There is absolutely no one in the inner circle of Obama’s economic advisors who doesn’t believe fully in that the current financial/corporate, free market economy. There is no one within the administration to tell Obama of the pressing need for fundamental changes in the management and operation of our economy and in the political economy of power. Even Paul Volcker, who is no radical thinker, has apparently been pushed to the sidelines.

When you add to Bernanke to Summers and Geithner, you have a trio seemingly hell-bent on transferring whatever the required amount of wealth from savers and taxpayers to the financial institutions to reinflate them to the bloated size they were before the meltdown. The biggest banks are being made whole while the rest of us are living with our wealth reduced by one-third to one-half, or more for many unlucky enough to buy and mortgage houses at the top of the bubble.

When I read a number of news items last week, my sense of discouragement grew. The biggest investment banks, led by Goldman Sachs, the biggest, baddest, and most successful, are upping bonuses, ramping up speculation, and using all of their political clout (which is massive) to water down the gentle regulatory reforms proposed by Obama.

As a hopeful investor, I was particularly struck by news that Goldman Sachs and Credit Suisse had both mightily expanded their “program trading” activities. Program trading is minute by minute trading in massive quantities, using computers and sophisticated programs to profit from discrepancies in the pricing of securities – and also to profit from inside information and from their abilities to move the market. The numbers are staggering. In the week ended June 19, 2009, 40 percent of all trades on the NY Stock Exchange were program trades. This was an increase from 30 percent the prior week. As Zero Hedge said in reporting these numbers:

Virtually every broker saw their Principal PT operations double week over week: seems like everyone is brokering those ETF trades now. Poor SPY and IWM [popular ETFs] are being mangled 10 ways from Sunday nowadays.

The absolute numbers are equally staggering. Goldman Sachs’ program trades were almost a billion shares in the week, and Credit Suisse’s were half a billion.

With this amount of domination in the market by the investment banks, it makes me wonder what are the odds against me in the market?

The resurgence of the investment banks is not just in the US, but in Europe, too – where governments are equally dedicated to bailing them out. Reuter columnist Paul Taylor wrote on June 24, 2009:

No sooner has the financial system begun to stabilize than Big Finance is reverting to its old ways — aggressive hiring, remuneration on steroids, wriggling out of regulation or threatening to decamp to evade tougher supervision.

These are is not the rantings of some crypto-Marxist City-basher, but the considered view of one of Europe’s most thoughtful financial regulators.

Today’s Der Spiegel has a lengthy article, “A Real Free Lunch” detailing the extent of the transfer of wealth to investment banks in Germany, and their use of the low-interest loans from the central bank to make safe, profitable investments and speculations, rather than to loan to businesses – the ostensible, public justification for the bank bailouts.

The extent to which speculation appears to be driving the markets is indicated by how closely all asset classes –stocks, currencies, and commodities – have been moving together. I’ve noted that there is an almost perfect correlation between the price of the Australian dollar and the S&P 500! This seem completely bizarre.

In the chart below, the blue line is the S&P 500 index. The weekly ups and downs tracked very closely, though the change in the Australian dollar was generally more muted.

The close correlation in prices has been widely noted, and taken by some as a warning sign. A recent article in Bloomberg spelled out:

Cash Best as Record Correlation Hints Herd Collapse (Update3)

By Eric Martin and Michael Tsang

June 29 (Bloomberg) — Investors are moving in lockstep like never before, driving up stocks, commodities and emerging markets and risking a replay of last year, when they all plunged the most since World War II.

The Standard & Poor’s 500 Index, whose increase in the past three months was the steepest in seven decades, is rallying in tandem with benchmark measures for raw materials, developing- country equities and hedge funds. The so-called correlation coefficient that measures how closely markets rise and fall together has reached the highest levels ever, according to data compiled by Bloomberg.

…

The gains [in all markets’ pushed correlations between the indexes to 0.74 this month, based on percentage changes over the past 60 days. That’s the highest in at least five decades, data compiled by Bloomberg show. A reading of 1 means two assets move in tandem, while zero means no relationship.

