Friday, October 31, 2008

This Week in Bank Failures

I am just guessing there won’t be any bank takeovers reported today as we head into the pre-election weekend. The longer the economic turmoil continues, though, the greater the potential for banks to falter. In normal times, when you have money, you want to keep it in the bank as long as you can so you can earn more interest on it. That’s a habit you may want to reverse now. With interest rates so low, all the more so after this week’s Fed rate cut, it makes sense to concentrate instead on keeping your money safe. When you have money, keeping money in the bank is still a good way to protect it from theft. Still, here are seven things you can do to have a little less of it at risk in the bank:

  1. Pay bills as soon as they come in.
  2. Pay bills online when you can instead of writing a check that might spend several days in the mail.
  3. Pay off credit cards as often as once a week.
  4. Pay for items you order in advance when you can.
  5. If you have taxes to pay, don’t wait for the deadline. Pay as soon as you have the money together. Consider making quarterly income tax payments even if it might not be required.
  6. Also don’t wait for deadlines to make loan payments. The payment might be due at the end of the month, but it is perfectly okay to pay at the beginning of the month.
  7. If you are saving money to use for regular loan payments, keep the money in the same bank where the loan is.

All these suggestions represent a shift in priorities, so that being very sure you meet your obligations becomes more important than earning interest on your bank balances. In this way of thinking, when you know you have to pay for something you’ve received, you want to pay it as soon as you can. When you have money, this is the ultimate way of protecting it — using it to discharge your obligations. And it is simpler too. It might even make you feel more prosperous about your financial situation, as you say, “I must be doing pretty well if I can pay all my bills as soon as they come in.” In times like these, that feeling of prosperity is worth much more than the pennies you might be earning in interest.

Thursday, October 30, 2008

Standing on the Sidelines or Sprinting for the Exits

The stock market traditionally hits bottom after most investors are, in Wall Street terms, standing on the sidelines, waiting for prices to stabilize so they can start buying again. Every week since at least the end of July, including this week, at least one analyst has announced a bottom in the stock market. Most of these calls have met with disappointment as the market did not turn upward. I think there is an explanation for the excessive optimism we have been seeing about the stock market. Most of the analysts on Wall Street have not, in their lifetimes, seen the financial underpinnings of the market get so bad that many of the participants are not standing on the sidelines, but are instead sprinting for the exits. If you forget to ask how much of the money is standing on the sidelines and how much is sprinting for the exits, the market seems to be in a better place than it is.

Of course, I am not suggesting that everyone is sprinting for the exits. When I look at pension funds, for example, they seem to be staying put. It is hard to imagine where else they could go. But there are plenty of signs of market participants sprinting for the exits — grabbing what money they can and getting out of town, sometimes literally:

  • Why did Treasury Secretary Henry Paulson drop his original Wall Street Bailout plan, after going to so much trouble to get it railroaded through Congress, and replace it, at least for now, with a bank capitalization plan? One reason was that he did not want the money to get caught up in the rush for the exits. If he had gone through with his original plan, much of the bailout money would have left the country by now.
  • AP reported recently on Wall Street workers leaving the New York metro area, sometimes even leaving the industry or leaving the country. When some of the top financial talent in New York are selling their homes at a loss just so they can get out of town quickly, you know some of the money that is leaving with them is not coming back anytime soon.
  • Hedge fund liquidations continue at an alarming rate that is not fully explained by institutional or market forces. Rather, it appears that many hedge fund holders are being forced to liquidate to cover losses elsewhere. That is to say, trillions of dollars in paper assets are simply vanishing in thin air. These investors won’t have the money to put back into the markets when the markets hit bottom. One current sign of forced liquidations is the 15 percent decline in safe-haven assets in categories such as gold, utilities, and health care.
  • An unprecedented number of U.S. investors are nearing retirement. In many cases, the most rational action for them is to take all the money they know they have and live on it for the rest of their lives. Not all of them will take that rational course of action, of course, but many will. As one journalist recently put it, “That money shouldn’t have been in the stock market in the first place!” and it won’t be coming back to the stock market, at least not much of it, during the lifetimes of its owners.
  • When the major brokerage houses converted to bank holding companies, CNBC called it the end of an era. What I think they meant, but couldn’t quite say, was that it was the end of Wall Street as we know it.
  • The recent record levels of volatility in the stock market suggest that some of the billion-dollar players who previously smoothed out market fluctuations have now run out of money.

With so much more de-leveraging and liquidating to come, it is hard for me to imagine that the stock market can stay consistently at this month’s levels. But I also don’t think the market bottom will be a dramatic event that will be obvious at the time. It could easily be just a momentary dip, and it may be a year later before we can look back and say, those 15 minutes were the lowest the market went.

Wednesday, October 29, 2008

Housing Slump Accelerates Telephone Changes

The real estate slump in the United States has foreclosures and evictions occurring faster than ever before. These, in turn, are accelerating changes in the way people use telephone service.

These days, home telephone service is just for those who have a permanent home. The hours of administrative hurdles and $100 installation fee that go with establishing a wireline, also called a land line, usually make economic sense only if you plan to stay in the same place for years. When you are not sure of your plans, it makes more sense to rely on a wireless service and other forms of telecommunications.

The real estate slump is affecting both homeowners and renters. Politicians have been talking a lot this year about homeowners losing their homes in foreclosure, but according to the people who keep track of such things, at least as many tenants are being evicted as real estate owners get squeezed. For many tenants, there is no advance warning that the eviction notice is coming, so they have to move with little time to plan anything. This almost always means moving somewhere temporarily, and with all the costs of moving, a new wireline may be out of the question. This is one scenario by which millions of people have given up their wireline service this year.

In the third quarter, according to its report issued Monday, Verizon added 1.5 million wireless subscribers while losing 1.2 million wireline customers. These numbers are larger than industry observers had expected but make sense when you consider the effect of foreclosures and evictions.

The accelerating decline in wireline service also led to a merger this week, with CenturyTel acquiring Embarq (the spinoff of Sprint’s wireline business) in a stock swap. Both companies were profitable before the merger, but want to cut costs as the volume of business declines.

There was already a trend from wireline to wireless, and the turmoil in real estate is just making some of the transition happen sooner. This is in keeping with evolutionary theory, which holds that the most rapid change occurs in times of high stress.

Tuesday, October 28, 2008

With Stevens Conviction, Hope for Democracy

The conviction of Sen. Ted Stevens says that democracy is still alive in America.

Representative democracy works only when the representatives have to answer to the people. If most of their income comes in the form of favors from business interests, that makes them effectively employees of those businesses, and then they cannot help but serve the interests of those businesses and fail to serve the interests of the public.

As long as we cannot prevent politicians from making money, we must at least know the sources of their income so that we can call them out on their conflicts of interest. That is the purpose of financial disclosure. Ted Stevens clearly did not want his conflicts of interest to be known. The trial of Stevens showed that he was receiving concessions on business transactions that easily exceeded his salary as a senator. In effect, he was not really a senator, but a lobbyist posing as a senator. The evidence showed that Stevens concealed a fortune in income, and that even after he knew what he was being investigated for, he still took actions to conceal his other income, his lobbying income, if you will.

Stevens’ reaction to the conviction show how badly this prosecution was needed. Stevens was visibly angry when the verdicts were read. Later, when he finally talked to the press, it was to issue thinly veiled threats to his fellow senators, Alaska voters, and the Justice Department. If Stevens really believes he is powerful enough to threaten the whole world from a jail cell, then he is not mentally or morally qualified to hold any position of responsibility.

The judge in this case might have been intimidated by the power of the defendant, as he seemed to do everything within his discretion to give the trial to the defense. The jurors, though, were having none of it. In returning such a quick and decisive verdict, they may give other Washington politicians reason to worry — to worry that the American people are sick of politicians who act as if they are above the law.

It is hard to get voters anywhere to vote for a convicted criminal, and Alaska voters are particularly known for their spirit of independence. By threatening the voters, Stevens reduced his already minimal chances of winning next week’s election. It is really too late for him to pull out of the election, but I hope he will have the decency and good sense to resign next week after the election is over.

There is much more to be done to restore the functioning of democracy in the United States. The conviction of Sen. Stevens is nevertheless a decisive step in that direction.

Monday, October 27, 2008

Stunned By Disappointment

Economists don’t traditionally talk much about disappointment. You could go through an entire economic textbook and not find the concept of disappointment mentioned even once. Yet a great deal of our economic success, both individually and collectively, depends on how we respond to disappointment.

Disappointment happens after we put a great deal of energy toward a particular outcome. It doesn’t matter so much what form the energy takes, or what form the disappointment takes. The important question is what happens to the energy. When disappointment leaves us stunned, that is when it causes the greatest difficulty. It means all the energy we had put into something has dissipated.

When you are stunned by disappointment it is hard to keep perspective. Yesterday Joe Vitale wrote a personal story about this in order to emphasize one way of keeping perspective, by remembering how much things can change:

If you’re in a place right now that doesn’t feel so good or seem too safe, I urge you to remind yourself that this is only temporary.

This is the cure for despair.

As I say in my book, The Attractor Factor, this is simply current reality, and current reality can change.

You can help it along by doing what you know and need to do.

But remember, the sun will shine again.

It always does.

