Sunday, September 21, 2008

U. S. Financial System Crisis

From a financial, economic and political standpoint, in the the last week or two we have witnessed perhaps the most serious and far-reaching crisis facing the country since the years of the Great Depression in the 1930's. While many important, necessary but controversial corrective steps have been taken by the federal government, it's still far too early to see how this will end up and how our economy is likely to fare the rest of this year and in 2009. An economic depression or continuance of the de facto recession are still both possibilities.

The majority of leading economists and financial market observers have placed primary blame on overly aggressive, high-risk taking, greedy and imprudent mortgage lenders and investment bankers who unwisely were confident that home values would continue to rise for an extended further period. The mortgage lenders, such as Countrywide Financial and Washington Mutual (WaMu), very successful for a number of years, made aggressive loans requiring inadequate or even no down payment to frequently unsophisticated borrowers who in many cases could not afford the loans they were granted. Many of these loans were risky, rate adjustable loans with initial 'teaser' rates to make the loans appear more attractive to borrowers. Blame also has been fairly placed on inadequate oversight and outdated regulation by federal agencies, including the SEC, FDIC, Treasury Department and the Federal Reserve System (the Fed).

Investment bankers, many with weak balance sheets, made a big, initially profitable business of purchasing the mortgage loans without much analysis and securitizing them into so-called mortgage-backed securities, and selling them to institutional investors, including insurance companies, pension funds and other banks. To a great extent the investment banks purchased the mortgages by borrowing a great deal of money from the larger banks, putting a lot of debt on their books and thereby leveraging their balance sheets. They also used cash they had on hand, which began to impair their liquidity.

This worked out very well for several years, until home prices began to fall significantly in many of the country's key housing markets towards the second half of 2007 and this year, the result being that a high percentage of the mortgage loans became larger than the current market value of the homes securing the loans. This understandably caused a lot of anxiety among the lenders who became pressured to recognize substantial losses on their income statements, impairing credit ratings, and initiate foreclosure proceedings against the great number of homeowners involved. Another negative factor was a rising unemployment rate caused by a number of factors: a dramatic slowdown in construction activity; globalization, including corporate outsourcing to purchase products and components abroad, especially from China, where they could be made much more cheaply; and initiatives by U. S. companies to reduce expenses to better compete through laying off people and employing more technology and productivity-enhancing measures.

All this led to a lack of liquidity, poor credit availability, declining stock and bond markets, and an overall crisis of confidence in our financial system threatening our economy and that of our allies abroad. A team led by Treasury Secretary Paulson and Fed Chairman Bernanke concluded that immediate and drastic government intervention was needed and they acted decisively in a series of high-level meetings. As most of us know, the outcome included so far the bankruptcy of Lehman Brothers, one of the major investment banks; government takeover/bailout of Freddie Mac and Fannie Mae, the huge mortgage buyers; the takeover/bailout of AIG, the country's largest insurance company; the Bank of America's takeover of Merrill-Lynch, one of the other major investment banks; and the plan led by Paulson and Bernanke for the federal government to purchase up to $700 billion of "toxic", high-risk and illiquid investments held by investment banks and commercial banks, including the infamous mortgage-backed securities.

The only two major independent U. S. investment banks left at present are Morgan Stanley and Goldman Sachs. Morgan Stanley has apparently entered into merger talks with Wachovia, one of our largest commercial banks, and over the weekend the Fed agreed to convert the two of them into better regulated traditional bank holding companies.

Most of our political leaders and market analysts seem to support the government intervention as led by Paulson and Bernanke, although great concern has been raised by many of the dangerous precedent this has set, the great concentration of political and economic power involved, and the liability and debt load facing the country and the taxpayers. However, the consensus key objective is quickly restoring confidence and stability to our financial and housing markets. Importantly there is also a general conclusion that this intervention will likely have a very restrictive impact on the next presidential administration to carry out its political agenda.

