Happy New Year!

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

The Dow was down for the first full week of the year, with bad news on retail sales and job losses, and carping from all sides about the Obama stimulus plan. The last item is the only piece of good news, in that if Barack has managed to displease so many CNBC “free-markets” pundits (CNBC is fast becoming the Fox News of Money – “we report, we decide”) as well as Paul Krugman, he must be getting something right.

Give the man a chance already. He didn’t cause this mess, and in a few days he will be the one President we’ve got, at which point he of course loses all immunity from attacks from any quarter because he’s in charge of things, if only by inheritance. But until then, blaming him for getting it wrong already seems to reflect more the prevailing state of pessimism than any rational critique of policy proposals. As to the latter, he has publicly welcomed them anyway, so what’s the problem?

There are many divergent views as to what measures precisely would lead to economic recovery in a reasonable time, but the key fact seems to be that there is none that would provide the very kind of “instant gratification” we still seek — although lusting after precisely that is what got us into this mess in the first place.

It’s a new deleveraging world out there, and it will take some time to get used to; but when even orthodontists are discounting, you know there is change we can believe in.

If we are painfully honest about it, there is a lot of excess still around in the American experience, and I don’t just mean obesity — some of which results from the effects of malnutrition borne of poverty. Look at your average cable TV programming — the Real Wives of Orange County;  any number of Spring Break videoramas; the remaining reality TV shows. But I also noticed how many bowl games — even the bedevilled BCS ones — had many visible empty seats at ’sellouts’ . The party, it seems, is well and truly over — get over it!

I expect the new President to issue a call to a “‘generation of responsibility” in his Inaugural Address — a shift from self-indulgence to service particularly among the young, and “Generation Y’ has already demonstrated that it will be fertile ground for such a calling. That would be change we need.

A Breath of Fresh Air

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Could it be that the “worst Christmas in modern memory” for the nation’s retailers is really a good thing?

Is an economy that’s over 70% dependent on consumerism a good thing?

As we pause for reflection at year-end, it may be worth noting a sense of relief  rather than despair that spread among shoppers before the Holidays. Could it be that people were glad to have the excuse of the Recession to dial back their expenditures and take a pause on the spending treadmill?

Of course, for many, the hard economic times are far more than “excuse” to  cut back; for them this season involved painful self-preservation.

 

But for the vast majority of US mortgage-holders, for example, who are making their payments and not underwater in terms of loan to home values, perhaps this year-end signals the beginning of a new perspective on why they spend money, and what they really need to own or to give.

Instead of the search for the “next bubble”, perhaps these shopper-investors will be thinking that the quality of their lives ought not be defined by the spending habits of yesterday’s mega-millionaires. In this new environment, it may not be so easy to defend tax cuts for the super-rich on the notion that maybe we all can aspire to be super-rich someday, too.  Maybe Joe the Plumber is well,  just Joe the Plumber, which is not such a bad thing, really.

The country obviously need a hearty does of optimism, which it is not getting from the financial media (especially cable), which seems these days to be revelling in trying to be first to call the death of  “free-market capitalism” at the hands of Obama. The voters generally didn’t buy the idea that the President-Elect is a Socialist, and neither will investors, so why are so many anchor/commentators (Jim Cramer for once a notable exception in this case) on the leading financial news network trying to sell that line?

Everyone should just take a deep breath and let the new team lay out its plans in its chosen time — then by all means have at them and do more vetting than was done, say, about Bush’s move into Iraq or Greenspan’s 1% rate  regime or the magic of derivatives. Obama has already moved faster than any other transition to lay out his agenda and pick his team, so what’s the problem if he doesn’t answer every question right now?

Indeed, it may be the case that, with the “recession we had to have” (to borrow a phrase from former Australian Prime Minister Paul Keating), the “era of instant gratification” is what’s truly “over”.  If so, Happy New Year indeed!

What Are They Thinking?

