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Ways of the World

Carol Stone, business economist & active Episcopalian, brings you "Ways of the World". Exploring business & consumers & stewardship, we'll discuss everyday issues: kids & finances, gas prices, & some larger issues: what if foreigners start dumping our debt? And so on. We can provide answers & seek out sources for others. We'll talk about current events & perhaps get different perspectives from what the media says. Write to Carol. Let her know what's important to you:

Tuesday, November 25, 2008

New Government Officials, Financial Market Rescues and Food Pantries

The saga of the troubled American financial system continues, although early this week, following still another frantic weekend of "rescue" negotiations, there are some positive developments to commemorate. There are also new needs, to which we call your attention in paragraph 5 below. You might even read that first!

1. President-Elect Obama yesterday introduced his choices for the most senior economic positions in his Administration. As the media speculated last week over Attorney General and Secretary of State, we kept saying, "but the one we really want to know about is the Secretary of the Treasury." That person, after all, is the one who has to hit the ground running right on Day 1, or even sooner. So finally Friday afternoon, we heard: Timothy Geithner, age 47, current President of the New York Federal Reserve Bank.

We are glad about this selection. Geithner has been in the midst of all the rescue work so far, and he has previous experience at Treasury and the International Monetary Fund. So he doesn't need a shakedown or training period. The New York Fed is the operations center for Federal Reserve policy actions. Its trading desk conducts daily reserve operations with banks and securities dealers and monitors foreign exchange activity. The bank is responsible for the management of new commercial paper lending programs and other recent outreaches. Geithner helped to design these programs, which mushroomed immediately into a giant financial support system. So his choice is a good one.

Further, at yesterday's news conference Obama stated clearly that he will not reverse or materially alter the actions of the Bush Administration in its closing weeks. Thus, institutions and investors can now be assured that efforts made so far will not be repealed or undone. This too is a good thing, whether we agree with all those actions or not, since the programs will not be disrupted at this sensitive time.

2. Other members of the new President's economic staff include Lawrence Summers as chair of the National Economic Council and Christina Romer at the Council of Economic Advisers. Summers, former president of Harvard, is a well-known economist whose job will be to coordinate economic policy among various departments and agencies. While this office has been of little importance in the Bush Administration, the current economic conditions make it totally appropriate to re-emphasize such a role now. Professor Romer is a widely respected researcher at the University of California at Berkeley. She specializes in monetary theory and macroeconomic policy issues; she is a member of the Business Cycle Dating Committee of the National Bureau of Economic Research, the private organization that arbitrates the official state of the U.S. economy. In these personnel choices, Obama has picked mainstream macroeconomists who are not particularly ideologues, but mainly interested in economy-wide stabilization policies. They will be designing a sizable stimulus package in coming weeks, even before the Inauguration.

3. The weekend in Washington was spent in elaborate negotiations over the state of Citigroup, one of the world's largest banks. Late Sunday evening, current Treasury Secretary Paulson announced a kind of rescue effort involving government guarantees of troubled assets on Citi 's balance sheet totaling some $306 billion. These include residential and commercial mortgage-related instruments. The Treasury will add another $20 billion in capital funds to the $25 billion it granted in October. The Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) will participate in this support program.

The problems at Citi were already severe, but they took a real turn for the worse after Secretary Paulson announced two weeks ago that the TARP programs would not involve the "toxic asset" purchases originally planned. We wrote here last week how we were dismayed at the change in strategy for the use of the $700 billion in TARP funds, and apparently we weren't the only ones. Participants in the markets for the specific investments had factored the prospective Government purchases into the prices of those securities, and when they learned the Treasury wouldn't be buying them after all, they pushed the prices back down. Trading in those markets was again disrupted and debt markets were described as "seizing up" as they had back in September. Many investors have again run to the safety of Treasury securities, and demand is so strong and prices so high that the market yield on 3-month Treasury bills has been driven down to a mere 0.02%.

3a. This Just In. In this regard, the Federal Reserve announced just an hour ago that it will begin next week to purchase mortgage-backed bonds for its own account, up to $100 billion. These purchases will be from among the standardized Fannie Mae- and Freddie Mac-issued securities. Some years ago, the Fed routinely bought bonds directly issued by those agencies, but it has never acquired the mortgage-backed debt. The Fed's announcement says that the change today is in direct response to the seizing-up of that market last week. The Fed also said it will be looking to the development of a broader program to begin early in the new year. In addition, it will be establishing a consumer credit purchasing facility similar to the one recently put in place for companies' short-term commercial paper debt.

