Posted tagged ‘banking’

Formulating Foreign Policy

October 28, 2013

The Cold War was both the best of times and the worst of times.  Communism versus Capitalism.  Which system would win?  American leaders believed that if American businesses were given the opportunity, they would convince the world that democratic capitalism was a superior form of government.

So, “containment” was the code word for America’s foreign policies. It was easy to understand.   In essence, American foreign policy was based upon the notion that if the Soviet Union and any other country that fell under the Soviet shadow could be contained (not allowed to further expand), that in time Communism would die.  Why?  Because its businesses would be less efficient.

For the most part this was a pragmatic foreign policy.   With US ships, planes, and troops, it allowed American businesses to have free range over most of the world’s population and geography.  To be sure there were plenty of white knuckle times, when America was close to pressing the nuclear weapons button in response to some provocation.  But as history has shown, cooler heads prevailed.

So fast forward.  Try and answer this question, “what is the basis for today’s American foreign policy?”

Consider the major American business successes.   Large traditional manufacturers like GE, DuPont, General Motors, Ford, Boing etc expanded from their US developed markets by exporting to foreign countries.  In time these companies built foreign plants, set up joint ventures and in many cases built their own foreign operations from top to bottom.  Keeping the seas open, access to key raw materials assured, and protecting against foreign appropriation of American assets underlaid US foreign policy.  What was good for these companies was good for America.

Now American business leaders are comprised of different types of companies.  Apple, Google, Facebook, or Microsoft are emblematic of this new group.  While their products have been hugely successful and world demand is high, all have engaged in multi-country strategies whereby they incorporate in dozens of countries primarily for the purposes of limiting liability and avoiding tax payments, not building revenue.  What type of foreign policy can this “tax avoidance” strategy justify?

Or consider, financial institutions whose “business” is manufacturing profits from bizarre derivatives.  In this game played in computers and in cyber space, money knows no boarders.

So what role should US foreign policy play, and how should this policy be formed?  Hmmm.

It should be pretty clear that Syria or Iraq with bombs exploding daily does not represent a challenge to US business (new or old).  It should also be clear that the Israeli-Palestinian issue need never be settled if the concern was how to support healthy US business growth.

And it can be easily argued that military presence in countries such as Iraq, Syria, Afghanistan or any number of African countries serves no useful purpose if American business (including banking) growth was a justification.  Hmmm.

I do not know whether President Obama (or his advisors) have had thoughts like this.  I am unfamiliar with details of any coherent US foreign policy.  Compounding this problem, how does any government form foreign policy for businesses whose primary goal is to avoid taxes or banks whose loyalty is to a unit of currency and not where the currency is located?

I wonder whether President Obama recognized the true depths of the mess he inherited from former President George W Bush?


Alice In Wonder-Jobs-Land

August 21, 2011

Lets review the bidding.  Its 2007 and the housing bubble, well actually there were many housing bubbles all around the country, began to burst.  Suddenly roofers, metal workers, framers, appliance dealers, and all the other trades that together had been constructing all sorts of houses, condos, and apartments stopped working.  When they stopped working, they bought a lot less at Starbucks and Walmarts.  They bought a lot less from everyone.

The building industry stopped working largely because they had already built far too many units and there were too few people who could qualify for a mortgage even if they wanted to buy new.

Oh, yes, lets not forget the near collapse of the world banking system.  This was triggered by the decline in housing prices and the realization that much of the securities based upon mortgages was not worth the paper they were printed upon.  So banks stopped lending and routine new business creation dried up.

The US was experiencing the best (or worst) of greed and overconsumption.

Companies of all types began in 2008 to empty their offices, warehouses, and factories of workers.  There was, they said, less demand for their products and services.  While true, it also provided a chance for companies to “right-size” themselves.  Right-sizing was all about fully incorporating all the productivity improvements that these companies have invested heavily in since the early 90’s.  Surprise, surprise, companies could run with fewer employees.

Unemployment stands now slightly above 9% and full employment would carry about 4.5% unemployment number.  How do we get there?

Over the past year and a half we have heard many ideas and excuses.  Banks were not lending.  People were worried about their own future employment so they were not buying.  (No buying means no demand means no need to hire).

We saw stimulus money flowing across the country.  Not enough many said, too much said others.  As first aid, the stimulus money probably saved a lot jobs, that is enabled people to retain jobs in road construction, law enforcement, and teaching.  But there was no ignition of sustained new jobs growth.