To those Senators and Representatives who are opposing the draft legislation agreed between the Bush Administration and Congressional Democratic leadership to provide a bridge loan for the auto industry — have you forgotten that the bravado chorus in mid-September to “let Lehman go under” wound up costing the country a $700 billion bailout of the entire financial system, plus another $100 biliion or more to bail out AIG which was going belly-up precisely because it was on the hook for insuring (without reserves or offsetting derivatives) Lehman Brothers’ debt?

Do you really want to play roulette with the entire financial system again, this time for real money?

Do you not realize what will happen in bankruptcy to the unsecured creditors of these companies, whose debt is now trading in the open markets at levels as low as 20 cents to the dollar of principal?

Do you understand who holds this debt — your pension funds and mine, your insurance companies and mine, not to mention the entire financial system, which will be forced to take another gigantic round of write-offs, thus further impairing their capital and restricting their ability to lend to Main Street or mortgagors?

Do you not understand that the problem with companies being “too big to fail” is that we let them get that big in the first place, and that it is no solution to that problem to go ahead and let them fail no matter the consequences to anybody else or the overall economy?

 Do you understand that the Federal Government itself will be on the hook for hundreds of billions or dollars in pension claims if these companies go into bankruptcy, and that these billions will not be loans, as currently contemplated in the bridge legislation, but outright payments right off Uncle Sam’s bottom line?

Do you not understand that no one but the US Government would possibly contemplate extending  credit during bankruptcy proceedings to the “debtor in possession” of the car companies, and that those credit lines from the taxpayer would have to far exceed the $15 billion in the bridge loan legislation?

Do you not understand that without such a line of Federal credit during a Chapter 11 restructuring, the companies will be forced into Chapter 7 liquidation and then the whole economy  will be at profound risk and we really will see again what a Depression looks like?

Do  not understand that the only consumer who would buy a new car from a bankrupt company would be the same person who would take an appointment to the US Senate today from the current Governor of Illinois?

Is there something about basic reality that you don’t understand; or are you just off in ideological Fantasy Island  — as you were in September when it  looked so easy to let Lehman go down?

The Dean’s Traditional Thanksgiving Prayer 2.0

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

 

It’s Thanksgiving: let’s not carp;

Be grateful for the leaky TARP.

So thank You for our daily bread

(And turkey stuffing from the Fed).

 

Take Friday off, it’s not a shirk

If you’re already out of work.

And while you’re missing honest toil,

Be grateful for the price of oil.

 

The table seems a little bare:

Wachovia’s no longer there;

WaMu, Bear and Lehman — gone;

And AIG just hanging on.

 

Detroit’s Big Three all in a row

To grab a share of Paulson’s dough:

Like ”Harry Met Sally’s” diner craving,

They want to have what Citi’s having.

 

But if taxpayer funds they want to poach,

The next time they will travel coach.

The people don’t trust banks or cars;

Folks keep their bucks in cookie jars.

 

As financial globalization

Brings distress to every nation;

And trashes our four-oh-one-kay’s –

Not to mention IRA’s!

 

In response — bailout buffet:

Too bad  Warren missed the play;

He’s already long GE,

And Goldman, too — don’t try for three!

 

But Congress braked on General Motors.

They must have listened to the voters;

Who dissed incumbents (not Left, most Right)

And gave Obama one big night.

 

McCain saw the crisis, and he acted:

Stopped campaigning, then retracted;

Brought in Palin, brought up Ayers,

But couldn’t beat the Wall Street bears.

 

And does anyone have a hankie

For our noble friend Bernanke;

The only Duck who isn’t Lame;

He really shouldn’t cop the blame

 

For sins of Wall Street engineers

Who only worked with forward gears

And interest rates adjustable

That quickly turned combustible.

 

And ratings firms that never met

An issuer they couldn’t vet

And dearly charge to certify

That trees indeed grow to the sky.

 

Even Greenspan changed his tune:

He who praised ARMs to the moon.

Now he sings a different song:

“I’m sorry folks, I got it wrong!”

 

He just could not believe his eyes

When he beheld the bankers’ lies.

He trusted them with laissez faire

Instead of good old “buyer beware”.

