September 2008 Archives

We all know that rising gasoline prices have put a crimp in household budgets, But the Economic Policy Institute has a nice item today comparing healthcare costs and energy costs.

Since 2000, spending on health insurance premiums actually grew faster than spending on energy; by the first half of 2008 American consumers were paying $370 billion more for insurance premiums than in 2000. Spending for energy is a relative laggard by comparison, increasing "only" $320 billion since 2000.

Rising energy prices constitute a real drain on family budgets. Rising prices for health care, however, are also eating away at other consumption possibilities, and we shouldn't lose sight of this just because we're not given weekly reminders when we pull up to the gas pump.

The Democratic and Republican conventions are over. The barricades are down and the party faithful are fired up. Pollster.com now puts it as a "tossup" between John McCain/Sarah Palin and Barack Obama/Joe Biden. It's a tight race. .

Wanna bet the polls are right? You can on the Iowa Electronic Market prediction market. It's an online futures market that allows investors to gamble up to $500 on the election's outcome. At current prices, the market is betting that Obama has a 57% chance of winning the White House come November. To be sure, that's down from a recent peak of 63%. But it's still significant gap. The bottom line: Obama is in the lead.

Will the polls or the futures market prove to be a better predictor? Many economists lean toward "follow the money." For example, a recent paper by three accounting professors at the Henry B. Tippie College of Business at the University of Iowa compares futures market predictions to 964 polls over the five Presidential elections since 1988 and found the market more accurate 74% of the time. The market outperformed the polls in every election when forecasting more than 100 days in advance.

Of course, these professors are from the business school that runs the futures market. Still, a considerable amount of historic data has been mined to give the futures market credibility. In essence, if you believe markets are reasonably efficient, then you'll expect the polls to turn Obama's way as the election gets closer.

Of course, the superiority of political markets as election predictors is controversial, and fare from everyone buys into the market efficiency story. Nevertheless, the great virtue of a prediction market--like all markets--is that it's a relatively objective way of aggregating a lot of information. Plus you can check up on it whenever you like.

After announcing the largest loss in its 160 year history, no one will be suprised if Lehman Brothers turns to Treasury and the Fed for a bailout. The federal government should just say no.

By this time, everyone has known for a considerable period of time about Lehman's problems. The financial exposure to Lehman has to have shrunk. The government needs to show that it isn't in the business of bailing out every high-priced pinstripe suit on Wall Street. The taxpayer should only be on the hook to avert threats that might take down the economy and financial system. That's not Lehman. Not now.

The U.S. Treasury and the Fed should politely tell Lehman to go away. It has to find its saviour in the private markets.

The consensus expectation has been that the Fed will keep its benchmark interest rate steady for now, but that when it does move the central bank will hike its benchmark interest rate, probably from 2% to 2.25%.

But what if the consesnsus is wrong. In the light of the weakness in the economy and the ongoing credit crunch, what if the next move by the Fed is to cut its rate to 1.75%--and at its next meeting?

Yes, inflation remains a public concern of the Fed, but it might get some relief on that front with commodity prices weakening and the global economy slowing.

Inflation is not the problem. The real risk is the the U.S. and the rest of the world economy get locked into a downward spiral.

Nouriel Roubini, professor at New York University and well-known blogger, has been in the forefront of understanding the depth of the current credit crunch. I was just reading his post from September 9, and its worth quoting at length. The title of his piece is "Comrades Bush, Paulson and Bernanke Welcome You to the USSRA (United Socialist State Republic of America)."

The now inevitable nationalization of Fannie and Freddie is the most radical regime change in global economic and financial affairs in decades. For the last twenty years after the collapse of the USSR, the fall of the Iron Curtain and the economic reforms in China and other emerging market economies the world economy has moved away from state ownership of the economy and towards privatization of previously stated owned enterprises. This trend was aggressively supported the United States that preached right and left the benefits of free markets and free private enterprise.

This biggest bailout and nationalization in human history comes from the most fanatically and ideologically zealot free-market laissez-faire administration in US history. These are the folks who for years spewed the rhetoric of free markets and cutting down government intervention in economic affairs. But they were so fanatically ideological about free markets that they did not realize that financial and other markets without proper rules, supervision and regulation are like a jungle where greed - untempered by fear of loss or of punishment - leads to credit bubbles and asset bubbles and manias and eventual bust and panics.

You can readt the whole article here.

I'm doing some research into the trend in personal bankruptcies this morning, and I came on this blog,Bankruptcy Law Network: It's by bankruptcy attorneys from around the country.