Sunday, October 26, 2008

Health Care Is Peaking

Last week’s health-care news provides the strongest indication yet of a decline in the health care sector. Drug maker Merck announced a reduction of 7,200 workers. The company blamed problems in product development for its cutbacks, but also conceded that consumer spending on drugs has declined across the board.

Less drugs means less illness, and not just because the purpose of drugs is to treat illness. Drugs also cause or contribute to a significant fraction of illness.

Drugs are declining. People are using over-the-counter drugs less often. Doctors are prescribing fewer prescription drugs, and patients are filling fewer prescriptions. The prices of some popular prescription drugs have fallen. It is getting harder to get insurance companies to cover expensive new drugs. Lobbyists six years ago could get government officials to force people to take drugs, but now those lobbying efforts are falling flat.

Drug sales have declined for two years in a row, and although the declines are tiny, they are large enough to shake up an industry that, much like the automobile industry, thought it was guaranteed to continue growing year after year.

But drugs are only a small part of the health care sector. A stronger indication of a decline in health care would be mass layoffs at hospitals. And that is exactly what happened last week. Thousands of workers lost their jobs in instant layoffs at university and community hospitals. Typically, the hospital was laying off 1 percent of its staff. Most were east of the Mississippi, but I also found reports of hospital layoffs in Texas and California. All of the layoffs seemed to be the result of the same trend: a declining number of patients. Some hospitals blamed the decline on expansion at competing hospitals, but the same kind of decline also occurred in counties that have only one hospital.

Press reports have suggested that the decline in health care is the result of consumers getting squeezed economically, yet that contradicts past experience that says that health care is “recession-proof.” Indeed, venture capitalists are investing record amounts of money in health care in the belief that it is one of the few growth opportunities in the current economy. Yet no business can expand without a growth in customer spending, and consumers show little indication of wanting to spend their lives in the health care system.

Most of the “growth” in health care is really just the expansion of facilities, which is happening because hospital boards and investors are looking too superficially at demographic trends. Yes, it is true that the U.S. population is growing and aging. Yes, past experience suggests that this would lead to a greater need for health care. But it would be a huge mistake to imagine that the 70-year-olds of 2010 will be the same as those of 1990.

The whole culture has changed. In the 1980s most people thought that physical activity was undignified for an adult. Now the thought is that physical activity is necessary for survival. The cultural idea of acceptable muscle mass has increased, especially for women. In the 1970s, a woman who showed any muscle at all was quite unfairly thought by many to be grotesque. By 2000, women who failed to show at least an average level of muscle definition were being accused, equally unfairly, of anorexia. The perception of cigarette smoking has gone from a nuisance to an offense as the total numbers of smokers has declined by half. (Smoking was banned in Pennsylvania workplaces last month, and people say, “Really? That was just last month? Are you sure that wasn’t five or ten years ago?”) In the last five years there have been substantial declines in other vices, most notably beef and beer. Food labeling has improved so that the average consumer is now aware of fat content and trans fats. Technology has improved the quality of everything from drinking water to shoes. Wonder Bread went from being the most popular bread 30 years ago to going bankrupt last year.

A best-selling book, Natural Cures “They” Don’t Want You to Know About, and one of the top movie documentaries ever, Sicko, have forever changed people’s ideas about health. People know longer base their health strategies on the idea that the doctor will have something to make them feel better. Instead, people are looking for ways to live better — and increasingly finding them. Those who invest in the current boom in health care are betting against the ingenuity of the American people. That is not likely to be a winning bet.

I hate to see the massive expansion projects going on at so many hospitals when I know that half of the hospitals in the country will close in the next 30 years as demand for health care falls off. And it is not a case of the builders getting ahead of the growth curve, as in the overbuilding of retail space 20 space. Some stores that were built 20 years ago are just now being occupied. But some of the rooms that hospitals are adding this year will never be occupied.

It seems to me that the venture capitalists are wrong again, and that health care is peaking right now. Drug use and hospital visits are declining already. Doctor visits and medical tests will be next. The threat of unemployment will hasten this trend. People who know they can’t afford to be sick take fewer risks with their health — and once they learn how to be healthy, they won’t suddenly stop when the economy improves. Fifteen years from now, we will look back on this period and say, “How did we ever let the health care system grow so big?”

It’s a trend that Michael Moore, the filmmaker who made Sicko, talked about when that movie was released. Seeing the stories he captured in his movie inspired him to take charge of his own health. The change is obvious if you look at Moore this year and compare that to the way he looked four years ago, which you can see in his newly released movie Slacker Uprising. Moore may still not be the picture of health, but he has a healthy glow now that tells you he is twice as healthy as he used to be. Nearly all of us will be making the same change in the coming years as cultural changes push us in that direction. People think I’m exaggerating when I say that the demand for health care will fall by half. But that’s what’s going to happen.

Saturday, October 25, 2008

The U.S. Commerce Department is setting up a new web site,, to help citizens who find themselves squeezed by the economy. “We’re calling it a ‘one-stop-shop’ for the American people to find help to keep their homes, find jobs and protect their savings.” That’s Commerce Secretary Carlos Gutierrez’s description of the planned web site in a question-and-answer session yesterday.

The domain name is live but the site itself is still in the planning stages. So far, there are only links to the participating agencies.

Friday, October 24, 2008

This Week in Bank Failures

The focus in Washington has moved on from banks to money market funds. In a new initiative, JPMorgan Chase is taking $540 billion in funding from the Fed to operate five funds to purchase certificates of deposit, bank notes, and commercial paper from money market funds. This will benefit banks indirectly as banks are managers and shareholders of money market funds.

U.S. economic news shows that problems with jobs and foreclosures are getting worse. RealtyTrac says foreclosure counts are up 71 percent from the already elevated levels of a year ago. U.S. banking authorities are trying to put together a plan to reduce foreclosures, which might include FDIC guarantees of modified mortgages, but they do not yet seem ready to consider the obvious stopgap measure of a moratorium on foreclosures of owner-occupied buildings. Half a million workers lost jobs last week, and economists now expect the U.S. economy to continue to shed at least a quarter of a million jobs every month through next year. Layoffs were announced at Goldman Sachs (3,260), Yahoo (1,500), Merck (7,200 worldwide), Xerox (3,000), across the U.S. auto industry (thousands), and in hospitals (thousands). Layoffs are a concern for banks primarily because they tend to lead to mortgage defaults and foreclosures.

Problems in banking continue on a massive scale worldwide, and moves to shore up banks that would have raised eyebrows just three months ago go practically unnoticed. One example is the 10 billion euro capital package provided to one of my banks, ING Group, by the Netherlands government. The comparatively small size of this bailout has left observers imagining that ING’s problems must not be very serious. This is not the reaction the move would have drawn had it occurred in July or August.

What’s worse than a run on a bank? BBC News business editor Robert Peston writes about runs on countries, as billions of dollars are pulled out from under a growing list of countries: Iceland, Hungary, Pakistan, Ukraine, Belarus, South Africa, Argentina, South Korea. Without international intervention, a run on a country could bring down every bank in the country.

The Lehman Brothers credit default swaps were settled quietly Tuesday with a surprisingly low $5.2 billion changing hands, according to the clearing house. That is less than 2 percent of the total amount issued, as the vast majority were canceled out by subsequent trades. Some observers had worried about billions of dollars in liabilities for AIG. Instead, AIG had to pay just $6 million to settle its share of derivatives on Lehman debt. Nevertheless, AIG continues to burn through more than $1 billion a day in government money, and few observers believe its current $123 billion credit line will be enough to get through the rest of the year.

Wachovia, which is preparing to be acquired by Wells Fargo, reported a $23.9 billion quarterly loss. This is bad, but not as bad as it sounds. Wachovia removed phantom assets so that they do not have to be reported as losses later by Wells Fargo. The accounting adjustments provided most of the losses. In the meantime, a shareholder lawsuit seeks to block the acquisition. If successful, the suit would effectively put Wachovia in liquidation, with little reason to hope that there would be any money left over for the shareholders. Wachovia’s stock value has continued to decline.

National City Bank, which has been a subject of concern all year, agreed this morning to be acquired by nearby PNC Bank in a stock swap. The U.S. Treasury is providing $8 billion in financing for the deal. National City’s stock price had fallen by 92 percent in a little over a year since its financial troubles became known, giving it a market value of $5 billion. The stock swap values the company at a little over $4 billion. Earlier this week National City reported a quarterly loss approaching $1 billion and announced 4,000 job cuts.

PNC, centered in Pittsburgh, has been focusing this year on expanding its reach in the Mid-Atlantic; the National City acquisition gives it a much stronger presence in the states to its west, from Ohio to Missouri. The combination makes it the fourth largest bank in the United States according to the number of locations.

Alpha Bank & Trust of Alpharetta, Georgia, was shut down tonight by Georgia banking officials and the FDIC. Alpha Bank had $346 in deposits at the end of September, and the FDIC estimates that $3 million were uninsured. Regulators said the bank failed to meet requirements for minimum operating capital. Alpha’s business model, based on rapid growth in a niche lending market, may have been its downfall. The Atlanta suburbs where it was located was one of the first areas to be hit by the real estate decline, more than a year before it hit nationwide. Alpha opened in May 2006, after the problems with Georgia’s economy had started to take their toll, and rushed to make loans that other banks in the area were hesitant to make at that point, especially for residential construction and land development. It made almost $200 million in loans in its first year at a time when unprecedented numbers of real estate loans were going bad. Closing after just 29 months, it is apparently the fastest failure ever for a bank with a Georgia charter. It is the second Alpharetta-based bank to fail this year.