The correlation never rose above 0.66 before this month.

Gains in U.S. stocks have mirrored those in crude oil as never before, with correlations above 0.7 this month, according to data compiled by Bloomberg.

Full Article

David Rosenberg, of Gluskin Schiff, a Canadian economist whose insights I respect, pointed out the correlation and warned of its implications:

June 4, 2009
Everyone is back in the same trade

• Buy stocks (massive multiple expansion – S&P 500 priced for $75 operating EPS)
• Buy commodities (still long-term bullish but a pullback is definitely overdue)
• Buy non-Treasury bonds (same story as commodities – long-term bullish on corporates, but supply is now coming in droves and being gobbled up – this is NOT the contrarian trade of six-months ago)
• Buy gold (again, in a secular bull phase, but the dollar is not going to zero and being bearish on the greenback has become far too fashionable – especially in the wake of Bill Gross’s latest missive; the Euro is saddled with problems at least as deep as the USD, if not deeper)
• And of course, sell Treasuries (that was a good trade coming off the 2% lows on the 10-year note, but what we just saw crammed into six months, which took 48 months to accomplish in the last bear market in govie bonds, was yields soaring 175bps from the low). Sentiment on government bonds is exceedingly bearish and inflation views have become too extreme for my liking. I believe there is a lack of appreciation from what history tells us about the aftershocks that occur after a cycle that was dominated by a credit collapse and asset deflation, as opposed to a garden-variety inventory-led recession. In five words: economic fragility, lingering deflation pressure.

  Full Report (requires free registration)

What we are seeing is the re-creation of a finance-dominated economy, with the hedge funds and investment banks using easy money to play with our futures. This is not a pretty picture, and it is not one that seems likely to get any better. The central banks, which are creatures of the banks, are calling the tune around the world. Most politicians, even if not in the pay of the banks, appear to see no alternative for “saving the economy” to pumping up credit through the banking system.

I have more reasons for being discouraged, but I’ll save those for another day.

Credit Card companies are getting desperate

This is from the NYT, hat tip Calculated Risk.

… Mr. McClelland’s credit card company was calling yet again, wondering when it could expect the next installment on his delinquent account. He proposed paying half of his $5,486 balance and calling the matter even.

It’s a deal, the account representative immediately said, not even bothering to check with a supervisor.

As they confront unprecedented numbers of troubled customers, credit card companies are increasingly doing something they have historically scorned: settling delinquent accounts for substantially less than the amount owed.

If we were to continue the path of the Great Depression, real economic activity would have still a lot further to fall, and the stock market, though it has fallen a lot this time, would still have another 50% decline to go. Still, if the Great Depression is a guide, the stock market now is well below the level it was at the same relative point in time.

To me, the real question that these charts raise relates to the effectiveness of the fiscal and monetary measures that have been taken this time. Here are some comparison charts:

Clearly, short-term interest rates were lower initially and have since been pushed down to unprecedented levels.

The money supply, which is another indicator of monetary policy, is shown starting 4 years before the downturn (unlike the prior charts):

The authors comment on this chart:

Figure 5 shows money supply for a GDP-weighted average of 19 countries accounting for more than half of world GDP in 2004. Clearly, monetary expansion was more rapid in the run-up to the 2008 crisis than during 1925-29, which is a reminder that the stage-setting events were not the same in the two cases. Moreover, the global money supply continued to grow rapidly in 2008, unlike in 1929 when it levelled off and then underwent a catastrophic decline.

Fiscal policy, as represented by government surpluses or deficits, is shown again starting 4 years before the downturn.

While monetary policy is wildly different than following 1929, fiscal policy is much less radically different. If we look at year 5 (2009), the fiscal deficit is about 2% of GDP. In 1930, it was zero; but 2% of GDP is not very significant. In 2010, the deficit is projected to be much larger, over 5%, compared to still zero in 1931.

The burning question is whether these differences are enough to push the world economy onto a different, more positive path than occurred in the 1930’s. There are certainly skeptics, especially followers of the Austrian school of economics. The current prevailing view, though, is that these measures, plus more that will be tried if these seem inadequate, will succeed. This seems overly sanguine to me. Rather, I think it is best to view us as in the midst of a grand economic experiment on the largest scale ever tried. Experiments, by their very nature, have uncertain outcomes.