We get a lot of questions from homeowners interested in doing a "short sale." In essence, they'd like to walk away from their property rather than go through foreclosure. Although there's a certain lure and satisfaction to the idea of sending the keys to the house to the bank, it actually takes a lot of negotiation.It isn't easy, and there are pitfalls. Here's part of a post on the risks of a short sale and why foreclosure is not necessarily bad. It's by Attorney Craig Andresen of Bloomington, Minnesota:

...Without a release of liability on the mortgage note, the homeowner will continue to be liable for the unpaid balance owed on the mortgage, eliminating the entire reason for the homeowner to do the short sale in the first place. This means the homeowner needs to obtain not just a release of the mortgage, but a release of personal liability as well. Worse, the resulting debt forgiveness will be treated as income by the IRS. If the amount of the mortgage which is forgiven is substantial, the resulting income tax owed could present a serious, or even catastrophic, problem for the well-meaning homeowner. It may be necessary to hire a CPA to prove insolvency, if possible, to avoid the tax consequences of short sale mortgage debt forgiveness.

A distressed homeowner contemplating a short sale as a means of avoiding foreclosure needs to think carefully about whether a short sale will solve the problem, or merely create additional problems.

I'm not surprised that Lehman Brothers went into bankruptcy. But Merrill Lynch worried enough to sell itself to Bank of America? That's a stunning development.

AIG is an extremely complicated, global insurance company with a large presence in Asia. Technically, its regulated by the states, but the Feds are deeply involved this time around.

Who's next?

George Magnus, senior economic adviser at UBS Investment Bank in London has been one of the more accurate observers of the ongoing credit crunch.

A couple of highlights from his latest thinking:

...In terms of events, it's not possible to know exactly what happens next, but as you all know there are other major institutions in the financial instability frame, not to mention the maybe 100 or more smaller or non-diversified banks that in all probability could get into bad loan difficulties or fail. The problem at the moment of course, is the speed at which the de-leveraging is unravelling, and the not-knowing how and when a systemic solution will be found. I don't think there's any question about 'if' this will happen, but when and under what circumstances.

Fifth, legislation to provide borrowers and lenders, whether in the financial or housing sectors, with a framework within which to work out loans and payments. The recently passed FHA Housing Stabilisation and Homeowners Retention Act was of course the first major example.

You can see how seriously he takes the credit crunch. Here's how he summarizes his current thinking:

First, a reasonable, orderly work-out of financial deleveraging, if it were ever a possibility, now no longer seems possible

And fourth, the economic consequences cannot be fairly estimated really until financial stability has been restored. At this point, it would seem as though the recession in the US, and in some other countries, may continue into the first half of 2009; and that a new cause for concern is the impact of the policy response to the financial crisis on US debt instruments and the US dollar.

...that a major money market mutual fund has "broken a buck"! Say what?

That's Wall Street jargon for this expectation: When you put a dollar into a money market mutual fund you expect at minimum a dollar back. Of course, you also expect to get paid some interest.

Money market mutual funds aren't backstopped by the Federal Deposit Insurance Corporation. But the product has been sold--and individual investors have assumed--that it's a safe haven for emergency money and similar funds. Now, that promise has been broken, thanks to a money market fund run by Reserve Management Corporation. It owned a slug of Lehman Brothers debt.

Here's part of a release put out last night by the Investment Company Institute, the main trade association for the mutual fund industry.

Today, Reserve Management Corporation announced that one of its money mutual market funds is unable to maintain a $1.00 net asset value (NAV), an event triggered by unprecedented market conditions that have affected a wide range of financial firms. This type of event--known as "breaking the buck"--is extremely rare.

Money market mutual funds have been a successful financial product for millions of investors. Although money market funds are not guaranteed, investors have benefited from the security, liquidity, and diversification that these funds provide under stringent and effective regulation. Today, money market funds hold $3.5 trillion in assets for a wide range of individual and institutional investors.

The last time a money market mutual fund broke a buck was in 1994, and it was a small fund.

No, Wall Street and the regulators have to be very worried in the current environment if individual investors decide they don't want to put their "safe" money at risk in money market mutual funds anymore. Already, U.S. Treasury bills are at their lowest level since 1954, according to a story on the Bloomberg newswire. And to say that more funds will "break the buck" isn't an outlandish forecast, considering the disaster in the auction rate preferred market and the stunning list of companies that have been bailed out by the government or the private sector, Bear Stearns, Freddie Mac, Fannie Mae, Lehman Brothers, Merrill Lynch, AIG--and whomever is next. The unthinkable is suddenly thinkable.

Nervousness about the money market mutual fund industry is one reason why we'll continue to see ad hoc bailouts of financial institutions until a more systemic solution is decided on. And that will come sooner rather than later.

The 3 month Treasury bill yield is almost zero. It's at 0.03%. That's a stunning sign at how much capital flowed into the safest security in the world. Investors want to be free of default risk, and their willing to accept no interest in exchange.

Forget all the talk worrying about inflation, or rising prices. With this kind of asset implosion, the real risk is deflation or falling prices. The slowing global economy will put additional pressure on companies, especially in Asia, to cut prices in an attempt to maintain sales. Corporate price cutting, in turn, will add to the downward deflationary pressure.

Do you remember the kids book, Where's Waldo? It was a fun picture book for youngsters searching for Waldo who was cleverly hidden in the crowd.