Alpha’s deposits are being taken over by Stearns Bank, a commercial lender based in St. Cloud, Minnesota. Stearns is buying a small fraction of Alpha’s assets, but does not plan to buy either of Alpha’s offices. The offices will reopen Monday as Stearns Bank, and Stearns will sort out its plans for a permanent office in Georgia over the coming weeks. Currently, Stearns operates in Minnesota and Arizona.

Unlike previous bank takeovers arranged by the FDIC this year, Stearns does not seem to have a strategic plan in taking over Alpha Bank beyond the thought of setting up an office in the Southeast. Stearns’ CEO suggested in an interview that they would take their time to consider the new opportunities that the acquisition provides.

The FDIC will spend an estimated $158 million in taking over most of the assets of Alpha Bank.

Thursday, October 23, 2008

How Inflation Undermines Financial Security

Members of Congress have started to discuss a new round of economic stimulus measures. I am opposed to this in principle — untargeted economic stimulus has never solved anything more than the most mild recession, and what is needed now is not a boost of economic energy, but a change in direction. Another problem with the fiscal stimulus being considered is the inflation it is likely to cause. The federal government is already looking at a budget deficit the likes of which we have never seen. Budget deficits contribute to inflation, and if we add more borrowing and spending to what is already a record deficit, we are likely to see inflation to a degree that few of us have ever experienced, at a sustained annual rate of 20 percent or more, and perhaps much higher for shorter periods.

This kind of inflation is more than just the annoyance of paying higher prices and the hidden tax that takes away the value of your savings. It undermines all the financial arrangements that are supposed to provide us with financial security.

With high inflation, when you have to wait for money, it’s almost like not getting it at all. If the inflation rate is 20 percent, and you have to wait one year to get a payment, by then, the money will buy only 83 percent as much. If your cost of living adjustment comes only once a year, you may be living in poverty in the weeks before the increase. If a hurricane destroys your house, by the time the insurance company agrees they have to pay you, the money you get may be just half of what it takes to build a new house. You might have thought you had saved $3 million for your retirement, but after three years, the money might be only worth $2 million if the rate of inflation is much higher than the interest rate you are earning. These are some of the financial arrangements that lose much of their punch in periods of high inflation:

  • Money-back guarantees
  • Insurance — every kind
  • Savings and financial investments
  • Long-term contracts
  • Royalties for authors
  • Litigation
  • Advance reservations

Consider the effects of high inflation on health insurance. Health insurers are notorious for taking a long time to pay. Inflation gives them an incentive to pay even slower. But your physician has to pay in advance for all the supplies used to treat you. If your insurance company takes a year to pay your physician, it might not look like much of a problem to you, but your physician might go broke.

All this is troubling, but for the stability of the economy, the most troubling implication of high inflation is its effect on deposit insurance. The FDIC, which insures most U.S. bank deposits, is just one bank failure away from going broke. The FDIC can borrow from the U.S. Treasury, but the Treasury is also already frighteningly close to insolvency. If your bank fails in this unusual situation, the FDIC might not be able to pay back the amount of your deposits until after Congress agrees on a budget. In other words, it could take a year or two. And by then, the money you get won’t be worth so much. It’s a powerful disincentive against putting money in the bank — and with interest rates on savings that are already lower than the rate of inflation, and about to fall further, the incentives to keep money in the bank are almost nonexistent. But of course, if everyone takes their money out of the banks, the banks will all fail.

The banking system is a screwy system in times like these, a financial house of cards built on the savings accounts of savers who aren’t really being paid anything to participate in the scheme. The Fed should be raising interest rates to give people an incentive to keep their money in the banks — and even more important, Congress should be sending half a trillion dollars urgently to the FDIC so that you won’t have to worry about possibly losing most of your money in the event that your bank fails.

Most of all, though, Congress has to give up on the idea of massive deficit spending as the solution to every problem. It’s the deficit spending that makes inflation inevitable, so by spending less freely, Congress can rein in the most destabilizing effect in the economy right now. It is easy to be overconfident when inflation has been kept relatively under control for two decades. Yet no country that has pushed deficit spending to the limit the way the United States has this fall has ever avoided the perils of inflation. It is foolish to imagine that this time will be the one exception.

Wednesday, October 22, 2008

“Hello, Jimmy?”

“General Motors, according to various reports, is negotiating a merger with Chrysler LLC’s majority owner, Cerberus Capital Management LP. Why? Because the bosses at GM and Chrysler are deal makers who just can’t help themselves.” [Jeremy Cato writing yesterday in the Globe and Mail] Will a GM-Chrysler merger really accomplish anything beyond creating a bigger bankruptcy a few months down the road? Yes, it will. I know, because I was there.

I’ll be the first to admit that my work at GM was a little too much like beating my head against the wall. My advice about streamlining the company, slowing down production, and putting less pressure on the dealer network seemed to fall on deaf ears. I don’t mean to point fingers, though. When a company goes from being worth 11 figures to being worth 11 figures with a negative sign — well, you’re just in uncharted territory, and it’s no surprise that no one quite seemed to know what to do.

For my part, I was sick of it all. I just wanted to get out of there — I didn’t care if I ever saw another Allanté, Bravada, or Corvair for the rest of my life. And so, just like that, I was out of GM and back at Chrysler again. I walked in the door the same day they were taking the “Under New Management” sign out to the dumpster. And, perhaps not by coincidence, the new managers seemed eager to go out the door themselves.

Chrysler, as it turned out, was facing all the same problems as GM, but had almost the opposite attitude about them. At GM, if you tried to address the company’s problems, it would get you banned from the company picnic. Chrysler canceled its company picnic, then went on to fire everyone who thought the company was doing fine. Profits had not been good, to say the least, and with all the red ink they had on their fingers, it was hard to persuade my bosses at Chrysler that there was any reason for hope.

“Cut costs, and figure out the new motor technology, and you’ve got a future,” I told them.

But they wanted more than just to keep the company going for another ten years with the hope of turning it around. “We just want to be the biggest automaker in the world,” they told me. “When we started here, our plan was to get that done in two or three years, and then have a big pizza party and retire. But what can we do when our own sales are falling almost as fast as the sales at GM?”

“You could buy GM,” I suggested. “At this point, I don’t think its market cap is more than a couple million.”

“We don’t want to sink any more money into this business,” they said. “If we can’t make money in cars, maybe we’ll try video rental next.”

“But you just need someone else to pay for it,” I said. ”Maybe your friends at Wachovia will put up the money.”

“I hear what you’re saying, but I don’t think it will work,” they said. “The last time we talked to Wachovia, it seemed like they didn’t have anything left. It was so bad they were burning the furniture to keep warm.”

“But still,” I insisted, “there must be a way. Aren’t you the company that got that loan guarantee from Washington way back?”

“Well, yes, but that was Lee Iacocca. That was ages ago. And as soon as he paid it all back, he retired from the auto business and started that cola business of his.”

“But still,” I said. “Just mention the words, ‘loan guarantee,’ and I think Jimmy will be willing to talk about the future of GM. Do you have any idea how bad things are over there?

“I’ll see if I can get him on the phone right now,” I continued. “I think you might get your pizza party after all. Oh, and I won’t mention Iacocca’s name.”

I dialed the phone, and to my surprise, Jimmy answered on the first ring. I knew just what I wanted to say. “Hello, Jimmy? Remember that one and a half billion dollar lifeline you were looking for? Well, it turns out that Chrysler went to talk to the people in Washington and they got all the money. . . . Jimmy, calm down. I happen to have them in my office right now, and I think you might want to talk to them.”

They ushered me out of the office less than a minute later, of course, but if what I’m reading in the paper is true, they may already be making plans for their pizza party. I might not be invited to the event that I was so instrumental in setting up, but I’m not bitter. As a consultant, if I can find a solution to your problems and get paid for it, that’s all I really ask.

Tuesday, October 21, 2008

Why McCain Is Back in the Keystone State

John McCain has adopted a Pennsylvania-or-bust strategy.

That’s what I’m hearing. The McCain campaign’s plan is to win my state, Pennsylvania, and just hope everything works out for him in states like Virginia and Nevada.


It’s not a strategy so much as an admission of defeat.

Here are five reasons the McCain campaign might think they can win Pennsylvania:

  1. Pennsylvania went for a Republican presidential candidate as recently as 1988.
  2. Deep-seated racial prejudice might still be a factor in five or ten counties in the state, if you looked hard enough. (To be fair, no one seems to have found any of those counties yet.)
  3. Cindy McCain plays well here. Pennsylvania does not seem to share the resentment of “heiresses” that you would find in many other areas.
  4. Barack Obama lost the Pennsylvania primary. Hillary Clinton’s negative campaigning here left lingering doubts about Obama.
  5. With the election seemingly locked up, Obama may focus more on states that have competitive Senate races. There is no Senate race in Pennsylvania this year.

