Toxic Banks: Not Just US Problem

I've heard some people remark that the credit crunch has shown the weakness of US banks as compared to the rest of the world (which generally means Europe, when it comes to the financial industry). I found that hard to believe, because it seemed that some of the names hit hardest were European banks. So I was interested to read in the Financial Times Lex column (sorry, no free link) that sub prime credit write downs by banks have totaled $493 billion worldwide. Of that, $250 billion was in the US, but $221 billion was in Europe, with $22 billion elsewhere.

And yet, the European economy has not taken the same hit as that of the US. The housing bubble in the US has been one factor, but there's been a similar bubble in many parts of Europe - Spain, Denmark, the UK, and Ireland. I'm guessing that the relative strength of the euro has been the reason. But it seems that won't be lasting long:

The US and European economies are of similar size, as are their banking industries, which both have market capitalisations of about $1,000bn. Yet European banking stocks have outperformed since the credit crisis began. So far, US banks have suffered most. The worst is yet to come in Europe.

Those in the US looking for economic salvation by investing overseas are likely to find that the safety is only temporary. Ah, well, misery loves company.

Home Prices Fall - No Surprise

Two major housing price indexes, a 20-city and 10-city compilation by Standard & Poor's and Case-Shiller, both hit record declines. But there's no surprise if you've been even cursorily following the economic churn in the country.

The "value" that people perceived was a result of demand, over-supply of money, speculation, and a general economic hysteria. Not being grounded in anything truly substantial, it was waiting to evaporate, and now we're seeing that happen. But I actually think this is good news for the economy, getting back to a more realistic state that might allow more moderate but supportable growth.

Pushing a Rope

Well, looks like everyone from the president to the Fed's chairman is ready for economic stimulus. There's only one problem, as I heard Robert Reich state well on Marketplace Morning Report. I have my own way of thinking about it. A rope can be a great tool to get something moving, but only if you are pulling on it hard enough. Push, and the mass of fiber collapses.

The problem with current proposals to stimulate the economy is that the people in charge are forgetting this simple yet telling physical experience. To put a few hundred into the hands of many, given the rise in energy and food prices, means that they might almost, but probably not quite, stay where they were. That's just holding the rope, not pulling. The richest part of the populace would have more free capital, but there's only so much they can consume; there are just not enough of them to make a difference.

Trying to get businesses to invest is like pushing the rope. Companies spent 15 to 20 years relearning the lesson that it makes no sense to invest in infrastructure, capacity, and inventory that you don't need. Make the money available, and corporations won't invest money in stimulating ways because for them it is a waste. Instead, they'll look for other places to park the cash that might offer some return.

And to stimulate the economy, the government and the Fed effectively have to loosen the money supply, reducing the value of the dollar and burying the country under the weight of even more debt and unsupported currency. Better we should realize that sometimes you have to wait out unpleasant news rather than get a nasty rope burn trying to finagle your way out of it.

Waiting For the Shoe to Drop

We usually hear that we should wait for the other shoe to drop - that one event has happened, and its completion will catch up with us as certainly as reading glasses chase the middle-aged. But there is an assumption that people are cognizant enough to recognize that forces beyond their control are at work. This comes from experience and an interest in avoiding as much pain and suffering as possible.

Unfortunately, business has become an area where people prefer to remain blissfully unaware becasue they're after the Big Kill. They think that some things are too good to be true, but they want them anyway, and so plunge head first and will hear nothing of the rocks sitting at the bottom of the shallow pool below.

It would seem foolish that all these people with a library of degrees among them and more money than people can conceive of move on in such ways. But we are all creatures of emotion, and the dark side that drives greed and desire is exactly the part that harbors other weaknesses. So they ignore reason and move ahead, no matter what their experience tells them.

That's why we're waiting for the first shoe to drop - or at least for the echoes to catch up with us. Everyone seems to be watching each other for a clue. The US market is down, so Asia and Europe reacts, but then the US says, "Well, maybe it's not that bad after all." But Bank of America's earnings are down something like 95%. This is not the sign of a mild recession, but rather the a sign that something is seriously wrong. The banks have made unbelievably foolish mistakes and they now want to hide under a rock and not take chances. However, if the financial institutions that form the foundation of our economic system are cracking, what are the chances that everyone else will be if not well, then only mildly affected? Just how big a shoe - or boot - is waiting for its time to fall?

