Financial crisis interview

[jdonn]

I really enjoyed this interview. I universally agree, especially the point about investing in infrastructure and long term energy projects rather than cutting taxes. Not that I will be sending my tax rebate back :P

 

CNN spoke to world affairs expert and author Fareed Zakaria about the financial crisis.

CNN: Are we out of the woods with this credit crisis?

 

Zakaria: No, but eventually, the governments will win. They have potentially unlimited tools at their disposal, especially if they act in concert. They can nationalize firms, call bank holidays, suspend trading for weeks, buy up debt and equity, and renegotiate home mortgages. Most important, the American government can print money.  Watch Fareed Zakaria on the financial crisis »

 

CNN: But won't those actions cause more problems?

 

Zakaria: You're right, all of those tools have long-term effects that are extremely troublesome, but they are nothing compared with the potential collapse of the financial system.

 

Whatever can be done must be done, and Washington seems to have recognized that it must do whatever is required to shore up that system.

 

CNN: What do you think caused this crisis?

 

Every city, every county and every state has wanted to preserve its many and proliferating operations and yet not raise taxes. How to do that? By borrowing, using ever more elaborate financial instruments.

 

Easy money plus leverage equals financial crisis.

 

CNN: OK. So what do we do now?

 

Zakaria: In the short term, all the solutions require that governments take on more debts and larger obligations. This is inevitable and necessary. But that doesn't mean we should, as some noted economists advocate, stimulate the economy with more tax cuts.

 

That would be only one more way to keep the party going artificially, like asking a drunk to go to AA next year but in the meantime to have even more whiskey.

 

A far better stimulus would be to announce and expedite major infrastructure and energy projects, which are investments, not consumption, and therefore have a much different effect on the country's fiscal fortunes.

 

In the medium and long term, we have to get back to basics. Households, for instance, should save more. Governments should put incentives in place that make such savings more likely.

 

The U.S. government offers enormous incentives to consume (the deduction of mortgage interest being the best example), and it works. We have the biggest houses in the world, the thinnest flat-screen TVs and the most cars. If we were to tax consumption and encourage savings, that would also work.

 

Regulations on credit-card debt should be revised to ensure that people understand the risks and costs of these instruments. Moving in this direction would be good for families and for the government as well.

 

CNN: Seems this will be painful.

 

Zakaria: No pain, no gain. Ever since the collapse of the Soviet Union, the United States has operated in the world with no constraints or checks on its power. This has not been good for its foreign policy. It has made Washington arrogant, lazy and careless.

 

We didn't have to make strategic choices; we could have it all. We could make blunders, anger the world, rupture alliances, waste resources, wage war incompetently; it didn't matter. We had more than enough room for error, lots of error.

 

But it's a different world out there. If Iraq cast a shadow on U.S. political and military credibility, this financial crisis has eroded America's economic and financial power.

 

In the short run, there has been a flight to safety -- toward dollars and T-bills -- but in the long run, countries are likely to seek greater independence from an unstable superpower.

 

The United States will now have to work to attract capital to its shores and manage its fiscal house better. We will have to persuade countries to join in our foreign endeavors.

 

 

We cannot noisily denounce Chinese and Arab foreign investments in America one day and then hope that they will keep buying $4 billion worth of T-bills another day.

 

We cannot keep preaching to the world about democracy and capitalism while our own house is so wildly out of order.

[luke warm]

yep, sounds about right to me... our "leaders" have gotten a lot wrong in the past decade or so, and i'm not just talking about the administration (though it is the easiest to blame)... congress is and was a willing co-conspirator

[PassedOut]

I universally agree, especially the point about investing in infrastructure and long term energy projects rather than cutting taxes.

I agree with this also. Use tax money to rebuild our infrastructure and prepare for energy independence. And create jobs that way.

[barmar]

I universally agree, especially the point about investing in infrastructure and long term energy projects rather than cutting taxes.

I agree with this also. Use tax money to rebuild our infrastructure and prepare for energy independence. And create jobs that way.

It worked to get us out of the Great Depression.

 

Hopefully we'll soon have a Democratic administration. They're more likely to undertake a project like this.

[kenberg]

I universally agree, especially the point about investing in infrastructure and long term energy projects rather than cutting taxes.

I agree with this also. Use tax money to rebuild our infrastructure and prepare for energy independence. And create jobs that way.