But here are five reasons why McCain doesn’t have a prayer in Pennsylvania:

  1. Obama leads McCain in the polls 51–40, and that lead is growing. That is a bigger margin than in states such as Colorado and Michigan that the McCain campaign has already conceded. Obama got twice as many votes in the primary as McCain.
  2. More than half of the state’s voters are registered Democrats. McCain might need 90 percent of the Republicans, independents, and Clinton voters to carry the state, but he does not have that level of support among any of those groups.
  3. Obama has visited Pennsylvania much more than McCain has this year. McCain would almost have to camp out in Pennsylvania until the election to catch up.
  4. Joe Biden, Obama’s running mate, is a favorite son candidate, a native of Pennsylvania and well known and widely admired as a senator from the neighboring state of Delaware. By contrast, Pennsylvanians tend to see McCain’s running mate Sarah Palin as an embarrassment. She has an uncanny resemblance to the counter-culture moonshiner types that we hope will not frighten away the tourists when they visit here.
  5. Moderate voters are not warming up to McCain’s message. They are more likely to have an unfavorable view of McCain after they see him. Moderates are the key to winning Pennsylvania, so heavy campaigning or advertising here will not help McCain unless he changes his message.

Why Pennsylvania? It’s a matter of travel convenience. John and Cindy can campaign in Pennsylvania and go home to Washington at the end of the day. The alternative, to target three or four smaller states, would have the McCain campaign spending too much time traveling and too little time campaigning to have an effect.

Yet McCain must realize he has no realistic chance of carrying Pennsylvania. Making the conveniently-located Keystone State the cornerstone of his electoral strategy would seem to be his way of saying, “I just want to go home.”

Monday, October 20, 2008

The Downside of Compact Fluorescent Lighting

One energy efficiency proposal that has been heard frequently in the last two years is a ban on incandescent light bulbs, often coupled with a mandate to replace these bulbs with compact fluorescent lighting. Yet compact fluorescent lighting has advantages and disadvantages. This speech from the floor of the House of Representatives earlier this year highlights some of the more superficial problems of compact fluorescent lighting.

In this speech, Rep. Poe pointedly relies only on U.S. government documents and product packaging for his information. That is a way of emphasizing that his evaluation of the technology is not based on theories or emotions, but on established facts. There are other disadvantages of compact fluorescent lighting that are not nearly so obvious or certain, and with the various disadvantages, I do not believe any home should rely entirely on compact fluorescent lighting.

When a technology has both advantages and disadvantages, that also means that it is not suitable for every situation. Therefore, it really is not practical to have the central planners of the economy evaluate the technology and decide whether everyone should use it. Instead, we need to rely primarily on the ability of individuals to adapt the technology to specific situations.

Sunday, October 19, 2008

The Consumer Distraction Index

I didn’t realize quite how much energy I was putting into the presidential election until I stopped. I had been following the candidates’ positions and voter reactions day by day, but somewhere between watching the final debate and being locked out of a rally three miles from home, it struck me that the race had diverged so much that it wasn’t really a race any more. I stopped following the race, and suddenly, everything looked different.

I was not the only one following the presidential race. A major polling company estimated from a poll last week that 55 percent of eligible voters have been following the race on a daily basis. That is more people than usually vote in an election. We know also that the presidential debates and convention speeches drew huge television and Internet audiences.

In the television business, it goes without saying that a large debate audience takes viewers away from other programs. It is just as true that a large debate audience takes viewers away from the movies, the restaurants, the mall, the auto races — away from consumer activity generally. As I wrote a couple of months ago, the distraction of the presidential race led manufacturers to delay the introduction of thousands of products. They want to introduce products at a time when the public will pay attention, and many of those product introductions will come in the two weeks after Election Day and at the beginning of next year.

Also this month, people have been following the slow-motion collapse of the global financial system with considerable interest. And in my area, I can’t help but notice how much people are suddenly interested in baseball.

All such distractions tend to reduce economic activity. When you spend extra time following the news, you are not spending or looking for a job. People can even forget to eat — and if a lot of people eat 10 percent less on any given day, it’s economically significant. And it is not just the news headlines that distract people’s attention. The dramas of life are at least as gripping. A friend spent last night in a hospital with his ailing father. Another is eagerly waiting to find out whether he was chosen for a part in a theater production. The more time people spend on the events of their own personal lives, the less time they have available to act as consumers.

This has an enormous effect on the national economy, but as far as I know, no one measures the degree of distraction, and even in times like these, economists usually ignore the effects of consumer distraction on consumer spending. I don’t believe anyone has ever attempted a consumer distraction index, but without considering what is on consumers’ minds, we can’t really track what is going on in the economy.

The closest thing we have is consumer confidence. There are various measure of consumer confidence, and as far as I know, all the major ones are based on telephone surveys that ask questions such as, “Do you think now is a good time to buy a major appliance?” The inclusion of questions such as these tends to reduce consumer confidence when consumers are distracted. A consumer who is thinking, “No, now is a good time to watch the World Series,” will offer pollsters less enthusiasm about consumer spending. The consumer seems less confident, but is actually just distracted. My hunch is that between 2 and 4 percent of the variations in consumer confidence numbers actually reflect changes in consumer distraction.

Just as consumer confidence affects some industries more than others, consumer distraction affects different industries in different ways. Distracted consumers are less likely to eat steak and more likely to eat pizza and drink coffee. They may suspend spending on matters of style while burning through more cell phone minutes than usual. Visit the mall during a big playoff game involving a local team, and you can see how much consumer distraction affects the retail sector. It is easy to imagine ways in which it could be useful to track consumer distraction.

I am not suggesting a design for a consumer distraction index at this point. That will take more research. I am only suggesting that a consumer distraction index would be a useful thing to have. But even without any specific measures to rely on, distraction is an important effect to be aware of whenever we try to understand patterns of consumer behavior.

Saturday, October 18, 2008

That’s What I Call a Debate Performance

Before the final presidential debate I wondered if John McCain might want to demonstrate some kind of skill to impress voters. Maybe like this.

Image courtesy of Amy Guskin,

Friday, October 17, 2008

This Week in Bank Failures

Authorities around the world rushed to put fixes in place, hoping to strengthen the banking system before the next bad news hits.

FDIC Changes

Two actions by the FDIC this week were designed to maintain confidence in banks.

To make it easier for banks to borrow, the FDIC is launching a plan to guarantee senior unsecured debt. Qualified debt issued by participating banks between now and June 30 will be insured against bank failure or bankruptcy through June 30, 2012. The FDIC is charging a 0.75 percent premium and other fees to pay for this coverage.

The FDIC has been talking up its debt guarantee program all week. This morning it also announced a blanket guarantee for non-interest bearing accounts. These accounts are mostly corporate checking accounts, and the move is meant to make it easier for employers to pay their employees without putting money at risk.


Another U.S. banking giant fell Monday night. Sovereign Bank, based in Philadelphia, was acquired by Spanish banking giant Banco Santander. Santander already owned 25 percent of Sovereign, and will pay $2 billion for the remaining shares. After the deal was announced, Sovereign showed its third quarter results, with a surprise loss of nearly $1 billion. Sovereign had lost two thirds of its stock value since the beginning of the year, and Santander paid a 3 percent premium over the distressed stock price. The price is at least double what the stock price could have been if the earnings report had come first, but still less than half of Sovereign’s book value.

Half of Sovereign’s losses in the quarter were tied to its sale of collateralized debt obligations (CDOs). The value of CDOs declined as the mortgage-backed securities they were based on suffered from late payments and defaults on the underlying mortgages. Most of the rest reflected a writedown of its shares of Fannie Mae and Freddie Mac. Sovereign showed a healthy profit from its current operations, but it was not nearly enough to cover its losses from its past mistakes.

Santander already has a significant presence in South America, and the Sovereign acquisition gives it its first street-level presence in the United States.

Global Concern

There were fewer surprises in Europe this week, but leaders took the relative quiet as breathing room rather than a sign that the crisis is winding down. In Sweden, Glitnir AB has found a buyer. The Swedish branch of Iceland’s Glitnir will be purchased by HQ Bank for 60 million kronor. HQ Bank, a small Swedish bank with 250 employees, calls the move a natural expansion of its operations. Iceland’s banks have been trying to raise money this month by selling off overseas operations.

Asia-Pacific countries have rushed to expand deposit guarantees this week. Hong Kong, Indonesia, New Zealand, Australia, Singapore, and Malaysia announced blanket guarantees for bank deposits through at least next year. Japan has long had deposit guarantees.

Offshore Banking and Hedge Funds

All week long world leaders wrestled with changes that might be needed in the structure of the banking system. Offshore banking was the main focus of concern, as banks that locate in countries of convenience are virtually free of regulation. French Prime Minister François Fillon on Wednesday called for a ban on offshore banking as a preliminary step toward an international framework for rebuilding the banking system.

Offshore banking can also be a tax haven for billionaires and hedge funds. The U.S. Internal Revenue Service was forced to adopt new rules this week about offshore banking after discovering that banks were using rules intended to allow foreigners to invest anonymously in U.S. companies to help wealthy Americans sneak at least $20 billion and probably more than $1 trillion overseas. Much of that money went into hedge funds, and in the new I.R.S. rules, offshore hedge funds and similar investment vehicles owned by U.S. investors are no longer permitted to be classified as anonymous foreign investors. However, the new rules leave so many loopholes that they are probably still completely ineffective.