 

So what’s the future have in store

When Bush & Company is no more?

It seems the President-Elect

Is now the President-In-Effect.

 

In two more months we’re good to go

With Stimulus Package 2.0,

For jobs and unemployment checks

And fixing infrastructure wrecks.

 

We have fourth Thursday in November

To make us sit back and remember

That bad times pass like winter’s freeze,

If we pay our lenders Overseas.

 

It seems like what our bankers need

Are investors like Prince Al-Walid

Who really don’t get too perplexed

From one recession to the next.

 

Bank balance sheets are skin and bones;

All deferred taxes and toxic loans

That forced the Feds to bail them out –

$700 billion: we’ve lost count!

 

So let’s get lending, financiers;

We can’t just wait for four more years.

Enough of your timidity –

There’s now enough liquidity.

 

The truth is that we all got greedy;

So no surprise now that we’re needy;

New team’s in town to help, you’ll see:

Geithner,  Summers and A. Goolsbee.

 

But pause for thanks to Paulson, Hank;

Nancy, Ben and Barney Frank,

Fannie, Freddie, FDIC,

And the critics at CNBC.

 

At least we did get something done:

And we’ll know recovery has begun

When mortgage common sense abounds,

And we don’t pick stocks in “Lightning Rounds”!

Wouldn’t It Have Been Easier Just to Bail Out Lehman?

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Now that we’re injecting Federal equity investment into the broad spectrum of the US banking industry, the notion that a little help for Lehman at the critical moment was an unacceptable “moral hazard” seems a bit quaint. Of course, there would have been other shoes that dropped, most notably AIG, but without the spectre of sheer terror that enveloped the global “unsecured creditor of troubled financial institution” market that erupted as Lehman went under, and put global credit markets in the meat locker.

And why was it unacceptable for Lehman to convert to a bank holding company but a couple weeks later OK for Morgan Stanley and Goldman Sachs to grab that lifeline? While none of these institutions has a particularly sympathetic aspect in terms of their own involvement in getting us into the mess we are in, this discrimination in terms of access to the Fed  seems like a bit of “selective socialism” (which is, of course, a contradiction in terms).

Now of course we can’t bring back Lehman, but there is a need to rethink the premises on which Lehman was allowed to fail even though it was just as pivotal in global finance as was Bear Stearns, whose creditors were given a Fed-insured gift certificate cashable at JP Morgan.

It may be safe to say that Lehman will be the last example for a while where ‘”moral hazard” trumps “systemic hazard”  — otherwise, the folks running our Fed Reserve and Treasury just plain misunderstood the extend of systemic risk posed by a Lehman bankruptcy — they’re not supposed to get that sort of thing so terribly wrong, so let’s assume for the sake of our own sanity that they just were standing on principle.

Where to from here? It all goes back to housing finance — how, and in what form, do we recreate a securitization market for mortgage debt where: (1)  the originator retains enough of a stake in the outcome to assure prudent risk assessment; (2)  rating agencies are vaccinated by appropriate compensation  arrangments from the virus of blatant conflict of interest in terms of their own prudent judgment (ie, they should not continue to be compensated only if they grant the ratings requested); and (3) default insurance written against collateralized debt instruments is properly reserved against and transparently cleared.

More simply put, it is time for the end of “non-bank” banks; “non-insurance” insurance; and that greatest of all self-contradictions, “self-regulation”.  Character, indeed, is what you are in the dark — which is why some folks get the reputation as “shady”. Character will out, but considering the price we are all now paying for what went on in the dark rooms of finance, perhaps that old Socialist Ronald Reagan had it right with his maxim,  ”Trust but Verify”.  At least that seems the best way to avoid being forced to choose between “moral hazard” and ruination.

Bail Out Blues

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Who needs a bailout if JP Morgan can buy WaMu? The Federal Reserve, that’s who. The dirty little secret of the bailout debate is that the US taxpasyer is already on the hook for the toxicity in the financial system by virtue of the Fed’s now-abnormal balance sheet, which has been drained away from Treasuries by the less than stellar collateral it holds in exchange for its extraordinary lending facilities to financial institutions (hard to believe JP Morgan would have done the WaMu deal and taken on WaMu’s dirty laundry without access to the Fed “window”).