Well, where is Christopher Cox, head of the Securities & Exchange Commission. Where is the SEC? Like it or not, we know what Treasury secretary Henry Paulson is doing and Fed chairman Ben Bernanke (and I'm a fan of their actions so far). But the SEC? It's asleep, although it has imposed some limitations on short selling. Wow.

The credit crisis is having an impact on the race for the White House. The trading gap between Obama and MCCain had narrowed on the Iowa electronic presidential futures market after the Republican convention. Unlike the polls that placed them about even at the time, investors still gave Obama a slight edge. But the trading gap has widened again. The presidential futures market now gives Obama a 61% chance of winning in Novermber, with McCain down to 39%.

In the latest of a long list of stunning events, the U.S. Treasury (or really the American taxpayer) is now guaranteeing that money market mutual funds won't break a buck". The Treasury said: "For the next year, the U.S. Treasury will insure the holdings of any publicly offered eligible money market mutual fund -- both retail and institutional -- that pays a fee to participate in the program.".

Call it the FMMMFIC for Federal Money Market Mutual Fund Insurance Corporation. The limit is set at $50 billion, although that's probably a fake number. If a run really did emerge on money market mutual funds the Treasury would front even more money.

It's a good short-term measure to prevent a run on the Wall Street bank. But what happens later on? The genie is out of the bottle. Is the taxpayer going to guarantee $3.5 trillion in mutual fund assets from here on? (As of the latest figures, $1.2 trillion of that is individual investors; the rest is institutional.) In essence, federal insurance has now been extended to one of Wall Street's major products.

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"Money market funds play an important role as a savings and investment vehicle for many Americans," the Treasury said in statement.

Concerns about the value of money market funds falling below $1 have exacerbated global financial market turmoil and caused severe liquidity strains.

Last night, I was doing laundry and watching the news when Paulson, Bernanke, and the main powers of the House and Senate came out of their meeting about the financial crisis. It had become apparent to everyone that the ad hoc approach to stemming financial panic wasn't enough. It was time to go fight a systemic financial crisis with a systemic financial solution. It was striking during their press conference how leaders of both parties from the House and the Senate spoke with one voice, with no partisan sniping, no words of support to their partisans. You could almost hear the echo of Henry B. Steagall, head of the House Banking and Currency Committee in 1932:

Of course, it involves a departure from established policies and ideals, but we cannot stand by when a house is on fire to engage in lengthy debates over methods to be employed in extinguishing the fire. In such a situation we instinctively seize upon and utilize whatever method is most available and offers assurance of speediest success.

So, it looks like a trillion dollar or so bailout through an agency reminiscent of the Resolution Trust Corporation of the late '80s and the Home Owners Loan Corporation of the 1930s. Here's Yale University economist Robert Shiller in his new and prescient book, The Subprime Solution:

In a financial system seize-up such as the one we are now experiencing, we must, putting aside our political and policy differences, fall back immediately on a more basic social contract--one that dictates that we as a society will protect everyone from major misfortune and keep existing problems from spreading further, subject to the dictates of common sense. That social contract is out most valuable protection, for we as a society can never plan for all contingencies.

Will the mother-of-all-bailouts work? Yes.

Will the recession get worse? Yes.

Will households be forced tio continue to work down their debts even after the crisis and the recession passes? Yes.

Shoud the financial services industry be regulated diferently in the future. Yes.

Should you believe it when financial services lobbyists tell you new regulations will raise your cost of borrowing. No.

Will anything happen to Stan O'Neal, Charles Prince, Richard Fuld, Warren Specter, and other financial titans of Wall Street--the best and the brightest that always preached the love of free markets--after they perfected the art of privitizing profits and socializing losses? They pocketed enormous sums of money even after being pushed out of their CEO jobs. They'll never have to worry about their standard of liviong in retirement, worry about paying a healthcare bill, although may they'll have to sell one of their houses--and that's plural. Probably not. .

I got a note this morning from a certified financial planner that I really respect. It's a letter he sent out to clients. In the note,he makes an important point. In tumultuous times like this we all feel the need to do something. Anything.

But with a bit of reflection, it's apparent that "doing nothing" is often the smartest strategy:

We rarely need to 'do' anything significant when severe storms hit because of what we have already done (and not done) beforehand. We need to remind ourselves of this.

And what we have done and do know is significant: We have clearly stated policies, expectations and objectives. We have considered risk as well as opportunity. We have diversified precisely because of what we do not know with absolute certainty (or, to use a baseball analogy, because we know that the best way to strike out is to try to hit a home run). We have learned from the last time 'this' happened (2000 - 2002, and it was worse then) the kinds of mid-course corrections that can sustain withdrawals for income through even the stormiest of seas ... and published our findings for everyone to see. We have made sure that you have reserves or access to funds so that events we can't control won't unacceptably affect your lifestyle.

