure it can refinance itself through a recession.  The Portuguese will roughly need 100bn euros.  If those amounts were made available – will that support the confidence needed to buy Irish and Spanish bonds, or would it scare investors because the protests from Germany would be so large that it would be clear no more funds would be available in bailout mechanisms?

There is no easy answer to this question, but yesterday’s action suggested that markets are not at all confident policy makers are going to stop this crisis soon.  They are surely right:  Greek strikes, a weak Portuguese government deeply in denial, and German hatred for bailouts, all make a path to restore confidence very difficult.

Yesterday was also a wake-up call for the United States.  It is no longer reasonable or responsible to say:  “US banks have no exposure to Greece”.  US banks are heavily exposed to Europe, and this is turning into a serious Europe-wide problem.  The US badly needs to make sure this does not spread beyond Greece and Portugal/Ireland.

To restore confidence in buying Spanish and other major European nation bonds, it would surely help to have clear signals that President Obama himself, and the Federal Reserve, are taking an active stance now on making sure this does not spread to become another threat to global financial stability. A broader wall of preventive financing must now be put in place – after all, this is exactly why (in principle) the IMF was recapitalized this time last year.

Such a push by the US would be awkward, to be sure, as the French and Germans (and British) are not keen to have more US involvement in their affairs.  But the Europeans have handled matters so badly in the past few months, it is time for a much more scaled-up US role.

‘DON’T CRY FOR WALL STREET,’ by Paul Krugman in the N. Y. Times.

In Uncategorized on April 23, 2010 at 09:55

On Thursday, President Obama went to Manhattan, where he urged an audience drawn largely from Wall Street to back financial reform. “I believe,” he declared, “that these reforms are, in the end, not only in the best interest of our country, but in the best interest of the financial sector.”

Well, I wish he hadn’t said that — and not just because he really needs, as a political matter, to take a populist stance, to put some public distance between himself and the bankers. The fact is that Mr. Obama should be trying to do what’s right for the country — full stop. If doing so hurts the bankers, that’s O.K.

More than that, reform actually should hurt the bankers. A growing body of analysis suggests that an oversized financial industry is hurting the broader economy. Shrinking that oversized industry won’t make Wall Street happy, but what’s bad for Wall Street would be good for America.

Now, the reforms currently on the table — which I support — might end up being good for the financial industry as well as for the rest of us. But that’s because they only deal with part of the problem: they would make finance safer, but they might not make it smaller.

What’s the matter with finance? Start with the fact that the modern financial industry generates huge profits and paychecks, yet delivers few tangible benefits.

Remember the 1987 movie “Wall Street,” in which Gordon Gekko declared: Greed is good? By today’s standards, Gekko was a piker. In the years leading up to the 2008 crisis, the financial industry accounted for a third of total domestic profits — about twice its share two decades earlier.

These profits were justified, we were told, because the industry was doing great things for the economy. It was channeling capital to productive uses; it was spreading risk; it was enhancing financial stability. None of those were true. Capital was channeled not to job-creating innovators, but into an unsustainable housing bubble; risk was concentrated, not spread; and when the housing bubble burst, the supposedly stable financial system imploded, with the worst global slump since the Great Depression as collateral damage.

So why were bankers raking it in? My take, reflecting the efforts of financial economists to make sense of the catastrophe, is that it was mainly about gambling with other people’s money. The financial industry took big, risky bets with borrowed funds — bets that paid high returns until they went bad — but was able to borrow cheaply because investors didn’t understand how fragile the industry was.

And what about the much-touted benefits of financial innovation? I’m with the economists Andrei Shleifer and Robert Vishny, who argue in a recent paper that a lot of that innovation was about creating the illusion of safety, providing investors with “false substitutes” for old-fashioned assets like bank deposits. Eventually the illusion failed — and the result was a disastrous financial crisis.

In his Thursday speech, by the way, Mr. Obama insisted — twice — that financial reform won’t stifle innovation. Too bad.

And here’s the thing: after taking a big hit in the immediate aftermath of the crisis, financial-industry profits are soaring again. It seems all too likely that the industry will soon go back to playing the same games that got us into this mess in the first place.

So what should be done? As I said, I support the reform proposals of the Obama administration and its Congressional allies. Among other things, it would be a shame to see the antireform campaign by Republican leaders — a campaign marked by breathtaking dishonesty and hypocrisy — succeed.

But these reforms should be only the first step. We also need to cut finance down to size.

And it’s not just critical outsiders saying this (not that there’s anything wrong with critical outsiders, who have been much more right than supposedly knowledgeable insiders; see Greenspan, Alan). An intriguing proposal is about to be unveiled from, of all places, the International Monetary Fund. In a leaked paper prepared for a meeting this weekend, the fund calls for a Financial Activity Tax — yes, FAT — levied on financial-industry profits and remuneration.

Such a tax, the fund argues, could “mitigate excessive risk-taking.” It could also “tend to reduce the size of the financial sector,” which the fund presents as a good thing.

Now, the I.M.F. proposal is actually quite mild. Nonetheless, if it moves toward reality, Wall Street will howl.

But the fact is that we’ve been devoting far too large a share of our wealth, far too much of the nation’s talent, to the business of devising and peddling complex financial schemes — schemes that have a tendency to blow up the economy. Ending this state of affairs will hurt the financial industry. So?