Count me in on this also. Some of the other statements need more filling in before I can say whether I agree. For example:

 

"Regulations on credit-card debt should be revised to ensure that people understand the risks and costs of these instruments. Moving in this direction would be good for families and for the government as well."

 

From time to time over the last decade and more, the Post and other sources have run articles on people who get in credit card debt almost beyond imagining. There is a common theme. As with so many things, the people are quick to blame practically anyone except themselves. Basically their position often comes to: When I bought this new stuff for $2000 and signed the credit card slip I was never told I would have to pay $2000 and be charged interest if I delayed payment.

 

The argument's cousin has shown up more lately with those in trouble with their mortgage: I was shocked to discover that on my adjustable rate mortgage the rate is being adjusted.

 

 

It's not really that anything was unclear, the person simply saw that understanding the facts would prevent him from a course of action he wanted to follow, so he did not understand the facts. I realize that in some cases there has been deception but I believe that far more often it is self-deception.

 

Also as with the mortgage problem, if it were just a matter of a foolish person and a foolish lender getting together to do something foolish, it would not be my business. But the large scale of this threatens the financial health of the whole economy. The issuing of credit cards has somehow become profitable for its own sake just as the granting of mortgages became profitable whether or not the client could reasonably be expected to handle the debt. It will take some work to see how to regulate matters to make it be in the card issuer's financial interest to see that the card holder can and will pay for what he buys but I think this would be the direction to go.

[TimG]

It worked to get us out of the Great Depression.

It worked to get the US out of the Great Depression. I doubt many of us were around at the time, however.

[mike777]

IF the federal government can create jobs by simply raising income taxes and spending the money, this may be a way to solve unemployment forever. Frankly I am surprised Europe and other places do not follow suit and do this.

 

If it takes raising income taxes, corporate taxes, capital gains taxes to create jobs I am all for that, raise them to the roof!

[helene_t]

IF the federal government can create jobs by simple raising income taxes and spending the money, this may be a way to solve unemployment forever. Frankly I am suprised Europe and other places do not follow suit and do this.

please add a smiley, Mike. You know very well that that's exactly what we have been doing since the seventies.

 

Whether it has worked is debatable. It seems that some think it may be called for in the current situation.

[Al_U_Card]

IF the federal government can create jobs by simple raising income taxes and spending the money, this may be a way to solve unemployment forever. Frankly I am suprised Europe and other places do not follow suit and do this.

please add a smiley, Mike. You know very well that that's exactly what we have been doing since the seventies.

 

Whether it has worked is debatable. It seems that some think it may be called for in the current situation.

Mike is a smiley.... :P

 

When money returns to being the means and not the end, only then will we be able to direct our efforts fruitfully towards increasing the quality of all our lives without demeaning nor endangering most of them.

[y66]

Good story here re: George Soros' take on the financial crisis. The guy has something to say.

[kenberg]

Good story here re: George Soros' take on the financial crisis. The guy has something to say.

I might even buy the book. Perhaps I will even read it!

[Aberlour10]

Stock exchanges around the world may be sputtering, but at least one German company is enjoying a dramatic share price sure. Volkswagen AG.

 

No one at the Frankfurter Stock Exchange remember such a crazy trading day as this one. VW shares raised from about 400€/share to...700€...to .1000€!!! The surge was caused by so-called short-sellers grabbing up the declining number of "free floating" VW shares in a bid to close their positions. This company was for a few hours the most valuable incorporation in the word, more then ExxonMobile..etc!

What has is it all with real economic situation to do?

 

Robert

[Gerben42]

The shares were at €200 last week, so a mere 400% increase.

[Al_U_Card]

A semi-technical look at the markets.

 

http://vosblog.roicapital.ca/

 

He talks about why the volatility and how hedge fund manipulations continue to make month end interesting...

[mikeh]

I universally agree, especially the point about investing in infrastructure and long term energy projects rather than cutting taxes.

I agree with this also. Use tax money to rebuild our infrastructure and prepare for energy independence. And create jobs that way.

It worked to get us out of the Great Depression.

 

Hopefully we'll soon have a Democratic administration. They're more likely to undertake a project like this.

Actually, and I wasn't around at the time, and readily concede I may be in error, I thought that it was WWII that got the US out of the Great Depression.... the US made a lot of money manufacturing and selling goods to the UK and her allies, and in rearming itself.