As a former career banker, I generally agree with all these points. Given the impressive track record and resumes of Paulson and his highly experienced lieutenants, it will not be easy for critics to make a compelling case that a different course should have been pursued. As Paulson conveyed in an interview over the weekend, the decisions made were very difficult and complex and definitely involved controversial issues, but there was no good option. That said, it's probably a fair criticism that Paulson, his Treasury colleagues, supported by the regulators, should have anticipated the looming problems sooner and acted sooner. Paulson, after all, has been in office since July 2006. Moreover, his boss, President Bush, has been in office for nearly eight years.

The Executive Branch and the Congress now need to work on an urgent, constructive, and bipartisan basis to complete the overhaul to our financial system, including overseeing completion of the initiatives taken to date, and, over the next several months, prudently updating and streamlining regulatory oversight of our commercial and financial institutions.

Completion of the initiatives includes particularly Congressional action with respect to the pending $700 billion rescue plan proposed by Paulsen and Bernanke. Congressional leaders have acknowledged that they need to move fairly quickly, but are anxious to reassert their authority and include provisions for oversight, fairness and support for deserving homeowners and taxpayers, as well as limits to executive compensation at the institutions who have gotten themselves into trouble by poor management.

Given the urgency of the need to restore confidence in the markets, and the importance of structuring the right legislation for reform, the best approach might be to agree to a two-part solution. This would cover, initially, timely approval by Congress this week of the primary components of the Paulsen/Bernanke plan with limited tweaking and delay, and then, secondly, a subsequent broadly supported, comprehensive financial system reform bill hopefully to be signed into law by the next president after pragmatic deliberations and productive hearings by the Congress.

Saturday, September 20, 2008

Fuel Economy Standards

As almost everyone knows, the high cost of gas and diesel fuel for our vehicles, and our depressed economy and much tighter household budgets, are inducing the majority of owners to think more about the cars they buy and be more selective in their driving habits. Furthermore, political developments around the world, including especially the terrorist activities of Islamic radicals, have made most of us supportive of the U. S. moving forward toward much greater energy independence, particularly when it comes to the Middle East as a supplier. Energy independence is, in fact, an increasing national security issue.

To help deal with these issues, President Bush's Administration and the Congress has approved tougher fuel economy standards, despite resistance from the domestic auto industry and its suppliers. In an energy bill passed last year, auto manufacturers for vehicles (cars and light trucks) sold in the U. S. must comply with a fleet-wide average standard of 31.6 miles per gallon by 2015 and 35 miles per gallon by 2020. The standards are managed by the Department of Transportation and the Environmental Protection Agency (EPA) administers the testing program that generates the fuel economy data.

The EPA has recently reported that the average performance of new 2008 model cars and light trucks for vehicles sold was 20.8 miles per gallon, obviously a great deal lower than the 2015 and 2020 standards. Not surprisingly, the Japanese manufacturers had the best performance, with an average of 23.6 mpg for Honda, 23.4 for Toyota, and 21.2 for Nissan. General Motors had an average of only 19.6 mpg, Ford 19 and Chrysler had 18.9.

One can argue whether there should be any mandated standards. The domestic auto industry, libertarians and many other conservative voters would probably prefer to leave fuel efficiency standards to be entirely voluntary, up to the market, to buyers and sellers, without government interference. There is something to be said for this view. However, these are not "normal" times. As a pragmatic moderate, in view of the importance of moving toward energy independence, I think mandated fuel efficiency standards are appropriate, and probably are not aggressive enough.

It's my understanding that there are currently more than 100 different models offered for sale which can get 30 mpg or better for highway driving, somewhat less for in town driving. A few months ago my wife and I rented a new Chevy Cobalt in Minneapolis, drove about 4,000 miles, mostly on highways, but got an impressive 36 mpg. on average with good comfort and without any special effort.

It is widely recognized that General Motors, once one of the largest and most successful manufacturers in the world, has been performing very poorly for many years in terms of sales and financial results. GM reported a $15.5 billion net loss for its second quarter, continuing a string of losses. They are in very serious financial straits. They just announced that they intend to draw down the remaining $3.5 billion of an existing $4.5 billion secured revolving credit facility to boost liquidity and help them pay payroll and other bills.