We have already seen one part of the policy armada begin to come apart: the pushing down of long-term interest rates in order to make mortgages cheaper and house purchases more affordable. In the last month, the market has turned sour on US Treasuries. Yields on ten-year Treasuries have risen remarkably this year. The yield on the benchmark 10-year Treasury due May 2019 ended last week at 3.83 percent, up from the low this year of 2.14 percent on Jan. 15 (Bloomberg). Rising long term Treasury yields have pushed up mortgage rates from a low of 4.75% just a little over a month ago to a current 5.45%.

The rise in Treasury yields is being attributed to the massive deficits (the flip side of the economic stimulus). The federal government is going to need to sell $2 trillion of bonds to cover the deficit. There is skepticism in the market that this amount will be saleable at current yields, especially given the concern that all of the monetary measure will lead to inflation. Clearly, not everything is under the control of central government policy makers.

For some reason, a consumption tax has never gotten much political traction. I was interested to see a proposal for a consumption tax at Fivethirtyeight.com, the site made famous by its successful predictions in the 2008 election. It lays out how it would work and some of the benefits. Though it is an elementary discussion, it is a useful starting point for thinking about it. What do you think?

The Ultimate Tax on Harmful Activity?

by Robert Frank @ 10:01 PM, 5/22/2009

When the dollar, US treasury bills, and stock prices slumped yesterday because of growing concerns about the U.S. government’s debt rating, Treasury Secretary Tim Geithner hastily reassured nervous investors that the Obama administration has clear plans to reduce the country’s massive budget deficits going forward. But as I argued in a recent post, accomplishing that will require significant new sources of revenue. And if new taxes are indeed necessary, by far the best ones are those that discourage harmful activities.

But new taxes on congestion and pollution will not be enough. The president has already proposed to allow the Bush tax cuts for top earners to expire as scheduled in 2010. Many economists caution against even further increases in top marginal income tax rates, which would discourage effort and savings.

Fortunately, there is a compellingly attractive alternative: abandon the income tax in favor of a much more steeply progressive consumption tax. Doing so would generate more than enough revenue to balance the federal budget without requiring painful sacrifices from anyone.

Under a progressive consumption tax, each family would report its income to the IRS and also its annual savings, much as many now document their annual contributions to 401(k) and other similar accounts.  A family’s income minus its annual savings is its annual consumption, and that amount minus a large standard deduction—say, $30,000 for a family of four—would be its taxable consumption.  Rates would start low, perhaps 20 percent, then rise gradually with total consumption.  For example, a family that earned $60,000 and saved $10,000 would have annual consumption of $50,000, which, after subtracting the standard deduction, would mean taxable consumption of $20,000.  It would owe about $4,000 in tax, about the same as under the current income tax.

With savings tax-exempt, top marginal tax rates on consumption would have to be significantly higher than current top rates on income. But that’s not problematic, because higher top rates would actually encourage saving.

Consider, for instance, how the tax would affect a specific high-end spending decision. The Smiths, a wealthy couple approaching their 25th wedding anniversary, are trying to decide what kind of party to throw.   Their close friends, the Joneses, recently spent $2 million to stage a gala celebration of their own silver anniversary. The Smith would prefer not to spend that much, but one of their goals is for their family and friends to share a memorable celebration, and they understand a memorable occasion is an inherently relative concept. So they reluctantly decide to stage a $2 million party of their own.

But their decision would have almost surely played out differently under the incentives inherent in a progressive consumption tax. If the top marginal rate on consumption was, say, 100 percent, the after-tax cost of what would have been a $2 party under the current income tax would instead be $4 million.  Facing that extra cost, couples like the Smiths and Joneses would typically scale back, spending perhaps only half as much as they might have.  If the pre-tax cost of the party they chose were $1 million, the after-tax cost would be $2 million.  The government would get $1 million in additional revenue, which could be used to pay down debt.