Remember the Bush Administration's push to partially privatize Social Security? The privatization advocates warned that insolvency loomed unless dramatic changes were made to the system. Social Security was also labeled a terrible investment. The Bush team's argument: Let people invest a portion of their payroll tax money with the financial wizards of Wall Street in an account reminiscent of a 401(k). Workers would get a higher rate of return on their Social Security money, and the economy would benefit from a higher rate of savings.

"We heard the fear that Social Security will go bankrupt and the solution is privatize it," says Zvi Bodie, a finance professor at Boston University. "Yeah, right! It was a self-serving proposal from industry."

Imagine Bear Stearns, Lehman Brothers (LEH), American International Group (AIG), and other titans of finance managing Social Security? The late economist Robert Eisner told me during an interview in the early 1990s that "Social Security was not meant to be a get-rich scheme or a competitor to go-go funds." He was right.

Question is, in light of the current turmoil in the financial markets, should Wall Street manage any of our long-term retirement savings funds? Is the 401(k) plan, which has become the main retirement savings vehicle for the American worker over the past three decades, a mistake? The case for rethinking the 401(k) as a pillar of retirement savings is compelling.

To be clear, the democratization of stock ownership is a welcome and powerful trend. Two hundred years after 24 New York brokers and merchants met on Wall Street to sign the "Buttonwood Agreement," a pact that established standard commissions for trading securities, investing now has all the characteristics of a mass social movement. People's Capitalism has helped fuel entrepreneurship and risk-taking. Despite abuses, stocks options, restricted stock, profit sharing plans, and similar equity-based compensation schemes are critical building blocks to innovation, the driving force behind economic growth. Thanks to the Internet and advanced telecommunications networks, it's cheaper than ever for individual investors to buy securities.

No, the question is focused on retirement savings, the money employees set aside during their working years to smooth out their standard of living in retirement. Employees bear all the responsibility if they make mistakes, and time to make up for investment mishaps shrinks as stomachs go slack and hair turns gray. It's an axiom of modern finance that the only way to create the possibility of higher returns is to take on greater risk. But the risks employees are absorbing today seem disproportionate to the potential rewards.

For one thing, most employees work for companies that demand more of their time and effort, and that effort is showing up in high productivity numbers. For another, most people not only work but they also raise families, help their children with homework, spend time with friends, volunteer in the local community, vote in elections, and try and maintain their health with exercise and eating properly. At least, even if they fall short, these are all things they try to do and are encouraged to do. Yet, on top of all that, they're supposed to know how to allocate investment assets for when they retire in 5, 10, 20, or 30 years from now.

Now, look at what is happening in the financial markets today. The stock market is down more than 20% since its fall 2007 peak. Investor confidence in the bedrock money market mutual fund industry has been shaken now that a major mutual fund company has broken the never-break-a-buck pledge. The mortgage-backed securities market is in shambles. How is the average employee to cope with this? Is it good public policy for workers to be responsible for their asset allocation strategy during the worst financial crisis since the Great Depression?

A steady stream of scholarly research called behavioral economics and behavioral finance makes a persuasive case that many people aren't wired to invest well. The scholars have cataloged a long list of systemic investing mistakes, such as representativeness, a fancy term for an ingrained tendency to rely on stereotypes; overestimating an ability to predict the future; over-conservatism, because people fear a loss more than they relish a gain; a willingness to hold on to bad bets because we don't like to feel regret; a tendency to follow where the herd is going when it comes to the market. The list goes on.

Wall Street doesn't do well by the average worker. The standard advice that individuals fare best when they turn over their money to professional money managers is wrong. It's a bromide guaranteed to lose individuals money, with much scholarly evidence that actively managed mutual funds systematically underperform passively constructed index funds.

Plus, workers are paying a lot in fees for that underperformance. As Warren Buffett put it in Berkshire Hathaway's (BRKA) 2006 annual report, "Meanwhile, Wall Street's Pied Pipers of Performance will have encouraged the futile hopes of the family...will be assured that they all can achieve above-average investment performance--but only by paying ever-higher fees. Call this promise the adult version of Lake Woebegon."

Wall Street is rife with conflicts of interest, and the average worker is the loser. Who said that? Consumer firebrand Ralph Nader? No, it was David Swensen, the legendary chief investment officer for Yale University's endowment fund. In his book Unconventional Success: A Fundamental Approach to Personal Investment, Swensen wrote that "Individual investors lose. Mutual fund managers win."

Swensen makes a strong case that profit-maximizing mutual fund managers always choose to line their own pockets at customer expense through high fees, opaque charges, excessive trading, and other financial shenanigans. "When a sophisticated provider of financial services stands toe-to-toe with a naive consumer, the all-too-predictable conclusion resembles the results of a fight between a heavyweight champion and a 98-pound weakling," he writes. "The individual investor loses in the first-round knockout."

