Friday, April 23, 2010

Financial Regulatory Reform - Supplement

On more reflection, reading and research, I've decided some additional comments relative to my recent post are needed, and I hope the points made are included in the lobbying and hopefully bipartisan debates in Congress in the days and weeks ahead as the reform legislation moves toward a vote for approval.

1. I was favorably impressed with the comments made by BNY Mellon CEO and Chairman Robert Kelly in an interview covered by the Jim Lehrer PBS News Hour program yesterday. (For those not familiar with his firm, BNY Mellon, one of the largest financial institutions in the country, based in New York City, was formed in 2007 in a merger between Bank of New York and Mellon Financial.) He said he and most of his banking CEO colleagues agree with the need for financial reform and 80-90% of what's in the latest draft of the bill, but he has some concern with the details in several parts of the bill. It is interesting to compare these views with the very negative characterization of the entire bill made by Republican leaders in Congress.

However, another noteworthy comment he made was that he and his colleagues were concerned that the pending bill taken as a whole, particularly those parts relating to regulation of the complicated financial derivatives business, would likely make the major U. S. banks much less competitive with the large European and Asian banks, unless this aspect could be satisfactorily coordinated with regulators in those areas to make regulation fair to all the banks that are active in this business. Since competitiveness affects shareholders and employment at the American banks, I think it's a fair comment that should be addressed, but it will be very difficult to accomplish the needed coordination in this legislation. But that doesn't mean his point can't be pursued separately from this legislation.

Finally, Kelly noted there was a vital issue which was not included in the bill and that was what to do with the quasi-government housing finance agencies, Freddy Mac and Fannie Mae, whose poor performance was a significant factor in causing the financial crisis. He was right to bring it up, but apparently Congressional leaders have agreed to look at that issue next year.

2. It seems that the key part of the Senate bill where the majority of Democrats and Republicans have strongly different views relates to the $50 billion fund to be established with fees from the larger financial institutions to help wind-down any future failing firms. The Republicans are concerned that this represents a large and unneeded expense for the banks and that it will be used inappropriately to bail out failing banks. The Democrats are adamant that this is not the case. I've read that President Obama is prepared to drop this fund from the legislation. But if that's not the case, I don't see why clear agreement between the two parties can't be quickly reached. Agree on language that spells out clearly what is intended and what is not!

3. Another point of serious contention between Republicans and Democrats is apparently the part of the bill that would establish the Consumer Financial Protection Agency (CFPA) to protect consumers when they borrow money, make deposits, or obtain other financial products and services. As I understand it, the CFPA would focus especially on protection for subprime mortgages, credit card terms and conditions, and overdraft fees.

The Democrats generally feel this is critical to protect consumers from deceptive and unfair bank practices, which people definitely have experienced. Most Republicans, as I understand it, feel this issue was not a big factor in causing the financial crisis and is concerned that this legislation represents another unneeded layer of federal intervention and expense that will add extra costs to banks which they'll need to pass on to consumers. Additionally, I think Republicans feel that market competition and more transparency will adequately protect consumers, and there is merit in these views.

However, if done right I think it's reasonable to have a lean CFPA with a fairly limited number of clear guidelines and regulations to deal with the more blatant practices which are of widespread concern. For example, lenders should be required to make it very clear verbally and in the documentation what the primary pros and cons are of the main terms of a loan that is marketed or requested by the borrower. All fees and charges must also be made clear verbally and in the documentation. There ought to be reasonable guidelines for maximum interest rates for different types of lending, including interest on credit cards. It should not be difficult to get broad bipartisan agreement on this, but it will probably turn out not to be the case.

4. I agree with the critics that needed reforms should not require a 1,300 page bill. I should think 100 pages would be more than enough, but I'm sure at the end of the day the bill will still be fairly close to the 1,300 pages. Unfortunately legislators and the lobbyists continue to act like they get paid by the page!

Thursday, April 22, 2010

Foreign Policies Review

President Obama and his administration has an increasingly difficult and challenging situation with what's going on throughout the world and how this is affecting our many very important foreign policies and relationships with other countries, including key allies, those which are de-facto enemies or at minimum not friendly towards us, and the large number of others who are relatively non-aligned.

Why do I say this and what can and should be done about it?

First, while there has been some evidence of progress towards peace and relative stability, we continue to have an expensive, uncertain and increasingly isolated battle in achieving our objectives in Iraq, Afghanistan and Pakistan. The high costs are represented by military and civilian casualties, money we don't really have and largely need to borrow, and substantial military and government management time in dealing with these countries. With most of our European allies pulling back the bulk of their forces from this region for political and economic reasons, we are more and more facing bearing the burden relatively alone at the same time that we are also committed to reduce our own forces over the next year or two.