All the political posturing in the halls of Congress and the media will not change the fact that without Governmental intervention as the “patient buyer” of distressed securities, the US will have no choice but to print money to bail out the Fed, if nothing else. Ironically ‘Helicopter Ben” will be the recipient of this inflationary largesse rather than the dispensory!

Meanwhile, back in the CDO market, it will be dawning on unsecured debt holders of any bank that they are not exactly sitting pretty (think Wachovia) so expect more deals to follow like WaMu (pre- or post- FDIC intervention). Ironically, all these acquisitions in distress are creating a new rank of financial institutions that are again “too big to fail”!

So far as the debate in Washington over the weekend, how ironic that we are approaching the season of the Hebraic “day of atonement”. In what is left of the securitization market (ie, credit default swaps), it is the turkeys, not the chickens, that are coming home to roost. Once every political faction has gotten a piece of the draft legislation to call its own, something big will pass. But the question will remain, is the bailout bill “too big to fail”? The signals of success will first appear in the credit markets. Probably LIBOR. Ironically, the Fed as lender to AIG will for once be hoping that the interest on its “adjustable rate” loan  (8.5% above LIBOR) actually goes down.

Pilot Error; Nuclear Waste — A Financial Crisis Handbook

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Much is made these days of “systemic risk” — and we clearly have a lot of that on our hands. But some of the problems of Lehman and Bear Stearns and AIG, which have contributed centrally to our current credit seizure, are not simply the fault of the “system”, be it the structure of investment banking firms like Lehman and Bear, or financial conglomerates operating as hedge funds, like AIG. Some of the problem is plain old “pilot error” — those running these businesses made profound errors in judgment, most notably in the case of Lehman and Bear, by failing to bring their firms in for a safe landing in heavy weather through asset sales and outright mergers that they could have done but rejected.

AIG is a little more complicated because its new CEO Bob Willumstad was not given enough time by circumstances to lay out and execute a recovery plan, but there was plenty of pilot error that went before him at the company. And it would be amusing (if it were not so painful) to see the rating agencies that brought AIG low rediscover their spines in terms of downgrading firms on the wrong side of the credit default swaps trade. Those swaps were mispriced in the first place on the basis of the rating agencies’ own egregious pilot errors in terms of their “AAA” imprimatures on the various and sundry subprime mortage bonds.

The only solution to this massive credit seizure is to find a “Yucca Mountain” for the temporarily “nuclear” waste on the books of financial institutions that can no longer calculate their own — let alone their counterparties’ —  balance sheets. The Fed and Treasury must set up a separate, Federally-controlled “Resolution Trust Corporation II” if for no other reason than that the Fed cannot continue to be the holder of so much collateralized debt that it becomes a materially  interested player in the very interest rate game of which it is the chief umpire.

And while we’re at it, let’s not kill off the investment banking business model and culture, which has served us well in many ways over the years, including inventing the securitization market itself which brought us out of the corrupt savings and loan regime of the 80’s for mortgage finance. There is no such thing as a vibrant financial marketplace without risk. Yes, let’s get rid of the casino culture, but lets not replace it with folks whose idea of high risk is buying two cards at Church bingo.

“What to Expect from the Fed on August 5″.

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

I believe the Fed meeting will seem a lot like the most recent one: (1) rates — no change; (2) statement – hyper-vigilance on inflation; no bottom yet on housing; hyper-uncertainly on the economy; (3) votes – one, or more, dissents on the hawkish side.

(1) Despite the continued inflation alerts sounded by certain Board members and even the Chair himself, a Fed which just yesterday cited “continued fragile circumstances in financial markets” in extending its special liquidity credit lines for investment banks and primary dealers is not yet positioned to raise the funds rate. Driving with both the accelerator and brake depressed is occasionally warranted and may yet happen down the road, but it can be very confusing for an especially nervous driver following behind! And with the condition of the economy at best moving from pneumonia to anemia, it is not yet time to prescribe a sedative. That said, the inflation risks (and dollar concerns) rule out any cut now.