With the above background, it was therefore very striking and telling that I read in the L. A. Times last Friday that GM was promoting their new 2009 Cadillac CTS-V, a car priced at an estimated $65,000, with 556 horsepower, and EPA measured fuel economy of 14 mpg in the city and 18 on the highway! One of its big features is that it can go from 0 to 60 mph in 4 seconds. I suppose there is a small market for a car like this and perhaps the profit margins are better than on many of their other models. However, I don't see how this car is what GM needs to recover financially and help them achieve the mandated fuel economy standards. Why don't they promote a car like the Chevy Cobalt?

Wednesday, September 17, 2008

Republican Convention

On August 29th I published a post on the Democratic Convention held in Denver. It's therefore appropriate that I now belatedly publish a post on the Republican Convention held in St. Paul, Minnesota in the first four days of September.

Republicans and many Independents no doubt felt it was a highly successful convention, highlighted by the impressive speech delivered by John McCain's very recent Vice President nominee, Governor Sarah Palin from Alaska. The apparent success seemed to be evidenced by the post-convention bounce in the polls given to the McCain-Palin ticket showing them virtually even, and in some polls slightly ahead of Obama and Biden. There is little doubt that Ms. Palin has energized Republican Party supporters and, at least for the time being, raised the confidence of Mr. McCain and his campaign staff.

However, just as the Republicans have been quite critical of Barack Obama's experience at the top of the Democratic ticket, which has not been an unexpected or unjustified charge, criticism has been raised by both Democrats and even some Republicans of Ms. Palin's experience. As a reminder, she served on the city council and later as mayor of the small town of Wasilla with a population of around 7,000 when she served, and for the past twenty-two months has served as governor of the state, apparently quite successfully, based on her widespread popularity up there. Her experience and qualifications are more important than in most presidential elections for two fairly obvious reasons: first, the relatively advanced age (72) and previous health issues of Mr. McCain, and second, the extremely serious economic and international issues currently facing the country.

Ms. Palin's qualifications will be tested in her October 2nd scheduled debate with Joe Biden and expected interviews with a number of TV and radio talk show hosts over the coming weeks. There will likely be some challenging questions about foreign policy and national security issues, as well as on her questionable recent comments on support for and against the "Bridge to Nowhere" and pursuit of earmark legislation for a variety of Alaskan projects. While she's a smart and impressive woman in many respects, she will most probably not get a pass on foreign relations expertise because of Alaska's long border with Canada and the fact that one can see a Russian island from an Alaskan island or peninsula across the Bering Strait.

One thing that particularly concerned me on this subject, although it was not incorrect, was her widely publicized recent statement, in a recent interview with ABC News anchor Charles Gibson, that we may have to go to war with Russia. I'm not sure she understood that that was a highly provocative statement for a candidate for vice president to say at a time like this when resumption of the Cold War we had with the Soviet Union is a real and serious possibility.

In any case, I suspect it will be, surprisingly, a very close election and many experienced political analysts believe it will come down to how the candidates do in the upcoming debates and the voting in three critical states: Michigan, Pennsylvania, and Ohio.

It is very unfortunate for the American people that under our present system so much time and effort needs to be spent on endless fundraising and negative campaigning, despite earlier promises to take the high road, and expensive TV advertising that frequently contains erroneous and misleading statements about the opposition's viewpoints. Both major campaigns are guilty to varying degrees. It is tradition to say the American people "deserve better," and we do. However, it's a fact that to a significant extent, it's also our own fault, because much too high a percentage of our people don't vote (close to 45% on average in national elections!) and don't contact their elected representatives to convey their views on important issues.

Monday, September 1, 2008

Energy Independence and Foreign Policy

Recent troubling international events, involving especially Russia, secondarily Iran and Venezuela, have made it even more urgent for the U. S. to work more closely with our allies to deal with serious threats from these three oil and gas producing major players and accelerate movement towards a high degreee of energy independence. It's not necessary to be 100% independent, but I think we need to be at least 80%, and preferably 100% when it comes to the Middle East. If need be, we can rely on any relatively small emergency shortfall on more drilling from domestic wells, conservation, and a temporary release of some of the oil in our Strategic Petroleum Reserve, now with an inventory of more than 700 million barrels.