In 1940, Fred Schwed Jr. famously captured the essence of Swensen's perspective with one of the most memorable Wall Street book titles ever: Where Are the Customers' Yachts? It's worth repeating the allegory that starts off his book:

Once in the dear dead days beyond recall, an out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides indicated some handsome ships riding at anchor.

"Where are the customer yachts?" asked the naive visitor.

Where indeed? What is good for Wall Street isn't always good for Main Street. Swensen called for government to act "in loco parentis" and create powerful incentives for companies to put their employees into passively managed well-diversified portfolios, perhaps similar to the low cost, broad-based, limited-choice offerings of the Federal Thrift Plan. But other ideas are worth pursuing. For instance, why not attach to every Social Security number an account consisting of a 60% equity index fund and a 40% Treasury Inflation Protected Securities portfolio? The retirement savings plan would essentially do as well--or as poorly--as the U.S. economy.

Better yet, a number of academic quant jocks are exploring creating annuity-like products that would guarantee workers a steady, inflation-protected income during their golden years but would be less expensive for companies to offer than the traditional defined-benefit pension fund. The demand then would be on workers to take the responsibility of saving but avoid the burden of investing. These ideas are not only worth exploring--they're an improvement over the status quo.

Right now, the Federal Reserve and U.S. Treasury are trying to shore up a crumbling financial system. Now isn't a time for action on big questions. That will come when the panic subsides and the foundation of the U.S. capital markets is stabilized. Among the issues to explore is whether the great 401(k) experiment has run its course.

I haven't found much of the commentary criticizing the Bush/Paulson/Benanke engineered bailout very convincing. I don't think there is any doubt that the markets were unraveling, and that stronger action than ad hoc bailouts was needed.

Still, this comment by Luigi Zingeles is compelling--courtesy of Tyler Cowen at Marginal Revolution. Zingales is a professor at the University of Chicago graduate school of business. He and Raghuram G. Rajan wrote a terrific book several years ago, Saving Capitalism from the Capitalists:

As during the Great Depression and in many debt restructurings, it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for-equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture. But if it is so simple, why no expert has mentioned it?

The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers' expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few.

Barry Eichengreen, political economist at the University of California, Berkeley, is one of the leading scholars on the Great Depression.

Thanks to economist and blogger Mark Thoma, I came on this article by Eichengreen in Egypt's Daily News.

Getting out of our current financial mess requires understanding how we got into it in the first place. The fundamental cause, according to the likes of John McCain, was greed and corruption on Wall Street. Though not one to deny the existence of such base motives, I would insist that the crisis has its roots in key policy decisions stretching back over decades.

It is important to note that these were unintended consequences of basically sensible policy decisions...

This is nuts:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

The proposed Treasurt rescue plan gives the U.S. Treasury secretary fall too much power. This takes "trust me" to the ridiculous.

Now that Wall Street investment banks have disappeared and reemerged as commercial banks are the private equity buccaners like Kohlberg, Kravis Roberts, become the new investment banks?

One of the economist bloggers I routinely check is economist James Hamilton at Econbrower. He's an eocnomist at the Ujniversity of California, San Diego. Thsi is from a recent post on the Paulson $700 billion rescue plan which, as Hamilton points out, is really a $6 trillion rescue package so far after adding up all the efforts taken to date.

But there is also a deeper question here that is harder to answer. How did the financial system come to be susceptible to such a profound degree of miscalculation and inappropriate leveraging of risk in the first place?...

How you get from our current situation to one where financial institutions are adequately capitalized is of course one of the key challenges of the moment.... Transparency strikes me as something that ought to be easier to achieve. I would start with a centralized clearing house for reporting all derivative contracts and collateral pledged for them.... the taxpayers are asked to commit such sums, we are owed a coherent and compelling explanation of why this kind of problem is never going to occur again...

A puzzle about the 1930s is how did a severe recession turn into a Great Depression. Much of the blame rests with the monetary authorities and, even more importantly, the powerful belief in the gold standard. So, if the Fed and the Treasury have averted a Great Depression, how severe will the recession be in coming months? My own feeling is that the downturn will be bad and long.

I've always felt that the problem of moral hazard has been exaggerated. But this time, no.

Here's Peter Bernstein, dean of finance economists, on moral hazard in his latest newsletter:

For as long as I can remember, every government or Fed bailout has elicited cries of alarm about moral hazard: "If we bail out today the miscreants who overreached in risk-taking, then we can expect a huge increase in overreaching miscreants tomorrow. And an even larger gang next time around." Why not? Why not make high-risk bets when you are confident the government will restore you to life even if you end up financially dead?

The government is now indulging in moral hazard in extreme orders of magnitude. How do we control the consequences? When all bad bets are made good by the government, or at least settled somewhere over zero, how do we prevent a replay of the light-hearted risk-taking of this era next time prosperity takes hold? Jiggling with the fed funds rate is hardly a barrier. The implication is that today's crisis and tomorrow's bailout could be just a minor prelude to a more grandiose climax somewhere in the not-too-distant future.