Hedge funds are important to watch because of the way they connect the banking system to the stock market. Distressed hedge funds are now liquidating at alarming rates according to stock traders in New York, threatening a collapse of stock markets worldwide. Could a domino-style collapse of hedge funds be next? It’s a big concern because there is little that governments can do about offshore hedge funds when something goes wrong, and no one really knows how many bank assets could be erased in a broad hedge fund collapse.

Wall Street Bailout Declared a Failure

President Bush defended the Wall Street Bailout plan this morning, saying it would take time to work, but that it was large enough and bold enough to do what was needed. He gave his speech in front of the U.S. Chamber of Commerce building, as if to say that the program is meant to enrich business owners broadly.

Nevertheless, so far, the money is going only to banks and financial institutions, and Wall Street analysts are already calling the program a failure, citing bank executives who say they are likely to sit on the new money for at least a quarter, if not a couple of years. In other words, the executives are not so sure that even with the additional capital they can keep their institutions above water. “You can’t force banks to start lending money,” is the widely repeated line that seems to sum up the situation.

One More Crisis for AIG

Tuesday is the deadline for paying on credit default swap (CDS) contracts that guaranteed bankrupt brokerage Lehman Brothers. No one officially knows who holds these contracts or how much they may owe (credit default swaps are basically secret). I have seen estimates as low as $6 billion (though the total is now known to be more than that) and as high as $270 billion. Only about $8 billion in obligations had been declared as of this morning. This has people looking at AIG (American International Group) with considerable concern. AIG was until recently the center of the CDS world, so it is hard to believe that its share of the mess will be less than a few billion dollars. AIG could easily have to pay more than enough to wipe out its remaining $6 billion in market capitalization. AIG’s statement that it will need an additional $38 billion is taken by some as a reference to its impending Lehman Brothers obligations.

AIG, you may recall, is essential to the continued existence of the world’s major banks. AIG-issued credit default swaps are guarantees that allow banks to keep trillions of dollars in obligations off their balance sheets, and an AIG insolvency would force banks to recognize all those obligations at once, making an unknown number of banks also officially insolvent. To maintain this accounting fiction that allows banks to pretend to be solvent, the U.S. government will surely be forced to fully nationalize AIG (in the past month, the government has already come to own more than half of the company).

Thursday, October 16, 2008

John McCain Comes to Town

John McCain’s presidential campaign brought him to Downingtown this morning for a rally just 11 hours after the final debate last night on Long Island.

My first reaction on hearing this news was how fortunate I was to have two presidential candidates come to my town in the same year. But I was mistaken. McCain’s “rally,” which I understand is now underway, is an invitation-only event, not open to the public. No ticket? Just don’t go, because you absolutely won’t get in.

What is going on? If only loyal supporters and powerful people with money can get into political rallies, is there any connection at all left between the candidate and the voters? How can the people who have been excluded from the rally help but feel excluded from the campaign?

Where will McCain get the votes he needs if he is shutting the public out? He certainly didn’t win any friends with his performance in last night’s debate, a dull exchange in which the only time McCain’s eyes really lit up were when he was talking about who was on what committee when. McCain’s views and angry demeanor in the debate were so poorly received that CNN’s instant polling recorded McCain’s unfavorable rating increasing, in two hours, from 45 percent to 49 percent. A Republican-leaning Fox News focus group agreed unanimously (!) that Obama won the debate. Perhaps most damning for McCain was the large number of viewers who tuned out before the debate was over — because the election is over.

And maybe that’s the real point of McCain’s closed doors. He won’t win the election, doesn’t have a prayer of carrying Pennsylvania, but he hopes he can do some kind of damage control to start to rebuild the Republican Party and pay off his campaign debts. Yet some of my neighbors who were turned away at the club entrance may not be Republicans anymore after today. In a political campaign, you can’t completely shut the public out without making yourself irrelevant. I just don’t get it.

Wednesday, October 15, 2008

Food in the Cupboard

I hope you’re spending less than you’re making, so that you have some money left over.

In normal times, you could add to your financial strength by putting money in the bank or the stock market. That still might work, but I wouldn’t rely on it entirely.

One of my banks recently notified me that it was cutting my money market interest rate to 0.15 percent. That means if I keep $8,000 in my account for a month, they will pay me, you guessed it, one dollar in interest. If I were a multimillionaire reckless enough to keep $2 million in the bank, they would pay me a whopping $250 at the end of the month. Even a multimillionaire could go hungry trying to live off the interest on their money.

It’s not like the bank really wants my money, is it? But it’s not really the bank’s fault. Interest rates generally follow the interest rates set by the Federal Reserve Bank, which just decided 2 percent was too high for one of their reference interest rates, and cut it to 1.5 percent. Savings rates traditionally run about 2 percent less than the Fed’s rates, so the bank can pay its expenses — but that would be negative one half percent. So the bank is actually doing me a favor by paying me a little over a seventh of a percent in interest.

My money is safe in the bank — safe from burglars, that is. But how safe is it really? Not very — because of inflation, bank failures, a near-broke FDIC, and a near-broke U.S. Treasury. More about that another day.

And the stock market — Wall Street seems to be in the process of shutting down and moving out as fast as it can go, so right now, the less said about stocks, the better.

You’ll probably still want to keep some of your money in the bank, and put some of it in the stock market after it hits bottom, but it is more important now to keep a little money at home, and to start buying things you are sure to need in the near future.

I don’t want you to rush out and stock up on three months’ worth of supplies this morning, because if everyone did that all at once, the supermarkets would be stripped bare and there would be a nationwide panic. But if you have the money, gradually start accumulating a few month’s worth of supplies. Get an extra bottle of mouthwash, a box of laundry detergent, some toilet paper. The next time, bring home some extra canned vegetables, pasta, flour, beans, and rice.

When you store food for a period of time, remember that you have to protect it from rodents and insects. This means keeping it in solid containers. Don’t accumulate more than you really have room for. Don’t stock up at all if you are getting ready to move.

In normal times, stocking up like this is something I would never recommend. But I am not sure these are normal times.

Stocking up serves two purposes. First, it guards against the calamity that would hit if you lost your paycheck, savings, and credit accounts simultaneously. In normal times, there would no reason to worry about that happening. Over the next two years, it absolutely will happen to a few unlucky people, and if things go badly, to more than a few people.

Second, stocking up is a hedge against inflation. In inflationary times, buying things a little sooner is like buying them at a discount. When prices are likely to go up month after month, and unlikely to go down, you pay less if you buy this month than if you wait till next month.

And these are inflationary times. The Wall Street bailout plan and the subsequent initiatives that have come out of Washington are almost all inflationary by nature. Other countries that have undertaken similar deficit spending binges have seen inflation rates of 80 percent or 500 percent. The U.S. economy is stronger than those countries were. Still, we could see inflation of 20 to 50 percent a year, more than anyone has ever experienced in the United States. Even if inflation is “only” 8 percent a year, that still makes buying things in advance, if you do it right, better than money in the bank.

It is a rare economic time when food in the cupboard is a surer investment than money in the bank. In my opinion, you should still have some money in the bank. But it is just as important to make sure you have food in the cupboard.

Tuesday, October 14, 2008

Angry and Economically Vulnerable

For two hours over the weekend, the top video on YouTube was “The McCain-Palin Mob,” a rough-cut sequence of interviews with voters outside a political rally. These voters were angry about what they had heard — stories about a suspicious candidate who had materialized seemingly out of nowhere within the past year to take over their country by winning a national election. They were so angry they couldn’t think straight. More than a million people have watched this video on YouTube, and I believe many are watching to laugh at the inane things people can think when they are angry enough.

The anger the voters show in the video is not a reaction to anything anyone did to harm or threaten them, and it is not a random accident either. It is the result of a political campaign. This is something that has happened before. From time to time, candidates think they can manipulate voters by telling them stories that make them frightened and angry. But there is a serious flaw with this as a political strategy.

First of all, as others have commented recently, there is little evidence that anger gets people to vote. On the contrary, anger is a technique used, mostly by incumbents, to keep people from voting. It is a vote suppression technique. When voters are angry, they show their anger mainly by staying home on election day. As a candidate, if you tell people things to make them angry, the people who are most likely to not vote are the people who are paying the most attention to you. You are suppressing the vote of your own supporters. That is hardly a way to win a popular election.

But that is not the flaw I am referring to. There is a worse problem with anger as a political tool, especially right now. Angry people are economically vulnerable. With their diminished ability to separate fact from fantasy, it is very hard for them to adjust to changing economic circumstances. They have trouble making the changes that get the economy going again in a recession. If many people in any particular area are angry, the recession could hit harder and last longer there. And so a politician who uses a strategy of anger risks impoverishing her own supporters.

This fits with the distinction between energy and direction that I wrote about yesterday. The purpose of anger is to raise your energy — specifically to give yourself a boost of energy for a few minutes of physical combat. As I wrote yesterday, extra energy can compound the problems of a recession, which is caused in the first place by too much energy and the lack of a strong enough direction.

When you put together lots of people who have lots of angry energy and no coherent direction, what you have is a mob. That is what the video shows. If you watch it, it will remind you how hard it is for a mob to solve even the simplest problem. This is a time when we need to be empowering people to solve economic problems. Anger is not the right emotion to make that happen.

Monday, October 13, 2008

Energy and Direction

When you reduce it to the most primal terms, economic success is based on two forces: energy and direction. Things go best when these are in balance.