4. The stock market still has no idea what anything is really worth. Last week, it fell steeply Wednesday and Thursday, and then roared back Friday as word came of the key Obama economics nominations. That improvement continued yesterday, ostensibly on the back of the Citigroup rescue. While we'd like to say that the rebound is a concrete move that will have some staying power, volatility has simply been too great recently to let us conclude anything; we recall having hopeful expectations when earlier bailout actions were taken, but gains then proved fleeting. In particular, there is still no systematic approach in the government's rescue policy; they seem to be taking one line one week and something different the next. Further, all of this action prevents the painful but necessary cleansing of money-losing operations which would allow the formation of a solid base on which to move forward. "Too big to fail" needs some definition. We hope Summers, Geithner and Company, will provide that.

5. It's Thanksgiving. Obviously, we wish all of you a Happy Day, with a break from all of this. We also urge you to give generously to the Food Pantry of your choice. From several unrelated sources, we've heard that these important institutions are having their budgets cut at the very time when more people need them. Supermarket chains that have given away turkeys in recent years are not doing so now, cutting off a significant source of donated food. Please pitch in; help food-pantry patrons have a Happy Thanksgiving too!

Monday, November 17, 2008

TARP: A Cloudy Clarification?

Last week, in our round-up on financial market conditions, we made brief mention of "TARP", the special U.S. Treasury "Troubled Asset Relief Program". We indicated that its funds have not yet been spent in size. This is actually not a correct characterization of what's going on with that program. In fact, $115 billion has been spent, no small piece-of-change. Our own confusion comes mainly from the fact that the funds are not going to buy troubled assets in the way that was initially conceived. Secretary Paulson explained soon after we wrote that the Treasury no longer thinks that buying mortgage-backed bonds is the best use of these funds, so the headline we kept watching for, "Treasury Buys $25 billion MBS" or whatever, will never show up exactly that way.

"Capital Purchase Program"
The "troubled assets" the Treasury has been buying in size are pieces of banks themselves. Few will argue that the banks are troubled, at least to some degree; even if the vast majority of them are still earning profits, those are slimmer than before. And Secretary Paulson is right, buying stock in the banks is much more helpful than buying specific securities. In mid-October, the Treasury announced a Capital Purchase Program, whereby the federal government would buy as much as $250 billion worth of a special class of preferred stock in a number of the nation's banks. The first half of that went to the nine largest, Bank of America, JPMorgan Chase, Citigroup, etc. We assumed that it would take some time to consummate these transactions, but they were completed on October 28 and $115 billion in funds were paid out. Applications for the second half of this offering were due just a few days ago. According to a list published Friday by the Wall Street Journal, so far, 54 more banking institutions have applied for $49 billion, and the Treasury is processing an investment of $40 billion in American International Group (AIG).

If the Treasury's funds were dedicated to a specific asset, it would be only those assets that could be helped by TARP. But putting the money into underlying capital means it can be used to shore up the overall operations of each institution. There is then some discretion in what individual banks can do with it, and the intention is that they will increase lending and help needy borrowers work through difficult situations. At the same time, Treasury officials were said to have complained already that they hadn't yet seen evidence that lending was picking up. Certainly, news instead of still another "retreat" at a posh resort for employees and agents of AIG was not well received. Federal Reserve weekly data on bank balance sheets lags a bit, so hardly enough time has passed to see any major change in the aggregate numbers; what the figures do show through November 5 is a marked reduction in the banks' borrowing from the Federal Reserve, that is, possibly they cut their current liabilities first. That's not a wholly bad thing for them to do. We're not sure, though, if this read of the data is a correct interpretation or only a numerical coincidence. We'll keep up with this to see how it develops, now that we know what to look for!

There Is Help for Consumers
Meantime, there seems to be a lot of public comment about whether anybody is actually reaching out to consumers. Secretary Paulson suggested the other day that some of the remaining TARP funds would be directed at consumer debt, but he didn't offer any specifics. Members of Congress and even the President-Elect continue to beat a drum for mortgage foreclosure prevention. But, as we've talked about before, here, this is already happening. We described here in our article about the Hope Now program (October 27) how more than 1.5 million homeowners have been involved in their efforts so far this year. Just days after that article, a couple of major banks announced on their own similar programs for seriously delinquent mortgage loans that they hold in their portfolios. A third major effort is coming from Fannie Mae and Freddie Mac, sharply increasing the Hope Now activity. Delinquencies are still mounting, so expansion of this work is still needed. But consumers are hardly being neglected.

Inconsistent Policy Choices
We're talking about these issues for a couple of reasons. One is that we needed to correct an error we made here a week ago, albeit an innocent one. But that in itself brings the second reason for our discussion. These are your tax dollars. No one can say that they're not going to good use. And we're glad the government is stepping in with support. But the Treasury is not using the money the way they themselves originally proposed. Congress was not in session in October, so officials couldn't go back to get the changes formally approved. Time was of the essence, and as Secretary Paulson explained*, the program was implemented so quickly it set a "land-speed record" for such government action. But we would caution that this massive revision of the policy does not set good precedent; Members of Congress have indeed criticized him. It highlights the danger of putting too much power in the hands of government officials. If it's a single firm that encounters trouble, that's bad enough. But if someone has broad public authority and changes their mind about a policy, many people can be harmed. This isn't likely to be the outcome here, but the way it has come about rings all kinds of alarm bells for us. Further, the shift has only encouraged other firms and industries to reach for some of the money. One major business finance company became a bank in order to qualify, another insurance company is trying to buy a bank. And the beleaguered U.S. auto companies believe they should be eligible for something. Thus, there is now no way to draw a clear line.