 

This statement, whether true or not, is not intended as a criticism of the American position... without the help of the US (which was entitled to make a profit and seems to have been moderate in its demands compared to the assistance it supplied) the UK would almost certainly have been defeated, if only as a result of the submarine war in 1940-41.

 

I hope that economic theory is better developed these days.. a global war is not an ideal solution to a depression... all the more so in a time when many tens of millions of Americans believe that we are living in or approaching the end of days.... and triply so when there seems to be some chance that one of those lunatics is running for the position of VP to a 72 year old with an extensive medical history. At least, that is the impression I have gained from various media reports concerning Ms. Palin.

[kenberg]

Birth date 1/1/39 so I was barely around during the depression. I recall, in the sixties I think, listening to Firing Line back when William Buckley was the host. He had a guest on who was speaking of the New Deal and its success in working us out of the depression.

Buckley: "Are you familiar with the economic figures during those years? I warn you, I am."

 

Well, actually, I am not. But my understanding is that Roosevelt's efforts alleviated some pain and the WPA did some very good construction work, but unemployment was still extremely high right up until Pearl Harbor. Prosperity is just around the corner? Buddy can you spare a dime.

 

My general idea, untutored and perhaps even simple-minded, is that we need bridges so building bridges cannot be all that bad. We had better keep our scientific base energized so supporting science cannot be a mistake. And so on. The WPA and CCC were sometimes portrayed as make-work and perhaps sometimes were, but the projects did a lot of good (you can still see the results in our national parks) and they provided men with work and money. That can't be bad either.

 

Obama sounds to be on a similar line of thought and although it has much to be worked out, it seems to me to be roughly right.

[PassedOut]

My general idea, untutored and perhaps even simple-minded, is that we need bridges so building bridges cannot be all that bad. We had better keep our scientific base energized so supporting science cannot be a mistake. And so on. The WPA and CCC were sometimes portrayed as make-work and perhaps sometimes were, but the projects did a lot of good (you can still see the results in our national parks) and they provided men with work and money. That can't be bad either.

Yes, when you have (1) public work that needs doing, (2) people looking for jobs, and (3) an economy with jobs disappearing, it makes perfect sense for the government to spend money on public works.

 

If the US can spend $700 billion on a welfare program for bankers and financiers and can consider billions more in welfare for auto companies, it can surely support projects that benefit all citizens and that provide jobs for people thrown out of work.

 

A huge downside of the Reagan-Bush-Bush strategy of using deficit spending to pump up the economy in good times is that it becomes much more difficult to prop up the economy when hard times hit.

[PassedOut]

Conservative columnist David Brooks has the right idea: A National Mobility Project

 

In times like these, the best a sensible leader can do is to take the short-term panic and channel it into a program that is good on its own merits even if it does nothing to stimulate the economy over the next year. That’s why I’m hoping the next president takes the general resolve to spend gobs of money, and channels it into a National Mobility Project, a long-term investment in the country’s infrastructure.

 

Major highway projects take about 13 years from initiation to completion — too long to counteract any recession. But at least they create a legacy that can improve the economic environment for decades to come.

 

A major infrastructure initiative would create jobs for the less-educated workers who have been hit hardest by the transition to an information economy. It would allow the U.S. to return to the fundamentals.

Right on!

[goobers]

To echo mikeh, I do not believe FDR's plan pulled the US out of the Great Depression.

 

http://online.wsj.com/article/SB122541582835686689.html

[PassedOut]

My general idea, untutored and perhaps even simple-minded, is that we need bridges so building bridges cannot be all that bad. We had better keep our scientific base energized so supporting science cannot be a mistake. And so on. The WPA and CCC were sometimes portrayed as make-work and perhaps sometimes were, but the projects did a lot of good (you can still see the results in our national parks) and they provided men with work and money. That can't be bad either.

 

Obama sounds to be on a similar line of thought and although it has much to be worked out, it seems to me to be roughly right.

And Obama plans to follow through on this: Obama Sets Expansive Goal for Jobs

 

President-elect Barack Obama is developing a plan to create or preserve 2.5 million jobs over the next two years by spending billions of dollars to rebuild roads and bridges, modernize public schools, and construct wind farms and other alternative sources of energy.