There are times when you know exactly what to do, and you just want to go ahead and do it. This is when you hope you have enough energy to match your direction.

I remember a time seven years ago when I was writing urgently needed software fixes and preparing one of my books to go to press. Both projects perfectly fit my talents, they paid well, and they were needed quickly, so could I get myself through the 14-hour days? That was a case of having more direction than energy. It worked out well enough, but it wasn’t balanced; I wouldn’t have been able to keep it up for more than a few weeks.

The other extreme happens when disappointment strikes. You fail the test and don’t get the job after all. Your business keeps losing money and all you can do is shut it down. And you don’t know what to do next. But in the bigger picture, disappointment is not a bad thing. It is what stops you when you are putting your energy in the wrong direction.

When you are figuring out where to turn next, what you don’t need is more energy, at least not the same kind of energy you pour into your work when you know exactly what to do. What you need is direction — the other primal force that goes into economic activity.

It is important to be aware of the distinction between energy and direction whenever there is an economic problem. If there is an imbalance in one of these two economic forces, you usually cannot solve the problem by adjusting the other one. If you do not know your direction, it does not help to add energy or to go faster. If you cannot get yourself going, even though you know what to do, the only solution is to add energy; it will not help to further refine your direction until the energy is there.

The same is true of the economy as a whole. A recession is often described as a “sluggish” economy, but it is not really a shortage of energy. Rather, it is a deficiency of direction, a natural result when competing businesses put too much energy into staying ahead of each other when they are all going in the wrong direction. A recession is not solved by adding more energy, but by adding direction. This means that efforts to “stimulate” the economy will not resolve the recession, but will actually make things worse. Unless, that is, they are focused narrowly on the direction we need to go. The economic stimulus package of May and June did not end the recession, because it did not provide any direction. It served only to make the coming crash more spectacular when it happened.

Other non-directional proposals such as investment tax credits or a reduction in taxes on investments would do similar harm. But a massive investment in energy independence for the country — that is the kind of thing that could pull us out of the recession, because energy independence is a direction we need to go in right now.

Trying to rescue the national economy by pumping it up is rather like giving a man cocaine because he just lost his job — the buzz is dangerous and doesn’t do anything to solve the problem. A recession is a time for us collectively to find our new direction. And if we do it well enough, there might not be another recession for a long time.

Sunday, October 12, 2008

A 1 Percent Change

Gasoline prices are falling here in Pennsylvania. At this rate, they might be below $3 a gallon by next weekend. People are happy about this, and one of my friends told me, “It’s a good time to take a road trip.”

But no one I know is taking a road trip beyond the traditional weekend at Grandma’s house.

If you went to the mall in King of Prussia yesterday, you would think boom times never left. You would have to really like crowds to approach Starbucks or the Apple Store.

But retailers, including Starbucks, say that sales totals continue to be disappointing, perhaps even a little lower than last year. And go into one of the high-end department stores, or a few miles down the road at Target or Circuit City, and the place is so quiet you might feel like you should ask whether the store is open.

The difference between boom times and depression are so stark in national economic terms that you would think they are the result of drastic changes in behavior, but they aren’t. It only takes small changes in the way people perceive their financial options and make decisions to make major changes in the economy.

In recent years, the U.S. economy has wavered mostly between 1 percent and 2 percent growth rates. At 1 percent growth, the economy is faltering, unemployment is rising, it’s hard to get a raise, businesses postpone major investments — that’s a painful state for the economy to be in. At 2 percent growth, the economy is basically working. More people are finding jobs, and workers can expect to get a pay raise that keeps up with inflation. Businesses can modernize and invest for the future. And if we could get to 3 percent growth, that would be a boom time, when businesses would try to accelerate their plans and would be offering raises so their best workers wouldn’t leave.

That gives you an idea how much a 1 percent change affects the economy as a whole. And a 1 percent change in the whole economy could, in theory, occur just from every single person making a 1 percent change in their economic behavior.

But some of your economic behavior can change by 10 percent or more before you even notice you are doing anything different. When I heard, “It’s a good time to take a road trip,” that’s when it occurred to me: no one has been taking road trips. That used to be a regular part of life, but sometime around June, it seemed like everyone stopped doing it. Obviously, we were discouraged by the high cost of driving, but I’m not sure it was a conscious decision on anyone’s part. It’s more like life is busy and everyone just forgot.

I know a few people who are political organizers, and in the middle of everything else they are doing this fall, they never got around to buying any new fall clothes. They were busy doing other things, and perhaps the mild September weather didn’t remind them that it was the fall clothing season. To them, it’s a minor omission that goes almost unnoticed. Skipping a season also means that their clothing purchases for the year will be about 25 percent less than usual.

If enough people are just forgetting to spend money in this kind of way, it’s enough to drag down the economic aggregates.

Or, think of it this way. If you are feeling just the slightest bit cautious, you might go to the mall 5 percent less often, go into 5 percent fewer stores while you are there, and spend 5 percent less on average in each store. You may not be able to tell that you are doing anything different. After all, you are still doing all the things you expect to do. Yet you are spending 14 percent less.

It is the same in business. Feeling just a hint of budget pressure, managers may go ahead and interview for all their open positions, yet end up hiring only half as many people, leaving some positions vacant. “Those weren’t the ideal candidates we were hoping for,” they may say, yet it is really the possibility of budget trouble that makes them hesitate.

This is the kind of thing we’re seeing across the economy now. In a growing economy, the hesitation in some areas would be balanced out by enthusiasm in other areas. The areas that are suddenly growing now — natural food, electric cars, insulation, alternative energy, espionage, hurricane recovery, political advertising, and so on — are not nearly large enough to carry the economy as banking, construction, real estate, personal services, health care, restaurants, fuel-burning cars, consumer products, movies, and other areas falter. The growth we are looking for will come soon enough, as more business adjust to provide the things that people are willing to buy now.

Saturday, October 11, 2008

Derivative Anxiety

President Bush poked his head outside yesterday just long enough to read a prepared statement about how bad the economy is. Using phrases such as “losing their homes,” “abusive practices,” and “freezing up,” he so firmly emphasized how fraught with peril the current economic circumstances are that I am not sure more than a few people heard the rest of what he said.

Bush hinted that Washington had done, or started on, essentially all that it could do, and that there was little more he could do at this point but wait to see whether these actions have any effect.

And he suggested that ordinary citizens and Wall Street traders were partly to blame by buying into the sense of crisis that he himself had created in Washington to try to get the Paulson slush fund through Congress two weeks ago. Anxiety, he said, can feed anxiety, and that doesn’t solve any problems.

Bush might as well have said, “I have nothing to be anxious about but anxiety itself.” He was very clearly anxious, and rightly so, as the anxious actions of most of the people in the country are currently making his policy initiatives look downright foolish.

But where does anxiety come from? Anxiety is a kind of fear, but with a focus on dangers that are mostly unknown. There is a lack of clarity in the financial system that makes the current crisis seem to move in frightening fits and starts. If we knew what was really going on, we would not be nearly so anxious.

But we know there is much we do not know about what is going on in the financial system. We were startled to learn this week that the financial statements of Wachovia, one of the largest banks in the country, had given us the wrong idea about that bank’s financial condition. They seemed to say that Wachovia had two or three quarters to try to turn itself around. In court papers this week we found that Wachovia was already on the brink of collapse last week.

If a company that merely seems to be stumbling is actually dying before our eyes, what other surprises are on the way? And if the President cannot keep a straight face while telling us that the economy is likely to survive, what does he know that we don’t know?

The overarching sense of uncertainty about the economy is an accurate reflection of the magnitude of things that are kept hidden. As we have learned how derivatives function in the financial system, for example, one of the things we have learned is that much of what happens at a large 21st century bank is not on its financial statements at all. A bank could have paper assets and situational obligations that amount to trillions of dollars, and we would have no way of finding out. Even the banks’ own executives cannot get this information, although some are now trying to. But the best estimates we have so far is that the average large bank is, in financial terms, a tower of derivatives that stands much, much higher than all the assets and liabilities that are reported on the balance sheet.

This is why Washington would not let AIG fail last month. Trillions, probably tens of trillions, in liabilities are not recorded on banks’ balance sheets because of the convenient fiction that they are guaranteed by AIG. It should be obvious to everyone that AIG is not in any financial condition to guarantee anything — it has managed to keep itself going only because Washington is feeding it a billion dollars a day — yet its solvency is the key to keeping the financial system standing. If AIG were found to be insolvent, accounting rules would require banks to recognize trillions of dollars in liabilities that they currently are allowed to ignore. The day that happened, we are led to believe, almost every major bank in the world would instantly be insolvent.

How large is the derivatives bubble? One economist two years ago estimated it at a little over $10 trillion in paper assets. That was an eye-popping number that at the time he hesitated to publish, but as we have learned more, it now seems naively conservative. A separate, more recent estimate is that over $100 trillion in derivatives change hands each year in the United States alone.

To put these numbers in perspective, the largest company in the world is worth less than $1 trillion. The total amount of U.S. currency in circulation is a similar size, less than $1 trillion. Given the size disparity, it should not surprise anyone if the derivatives market sneezes and the economy falls over.

It certainly seems as if derivatives are being overused, to the point of becoming an accounting fiction at times, and that they are a dangerous and destabilizing influence on the economy, but how can we know when derivatives are unregulated and almost entirely secret?