One other recent development of note: late Sunday, even as we were drafting the first few paragraphs of this article, Goldman Sachs announced that its executives would forgo their bonuses this year. Partly, we want to say, good thing! as a couple of our friends were victims of the latest round of that company's layoffs. However, on the whole, Goldman has done well, not becoming overly involved in excessive mortgage investment and other risky trading; if any Wall Street executives deserve "performance-based compensation", it is likely them. So their decision on this question is a constructive one for the entire industry. It addresses the one aspect that has the most public ire: really enormous compensation for the big shots while people's loans are going sour and their friends are getting laid off.
* U.S. Treasury. "Remarks by Secretary Henry M. Paulson, Jr. on Financial Rescue Package and Economic Update", November 12, 2008.

Monday, November 10, 2008

Where Do We Stand Now?

The first answer to "Where Are We?" has to be that we have a new President. This election will stand forever as a landmark in American history. To us, it is the culmination of the American dream, the American Idea. We have written here before about "The Radicalism of the American Revolution" (see July 7, 2007) and how the social consequences of our break from England broke apart the centuries-old notion that society should be organized in tiers, with patrons and clients – and slaves. Yes, it took another 90 years to free the slaves and another 100 years after that to ensure their descendents full voting rights. But the porousness of society that allows the son of Kenyan and Kansan parents, raised by a single mother, to rise through the political ranks to the top, had its roots in the foundation and invention of America.

This said, we can't stop long to celebrate, nor can Barack Obama bask in the glory too long. This man, with a liberal mandate from the American people, is now the primary source of hope in fixing our economy that is in such distress. Here are four parts of the economic challenge that marks "Where We Stand Now".

The Stock Market
The last four days of last week, the Dow Jones Industrial Average was up and down like a yo-yo: it surged 350 points on Election Day, plunged by more than 900 points Wednesday and Thursday, then regained 250 points Friday, and turned back down 140 points or so today. Friday's rise came despite a sharp fall in General Motors, which issued poor third-quarter results and a caution that it could run out of cash fairly soon. But shares of Ford, the other big American auto company – and also expected to report a Q3 loss – ticked up in price Friday, as did 28 of the 29 other firms that make up the Dow Jones Average. With all this volatility and counter-intuitive responses, there is clearly no consensus among investors on the value of any company or group or any way to know whether the market is finding a bottom.

One element of concern is the repeated statement by Candidate Obama that he would engineer a rise in the capital gains tax. Now that he has been elected, some investors are selling stocks to ensure that they will owe the current lower tax – assuming they still have gains at all – and not a prospective higher one. This phenomenon, known in the jargon as "tax-loss selling", isn't helping.

Interest Rates
The Federal Reserve and other central banks have poured billions and billions of dollars into money markets to support the strained banking system. The so-called "monetary base", the Federal Reserve's underlying liquidity pool for the economy, stood last week at $1.237 trillion, up nearly $400 billion or 47% just since mid-September. The idea was that banks, money market funds and dealers in short-term debt would be able to use these funds to increase the availability of credit and lower its cost. Then, borrowers of all kinds could begin to get back on their feet. However, fear gripped potential lenders so that several weeks passed before short-term business debt stopped contracting, and initially, interest rates rose, instead of falling. LIBOR, the London Interbank Offered Rate, the headline rate for one bank to lend to another, surged on 1-month loans from 2.5% in mid-September to 4.35% in early October. Now it has finally retraced that rise, reaching 2.29% on November 7.

LIBOR is widely used in setting rates on longer-term debt, especially mortgages. Mortgage rates themselves have also remained higher than helpful, as lenders are squeezed by the fear their creditors have in them and the fear they have in their would-be borrowers. The benchmark rate on 30-year fixed rate mortgages was 6.28% this past week, hardly different on balance from its level in mid-summer. Mortgage credit availability also remains tight, regardless of rate.

The $700 billion "bailout" is meant to help all of this, but funds from it have not yet flowed out in size, as the Treasury Department needs at least some weeks to set up the administration of its various programs. As you have probably read, the latest wrinkle is an appeal by auto companies that they should have a share in these funds, and some are being invested in AIG stock. We will detail more of this in a subsequent article.