By staging a lavish party, a couple typically has no intention to harm its friends and relatives.  Yet the bar that defines how much one must spend to mark a special occasion is an inescapably social construct.  When some spend more, others must follow suit or be seen as having failed to grasp the magnitude the occasion.  The rub is that when all spend more, the occasions seem no more special than before. As in the familiar stadium metaphor, all stand to get a better view, yet no one sees better than if all had remained seated.

Like a tax on congestion or pollution, a progressive consumption tax is thus a tax on harmful activity. The real attraction of all such taxes is that they essentially create real resources out of thin air.  They cause people to build less expensive mansions, buy cleaner, lighter vehicles, and stage less costly parties, all of which end up being just as satisfying as the more elaborate versions would have been.

Some worry that by discouraging consumption spending, a progressive consumption tax as politically unrealistic. But in a future post, I’ll cite evidence that this tax enjoys support from across the political spectrum.

The focus on US deficits was given a big boost by the news that Moodys downgraded the debt of England. Who would have thought that England, once the financial center of the world and still one of the largest financial centers, would have come to this state? Even more surprising to many is the increasing perception of the possibility that US government debt will be downgraded from the world’s most secure to a lesser status. The news of Britain’s downgrade also caused a sharp fall in the price of US treasuries, because people judged that what happened in England could happen here. Bill Gross of PIMCO (the largest bond company in the world) said that this is not unthinkable (which means it is thinkable).

I recently posted an article on the negative for Britain of the dominance of the financial sector there, arguing that the parallels with the US are all too great. One of the parallels is the massive deficit that both countries are incurring in trying to keep their financial sectors and the economy afloat in a world that imploded as a consequence of financial excesses.

John Mauldin has an insightful, very detailed review of the magnitudes of coming US deficits, their likely consequence for interest rates and bond prices, and of his own gloomy thoughts on the implications for the future non-prosperity in the US. Below are some selected quotes with a link to the full article.

John Mauldin at frontlinethoughts.com, 5/23/2009

A Trillion Dollars as Far as the Eye Can See

As of this week, total US debt is $11.3 trillion and rising rapidly. The Obama Administration projects that to rise another $1.85 trillion in 2009 (13% of GDP) and yet another $1.4 trillion in 2010. The Congressional Budget Office projects almost $10 trillion in additional debt from 2010 through 2019. Just last January the 2009 deficit was estimated at "only" $1.2 trillion. Things have gone downhill fast. …

The Global Recession Gets Worse

Let’s take a quick trip around the world. In the first quarter, the German economy fell by 14%, Japan by 15%, Mexico by 21%, and England was down almost 8%.

Global trade is simply collapsing. The chart below is the ugliest it has ever been. Chinese exports are down 41%, Japanese exports down 38%, Germany’s down by 32%, and so on. (chart courtesy of www.variantperception.com )

…

European banks are in far worse shape than their US counterparts. That is because they utilize far more leverage, on an average about 30 times leverage. How can that be, in what is supposed to be a conservative industry?

"European banks were only restricted on the basis of risk-weighted assets, unlike the US where it is the total leverage ratio that matters, so most European banks bought assets that were rated by Moody’s and S&P, who couldn’t rate their way out of a paper bag, and for anything that wasn’t highly rated, they bought credit default swaps or guarantees from AIG and MBIA. Because of that European banks were able to lever up a lot more than their US counterparties. Given the much higher leverage levels and general worsening of collateral values, we think that all the shoes in Europe have not dropped."

European banks have assets of about 330% of their GDP, compared to US banking assets, which are about 50%. They have over $700 billion in loans to Asian businesses (which are watching their exports collapse) and $1.3 trillion in loans to Eastern Europe, which is in a very serious recession, and so many of those loans are simply not going to be worth anything. Simply put, there is going to be a need for massive amounts of money to bail out European banks, or we’ll watch their economies simply implode. …

Governments around the world are responding to the global recession by running massive deficits. In addition to the US, the UK, Japan, Russia, Spain, and Ireland are all running deficits of over 10%.