If we want people to believe the financial system can still function, the derivatives it is built on cannot remain secret. A good first step would be to require the public disclosure of all derivatives. And to make sure that there are no loopholes, it would make sense to require the public disclosure of all contracts that spell out financial arrangements between public companies, including their subsidiaries and partnerships. Is there really any public purpose served at this point by keeping these documents secret? Don’t the stockholders, at least, have a right to know?

And so that is my proposal: a law that would override the secrecy clauses in derivatives contracts and other contracts that spell out financial arrangements between public companies, and require these contracts to be disclosed or disclaimed within a relatively short period of time.

Until that is done, no one can really say whether the U.S. financial system will stand or fall. But after the secrets are out in the open, we’ll be able to say. And then, the President may be able to keep a straight face when he talks about the economy.

Or maybe we will find out that the whole system is already bankrupt. But it is better to find that out now than to delay, as Iceland did, and allow the system to keep piling up losses. Now people are asking whether the entire country of Iceland could be bankrupt. As far as I am concerned, that is all the warning we need about the potential cost of the secrecy our financial system currently employs.

Most politicians agree by now that derivatives need to be regulated. As Ralph Nader wrote last night:

Defenders of deregulation argued that sophisticated players were involved in the derivatives markets, and they could handle themselves.

It’s now apparent that not only could these sophisticated players not handle themselves, but that their reckless gambling has placed the entire world’s financial system at risk.

It seems to be then a remarkably modest proposal for derivatives to be brought under regulatory control.

Perhaps that is true, but what regulations are needed? How can we tell when the derivatives themselves are protected by a veil of secrecy? A blanket requirement to disclose derivatives would help us pinpoint abuses and show areas where legal restrictions could make the economy more stable. It would also help to avoid the financial calamity that could result from poorly conceived regulatory language. If we are at risk of having our economy toppled by derivatives, it is only prudent that we look at them and add them up. At this point, we cannot even do that, and so it is no wonder that there are people who feel anxious about the economy.

Friday, October 10, 2008

This Week in Bank Failures

Last weekend brought a new European huddle to try to address the rapidly deteriorating banking conditions there. Leaders decided the European Union could not put together a special fund to support the banks, but the separate countries are alert to opportunities to act in a coordinated way, as several did midweek in a simultaneous interest rate cut (which the United States also participated in). There was a hint that executives may be held responsible when banks fail — though that may be little more than an admonition to bank executives to be sure they are making responsible decisions.

I learned how bad the Iceland situation is: banks there have borrowed 6 times the nation’s annual GDP, and now it is hard to imagine how this can be paid back. The country began negotiating for help from its trade unions. On Monday, trading was halted in shares of Iceland’s major banks, while the government guaranteed all deposits and the banks sought to sell off overseas holdings. ING Direct UK quickly offered to purchase £3 billion of UK deposits from two Icelandic banks. The government took over the third largest bank, Landsbanki, after it failed Tuesday. Wednesday, the larger bank Glitnir, already nationalized two weeks ago, was put into receivership. A day later, Iceland nationalized its largest bank, Kaupthing, and shut down its stock market for the rest of the week.

On the continent last weekend, Germany’s chancellor tried to reassure depositors after a 35 billion euro bailout package for Hypo fell apart. The message was, please continue to put your trust in the banks, and, we promise to hold things together. By Sunday night, a new bailout plan, valued at 50 billion euros, was on the way.

Germany’s promises to depositors seemed to fall short of the blanket deposit guarantees put forward a week ago by Greece and Ireland. There was some concern that deposits would flow to those countries, emptying out the banks in other countries, but that did not seem to materialize. On Tuesday, the European Union raised its minimum deposit guarantee to 50,000 euros.

Benelux banking giant Fortis, after being propped up for a week, was nationalized in the Netherlands and sold off to a French bank in Belgium and Luxembourg.

Russia, whose stock market has suffered the worst, put a trillion rubles into its banking system to keep it liquid.

Another stock market in crisis is Brazil’s, yet that country is in a strong financial position and took further steps to protect its banking system from the global crisis.

In the United States, the Treasury Department took its Wall Street bailout plan back to the drawing board to try to figure out how to morph it into a bank liquidity fund within the limits of the legislation that was passed a week ago. The original plan would have done little or nothing to slow down bank failures, a concern that has become a higher priority in the weeks since the plan was proposed. The Federal Reserve, though, cautioned that bank failures would continue regardless of anything the Treasury might do.

Citigroup spent the week disputing the deal between Wells Fargo and Wachovia before finally relenting Friday morning. In court papers from one of the many lawsuits Citi filed, we learned how close to the edge Wachovia has been. It had been advised by an FDIC official that it could be taken over within a day if it could not find a buyer. Obviously, an adverse court ruling could leave Wachovia in receivership. One resolution that was floated would transfer hundreds of Wachovia branches to Citi, but this idea fell apart when Wells Fargo and Citi could not agree on a division of the Mid-Atlantic offices. An arrangement along those lines could still be negotiated and would leave Wells Fargo less top-heavy while providing Citi the geographical expansion it is seeking.

Citi’s aggressive posture in this dispute has resembled that of a wounded animal, and this raises questions about Citi’s own financial health. We now have to take seriously the scenario that Citi could fall before the year is over, rather than next year as observers had previously worried. If the wrangling between Citi and Wells Fargo over Wachovia had led to all three banks collapsing, that would have been the worst possible outcome, so the FDIC was reviewing all the proposed deals carefully to try to minimize the risks.

It was in some ways the worst week ever in the stock market, setting new records day after day for volatility. U.S. banking stocks fell roughly in line with the rest of the market, that is to say, down roughly 16%. The market turmoil reportedly led the White House to consider more drastic actions to intervene in the economy, but President Bush read a statement from the Rose Garden today that seemed to say that the actions taken so far would be sufficient.

On Friday night the FDIC closed two banks. It was the first simultaneous closure of two unaffiliated banks this year. These are small banks. Main Street Bank of Northville, Michigan, had $98 million in assets earlier this week. It had two offices in the outer suburbs of Detroit, in Northville and three miles south in Plymouth.

Meridian Bank of Eldred, Illinois, had offices in five Illinois towns near Saint Louis, Missouri. It last month had total assets of $39 million.

Main Street Bank was hurt by late payments on mortgages and construction loans, but most of all by the decline in manufacturing in eastern Michigan. Monroe Bank & Trust is taking over the deposits of Main Street Bank along with $17 million in assets. The FDIC is giving it 90 days to decide whether to purchase any of the Main Street Bank offices.

Meridian Bank had operated since 2003 as a successor to the troubled State Bank of Eldred. It had been cited in July by regulators in Illinois for sloppy lending practices and other procedural and financial problems. One problem was a $2.5 million loan to local travel agency YTB, whose web site emphasizes franchise and investment opportunities rather than travel destinations. That loan was due to be repaid in 2007, but nothing was paid until January 2008, when YTB repaid a fifth of the amount due. National Bank of Hillsboro, Illinois, is taking over the deposits and a small part of the assets of Meridian Bank. This represents a geographical expansion for National Bank, whose previous locations are all in south central Illinois.

Customers of both banks have had uninterrupted access to their accounts.

Thursday, October 9, 2008

Soy Overload

There are some foods Americans just eat too much of. Wheat, milk, corn, and refined white sugar are prominent examples. Most of us eat each of these every day as processed food ingredients. Eating the same thing every day, even in moderate amounts, presents far greater risks of subtle toxic effects and undetected food allergies than if you eat something just occasionally. It is perfectly fine, most experts think, to eat the same thing two or three days in a row, but it is safer not to eat the same thing week after week. Another food we get too much of is soy, and the risks associated with soy are becoming more clear all the time.

Through the 1990s, soy was a fad “health food.” The fad faded as safety questions started to pile up. I was always skeptical about the health claims associated with soy, knowing that much of the early research that claimed health benefits for soy was done by the same people who claimed that tobacco use was safe. We have since sorted out the most egregious lies about tobacco, so what happens when we sort out the lies about soy? It is becoming abundantly clear that although a few of the health benefits of soy are real, they are smaller than we thought, so that the damage done by soy greatly outweighs its benefits.

Joseph Mercola this week collected recent research and analysis on soy. Taken together, the evidence is so one-sided that the title he chose for his article is “The Evidence Against Soy.”

Most damaging to what is left of the soy fad is an American Heart Association Science Advisory that found that soy has only a trivial effect on cholesterol and no measurable effect on other biomarkers for which a benefit from soy had been claimed. No significant beneficial effect was found even when excessively large amounts of soy were consumed. People ate so much soy in some studies that, for example, the soy alone exceeded the ideal levels of total daily protein.

Many of the health risks associated with soy are now well established. It blocks absorption of various nutrients and neutralizes essential body chemicals, creating imbalances and deficiencies that have caused widespread diseases including birth defects. All this was the result of people eating too much soy, often in the mistaken belief that soy was a good thing to eat. The evidence against soy does not suggest that everyone should avoid soy entirely. Rather, it suggests that soy in its unfermented forms should be classified as a junk food, to be eaten sparingly and not used as a substitute for real food.