These events, as most of us know, include particularly Russian aggression in the little neighboring country of Georgia, threats to Turkey for allowing U. S. naval vessels to enter the Black Sea, implicit threats to Western Europe for generally supporting the U. S. in discussing sanctions against Russia for their aggression, support to Iran for developing their nuclear energy development, and potential threat to Russia to expel the country from membership in the exclusive G8 group of developed countries. These events are strategically highly sensitive because many European countries are very dependent on substantial imports of oil and gas from Russia, the U. S. needs Russian cooperation on dealing with international terrorism and the multiple threats posed by Iran. Furthermore, no one wants a return to the Cold War.

Iran, of course, is believed to be very possibly developing nuclear weaponry that could be a major threat to the entire Middle East, particularly Israel, and is causing a great deal of trouble with our current mission in Iraq. Venezuela's Chavez is establishing suspicious alliances with Iran and Russia, is a trouble-maker in our ally Columbia, and seemingly taking steps to corral oil producers Ecuador and Bolivia into their political camp. Finally, another troubling Latin American event is clear evidence that Russia has now decided to renew a major relationship with Castro's Cuba, most probably to irritate the U. S. and serve as an aggressive reaction to many of our somewhat provocative diplomatic and military actions in eastern Europe and other former Soviet Union republics.

All of these events, and their prospective economic and political consequences, make it obvious that moving boldly and urgently towards a high degree of energy independence is critical for both the U. S. and our European allies, from whom we can learn a lot. As an example, France gets 16% of their energy from renewable resources, compared to about 6% for the U. S., and gets 87.5% of their electric power production from their 59 nuclear plants. Germany has the world's largest solar power installation at Hemau, a small town in southern part of the country, and is among the world's leaders in the percentage of energy consumption obtained from solar. Little Denmark was 99% energy dependent in 1973 at the time of the Arab oil embargo. Now, after developing a comprehensive energy plan, Denmark gets 20% of their total energy needs from electricity generated by wind turbines, and the proportion is growing annually. The cost of this electricity has been reduced by 75%since 1970. Biomass energy and conservation are other important parts of their energy plan. We can also learn from Brazil's success in becoming independent with their ethanol production from sugar cane, supporting their oil resources.

Fortunately both Senators McCain and Obama support some level of energy independence. McCain indicated in a recent comprehensive speech on his energy plan in Las Vegas that he is committed to "strategic independence by 2025." Obama said in his nomination acceptance speech last Thursday that he is committed to independence from Middle East oil within the next ten years. However, both candidates need to get more specific and ambitious. I don't really know what McCain means by "strategic independence" and, it seems to me, 17 years is too long a timeframe. In terms of Obama's commitment, I'd agree that independence from the Middle East should be a priority, but I'm also concerned with a high level of independence from Venezuela, Nigeria, Algeria, and Indonesia. Canada is the only major exporter I think we can consider reasonably secure and reliable.

As I indicated in an earlier posting, we need a urgent and comprehensive national energy plan that includes the above goals for independence and very significant roles for several environmentally sensitive and cost sensitive options: natural gas, nuclear, clean coal refining technology, hydroelectric, solar, wind and biomass sourced power. There is no reason why we can't over the next 10-12 years, like Brazil, France and Denmark, increase our energy consumption from renewable sources from our current 6% to at least 15% and a target of 20% in 15 years. Achieving these realistic goals will serve us well in terms of national security, dealing effectively with global warming, preserving our environment, as well as the critical economic benefit of generating millions of badly needed new, well-paying "green" jobs.

It is also critical that we pursue well thought-out ongoing diplomacy and dialogue with Russia as well as China, the two other super powers, much as we don't like their form of government, the way they treat their own people, and many of their actions. No nation will win if a serious Cold War develops between Russia and the U. S. or between China and the U. S. We need to try to maintain our military supremacy, but, with very limited exceptions, pragmatic diplomacy and dialogue must be exhausted, before we launch a military option.