And, as in the case of the US, these are not going to be one-time deficits. The IMF predicts that England will shrink again next year and the recovery in the US will be modest at best. The US economy is expected to grow by 0.2% (far from the optimistic projections of various US government agencies), the 16-nation eurozone will eke out a modest gain of 0.1%, and the Group of Seven (G7) leading industrial economies will, as a whole, only grow by 0.2 percent. They project that Japan’s economy will stagnate next year.

Where Will the Money Come From?

And now let’s look at what is bumping in my worry closet. The world is going to have to fund multiple trillions in debt over the next several years. Pick a number. I think $5 trillion sounds about right. $3 trillion is in the cards for the US alone, if current projections are right.

Just exactly where is that money going to come from? The US trade deficit is now down to under $350 billion a year. The Fed can monetize a trillion. Maybe. Look at the yield curve on US government debt below (Bloomberg). US savings are going to go up, but where is the incentive to buy ten-year debt at 3.5%? Four-year debt under 2% doesn’t do much for your savings growth. Even with monetization and the Chinese buying our debt with the dollars we send them, that still leaves the bond market about $1.5 trillion short, give or take $100 billion.

The world is deleveraging. Debt is being drawn down. Securitization of various types of debt has seriously slowed. Banks are cutting back on lending. Home prices are dropping all over the world. Commercial real estate is rolling over, and banks all over the world are exposed. "Recession turns malls into ghost towns" is the headline in today’s Wall Street Journal. Personal savings are rising and retail sales are flat to down. Unemployment is rising.

All this should be massively deflationary. Interest rates should be falling or at least not rising. But a funny thing is happening. In the past two months, the yield on the ten-year bond has risen by 1%. It has moved 0.38% or almost "4 big handles" in just two weeks. Look at the chart below. What is happening?

According to Merrill Lynch, the size of the world bond market is estimated to be approximately $67 trillion, with the shares of US, Euroland, and Japanese securities each representing less than 50 percent of this total. (PIMCO)

England has been put on negative watch for its debt rating. Bill Gross said yesterday that it is not unthinkable that the US could lose its AAA rating. I think the bond market is looking at the mountain of debt that will have to be somehow sold and wondering where such a colossal sum will come from. Where do you find $10 trillion in the next ten years for US debt?

And that is just for US government debt. $5 trillion for new global debt in the next two years? In a deleveraged world? How much will the other countries need? What about money needed for businesses and mortgages and credit cards and so on?

If you add $10 trillion to the current $11.3 trillion (including Social Security trust funds, etc.), that totals $21 trillion in 2019. Let’s be generous and suggest that interest rates will only be an average of 5%. That would be an interest-rate expense of over $1 trillion. That is 25% of projected revenues and 20% of expected expenses. And that assumes you have nominal growth of over 4% for the next ten years. If growth is less, tax revenues will be less. It also assumes massive tax increases from carbon credits.

…

Long before we get to 2015, let alone 2019, I think the bond markets will have called a halt to $1 trillion deficits. There will be a real crisis. The deficits will not be funded at anywhere close to an interest rate that will not break the budget. Taxes will get raised beyond what they were in the Clinton years. And Obama’s budget makes some very optimistic judgments about how much will be saved in medical costs, as if no one has tried to rein in medical costs before. The crisis may come much sooner if his universal health-care bill is passed as proposed without offsetting cuts somewhere else.

Watch the bond market. Rates should be going down, not up. The bond market is telling us the deficit simply can’t be financed down the road. Now, maybe a few cool heads in the Democratic Party will prevail in the US Senate and the deficits will be brought under control. (The Republicans have so far seemed as clueless as they are impotent.) We could (theoretically) run $400 billion deficits for a very long time, as GDP would be growing somewhat faster.

It would be best to run budget surpluses, but the game does not end if there are reasonable deficits. It ends with deficits that cannot be funded except by monetization. And that will tank the dollar, except against all the other countries that are monetizing their debt.

I am increasingly inclined to think that as the world comes out of its current malaise – and it will – US investors should think more globally with their investment portfolios. That is something we will explore over the coming year. But that’s enough for today.