The Recession Slide

Everyone seems to be using the term these days. Greenspan says we're doing it. Pundits say we're doing it. I understand that those who feel in a position to influence the economy - generally those who make a profit off how the public perceives it - are loathe to use the R word, lest they create a general perception that creates the condition it describes. But people I know have been tightening their belts for some time, now. Gas has been pretty far up for over a year, heating a house in winter is expensive, people fear losing their jobs, foreclosures are at a high, and everything gets more expensive. What the hell did the experts think about public perception? That everything was fine and dandy? People badly want things to be better, and yet see a greater and greater share of the common wealth being held by the relatively few. To play into fear and hope for your own purposes is a dangerous and dirty business. Those who are at the top of the economic food chain should remember that there have been periods of reckoning, whether a depression or heavy-handed regulatory interference, because politicians are even more scared of the public than the well-to-do. You can win for a long time at some games, but eventually your number comes up and you have to pay. Better to deal more honestly with things than to try putting a bright face on for too long.

Credit Crunch and Trickle Down Economics

We're starting to see the beginning of credit crunch fall-out. From the tech sector, Cisco Systems mentioned that if large banks are having to write down billions of dollars because of bundling debt into securities and getting rating agencies to give a better credit rating than the individual loans could often get, chances are they won't have money to spend on things like new technology. As a Financial Times story quoted:

“If there is a concerted slowdown in financial services you are going to have a big problem,” Richard Parower, managing director at J&W Seligman, said.

Makes sense, and investors agreed by suddenly knocking the NASDAQ composite down. Stocks recovered, more or less, but in a way that doesn't matter. Banks buy less and are wary of deals, which means that law firms don't get all the money they were used to. As things slow, there will be a drop in spending, and in jobs, probably. Tech and finance will affect virtually everything. Energy costs are hitting everyone and everything and food is getting more expensive, so consumers will have less to spend. Borrowing can't cover it, as the dollar is no longer so attractive a deal for those countries like China that are brining in the cash.

Personally, I'm steering more of my own writing business to publications that serve sectors that have some cushioning against recession, like legal, food, and I'm even considering getting a foot into the health care door. Now's the time to take stock of where things will go and to seek out the relative safety you might find.

Christmas in October

According to the New York Times, a number of retailers are extending their holiday marketing back into early October:

Shattering records for an early start, Wal-Mart is cutting prices on toys in mid-October, but the company is not calling it a holiday sale. L. L. Bean has started advertising free shipping — but it is shying away from the H word. And Toys “R” Us is marketing a temporary store in Manhattan, but consumers have to study ads to find the name: Holiday Express.

According to the article, what has pushed them back this far is the expectation of a lackluster holiday shopping period. So much for the day after Thanksgiving. This offers more evidence that there could be a broad economic slowdown, I think, or at least for a lack of business confidence, which can become the same thing. I see why retailers are about holiday sales, as many see 60% of their business from September to December. But I don't see a logical reason why worries transform into a strategy of starting the sales earlier. When you have the sales start so early, you lose the chance of getting anyone to pay higher prices at all. The result is a self-fulfilling prophesy of lower dollar sales and lower margins.

You can't solve a problem that stands outside the realm of efforts you currently make by doing more of the same. maybe retailers need to do something completely different and find a way to deliver value that isn't offering goods for less. Why not offer a shopping service, where people can call teh store, say what they want - maybe even get gift suggestions - and have all the stuff put together for them so they can simply pick it up? That does sound suspiciously like an online shopping facility, which is fine. Just add a little bit extra service and position it as what it is - a way of getting what you need done without getting strung out. Let a number of retailers work together on a holiday season gift registry, so you don't have to guess what Aunt Mildred wants, and you don't have to go to a particular store. Have a recovery zone in stores, where consumers can sit, rest, and get a free cup of coffee and cookie or other snack.

I won't expect to see any of this from now to the end of December. Businesspeople seem wed to continuing things they way as they have always gone, or to treat sales as a zero sum game, where the benefits go to either you or the customer. And zero is exactly what happens.

Stock Market High Evidence of High Investors?

I shake my head, looking at the new Dow record: 14087.55. With Citigroup and UBS melting down, with other financial services firms only showing strength when the financial reports don't include the late summer, with housing taking a beating and Wal-Mart and Target and Home Depot feeling the pinch, with the Supply Management index being weaker than was expected (though still just above the contraction level), you might not think this was a time to be betting on stock market prices sitting at high levels. But, even as top grade bonds are doing well, so are equities. The Financial Times has an "explanation" from an analyst:

“Everyone’s expecting bad news but, once it’s out, it’s either not as bad as everyone thought or at least it’s out in the open,” said Richard Sparks, senior equity analyst and equity options trader at Schaeffer’s Investment Research.