One implication is that to deal with situation, and forestall an even bigger disaster, the regulatory overhaul will have to be dramatic. It can't be regulatory changes at the margin. And the regulations can't be written by Wall Street and their well-paid lobbyists.

Another implication is that both Obama and McCain are going to have to rewrite their tax proposals. Any fiscal policy proposal has to take into account that we've raised the national debt by $6 trillion in just a few months. The fiscal tab is likelty to get bigger.

This makes no sense.

Fed chairman Ben Bernanke tells Congress today that it risks a recession, with higher unemployment and increased home foreclosures, if lawmakers fail to pass the Bush administration's $700 billion plan to bail out the financial industry.

Here's my problem. It has been sold as preventing another depression. If its going to be a recession, well, we haven't had this kind of massive bailout in dealing with any of the previous post World War Two recessions.

We're in a recession, and its going to get worse. No way the bailout stops that.

What is Bernanke up to?

New York City securities industry firms paid out a total of $137 billion in employee bonuses from 2002 to 2007, according to figures compiled by the New York State Office of the Comptroller. Let's break that down: Wall Street honchos earned a bonus of $9.8 billion in 2002, $15.8 billion in 2003, $18.6 billion in 2004, $25.7 billion in 2005, $33.9 billion in 2006, and $33.2 billion in 2007.

Those years were the heyday of the hedge fund pirate, the private equity buccaneer, the 9-and 10-figure-salary quant jock, and other financial creatures who created all kinds of complex securities and highly leveraged transactions, many of which are now coming a cropper, from LBOs to CDOs. What a deal. Financiers preached the free-market gospel and pocketed unheard-of sums of money--yet when times got tough, they called for a government bailout. So my question is: Why shouldn't the taxpayer, now that they are bailing out Wall Street, ask for the $137 billion back?

Now, the bigger right now is about limits on future compensation. The financial services industry opposes any limits. Here's the money quote from today's New York Times:

But Wall Street, its lobbyists and trade groups are waging a feverish lobbying campaign to try to fight compensation curbs. Pay restrictions, they say, would sap incentives to hard work and innovation, and hurt the financial sector and the American economy.

"We support the bill, but we are opposed to provisions on executive pay," said Scott Talbott, senior vice president for government affairs at the Financial Services Roundtable, a trade group. "It is not appropriate for government to be setting the salaries of executives."

That's fine if that's the industry's position. But then it's "not appropriate" for the taxpayer to fund a $700 billion bail out, either.

This post by Nanette Brynes of Business Week certainly grabbed my attention, especially since I've gotten a number of emails from management consultants saying why executive pay shouldn't be limited, despite the bailout.

But what justification is there for a $2 billion pay day for failure? How about $27 billion. Where is the relationship between risk and return?

The top executives at AIG, Freddie Mac, Fannie Mae, Lehman and Goldman Sachs pulled down more than $2 billion in pay over the past five years according to a new analysis by a professor at San Diego State University's Charles W. Lamden School of Accountancy, Dr. David DeBoskey. ...

$2 billion in five years to 57 individuals ought to give that cause some momentum. It certainly gives a whole new meaning to the concept of the price of failure.

What a life Paul Newman led. The New York Times has a terrific obit on him this morning. I oove this quote from him given during an interview with a reporter. It ends the obit, and is a fitting epitaph for a life.

"We are such spendthrifts with our lives," Mr. Newman once told a reporter. "The trick of living is to slip on and off the planet with the least fuss you can muster. I'm not running for sainthood. I just happen to think that in life we need to be a little like the farmer, who puts back into the soil what he takes out."

I did Minnesota Public Radio's Mid-day show hosted by Gary Eichten on Friday. The other guest was Louis Johnston: Economics professor, St. John's University and the College of St. Benedict. The topic? What else?

In the largest bank failure in American history, federal regulators seized Washington Mutual, the country's largest savings and loan, and sold much of the company to J.P Morgan Chase. Meanwhile, Congress is still working to hammer out a rescue deal for Wall Street. Midday explores the latest in financial news.

You can listen to it here.

As I am writing this at work on Saturday afternoon, Washington is still negotiating the details of the $700 billion bailout. It does look like a deal will be struck before the stock market open on Monday--at least that's the goal.

Assuming the negotiators strike a deal, I think the dicsussion will turn pretty quickly to how bad will the recession get. For instance, I was looking at some numbers calculated by Mark Zandi, chief economist at Moody's Economy.com. For instance, pre-financial panic he figured the unemployment rate would peak at 6.5% inb the third quarter of 2009. Post-financial panic he now expects the unemployment rate to reach its peak at 7% in the first quarter of 2010. Similarly, he has hiked the peak-to-trough decline in payroll employment from 800,000 in a pre-financial panic world to 1,250,000 post-financial panic. The change in his peak to-trough decline in home prices is from a guestimate of a 26% drop to a 30% decline.

Bottom line: The financial crisis will hit Main Street hard.