Obama's weekly YouTube addresses make it very convenient to follow what he is doing and why. I think they'll be even more useful once he takes office and can discuss results as well as plans.

[PassedOut]

I thought that it was WWII that got the US out of the Great Depression.... the US made a lot of money manufacturing and selling goods to the UK and her allies, and in rearming itself.

Today's NYT has a short piece by Tyler Cown that discusses lessons from the FDR experience, including the impact of WWII on the economy: The New Deal Didn’t Always Work, Either

 

A study of the 1930s by Christina D. Romer, a professor at the University of California, Berkeley (“What Ended the Great Depression?,” Journal of Economic History, 1992), confirmed that expansionary monetary policy was the key to the partial recovery of the 1930s.

World War II did help the American economy, but the gains came in the early stages, when America was still just selling war-related goods to Europe and was not yet a combatant. The economic historian Robert Higgs, a senior fellow at the Independent Institute, has shown in his 2006 book, “Depression, War, and Cold War,” just how much the war brought shortages and rationing of consumer goods.

 

While overall economic output was rising, and the military draft lowered unemployment, the war years were generally not prosperous ones.

The good New Deal policies, like constructing a basic social safety net, made sense on their own terms and would have been desirable in the boom years of the 1920s as well.

With the benefit of history and of smart, effective people now taking office, perhaps we can avoid many of the missteps of the past.

[y66]

Michael Lewis and David Einhorn posted some thoughtful suggestions for repairing the "broken financial world" on the NYT op-ed page today.

 

Click here for the full story.

 

Excerpts:

 

We should begin by breaking the cycle of deteriorating housing values and resulting foreclosures. Many homeowners realize that it doesn’t make sense to make payments on a mortgage that exceeds the value of their house. As many as 20 million families face the decision of whether to make the payments or turn in the keys. Congress seems to have understood this problem, which is why last year it created a program under the Federal Housing Authority to issue homeowners new government loans based on the current appraised value of their homes.

And yet the program, called Hope Now, seems to have become one more excellent example of the unhappy political influence of Wall Street. As it now stands, banks must initiate any new loan; and they are loath to do so because it requires them to recognize an immediate loss. They prefer to “work with borrowers” through loan modifications and payment plans that present fewer accounting and earnings problems but fail to resolve and, thereby, prolong the underlying issues. It appears that the banking lobby also somehow inserted into the law the dubious requirement that troubled homeowners repay all home equity loans before qualifying. The result: very few loans will be issued through this program.

 

THIS could be fixed. Congress might grant qualifying homeowners the ability to get new government loans based on the current appraised values without requiring their bank’s consent. When a corporation gets into trouble, its lenders often accept a partial payment in return for some share in any future recovery. Similarly, homeowners should be permitted to satisfy current first mortgages with a combination of the proceeds of the new government loan and a share in any future recovery from the future sale or refinancing of their homes. Lenders who issued second mortgages should be forced to release their claims on property. The important point is that homeowners, not lenders, be granted the right to obtain new government loans. To work, the program needs to be universal and should not require homeowners to file for bankruptcy.

 

There are also a handful of other perfectly obvious changes in the financial system to be made, to prevent some version of what has happened from happening all over again. A short list:

 

Stop making big regulatory decisions with long-term consequences based on their short-term effect on stock prices. Stock prices go up and down: let them. An absurd number of the official crises have been negotiated and resolved over weekends so that they may be presented as a fait accompli “before the Asian markets open.” The hasty crisis-to-crisis policy decision-making lacks coherence for the obvious reason that it is more or less driven by a desire to please the stock market. The Treasury, the Federal Reserve and the S.E.C. all seem to view propping up stock prices as a critical part of their mission — indeed, the Federal Reserve sometimes seems more concerned than the average Wall Street trader with the market’s day-to-day movements. If the policies are sound, the stock market will eventually learn to take care of itself.

End the official status of the rating agencies. Given their performance it’s hard to believe credit rating agencies are still around. There’s no question that the world is worse off for the existence of companies like Moody’s and Standard & Poor’s. There should be a rule against issuers paying for ratings. Either investors should pay for them privately or, if public ratings are deemed essential, they should be publicly provided.