“The expectation is still that there will be a rate cut when the Federal Reserve meets at the end of this month. The market has decided that it is going to happen.”

If ever there was proof that people are completely and unrepentantly nuts, this is it. There will be a Fed rate cut at the end of the month because the market has decided that there will be a Fed rate cut at the end of the month. If Sparks is right, then investors are walking right past investing, long beyond betting, and walking into the heart of the Faithful. Look at what the analysts are saying (again from the FT article):

The most significant economic data to come are the September payrolls figures due at the end of the week. Investors expect a rebound in job creation after the decline of 4,000 for August – the first fall in four years.

“We continue to expect overall payroll employment to be up 125,000 in September and look for little change in manufacturing jobs,” said Ted Wieseman, economist at Morgan Stanley.

Homebuilder stocks rose sharply on Monday after an analyst at Citi Investment Research said recent share price falls meant it was time to buy into the sector.

When you make your living leading the Faithful, I guess you can't afford to show doubt, even when that oncoming light in the tunnel is getting larger, and rounder, and there's the sound some equate to the roar of a tornado. The train is coming.

Greenspan and Trusting the Market

In a 60 Minutes interview, Leslie Stahl asked former Fed chairman Alan Greenspan whether he knew what was going on in the sub-prime lending market. His answer?

While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late. I didn't really get it until very late in 2005 and 2006.

Huh? An economist with his experience didn't understand that lenders will be happy to take outrageous risks if they think they can sell off the loans and not have to deal with the defaults? It's not as though no one brought it up. According to the CBS story, former Fed governor Ed Gramlich said that he had proposed examining the lending practices, but that Greenspan rejected the idea. Apparently that is the case:

"I thought that…we would not be capable of doing what he was suggesting," Greenspan says.

"But if sitting on them, taking some regula-what…" Stahl asks.

"Well, I think not," Greenspan replies.

"Even looking into it?" Stahl asks.

"It's nothing to look in to particularly because we knew there was a number of such practices going on, but it's very difficult for banking regulators to deal with that," Greenspan says.

So, he knew they were going on. I cannot - simply cannot - believe that Greenspan couldn't see the writing on the Wall Street, not after warning about irrational exuberance. No way to check on this? Not even with all the intellectual power and computing systems that the Fed has? Couldn't find a way to do some random checking on credit scores that were probably part of the lending record versus the size of loan and verified income? No way to see how many of the loans depended on lenders not verifying income, maybe? I don't believe it. This wouldn't be rocket science. and then there was this interchange:

"Just remember we raised interest rates at every meeting from June of 2004 till I got out of office," he says.

"You raised rates in 2004. But only after you held interest rates at historically low level for three years, while the bubble, the housing bubble was forming," Stahl points out. "And that you had 13 rate cuts in that period of time."

"It was our job to unfreeze the American banking system if we wanted the economy to function. This required that we keep rates modestly low," Greenspan explains.

Unfreeze the banking system? This sounds dubious. American companies had clearly over-invested in the 1990s and it would take them years to digest all that spending. Low interest rates weren't needed for investment - they were needed to get consumers to spend.

Perhaps Greenspan truly believed in the market the way I see many treat it, almost as a form of religion. Free everything up and it will all work out. I somehow don't think he's try to rig the system to let certain people take advantage. When asked about the major American car companies, he replied, "I would suggest they focus on selling, creating better cars for their customers," rather than depend on lowered interest rates. Perfectly sound advice. They aren't selling because they aren't producing products that consumers want most.

But there's a problem with the market-cures-all vision of unfettered capitalism. Depending on a market isn't relying on some invisible, rational, impartial mechanism that evens out the bumps. It means trusting to human greed, fear, and emotional goads that cause people to do the most unbelievably stupid things. Lending large sums at high interest rates, which will only go up, to people who will be unlikely to maintain payments is stupid business. It's hoping that enough of the money will come in to cover the losses. This isn't business; it's gambling.

As happens with most such decisions, what people do is rationalize why what they want to do really makes sense. Maybe that's what Greenspan was doing - hoping that things would work out as they were "supposed to."