Is this the trend of the future? Why isn't anyone upset about the bailout of the U.S. auto industry? What is the standard--campaign contributions and well-heeled lobbyists? I don't see how the consumer benefits from Congressional largesse, and I do see how it could make it tougher for competitors to continue to innovate on the energy efficiency front.

The U.S. Congress gave final approval to legislation providing the auto industry with $25 billion in loans... The auto loan provisions were sought by General Motors Corp., Ford Motors Co., Chrysler LLC and others who said they needed taxpayer help to finance a shift to making more fuel- efficient cars....

Bloomberg has the overall budget story.

Economist Ed Yardeni points out the the U.S. will now have the world's largest sovereign wealth fund.

Ironically, the world's largest state-sponsored sovereign wealth fund will be TARP if and when it is fully funded at $700 billion. And, of course, the US government now owns Fannie, Freddie, and AIG. Unlike other SWFs, TARP is 100% debt financed, so it is really the world's largest leveraged blind pool.

The Treasury has annonced the details of its money market mutual fund guarantee program:

Here's today's press release:

Treasury Announces Temporary Guarantee Program for Money Market Funds

Washington- The U.S. Treasury Department today opened its Temporary Guarantee Program for Money Market Funds. The U.S. Treasury will guarantee the share price of any publicly offered eligible money market mutual fund - both retail and institutional - that applies for and pays a fee to participate in the program.

All money market mutual funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, maintain a stable share price of $1, and are publicly offered and registered with the Securities and Exchange Commission will be eligible to participate in the program. Treasury first announced this program on Friday, September 19.

The temporary guarantee program provides coverage to shareholders for amounts that they held in participating money market funds as of the close of business on September 19, 2008. The guarantee will be triggered if a participating fund's net asset value falls below $0.995, commonly referred to as breaking the buck.

The program is designed to address temporary dislocations in credit markets. The program will exist for an initial three month term, after which the Secretary of the Treasury will review the need and terms for extending the program. Following the initial three month term, the Secretary has the option to renew the program up to the close of business on September 18, 2009. The program will not automatically extend for the full year without the Secretary's approval, and funds would have to renew their participation at the extension point to maintain coverage. If the Secretary chooses not to renew the program at the end of the initial three month period, the program will terminate.

To participate in the program, the Treasury Department will require money market funds with a net asset value per share greater than or equal to $0.9975 as of the close of business on September 19, 2008, to pay an upfront fee of 0.01 percent, 1 basis point, based on the number of shares outstanding on that date. Funds with net asset value per share of greater than or equal to $0.995 and below $0.9975 as of the close of business on September 19, 2008, will be required to pay an upfront fee of 0.015 percent, 1.5 basis points, based on the number of shares outstanding on that date. These fees will only cover the first three months of participation in the program.

Funds with a net asset value below $0.995 as of the close of business on September 19, 2008, may not participate in the program.

While the program protects the accounts of investors, each money market fund makes the decision to sign-up for the program. Investors cannot sign-up for the program individually. Funds should apply by October 8, 2008 for the program using the forms on the program webpage: http://www.treas.gov/offices/domestic-finance/key-initiatives/money-market-fund.shtml.

Eligible funds include both taxable and tax-exempt money market funds. The Treasury and the IRS issued guidance that confirmed that participation in the temporary guarantee program will not be treated as a federal guarantee that jeopardizes the tax-exempt treatment of payments by tax-exempt money market funds.

President George W. Bush approved the use of existing authorities by Secretary Henry M. Paulson, Jr. to make available as necessary the assets of the Exchange Stabilization Fund to guarantee the payment

The Exchange Stabilization Fund was established by the Gold Reserve Act of 1934, as amended, and has approximately $50 billion in assets. This Act authorizes the Secretary of the Treasury, with the approval of the President, "to deal in gold, foreign exchange, and other instruments of credit and securities" consistent with the obligations of the U.S. government in the International Monetary Fund to promote international financial stability. More information on the Exchange Stabilization Fund can be found at http://www.treas.gov/offices/international-affairs/esf/

Here is the Treasury's FAQ section.

September 29, 2008
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Frequently Asked Questions About Treasury's Temporary Guarantee Program for Money Market Funds

How does an investor sign up to participate in the Treasury's Temporary Guarantee Program for Money Market Funds?

While the program protects the shares of all money market fund investors as of September 19, 2008, each money market fund makes the decision to sign up for the program. Investors cannot sign up for the program individually.

How will investors know if their money market fund participates in the program?

Investors should contact their money market fund directly to determine if it is participating in the program.

What type of funds does the program cover?

All money market mutual funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, are publicly offered, are registered with the Securities and Exchange Commission and maintain a stable share price of $1 will be eligible to participate in the program. This includes both taxable and non-taxable funds.

Is an investor in a fund that is managed like a money market fund but that is not registered with the SEC covered?