Full Article

A good exposition of the reasons for concern about the economy and investments in the stock market was given by David Rosenberg in a TV interview on Bloomberg (thank to the Big Picture). Mr. Rosenberg is a highly regarded international economist.

click  image for video

>

Bloomberg:

The Standard & Poor’s 500 Index may fall beneath its 12-year low on March 9 because consumer spending hasn’t shown signs of a recovery, economist David Rosenberg said.

The S&P 500 rallied as much as 24 percent from an 11-year low of 752.44 on Nov. 20 to Jan. 6 on speculation the economy will recover amid government efforts to rescue banks and automakers. The measure erased those gains and fell another 10 percent to a 12-year low of 676.53 on March 9 as losses at lenders mounted and unemployment continued to rise.

The benchmark index for U.S. stocks plunged as much as 57 percent from an October 2007 record as writedowns and credit losses stemming from the collapse of the subprime mortgage market climbed to $1.47 trillion. The measure has rallied 34 percent since March 9 as the largest banks said they were profitable, the government and the Federal Reserve pledged $12.8 trillion to drag the economy out of recession and policy makers around the world cut interest rates to near zero.

>

Source:
Rosenberg Says U.S. Stock Market May Test March 9 Low
Eric Martin and Erik Schatzker
Bloomberg, May 21 2009
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aG.qtbxYIK_E

There is no doubt that a major shift in investor sentiment has occurred. The huge amounts of monetary stimulus engineered by Bernanke have unfrozen the credit markets, and the economic stimulus steps have apparently softened the declines in output. The market apparently believes that the declines in inventories and housing prices, and the aging of the car fleet, have set the stage for economic expansion in the future. Add to this that credit is once again available for more and more borrowers, and we have the makings of another round of debt-financed expansion. This looks to be good for the markets in the near term – though the pace of the rise has been so great that many are calling for a correction.

Words from the (investment) wise for the week that was (April 27 – May 3, 2009)

“Goodbye safe havens, hello risky assets.” This was the refrain of investors’ theme song during the past week. Safe-haven assets were out of favor as better-than-feared corporate earnings and signs of a budding economic recovery emboldened investors’ appetite for reflation trades such as equities and commodities.

Investors’ sentiment improved notwithstanding a number of influences that could potentially disturb financial markets. These included a three-day delay in the release of the stress test results of the 19 biggest US banks until May 7, the plight of the beleaguered US automakers with General Motors (GM) proposing a sweeping debt-for-equity restructuring and Chrysler filing for Chapter 11 bankruptcy protection, and fears of an escalation in the number of swine flu (H1N1) cases.

Source: Vita

As to be expected given the countless catalysts, the past week’s trading was bumpy, but the major global stock market indices nevertheless managed to resume their eight-week rally. Further testimony of investors’ zest for risky assets came from the following:

• a solid performance by crude oil, base metal and agricultural commodities (with the exception of pork bellies and lean hogs – despite the fact that humans cannot contract swine flu by eating pig meat)

• tighter credit spreads (especially high-yield corporate bonds)

• a jump in Treasury Note yields to levels last seen in November

• a decline in the US dollar and Japanese yen as traders switched to high-yielding currencies such as the Australian dollar, New Zealand dollar and South African rand (all resource-linked currencies)

The performance of the major asset classes is summarized by the chart below, expanded to now also include Treasury inflation-protected securities (TIP) and investment grade (LQD) and high-yield corporate bonds (HYG).

Source: StockCharts.com

…

By the end of last week, more than 70% of the companies in the S&P 500 Index had reported first-quarter earnings. According to Bespoke, the Index’s annual decline in earnings (Q1 ‘09 versus Q1 ‘08) on Friday was of 32.3%. This compares with analysts’ estimates of -37.4% at the start of the earnings season. Also, as shown in the graph below, the percentage of companies beating earnings estimates has been rising steadily during the reporting period to 62% on Friday. ”With three quarters of companies having already reported, this earnings season is shaping up to be one of the best in years,” said Bespoke.