The political rhetoric of the 2012 election is clouding any sensible discussion of jobs growth.  The GOP candidates all speak as if they would grow jobs just like avocados.  President Obama speaks just as strongly about stimulating jobs growth, getting Americans back to work.  I don’t think any politician has a real clue.

So lets ask why.

In 2006, the state of the economy saw close to full employment. But, should we try to go back to 2006?  The housing industry was building houses no one needed or could afford.  So, in effect, this level of national employment was a fantasy.  On top, banks were far too free with credit and almost forced people to keep buying even if they did not have the means to repay.  In short the economy was built largely upon hope.  Hope that everyone could outrun the bill collector.

If we are to see a full and vibrant economy again, America must retool.  The “silent hand” must reallocate resources beginning with good paying manufacturing jobs.  These employers must buy equipment and supplies from other good paying vendors.  A sensible immigration and guest worker policy will help provide labor for jobs others need but do not want to do.  Education policy needs to reflect practical skills as well as work ready college degrees.  This cannot happen overnight.

Alice-in-jobs-land is where we are.  We are living a fantasy if we think 2006 is suddenly going to return.

Teaching intelligent design, rejecting global warming and stem cell science, and passing on big tax breaks to big oil are real in the minds of some.  They are actually fantasy if anyone expects them to lead to economic growth and a return of jobs.


Reversing Reverse Mortgages

June 19, 2011

The recent Wells Fargo and Bank of America announcements that they were exiting the “reverse mortgage” business signals an end (for these banks) to a questionable practice.  These banks are not exiting these lending instruments for ethical or moral reasons.  They are quitting because they do not like their profit prospect.

And, in America, what’s wrong with that?

The answer is nothing.  These banks withdrawal, however, raises questions about why they ever entered this type of lending in the first place.  And the answer is, the profit prospects looked good.  What has changed?

It seems a combination of real world factors are worrying bankers.  People are living longer and in the process, too many (4-5% of those taking reverse mortgages) are running out of financial resources.  This leads these borrowers to skip paying taxes and maintaining home insurance.  Clear title to these “reverse financed homes” then becomes murky presenting banks with costly options to foreclose.

On top of these factors, banks see housing prices as either falling or not rising fast enough.  Home value appreciation (10+% per year) was the comfort blanket that encouraged banks to loan money to older (over 62) people in the first place.

Falling home values is almost assuredly a temporary event.  But when they will rise again is unknown.  A quick look at historic home values would show a steady increase keeping pace with or slightly exceeding inflation.  The last 15 years or so have been an anomaly where house price exploded.  In short, the market is going through a painful correction.  It would seem banks want to be your partner on the up side but prefer to let you go alone on the down or flat side.

Bank of America and Wells Fargo are two of the largest banks in the US.  Reverse mortgages are only a tiny piece of their business portfolio.  Given their size and sophistication, one would have thought that ethical and moral reasons might have weighed in.  The reverse mortgage borrowers paid fees to get the loan and the loan interest compounds annually increasing the loan amount.  When the owners die or decide to sell, there may be no equity left even if there is slight house value appreciation.

I guess it is no surprise then that these banks were also associated with “liars loans” when the housing bubble was growing.


Laying Blame

January 28, 2011

There are 633 riveting pages.  The 2008 Financial Crisis is a mystery no more.  The icing on the cake, the crisis could have been prevented.

As crisis go, this was not your average one.  It had a lot of moving parts.  There was the government-gone private Fanny Mae and Freddie Mac.  These twins would buy mortgages from just about anyone.  They were golden because they came backed by Federal guarantees.  Private businesses backed by Federal money.  Hmmm.

Of course there was money in it for banks when they granted mortgages.  As soon as they granted a mortgage, the bank could sell the mortgage to Freddie or Fanny.  This gave the banks new money to grant another mortgage and pocket the fees associated.  No risk and money in the pocket.  Hmmm.

Investment bankers saw some new angles.  Why not bundle these mortgages and sell bonds that promised to pay the equivalent of your money mortgage payment to bond holders.  The original bank had already collected its fees and was collecting more fees for providing local service.  Freddie and Fanny, as well as other lenders could sell their mortgages to the bundlers who would issue bonds.  The bonds issuers, of course, made fees too.  Hmmm.