(2) While the Fed may cite some recent amelioration in forward energy prices, there is also evidence that materials costs are being passed forward in the supply chain (US Steel) which will demand a high degree of inflation vigilance. On housing, they may cite the new financial “stimulus package” for Freddie, Fannie and the foreclosed, but that relief will hardly be immediate, and there is no call yet to call a housing bottom from the Fed’s point of view, especially with another round of mortgage resets coming in the autumn. Moreover, this week’s Treasury promotion of “covered” housing bond issues (where the mortgages stay on the issuers’ balance sheets) only serves to advertise that the securitization market as we knew it remains comatose. Finally, a Fed which no doubt remembers that just a year ago it had to change policy course within about 10 days of its August meeting has clearly learned the value of emphasizing ” uncertainty” in its statements about the economic outlook.

(3) Even with all their turmoil, the financial markets have seemed to show little concern about the fact Bernanke is presiding over a divided Fed on rate policy. Perhaps this is because both markets and even the Chairman himself recognize that the dissents by the inflation hawks serve the Chairman’s policy purposes by keeping the dollar bears somewhat at bay and inflation expectations marginally contained. Hawkish talk and minority votes are a lower risk alternative to rate hikes that could look premature in hindsight heightened by election fever. And if markets are really worried about possible rate increases,holding steady can seem like a cut!

A Floor for Housing — A Trap-Door for Banks?

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

Expected passage this weekend of the omnibus Housing Bill by both Houses of Congress and a quick but quiet signature by the President finally puts a floor under the cratered housing finance markets in the US, but at what price?

Some estimate the cost to the Federal taxpayer in the zip code of $25 billion, but that’s just an early guess. The final legislation does not authorize the Government to buy equity or even preferred stock in Fannie Mae and Freddie Mac, but it does authorize an open-ended extension of credit to support their operations, which may or may not be utilized — there is some sense that the option of going to the Federal Reserve’s discount window — now open to the GSE’s — may be more appealing and have fewer rating-negative consequences for the GSEs’ existing subordinated lenders: no small matter these days when it comes to market perception of financial institutions’ outstanding obligations. 

Could this new extension of Governmental credit to a troubled pair of financial institutions, moreover, again produce what we might now call another “Bear  Steans Effect” — namely, a run on the debt obligations of the very institution the credit extension was designed to save? There are some signs of that in the bond and preferred market already.

Not to say that the Government has any choice; the “last resort” has finally come to the fore: the Federal Reserve can do no more good for the housing finance collapse by cutting interest rates further, and is even  considering raising them. This could in the short run play havoc with remaining adjustable-rate mortgages (although in fairness any such increase would be designed to tamp down inflationary pressures affecting the long-bond rates that are the benchmark for fixed-rate mortgages, which right now are trending upward. The main point is that the Fed itself is in a bit of a fix, and the new housing legislation may give it some decisional breathing room.

In addition, the provisions of the Act that expand the lending limits (up to $625,000) and capacity (by $300 billion) of the GSE’s clearly provide an absolutely necessary base for any recovering in the housing finance market, where the securitization process (which tends over time to hold interest costs down) is completely shut down, and where the non-GSE banking institutions are all but out of the market themselves because they have no place to off-load the mortgage paper through securitization.

In short, the GSE’s are now about the only mortgage-writing game in town, and they are at least in the game with a new Government backstop that provides a more clear commitment of the Government to stand behind them — not quite an official “‘full-faith-and-credit” pledge, but a pretty good commercial “keep-well”‘ agreement, where the only real risk is Federal bankrutcy or future changes in legislation. And the only time we’ll know the real cost of this new arrangmenet is when the next market “wild pitch” at Freddie or Fannie goes “all the way to the backstop” — but at least there is now a well-constructed backstop, so the game maybe can resume.