Energy Prices
For consumers (i.e., us), at least energy prices have been moving in the right direction. We were in low-tax New Jersey on the weekend and saw an off-brand gas station selling regular for $1.97! That's right: less than $2.00!! New York's gasoline taxes are higher, but even there, the price at the pump is well under $3.00.

National personal income data are available through September and we calculated our measure of "take-home pay" – wages and salaries after deductions for income and social security taxes. A year ago, this gauge was rising about 0.5% each month. But in the last 3 months, the monthly change has been -0.25%, that is, income is actually falling a bit. Thus, it's a good thing energy is cheapening. There has been no such relief from food inflation, though; you have surely noticed! So food and energy necessities are still eating up a large portion of take-home pay: 27% of it in September, barely down from a high of 27.4% the prior three months, and burdensomely higher than 25% a year ago. The lower gas prices in October would have helped relieve this some more, although income is almost surely still weak.

Employment and Economic Stimulus
All this, and we haven't yet mentioned the mounting job losses and rising unemployment. Partly that's because they are not separate from everything else that's going on; they are the unfortunate and almost automatic fall-out. Enhanced unemployment insurance was enacted back in the summer, and in the latest week, October 18, 773,000 people were receiving the extra benefits. Some of the recent job weakness was related to the two major hurricanes in September and the Boeing strike, which ended only very recently. So some "improvement" could appear.

Meantime, there is already widespread talk of an upcoming stimulus package from Congress, apparently similar to the tax rebate we all got back in the spring. This may help, and while we're not excited about sporadic, one-time "gifts", that action may give the incoming Obama Administration time to get its act together on longer-term fiscal policy. One aspect we hope for: no tax increases for any segment of the income distribution, at least for a while. Herbert Hoover learned about raising taxes during a period of economic weakness and so did the Japanese in 1997. More economic malaise follows.

Also note that it's not really necessary to "pay for" economic stimulus programs. If they do their job, revenue will recover anyway. If they're not very effective, then trying to pay for them would bring still more weight on income-earners.

One last item, one we haven't read elsewhere: state and local governments generally aren't legally allowed to run budget deficits. So if their revenues start to weaken, as many have already, they have to respond promptly with contractionary actions. So an early "stimulus" from the federal government could be the reinstatement of the old program called "revenue sharing". If banks and auto companies need "aid", surely state and local governments deserve the same.

We haven't touched on several key current issues: the environment and health care especially. And every item we have talked about here merits more exploration. So there is clearly more to come. Let us know how your priorities run for more information. Email

Monday, November 03, 2008

Election Day: A "Sacred Occasion"

Yesterday, I attended Grace Church, Brooklyn Heights, New York*. Rector Stephen Muncie began his sermon with a sentiment I have often felt in these last weeks. As the media are now highlighting, the looming Election is a historic one. Depending on how it goes, we will elect either the first African-American President or the first woman Vice President. This fact makes this Election, even more than most, a "sacred occasion", Fr. Muncie asserted, a day "set apart" – for that is what "sacred" means.

So here, in recognition of the solemnity of this time, we try to set aside the media rancor and do what Christians might well do ahead of our particular quadrennial pilgrimage to the polling place and into the voting booth: pray.

For Our Country ~
Almighty God, who has given us this good land for our heritage: We humbly beseech you that we may always prove ourselves a people mindful of your favor and glad to do your will. Bless our land with honorable industry, sound learning, and pure manners. Save us from violence, discord, and confusion; from pride and arrogance, and from every evil way. Defend our liberties, and fashion into one united people the multitudes brought to this place out of many kindreds and tongues. Endue with the spirit of wisdom those to whom in your Name we entrust the authority of government, that there may be justice and peace at home, and that, through obedience to your law, we may show forth your praise among the nations of the earth. In the time of prosperity, fill our hearts with thankfulness, and in the day of trouble, suffer not our trust in you to fail; all this we ask through Jesus Christ our Lord. Amen.

For Sound Government (conclusion) ~
. . . teach our people to rely on your strength and to accept their responsibilities to their fellow citizens, that they may elect trustworthy leaders and make wise decisions for the well being of our society; that we may serve you faithfully in our generation and honor your holy Name. For yours is the kingdom, O Lord, and you are exalted as head above all. Amen.

The Book of Common Prayer
"Prayers & Thanksgivings", No's 18 & 22


*A most special visit to Grace Church on the Commemoration of All Saints. This day is a Holy Day of the Church Year, moved at many churches from November 1 to the first Sunday of November. As we celebrate all the saints, we join in making new ones through Baptism. Yesterday, there were 11 children at Grace, including one Wyatt Oliver Crafton Walker. As Mom and Dad and the Godparents came forward with the baby, Father Muncie introduced the Special Guest who was present to perform this particular baptism, the baby's Grandmother. The congregation responded with spontaneous and warm applause, and nestled in Barbara Crafton's arms, young Wyatt became a Christian.

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