The investment bankers struck another idea.  What would they do with mortgages that were a little questionable?  Eureka,   Why not bundle a mixed bag of mortgage backed bonds into what they called a collateralized debt obligation.  They would get ratings agencies (Standard and Poor’s, Moody’s, etc) to rate these CDOs.  The highest rated would carry the lowest return, the riskiest the highest return.  The beauty of this approach was that the assigned ratings would be all slight variations of good ratings (whether they really were or not).  Hmmm.

Other creative investment bankers hit upon “slicing and dicing”.  Here they created CDOs that contained pieces of high rated CDOs and pieces of lower rated ones.  The idea was that by mixing (homogenizing) all types of CDOs, risk was spread out and no one would be too exposed.  Sounds like a free lunch.  Hmmm.

The investment banking community could not have done all this if there were not a ready market.  Money was available around the world chasing attractive returns.  Banks and investment firms around the world lined up to by these CDOs.  Why not, home prices kept going up.  Everyone was doing it.  Hmmm.

Not everyone was convinced that home price would go up forever.  Further, the creators of CDOs began to become worried.  They could not sell all of their CDOs.  What was not sold was parked on the banks books.  This required the financial institutions to reserve money they might otherwise have used to generate more income.  How to get these obligations off their books?  Hmmm.

The answer came in the form of credit default swaps.  CDSs are sort of insurance.  Their beauty is that they are not official insurance so they are not regulated.  CDSs are bets that some obligation will default.  One side bets they will default, the other side bets they will not fail.  Their attractiveness is that one side pays the other side money now on the bet that in the future the obligation will default.  Bird in the hand…?  Hmmm.

Before anyone could react the financial sector was awash in CDSs.  Holders of CDOs claimed they had mitigated their risk by purchasing CDSs.  CDS issuers did not have to report the issuance of a CDS since these instruments were not regulated.  And no one check to see what might happen if the CDS issuer could not pay.  Hmmm.

This arrangement grew while house sales continued to grow and feed new mortgages.  When the housing bubble burst, the flow of fresh fees dried up.  In addition, weak housing sales translated into job losses and the onset of a recession.

The next domino was mortgages defaults.  Mortgage backed bonds lost value.  CDO’s became less valuable and in time, CDSs were called on for payment.  Suddenly everyone could see the king had no clothes.  Hmmm.

Banks and financial institutions are one thing if they are anything.  They are distrustful to a fault when their greed is not satisfied.  If there was a chance they would lose money, they would first shut down their money lending operations and attempt to be the last man standing.  The world economy soon felt the impact.  It was not pretty.

At this point the term “too big to fail” gained new life.  Governments around the world bailed out banks and investment firms.  The rest is history.

The conclusion that this crisis could have been prevented should be no surprise.  The report should have said “the crisis should have been prevented”.  The nature of banking and investing is well known.  The fallibility of humans is equally well known, the free lunch trips most everyone.

Dishonestly filled out mortgage application forms, predatory mortgage interest terms, no (or limited) retained mortgage liability (when sold), and unregulated and non-transparent insurance-like instruments all could and should have been regulated.  If already regulated, they should have been enforced.

Greed and hot money cannot be regulated.  They are part of human nature.  The minority report which purports the crisis could not have been prevented does everyone a disservice.  Everyone that is except the banks, mortgage originators, rating agencies, and investment firms.

Behind the Headlines

April 2, 2010

The right question was not asked. Yesterday the headlines read “Hedge Fund Managers Reap Billions”. The top “earner” reported a take of $4 billion. The top four “earners” took in over $12 billion. The question that was asked was what did these people do to “earn” this much.

The question not asked may be far more relevant. Hedge Fund managers accept other people’s money and invest those funds (and usually a lot of their own) in a wide range of investments. These managers charge a lot (maybe as high as 25%) of any appreciation. So far Hedge Fund investors have been happy to pay in order to get their return (usually double digit). But they are paid that much is not the question needing to be asked.

The highest paid hedge fund manager, David Tepper, said he bet that the Federal Government would not let banks fail, and so Tepper loaded up on Bank stocks when they tanked in late 2008. As the bank stocks rose during 2009, Tepper unloaded enough to make a tidy profit. We are now ready to ask the question.

Consider that In order to make money on buying and selling the bank stocks, stock owners (mostly institutional investors) had to sell (driving the price of the stock down) and then investors had to buy (driving the stock price up) the stock as it rose in value.