Al Qaeda, the Taliban and related Muslim extremist groups, though many of their leaders have been killed in recent years, will most likely find and train replacements, they are well aware of U. S. strategies and political constraints, and they are patient. We must assume that they await our eventual withdrawal of forces with plans to then renew their attacks on whatever government is in power. We certainly cannot expect the two other superpowers, China and Russia, to step up militarily when we leave. India, another major power, might step up in some fashion, especially if neighboring Pakistan, whom they have fought for years, becomes seriously threatened by the Taliban or other Muslim extremists.

Second, the deteriorating situation between Israel and the Palestinian territories and our longstanding pursuit of a fair and sustainable peace agreement under a United Nations supported two-state solution. Although the U. S. is by far Israel's most important ally, and we are strongly committed to preserving Israel's security, recent well-known events have strained President Obama's relationship with Israel's government headed by Prime Minister Benjamin Netanyahu. Making this issue more difficult and sensitive are Iran's continuing progressing pursuit of nuclear weapons capabilities threatening Israel and neighboring Syria supplying dangerous Scud-D missiles to the Hezbollah, Israel's Muslim extremist enemy in Lebanon.

Further negative factors in this region at present are that Syria has in recent months been deepening its alliance with Iran and that one of the regional powers, close by 98% Muslim Turkey, previously an ally of Israel, has now become more of an adversary under its Islamist government.

Third, China is increasingly flexing its economic and military muscles as one of the two largest national investors in U. S. treasury bonds, and sizeable widespread oil related investments in Africa, the Middle East and Latin America, the latest being news a few days ago of a $20 billion loan to Venezuela to be repaid in oil deliveries to China. China is also a key partner with the U. S. in trying to control the rogue regime of Communist North Korea, which is threatening two of our top allies in that region, Japan and South Korea.

Fourth, as commented on in recent posts, our policies are constrained by limited financial resources. The U. S. is heavily burdened by substantial budget deficits, a huge amount of national debt, uncertainty about the willingness of foreign creditors, especially China, to continue to lend us more money, and the fact that at least 50% of Americans are probably not going to support an increase in most taxes to help balance our federal, state and county budgets.

The above pose some, but certainly not all, of the most important foreign policy challenges facing the Obama administration over the next 2 1/2 years, if not longer, if he gets reelected in 2012. Others include making the United Nations more effective, achieving nuclear non-proliferation, a new comprehensive energy plan involving foreign suppliers, getting cooperation on dealing with global warming, and coordinating actions to promote international trade and commerce.

What can and should be done about all these tough challenges?? President Obama, his administration, the Congress, and probably most Americans are reasonably familiar with the challenges. Coming to good and necessary decisions, for sure, will be very difficult in most cases, many causing concern and even anger among allies and non-aligned countries. One of the biggest problems will be overcoming the blatant partisanship we've experienced in Washington since President Obama took office last year. Here are some thoughts I have, and I recognize some of the action steps I recommend are, or may be, already in various stages of implementation:

1. Accept the fact that we don't have the resources or compelling reasons to dominate the world's stage any more and nearly alone solve all its big problems. China, India, Russia, Brazil and the European Union, in addition to the United Nations, need to much more equally share the burdens and responsibilities.

2. Put a more serious and concerted effort into limiting the unwarranted, unproductive and blatant partisanship we've seen in Washington and many state capitals, especially when it comes to national security and foreign policy issues referred to above. The president must lead the effort and demonstrate by his actions that this applies to him, his staff, federal government agencies and members of Congress. The media should be encouraged to be more balanced in its coverage. Congress members should be encouraged to vote for their leaders that fully support this effort.

2. In coordination with Congress and key allies, review and update plans to withdraw combat troops from Iraq and Afghanistan as soon as is feasible, retaining in those countries a relatively limited contingent of non-combat advisers as the president and Pentagon considers a absolutely necessary, and as agreed to by the governments of the two countries. The plans must also address what can be done to satisfactorily limit expenditures in the wind-down phase and any future years, without materially and adversely impacting our strategic objectives.

3. Even though it's tempting at the moment to advise Israel that, while we continue to stand by them in terms of their security, they should decide how they want to deal with the Palestinian territories, Syria, Hezbollah, Hamas and Iran. We won't get involved. But I can't see that working. I still think we need to try harder and more creatively to serve as a fair mediator and facilitator for an agreed period, such as 18 months, providing that's completely agreeable to Israel, the Palestinian government, and preferably also Turkey, Egypt, Saudi Arabia, and Jordan, all of whom have a strategic interest in a viable peace agreement. If either party doesn't agree, we should leave prospective negotiations to them and go home. Another option, if they don't agree to our role, is to get the U. N. involved.