[There is much more: See the Full Article]

He offered a goal for his actions that I applaud:

…I want every American to know that each action we take and each policy we pursue is driven by a larger vision of America’s future – a future where sustained economic growth creates good jobs and rising incomes; a future where prosperity is fueled not by excessive debt, reckless speculation, and fleeing profit, but is instead built by skilled, productive workers; by sound investments that will spread opportunity at home and allow this nation to lead the world in the technologies, innovations, and discoveries that will shape the 21st century.  That is the America I see.  That is the future I know we can have.

He built on a parable in the Sermon on the Mount to lay out a five-point program for building an enduring prosperity:

There is a parable at the end of the Sermon on the Mount that tells the story of two men.  The first built his house on a pile of sand, and it was destroyed as soon as the storm hit.  But the second is known as the wise man, for when “…the rain descended, and the floods came, and the winds blew, and beat upon that house…it fell not:  for it was founded upon a rock.”

We cannot rebuild this economy on the same pile of sand.  We must build our house upon a rock.  We must lay a new foundation for growth and prosperity – a foundation that will move us from an era of borrow and spend to one where we save and invest; where we consume less at home and send more exports abroad. 

It’s a foundation built upon five pillars that will grow our economy and make this new century another American century:  new rules for Wall Street that will reward drive and innovation; new investments in education that will make our workforce more skilled and competitive; new investments in renewable energy and technology that will create new jobs and industries; new investments in health care that will cut costs for families and businesses; and new savings in our federal budget that will bring down the debt for future generations.  That is the new foundation we must build.  That must be our future – and my Administration’s policies are designed to achieve that future.

Again, these are goals that are admirable and upon which most can agree.

Where I continue to part company with the Obama Administration is in its handling of the financial crisis. Obama explained and defended the bailouts of the banking system, but I found the defense disingenuous and unconvincing [my comments interspersed]:

The heart of this financial crisis is that too many banks and other financial institutions simply stopped lending money.  In a climate of fear, banks were unable to replace their losses by raising new capital on their own, and they were unwilling to lend the money they did have because they were afraid that no one would pay it back.  It is for this reason that the last administration used the Troubled Asset Relief Program, or TARP, to provide these banks with temporary financial assistance in order to get them lending again. 

Now, I don’t agree with some of the ways the TARP program was managed, but I do agree with the broader rationale that we must provide banks with the capital and the confidence necessary to start lending again.  That is the purpose of the stress tests that will soon tell us how much additional capital will be needed to support lending at our largest banks.  Ideally, these needs will be met by private investors.  But where this is not possible, and banks require substantial additional resources from the government, we will hold accountable those responsible, force the necessary adjustments, provide the support to clean up their balance sheets, and assure the continuity of a strong, viable institution that can serve our people and our economy.

Of course, there are some who argue that the government should stand back and simply let these banks fail – especially since in many cases it was their bad decisions that helped create the crisis in the first place.  But whether we like it or not, history has repeatedly shown that when nations do not take early and aggressive action to get credit flowing again, they have crises that last years and years instead of months and months – years of low growth, low job creation, and low investment that cost those nations far more than a course of bold, upfront action. 

Those who argue for an alternative to taxpayer-financed bailouts are, for the most part, not opposed to “early and aggressive action to get credit flowing again.” To the contrary, they argue that propping up “zombie” banks is counter to the goal of getting robust bank lending established. Even after the bailouts, the banks with impaired assets are going to be reluctant to lend. In any event, the second sentence is not logically implied by the first, i.e., it is a non sequitur.

And although there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – “where’s our bailout?,” they ask – the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.

Again, while it is true that bank capital can support multiple dollars of lending, if there is sufficient demand for the loans, bailouts are not the only way to improve the balance sheets of banks so that they have the capital required to support loans. Obama continues:

On the other hand, there have been some who don’t dispute that we need to shore up the banking system, but suggest that we have been too timid in how we go about it.  They say that the federal government should have already preemptively stepped in and taken over major financial institutions the way that the FDIC currently intervenes in smaller banks, and that our failure to do so is yet another example of Washington coddling Wall Street. So let me be clear – the reason we have not taken this step has nothing to do with any ideological or political judgment we’ve made about government involvement in banks, and it’s certainly not because of any concern we have for the management and shareholders whose actions have helped cause this mess.   

