“A dynamic economy will always have booms and busts. But the story of the past twenty-five years is that Washington has created a financial system that cannot withstand the destructive part of creative destruction – necessary for free markets- without destroying the economy.  We’ve grown so accustomed to government-subsidized failure in finance that we feel we have no choice. In accepting subsidized failure, we harm America’s trust in free markets, we harm the world’s trust in American markets, and we harm the financial innovation that advances the economy rather than smothers it.”

From After the Fall:  Saving Capitalism from Wall Street- and Washington by Nicloe Gelinas

Does the rising stock market and improving unemployment numbers support Obama’s economic solutions?

It may appear so, but I remain skeptical for several reasons.

The stock market is rebounding off of the low of a year ago, which was largely oversold. The stock market may also be responding to a sharp increase in liquidity. There was almost 3 trillion dollars in money market funds earning a pittance in interest . The further away we get from the economic storm of 2008 the more likely investors will be to test the waters to get a better return.

Stocks seems a natural place to put that cash because it is so liquid. Once can liquidate with the push of a button on E-trade.  Real estate which is still depressed and business investment in expansion and equipment is very illiquid and unattractive in an environment of such political uncertainty.

Ironically in this sense, the political actions harming small business (higher taxes, cap & trade, card check, health care) may actually be serving to stimulate the sale of public securities, but this is not sustainable.

The shock to the system in 2008 and 2009 caused many companies to cut costs dramatically. I have never seen so many companies reduce salaries across the board.  With any rebound in business they will return to profitability very quickly. This would happen without any government stimulation, as it did in the stock crash of 1987.

I still believe it was necessary for the government and the Fed to bail out financial system, though I also largely blame them for getting the system into a position that required a bailout.

This rebound in securities may partially explain the improvement in employment. Even after accounting for substantial increase in government employment and the temporary bump from  census workers there is still a real gain. Yet the unemployment rate remains very high.  It is still conceivable that we will see an uptick in unemployment or more likely a very long slow drawdown from an economy burdened with political baggage, high taxes, and more regulation.

Warren Buffet noted that a weak economy can still support a rising stock market.  Productivity, employment, and growth are the signs of a strengthening economy.  It may be too soon to determine if the economic stimulus will counteract the political actions that are detrimental to job creation and a strong economy.

(this was published previously in the Macon Telegraph)

Being in the middle of a record economic crisis presents a rare learning opportunity.  Several books are worthwhile for those seeking to understand what just happened.

Too Big to Fail by Andrew Ross Sorkin details the action of the Fed under Benanke and Treasury under Paulson during the crisis period between August and December.  While Geitner as head of the New York Fed was also featured the central player of this crisis was Hank Paulson.

Monumental decisions involving billions of dollars of assets were made in days, sometimes hours.  Both Paulson and Geitner had a sense that the market was due for a correction long before the crisis hit, but they probably did not see it coming as fast and as broad as it did. Bernanke noted that just as there are no atheists in foxholes there are no ideologues in economic crisis either. Neither Republicans or Democrats wanted to bail out Wall Street , but the crisis dictated actions that were against the grain of capitalists of both parties.

Paulson worked tirelessly to find appropriate merger partners for weak players like Merrill Lynch, Wachovia, and Lehman.  He almost had Barclays ready to buy Lehman when the British Financial Services Authority ( FSA) refused to approve the acquisition/merger because of the risk it brought to the British financial system.

Lehman was singular in the fact that it was not acquired or bailed out and thus had to go bankrupt.  Part of this was timing; Congress was just in no mood to bail out a Wall Street player.  Part of the reason was George Bush’s cousin who worked for Lehman and his brother Jeb’s association with the firm. Such close political relations probably worked against the interests of the firm.

In retrospect bailing our Lehman’s may have forestalled the panic that engulfed the rest of the system. With Bear Sterns gone and now Lehman’s gone, depositors wondered who was next and there began a run of the other banks like J.P Morgan and Morgan Stanley.

While Paulson’s association with Goldman was suspect the fact was he had to severe his tie and sell his stock ($485 million worth) in order to take his job at Treasury. Since his actions were so scrutinized he was careful to avoid even conversations that would indicate favoritism toward his old firm.

The most difficult decision was to bail out AIG whose credit default swaps acted as insurance against many of the cdo’s (collateralized debt obligations) that infected the financial markets. As the underlying assets plummeted in value AIG was downgraded and had to put up more capital that it could not provide.