 

Regulate credit-default swaps. There are now tens of trillions of dollars in these contracts between big financial firms. An awful lot of the bad stuff that has happened to our financial system has happened because it was never explained in plain, simple language. Financial innovators were able to create new products and markets without anyone thinking too much about their broader financial consequences — and without regulators knowing very much about them at all. It doesn’t matter how transparent financial markets are if no one can understand what’s inside them. Until very recently, companies haven’t had to provide even cursory disclosure of credit-default swaps in their financial statements.

 

Credit-default swaps may not be Exhibit No. 1 in the case against financial complexity, but they are useful evidence. Whatever credit defaults are in theory, in practice they have become mainly side bets on whether some company, or some subprime mortgage-backed bond, some municipality, or even the United States government will go bust. In the extreme case, subprime mortgage bonds were created so that smart investors, using credit-default swaps, could bet against them. Call it insurance if you like, but it’s not the insurance most people know. It’s more like buying fire insurance on your neighbor’s house, possibly for many times the value of that house — from a company that probably doesn’t have any real ability to pay you if someone sets fire to the whole neighborhood. The most critical role for regulation is to make sure that the sellers of risk have the capital to support their bets.

 

Impose new capital requirements on banks. The new international standard now being adopted by American banks is known in the trade as Basel II. Basel II is premised on the belief that banks do a better job than regulators of measuring their own risks — because the banks have the greater interest in not failing. Back in 2004, the S.E.C. put in place its own version of this standard for investment banks. We know how that turned out. A better idea would be to require banks to hold less capital in bad times and more capital in good times. Now that we have seen how too-big-to-fail financial institutions behave, it is clear that relieving them of stringent requirements is not the way to go.

 

Another good solution to the too-big-to-fail problem is to break up any institution that becomes too big to fail.

 

Close the revolving door between the S.E.C. and Wall Street. At every turn we keep coming back to an enormous barrier to reform: Wall Street’s political influence. Its influence over the S.E.C. is further compromised by its ability to enrich the people who work for it. Realistically, there is only so much that can be done to fix the problem, but one measure is obvious: forbid regulators, for some meaningful amount of time after they have left the S.E.C., from accepting high-paying jobs with Wall Street firms.

 

But keep the door open the other way. If the S.E.C. is to restore its credibility as an investor protection agency, it should have some experienced, respected investors (which is not the same thing as investment bankers) as commissioners. President-elect Barack Obama should nominate at least one with a notable career investing capital, and another with experience uncovering corporate misconduct. As it happens, the most critical job, chief of enforcement, now has a perfect candidate, a civic-minded former investor with firsthand experience of the S.E.C.’s ineptitude: Harry Markopolos.

 

The funny thing is, there’s nothing all that radical about most of these changes. A disinterested person would probably wonder why many of them had not been made long ago. A committee of people whose financial interests are somehow bound up with Wall Street is a different matter.

[y66]

Good story here by Joe Nocera about the usefulness and limitations of risk models.

[Gerben42]

I talked to my dad about the mortgage problem. He says the biggest problem in the US mortgage market is the way it is structured. Let's say you buy a house for 100,000 Euros with a down payment of 20,000 and a mortgage of 80,000, for example. The house value will however be lower if it has to be sold on default, say that would be 90,000.

 

Now the value of the house drops 20%, i.e. value 80,000, default value 72,000. In the USA, you can now turn over the key and you will be debt-free. In Europe, however, the bank will sell the house (for 72,000) and say well you still owe us the mortgage - 72,000 = 8,000 Euros.

 

This was fine for the banks in the US, because as long prices went up, this scenario was in fact better for them. Now that prices go down, it's not.

[Winstonm]

I talked to my dad about the mortgage problem. He says the biggest problem in the US mortgage market is the way it is structured. Let's say you buy a house for 100,000 Euros with a down payment of 20,000 and a mortgage of 80,000, for example. The house value will however be lower if it has to be sold on default, say that would be 90,000.

 

Now the value of the house drops 20%, i.e. value 80,000, default value 72,000. In the USA, you can now turn over the key and you will be debt-free. In Europe, however, the bank will sell the house (for 72,000) and say well you still owe us the mortgage - 72,000 = 8,000 Euros.

 

This was fine for the banks in the US, because as long prices went up, this scenario was in fact better for them. Now that prices go down, it's not.

Although this is true - non-recourse loans - it is only a part of the problem.