Wednesday, October 8, 2008

Heating Costs Affect Different Places to Different Degrees

From Forbes, I found an article that digs into the regional differences of home heating economics. It’s the kind of analysis that economists use to forecast the effects of energy price changes on regional employment rates and other measures of economic performance, but the Forbes story attempts to explain it in non-technical, journalistic terms:

What It Will Cost to Heat Your Home

It is mainly the northeastern states where oil is heavily used for home heating, and it is here that rising oil prices will force us to adjust our heating strategies in the near future. Other energy prices could go up too, but oil is likely to go up first and fastest.

The obvious answer is to have everyone who uses oil switch to natural gas and electricity. Maybe that’s too obvious, because there could be a shortages if everyone switched at once. Ultimately, we need to use less energy for heat, which basically means better insulation, and find new sources of energy that we can deliver to homes for this purpose.

Tuesday, October 7, 2008

Real Hurricane Damage

Surfside Beach, Texas, has electricity again.

The sewer system is “still up and down.” And water? That will come later. They won’t be able to repair many of the leaks until more storm debris is moved.

Surfside Beach was well away from the center of Hurricane Ike as it made landfall near Galveston, Texas. On the right side of the storm, whole towns were effectively leveled by the 4-meter storm surge. Houston is finally back in school, but still watching to see which of its businesses will be able to reopen.

I wrote yesterday about the importance of the real economy and how the financial crisis could lead us to overlook things that are more important. The hurricane damage that is still being repaired in Houston, along most of the Texas and Louisiana coasts, at least as far inland as Missouri, and also along most of the length of Cuba, is an example of the real economy at risk.

The Federal government basically blew off the hard-hit greater Houston area, providing only the most minimal assistance for its hurricane disaster recovery as it sought to save its money to bail out Wall Street. That was almost a month ago. Now as Washington obsesses over a few small businesses that allegedly may have short-term layoffs because they ran out of money and can’t get short-term loans, the unemployment statistics are starting to pile up from Texas on north. It seems safe to say that more than a million people are or were temporarily unable to work because workplaces were not ready to operate. Sometimes all they are really waiting for is electricity.

The U.S. government has spent, I believe, over a billion dollars on recovery efforts from Hurricane Ike, and more for Hurricane Gustav before it. That is a lot of money. But it pales in comparison to the $3 trillion it has sunk into financial markets in the past three weeks — apparently over $1 trillion yesterday alone. All that money is being put out there to get the economy moving again. But one of the most powerful ways to get the economy moving again is to clear debris from roads and restore electricity so that people can go back to work and back to school. It matters how quickly that happens, and it would take a lot less than a trillion dollars to speed up the recovery by a matter of weeks.

The President claims to be a resident of Texas, but his recent misplaced priorities show that his real home is on Wall Street. Ultimately, the U.S. economy does not live and die by what happens on Wall Street. In the meantime, we still do not know how many people died when Hurricane Ike hit the Texas coast.

Monday, October 6, 2008

You Can’t Eat Credit Default Swaps

There is a problem with the way we measure economic activity.

We include products of actual value, such as food that restaurants cook and serve to customers, right alongside products of only theoretical value, such as food that restaurants cook and throw away unserved.

Some of the “products” we count are so very abstract, they could be completely empty of any value, and we wouldn’t be able to tell. This is especially true in deals between one public corporation and another in which no tangible product is exchanged. Many of these deals serve mainly to make each company’s financial statements show more profit or less risk than is actually present.

These abstractions threaten to crowd out the things we are really trying to create — food, drinking water, housing, clothing, transportation, and the other real products that go together to form what in financial circles is called the real economy. The real economy contains the things that really matter in the end. Abstractions are valuable only to the extent that they support the real economy. Eventually, you have to take out some of your money (an abstraction) and use it to buy food (something you really need). As my mother warned me when I set out to make my fortune on Wall Street, you can’t eat credit default swaps.

The abstract economy has become so much bigger than the real economy that it is no longer possible to measure economic progress using economic aggregates. GDP, the oft-cited measure of national income, can go up even as the real economy shrinks. Financial measures of wealth can go up while material wealth declines. Anecdotes are more powerful than economic statistics if you want to know how well the economy is treating people.

How about you? Are you focusing too much on statistics and abstractions and losing track of what you really want?

Forget your salary and bank account for a moment and consider this: How easily are you getting the things you really want? Stop worrying about health “coverage” and answer this: How is your actual health? Instead of checking the latest count of your online “friends” — how happy are you?

This kind of check is good anytime, but it is especially important when the economy around you has been affected by a bubble, such as the currently declining credit bubble. In economic theory we assume that values can be represented by amounts of money, but that assumption fails us when a bubble exaggerates the value of something. You can avoid or escape the influence of a bubble by looking at what is actually important to you.

This is the same thing the economy in the aggregate must do to recover from the credit bubble. It is harder for the whole economy to do, though, because the usual aggregate measures of economic success, such as GDP, can be especially misleading around a bubble. That’s why it is sometimes hard to identify the public policy moves that will get the economy going again.

Sunday, October 5, 2008

What’s Hot and What’s Not as the Credit Bubble Bursts

The collapse of the credit bubble will reshape the United States’ economic landscape. Here’s a quick rundown of some of the things that are on the way up — and on the way down.


Tourism. It costs less than ever for foreigners to spend a week or two visiting the United States.

World travel. If you only have U.S. dollars to spend, it will be hard to visit most countries.

Fitness. People are taking more responsibility for keeping themselves healthy, knowing that if they fail, there may be nowhere to turn.

Health care. Prices for drugs, surgery, and even diagnostic tests are rising so quickly that soon they will be mostly beyond the reach of most potential medical consumers — and beyond the scope of most health coverage.

D.I.Y. When all else fails, if you want something done, you still have the option of doing it yourself.

Financial arrangements. Loans, insurance, and retirement savings aren’t as reliable as they used to be.

India, South America, Australia, New Zealand. Areas that largely avoided the global problems of the last five years will have a chance to take on more leadership roles.

United States, Europe, China. Closer to the center of the financial troubles, people will spend a significant part of their attention adjusting to new ways of doing things.

Food, transportation. People will make the essentials of life and work a higher priority, even as prices go up.

Climate control, clothing, furniture, equipment, haircuts, television, formal education. There is already a massive slowdown in non-essentials as businesses and consumers try to make their budgets work in a low-credit world.

Retail. When it costs more to drive, consumers make fewer visits to stores — and that means fewer impulse purchases.

Online music, movies, and games. People who don’t have extra money to spend suddenly won’t mind the hit-or-miss quality of free online entertainment.

Saturday, October 4, 2008

The Buenos Aires Perspective

I couldn’t visit Buenos Aires myself in time to write today’s blog entry, so I read Janelle B’s account of her recent visit there and looked over her tourist photos. Even without seeing it in person, there is no mistaking that Buenos Aires is a happening, cosmopolitan city with a rich culture and history.

Why do I care about what is going on in Buenos Aires? It’s a way of not taking the United States’ looming banking and currency crisis too seriously. Yesterday’s political meltdown in Washington does mean the U.S. economy is in big trouble. After that large-scale blunder by political leaders, there is probably no stopping the collapse of a segment of the U.S. banking system and a crisis of the U.S. dollar in the coming year, or the difficulties that will spread across the U.S. economy. But it is not the end of the world.

Buenos Aires proves that. Buenos Aires was the focal point of a banking collapse just 7 years ago. It was a difficult time, but people got through it:

It took a while, but it all worked out in the end. Although many of the details are different, the fundamental problem was identical to the situation now facing the United States. The Argentine government had no cash and the foreign currency reserves were not capable of providing sufficient liquidity.

That is from “How Argentina Survived Its Banking Collapse,” written yesterday by Guy Bennett on the streets of Buenos Aires. The United States does not have much of a history of crises in banking and currency, so U.S. readers would do well to read Guy’s entire account of the Buenos Aires experience of its crisis and its perspective on the Wall Street crisis. You’ll understand why the Wall Street crisis is not the top headline all over the world. And the thought you come away with, I hope, is that if Argentina can do it, Americans can do it too.

Politically, there is no undoing yesterday’s mistake in Washington. After a week of running around Washington in a panic saying, “We have to do something,” politicians will not easily have a change of heart and say, “Whoops! Looks like we shouldn’t have done that.” There is little hope of leadership of any kind coming from Washington as the resulting economic turmoil spreads from one sector of the economy to the next. After blowing a trillion dollars gambling on Wall Street, Washington has nothing left. Washington cannot rescue us. We will have to rescue them.

I suppose today is a good day to be angry at Washington for putting this crisis together and dumping it on us. By Monday morning, though, we have to get over it, because there is so much we need to do. The top priorities:

  • Do everything you can to make sure you are healthy and able to work.
  • If you have money, don’t keep it all in one bank, and don’t procrastinate on buying things you know you will need to survive.
  • Make sure you are getting along with your friends and family. Get everyone’s contact information on paper. Having it in your telephone or on your computer may not be enough.
  • Do simple fixes to save energy. This is especially urgent if you live in a cold climate and have to heat your home to survive.
  • Develop basic skills that make you more self-sufficient, especially cooking. If you never walk anywhere, even though you could, build up your walking until you can comfortably walk at least two miles.
  • Get things done. Don’t let the word “depression” make you feel depressed. Don’t let the word “hyperinflation” make you hyper either, and don’t let the prospect of a “currency collapse” make you feel like collapsing in the nearest chair. This is a time for action.