The question to ask is “which major bank stock owners unloaded bank stocks on the way down, and which investors bought bank stocks on the way up?”

It may be a surprise to find out that many investment funds, held by many pension plans and private 401Ks, sold and bought back. In any case, someone’s investment in banks got a haircut on the way down, and on the way up, gave a tip to these hedge funds.

Sounds a lot like casino earnings to me. Maybe it should be taxed that way?


January 15, 2010

The world of economic prognosticators continues to worry about more home mortgage foreclosures. These pros point to the lack of jobs creation and that so many homes are “underwater”. There are now numerous reports of home owners who can afford their payments and who simply walk away from their home or condo because its mortgage value is more than if they sold it outright. Is foreclosure a big problem and how did it come to be?

As with most complicated problems, the first step should be to break the big problem into pieces. When one disaggregates the national foreclosure problem by states, an interesting phenomena emerges. For most of the country there is no exceptional problem.

Saying it another way, the US foreclosure problem consists of (1) a special problem with California (2.1%), Nevada (3.8%), Arizona (2.7%), and Florida (2.8%), and (2) every place else (less than 1% except Michigan and Illinois which are less that 1.4%). The foreclosure rates in these 4 states is 2-3 times that of all other states. There must be a special reason for these states varying so much from the average.

We have heard over and over about sub-prime mortgages and the killing effect that resetting the mortgage interest rate has on the home own. But these are nationwide phenomena. We have heard that the sinking economy has left many people without the means to pay their mortgage.  This too is nationwide.  We have also heard racially based reasons for increased foreclosures.  Alas, this too is nationwide.  Why does not Congress simply look at the real data for these states and share the facts with the public?

Each of the states with high foreclosure rates possess one or more of these characteristics. The are warm and desirable for living, they offer (offered) jobs in the service area to accommodate the State’s growing population, they possessed State Governments friendly to investment and growth in population, and these States were magnets for all sorts of high risk housing sector investment funds.

Until the root causes are established, Government will be wise to halt the bleeding. First, there should be no further unsecured loans (no liars applications and no zero down payments). Second, there should be no changes in interest rates (for say 5 years) unless agreed to by the borrower. If the economy has not recovered in 5 years, we have a much different problem on our hands and we will need a much different solution.

Lessons Learned?

May 20, 2009

Government officials are now signaling that the economy has stopped its decline and recovery is just around the corner. The critical question before the house is whether we will learn anything from the economy’s steep decline and will we take action to prevent or minimize the chances of its return.

First we must recognize that those who point to the “housing bubble” as the culprit, are pointing at the wrong target. We should expect bubbles like this will reoccur regularly as the normal actions of the free market work. It is normal to over build houses in times of growth (read optimism). This tendency is fueled by greed (profit motive) and frankly the inability to know when is too much. The natural cure, of course, is to stop building houses (directly following the consumer’s decision to stop buying them). Given a little time, supply versus demand will come back into balance and house building will resume.

Second, we should look more carefully at the near collapse of the investment and banking industry’s to find the real roots of the economy’s sickness. Consider that in 1997, the financial services sector produced the highest amount of earnings of all the business sectors in the US.    Since banks and investment firms do not inherently create any value, how was it possible? The flip side of the banks/investment firms’ earnings is that other business that actually create something were less attractive to investors than banks and investment firms.

There are two lessons staring everyone in the eyes.

  • The self management and governance functions of most large banks and investment firms (and some insurance companies) was broken and did not function as designed. The steady creation of new investment vehicles fueled a race amongst firms to earn the most and therefore attack more demand for their stock. This enabled top executives to earn unconscionable remunerations and at the same time allow their companies to go bankrupt or very close to it.
  • The question of how America is to once again create value has been laid before us. Fast food, certificates of deposit, and real estate exchange are not avenues that create value regardless of how we might appreciate these services. We must find new industries such as solar energy, biosynthesis, and light weight, long life batteries as well as bringing back historic industries such as machine tools, furniture, and textiles.

Lastly, the lesson of size is sitting out there waiting to be assessed. Did the size of these banking, insurance, and investment firms play an adverse role in the collapse? While it seems a tenet of capitalism and free markets that companies should be allowed to grow and acquire as their means allow, I think we would do well to look at whether there is a practical size above which the necessary governance capability is either missing or too expensive. Banking, investment, and insurance seem to me three businesses that do not belong together in any combination and like Citigroup, when combined are a disaster waiting to happen.