Rather, it is because we believe that preemptive government takeovers are likely to end up costing taxpayers even more in the end, and because it is more likely to undermine than to create confidence. Governments should practice the same principle as doctors: first do no harm.

I believe that Obama is sincere here, but I also believe that he has listened to and sided with advisors who have sold him one side of the argument, a failing in judgment that I attribute to his years at Harvard, where he gained an undeserved belief in the intellectual superiority of the the Eastern Scholarly Establishment, led by Harvard.  Notice that he says, “we believe that preemptive government takeovers …” He does not provide reasons and evidence, only belief to support his policies. Further, he mischaracterizes the situation when he says “preemptive government takeovers.” There would have been nothing “preemptive” in the takeover of Citigroup, Bank of America, and others that were realistically insolvent and only prevented from failure by the infusion of tens of billions of government funds and hundreds of billions of government guarantees.

Obama fails to provide answers to the thoughtful critics of his policies. Rather he mischaracterizes their arguments and rebuts the mischaracterizations. This is neither compelling nor honest. He continues:

So rest assured – we will do whatever is necessary to get credit flowing again, but we will do so in ways that minimize risks to taxpayers and to the broader economy.  To that end, in addition to the program to provide capital to the banks, we have launched a plan that will pair government resources with private investment in order to clear away the old loans and securities – the so-called toxic assets – that are also preventing our banks from lending money.

Obama doesn’t even attempt to answer the critics of his Private Public Investment Partnership (PPIP, or more accurately termed GASP – “Geithner And Summers Plan”), a sweetheart deal for investment banks and hedge funds that acts as a fig leaf for another trillion dollars of taxpayer bailout money.

Although I give Obama A’s and A-pluses on most of his actions and programs to date (including the stimulus package and budget), I give him between a C and D on his bank bailouts. My only hope is that Obama has said many times that he expects to make mistakes, implying that he is open to recognizing and learning from his mistakes. Let’s hope he recognizes this mistake sooner rather than later.

In a wide-ranging interview recorded by Bloomberg Television, Mr. Faber touched on a wide variety of subjects. Below is a link to the video. Note that although the headline emphasizes the downside of his remarks, it is out of context. In context, he says the correction would be a prelude to a further rally.

Play video

This is a major shift in outlook from a person who has an admirable track record.

George Soros was an early and avid supporter of Barack Obama, so it’s probably no surprise he gives the President high marks for his handling of international affairs, the stimulus package, the budget (the famed financier calls it "very courageous") and for "stabilizing" the financial crisis.

But President Obama "lost a great opportunity" by not taking a more radical approach in dealing with the banks, Soros says. "There’s too much continuity with the bumbling and mishandling by the previous administration. Not enough discontinuity."

Specifically, Soros wanted Obama to "come out of the gate with a well considered plan" to recapitalize the banks, rather than continuing with the TARP and related bailouts. But the President may have been hampered by his desire to create consensus, Soros says. "The nature of far from equilibrium situations is that public understanding is always lagging behind events. If you’re guided by desire to have consensus, you’ll always be a little bit slow."

Mr. Soros focuses less than I on the inequity of taxpayers bailing out bank investors. His concern is more on the ineffectiveness of propping up Zombie banks, instead of forcing recapitalization. He is not, however, any happier than I at the lost opportunity.

Below are links to all of the interviews, with the last in the series listed first:

 

• Americans Were "Living in a Fool’s Paradise" That’s Gone Forever, Soros Says
• Soros: Obama "Lost a Great Opportunity" to Fix the Banks
• Soros Says Fed in a Bind: Beware Stagflation, Bursting of Bond Bubble
• Soros: Dollar’s Strength a Measure of System’s "Sickness"; Euro Will Remain Viable
• Soros: "Danger of Collapse Has Passed," But Stock Rally Not Sustainable
• Soros "Very Concerned" About Global Unrest, But Sees Positive Signs in Russia