I say “maybe”  — because the housing finance game really can’t get back to anywhere near normal with the GSE’s as the only real lenders. At some point, the banks have to start ledning again, at economically reasonable rates. And that is where the risk lies for now.

Hopefully the very existence of new Federal commitments will be enough to put a floor under the price deterioration of currently outstanding mortgage-backed securities, so that our beleaguered financial institutions no longer will need to keep increasing their loss reserves and related quarterly write-downs of existing holdings — which impair the amount of capital available for future mortgage (and other commercial) leanding activity unless the banks engage in further expensive or dilutive (or both) infusions of capital from  foreign sovereign wealth funds or, more likely, US hedge funds. The Federal Reserve is conspicuosly clearing the way for the latter at an abnormally quick pace.

Hopefully, also, the new legislation will enable a restart of the securitization mechanism for distributing mortgage paper to the broad financial community beyond banks and thrifts and Wall Street, at least for GSE-backed mortgages to start with. But for this to occur, there must also be a renewed confidence in both the underwriters and the rating agencies, and that will take some time. This truly is becoming a season of ‘hope’.

The question in the coming days will be whether the legislation may in the short run provoke further runs on the deposits of the most troubled domestic banking institutions, based on the perception which the new Housing Act seems to imply — that the “market-based” housing finance model that has served this country so well for the past two decades is now so broken that only the Federal Government can save it, and that in turn the whole banking business model itself must now be called in to question (at least for banks in hock up to their capital eyeballs in red mortgage ink).  

If ordinary folks begin to fear that there is no longer anything “Automatic” about an ATM unless it’s Government-issue, we’re all in trouble. Call it “reverse moral hazard” — not the likelihood that institutions will feel free to tempt fate by again plunging into heedless risk next time around, but that depositors will feel fear that there will BE no “next time around”.

After all, if you see a boat being bailed-out in the harbor, you have a tendency to cancel your cruise (and not book a new one).

Is the Fed’s next move a cut?

Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.

With all the focus on Freddie and Fannie (not to be confused with Brad and Angelina), we can lose sight of the bigger game — namely, that the economy is clearly not out of the woods, nor have the risks to the economy clearly receded, because the housing finance and financial institution crisis is neither contained, nor indeed over.

There will be renewed focus on inflation this week, to be sure. with the release of the latest PPI and CPI data, and this could again suggest that the Fed’s next move in interest rates will be up.
Certainly the usual band of hawks in and around the Reserve Board and on cable news will say so.

But the Fed must first finish the task of making sure the economy does not collapse into a deep and prolonged recession (which, of course, is one sure way to take care of the inflation problem — the monetary version of the “destroy this village to save it” strategy).

It may simply be the case that the broader economy, having been Fed (if you will) a diet of interest rates starting with a “1″ by the famed Dr. Greenspan, now requires a similar level of rates to begin to get well again. Thus keeping interest rates at a number starting with a “2″, even followed by a bunch of zero’s, just won’t do the trick, even if the level of rates is clearly “accommodative” or even “negative” to inflation as economists look at it.

Psychology has a role to play in consumer actions and sentiments, and in business strategy and investment decisions as well. If we needed one per cent interest rates to get well from the combination of the dot-com crash and 9/11, who is to say we don’t also need them to get well from the “perfect storm’ of unprecedented oil prices, the collapse of the hosuing market, and the credit and liquidity crisis that still prevails among financial institutions.

The Federal Government of course stepped in aggessively in both military and civil defense areas after 9/11, but it didn’t move to rescue the dot-com casualties — because their collapse posed no systemic threat to the whole financial system.

But Bear stearns and “Freddie and Fannie” did and do pose such a threat — although with the collapse of IndyMac, we now know that there is at least one financial institution that is not “too big to fail”. The question now, as one TV commentator cleverly put it this morning, is whether Freddie and Fannie are “too big to fix” — that is what the equity markets are now debating. The answer will affect the Federal Reserve’s August interest rate decision (near the first anniversay of the first of many Fed “about-faces” on rate policy in the past year).