No, the program only covers money market funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940, are publicly offered, are registered with the Securities and Exchange Commission and maintain a stable share price of $1 will be eligible to participate in the program. This includes both taxable and non-taxable funds.

When will my fund be covered by the program?

Each fund must decide to participate in the program. If your fund participates in the program, your investment as of September 19, 2008 will be covered.

How much of an investor's money market fund is insured? What happens if the number of shares held in an investor's account increase above the level at the close of business on September 19, 2008? What happens if the number of shares held in an investor's account decreases below the level at the close of business on September 19, 2008?

The program provides a guarantee based on the number of shares held at the close of business on September 19, 2008. Any increase in the number of shares held in an account after the close of business on September 19, 2008 will not be guaranteed. If the number of shares held in an account fluctuates over the period, investors will be covered for either the number of shares held as of the close of business on September 19, 2008 or the current amount, whichever is less.

Examples include:

If an investor owned 100 shares in a money market fund as of close of business September 19, 2008, but owns 50 shares on the day the guarantee payment is made, after the fund breaks the buck, then that investor will be guaranteed for 50 shares.

If an investor owned 100 shares in a money market fund as of close of business September 19, 2008, but owns 150 shares on the day the guarantee payment is made, after the fund breaks the buck, then that investor will be guaranteed for 100 shares. The fund, upon liquidation, will distribute proceeds to the shareholder for the additional 50 shares, at net asset value.

If an investor owned 100 shares in a fund as of close of business September 19, 2008, subsequently sold 50 shares and later bought 25 shares, the investor owns 75 shares on the day the guarantee payment is made and will be guaranteed for 75 shares.

If an investor owned no shares in a fund as of close of business September 19, 2008, but owns 100 shares on the day the guarantee payment is made, none of the investor's shares are guaranteed by the program and the investor will receive the net asset value directly from the fund.
What if another fund in an investor's fund family breaks the buck before this program starts? Is the investor covered?

The program provides a guarantee on a fund-by-fund basis up to the amount of shares held as of the close of business on September 19, 2008. The performance of a different fund, even one in the same fund family of the investor's fund, doesn't affect the investor's fund's eligibility. Investors should contact their fund to determine if their fund participates in the program.

When does the program terminate?

The program is designed to address temporary dislocations in credit markets. The program will be in effect for an initial three month term, after which the Secretary of the Treasury will review the need and terms for the program and the costs to provide the coverage. The Secretary has the option to extend the program up to the close of business on September 18, 2009. In order to maintain coverage, funds would have to renew their participation in the program after each extension. If the Secretary chooses not to extend the program at the end of the initial three month period, the program will terminate.

Who provides this guarantee? Are investors able to get all of their money back whenever they want?

The U.S. Treasury Department, through the Exchange Stabilization Fund, is providing this guarantee. In the event that a participating fund breaks the buck and liquidates, a guarantee payment should be made to investors through their fund within approximately 30 days, subject to possible extensions at the discretion of the Treasury.

Is shareholder in a fund that broke the buck before September 19, 2008 covered?

No. This does not meet the program's eligibility criteria noted above.

What should shareholders in a participating fund that breaks the buck do? Who should they call?

If your fund enrolled in the program you will be covered and do not need to take any action. Shareholders should contact their fund directly.

Who should a fund contact if it has further questions about this program?

Please e-mail the Treasury Department at moneymarketfundsguaranteeprogram@do.treas.gov.

The Paulson plan is dead. I don't think it is worth trying to revive. The House Republican "alternative" was always a joke.

But the case for a systemic solution to the credit crunch is still needed. The global economic risks are too great. Congress desperately needs to act to at least restore something of its already bottom-basement reputation.

The basic idea comes from Jamie Galbraith, political economist at the University of Texas. Put half a trillion dollars into the FDIC. Wall Street doesn't exist anymore anyway. The agency has done a terrific job throughout the crisis. The takeovers of WaMU and Wachovia were smartly done, for example. It gives politicians cover because they aren't bailing out Wall Street, they're saving your deposits and savings. Throughout the credit crunch the FDIC has been concerned with homeowners and willing to pressure banks to slow down on their foreclosures. It's also a solution easy to grasp.

I'm not sure why Treasury and the Fed didn't embrace this solution earlier. But the risk of inaction is too great.

I see the presidential candidates are calling for raising the FDIC insured limits above $100,000. It's a good idea. I'd also make the rules a lot simpler.

But lets go farther and make the FDIC the center of the bailout?

The Bloomberg news wire has a story that Sheila Bair, chairman of the FDIC, has told House Financial Services Committee chairman Barney Frank that the agency will "be requesting authority to increase deposit insurance limits," says Frank. No details yet, but both Barack Obama and John McCain want to raise the insurance limit to $250,000.

The news article also says that New Hampshire Senator Judd Gregg, the chief negotiator for the Senate Repubicans on the bailout, is willing to consider proposals not only to raise the amount of insurance but an expanded FDIC role.

I smell a deal coming.