Having to make such massive changes and decision in such short time meant that perfection was not obtainable. Barney Frank justifiably wanted some assurance that compensation to the executives would suffer from their misdeeds, but there simply was not enough time to rule of thousands of contracts during the time period that decisions had to be made.

Wall Street clearly engaged in risks it did not understand, but neither did the regulators such as Greenspan and his successor Bernanke. Complicated risk models gave the CEO’s delusional certainty, but eventually the party came crashing down for the same reason all bubbles burst;  lack of trust and confidence.

But Sorkin spends little space getting into the detail of the causes of the crash and suitably stays focused on the urgency and the actions required in response. 

For more information on the background that caused the crisis I recommend The Housing Boom and Bust by Thomas Sowell,  Financial Fiasco by Johan Norberg, most of all After the Fall: saving Capitalism from Wall Street – and Washington by Nicole Gelinas.

Sowell and Norberg focus more on the misguided Government fiscal and monetary policies that inflated the housing bubble, but Nicole Gelinas also analyzes which good regulations were unfortunately removed (and by who) and which bad ones were inappropriately applied.

A crisis of this nature required the perfect storm of many great errors to all focus their retribution at the same time. Unfortunately the media large engages in partisanship and demonization and few people will take the time to understand what happened and why.  It is complicated but engaging the problem reveals basic principles of sound policy that were violated as they were in previous bubbles.

History repeats itself but never the same way.

Team Obama has missed the reason for high unemployment and slow growth in spite of low interest rates and seemingly endless stimulus.  In the Wall Street Journal Gary Becker, Steven Davis and Kevin Murphy writes “Uncertainty and the Slow Recovery”.

Excerpts:

Several pieces of evidence point to extreme caution by businesses and households. A regular survey by the National Federation of Independent Businesses (NFIB) shows that recent capital expenditures and near-term plans for new capital investments remain stuck at 35-year lows. The same survey reveals that only 7% of small businesses see the next few months as a good time to expand. Only 8% of small businesses report job openings, as compared to 14%-24% in 2008, depending on month, and 19%-26% in 2007.

The weak economy is far and away the most prevalent reason given for why the next few months is “not a good time” to expand, but “political climate” is the next most frequently cited reason, well ahead of borrowing costs and financing availability. The authors of the NFIB December 2009 report on Small Business Economic Trends state: “the other major concern is the level of uncertainty being created by government, the usually [sic] source of uncertainty for the economy. The ‘turbulence’ created when Congress is in session is often debilitating, this year being one of the worst. . . . There is not much to look forward to here.”

Government statistics tell a similar story. Business investment in the third quarter of 2009 is down 20% from the low levels a year earlier. Job openings are at the lowest level since the government began measuring the concept in 2000. The pace of new job creation by expanding businesses is slower than at any time in the past two decades and, though older data are not as reliable, likely slower than at any time in the past half-century. While layoffs and new claims for unemployment benefits have declined in recent months, job prospects for unemployed workers have continued to deteriorate. The exit rate from unemployment is lower now than any time on record, dating back to 1967.

According to the Michigan Survey of Consumers, 37% of households plan to postpone purchases because of uncertainty about jobs and income, a figure that has not budged since the second quarter of 2009, and one that remains higher than any previous year back to 1960.

These facts suggest that it was a serious economic mistake to press for a hasty, major transformation of the U.S. economy on the heels of the worst financial crisis in decades.

In  the American Metal  Market magazine Commercial Metals Company’s (CMC) metal fabrication division noted a drop in earnings to a $’17.3 million LOSS  in the most recent fiscal  quarter (three months ending Nov 30) from a profit of $66.6 million in the same period a year ago. Tonnage is down 32% and prices are down 34%.

Most metal fabricators are seeing similar results.  This highlights my previously stated point that our primary economic problem is not lack of credit but a lack of profits. Entire lines and companies are being mothballed until there is some uptick in construction and there is simply too much inventory to see this happening anytime soon.

For a few months I received auction notices for large fabrication shops about every week.

Imagine the impact of Commercial Metal’s report multiplied by thousands of companies.   My eyes tell me unemployment is getting worse, while the Bureau of Labor Statistics tell me it is getting better; I believe my eyes.

This excess inventory of buildings and housing was created before this administration, and the hardest thing to do at this point is nothing, but this is probably the best long term solution.  Efforts to prop up prices while inventory is still too high will only kick the problem down the road.

One idea would be tax credits for demolishing old buildings. This goes against my grain of economic common sense, but it would solve a problem of oversupply.