4. The pillars of our foreign policy focus should be the European Union, Canada and Australia, Russia, China, Japan and South Korea, Mexico, Brazil and India by virtue of their size, economic and military power, global influence, and proximity, in the case of Canada and Mexico. Most important of these, in terms of complexity and challenge, are China and Russia for fairly obvious reasons, including containing rogue North Korea for China and containing rogue Iran for Russia.

5. As I think President Obama is pursuing, we need a bipartisan energy plan approved by the end of the year, latest by the middle of 2011, that moves us close to virtual energy independence within 5 years, including Canada for this purpose as a domestic source. We should have no more than a maximum of 10% dependence on Middle East oil within 2 years. Major components of the plan should include increased natural gas production in the U. S. and Canada, environmentally safe offshore oil drilling, many more nuclear plants, cleaner coal technology, greater green source energy (especially solar) for electricity, and much more conservation with more energy efficient appliances and higher fuel mileage requirements for autos and trucks.

6. We significantly improve our prospects for successfully meeting the above challenges on a timely basis by getting our national economics in much better shape through a balanced federal budget, limiting if not stopping entirely the growth of our national debt, and gradually over time reducing its level. To start with we must get bipartisan agreement in Congress for a balanced budget to be achieved within 2-3 years through normal economic growth, reducing noncritical federal expenditures, and temporarily establishing a national sales tax, and/or an increase in taxes on gasoline, tobacco and alcohol sales.

Some of the logical targets for reducing federal expenditures are to reduce in size or close down entirely many of our noncritical military bases abroad, such as in Japan, South Korea, the Philippines, Germany and the U. K. Japan and Korea can take care of themselves. So can the other countries. I'm certain there are many other reasonable expenditure cuts that can be identified to help achieve and keep our budget balanced.

Sunday, April 18, 2010

Financial Regulatory Reform

A great deal is going on in Washington, D. C. and New York City these days relating to the country's financial system and its major financial institutions, as well as with their oversight and regulation by the federal government. Many books and scholarly articles will be written about this. Even a big movie or two may deal with the situation and what happens. Most Americans no doubt find the subject very complicated, uninteresting and perhaps also boring. Nevertheless, how everything ends up, while currently difficult to predict accurately, is extremely important.

In the limited space a post provides, I'll try to fairly briefly cover the main points and share some of my personal viewpoints.

For a variety of reasons still being investigated, the U. S. economy fell into a deep recession beginning in December 2007 that most economists consider the most serious since the Great Depression of the early 1930's. It was triggered by many factors, including a substantial liquidity shortfall in our banking system, probably largely caused by excessive and imprudent mortgage and commercial real estate lending by the major commercial banks and other financial institutions like Washington Mutual, Countrywide Financial, and IndyMac Bank.

To make a great deal of money on this lending activity, and the related housing bubble, several of our largest investment banks, led by giant Goldman Sachs, created marketable securities, known as collateral debt obligations (CDO's), backed by huge volumes of the mortgages, a large percentage of which were subprime, and sold them to substantial investors in the U. S. and abroad. They also created complex derivative products to enable supposedly sophisticated market players to bet on future prices of these securities. When the housing bubble burst and housing values fell dramatically in 2007, 2008, and into 2009, the securities and mortgage loans themselves greatly declined in value, causing large losses to both the lenders and the investors in the securities.

As most of us know, the end result of this and other related developments was that banks substantially restricted availability of credit, harming individuals and businesses, as well as many municipalities, millions of people were laid off, many of them lost their homes through foreclosure, many banks and other businesses have gone bankrupt, and the federal government felt compelled to step in with a very large financial stimulus package last year and extensions to unemployment compensation payments this year.

One of the big things going on now in Washington is that former California treasurer, Phil Angelides, is chairing the bipartisan Financial Crisis Inquiry Commission, holding a number of hearings, to determine exactly what happened to have caused this crisis and what needs to be done to prevent a similar future event. A report to the Congress and President Obama is due this December.

However, in an action that was considered a surprise and shock to our financial markets, the Securities and Exchange Commission (SEC) last week filed a high profile lawsuit against Goldman Sachs, accusing the company of fraud in misleading investors in one of their complex transactions. More similar filings are expected.

Another big thing going on in Washington is that the Senate's Permanent Sub-Committee on Investigations, chaired by Senator Carl Levin of Michigan, is conducting their own hearings to assist the Senate in its work in coming up with an appropriate financial regulatory reform bill, which is high on Obama's legislative priorities for the next several months. Because the stakes involved are so high, lawyers, accountants, board members, lobbyists and advisors in New York and Washington for all the institutions and governmental agencies are working hard to assist their clients and colleagues prepare for and achieve the best outcomes possible.

Like with the recently approved major healthcare reform legislation, the ongoing debate in Congress on financial regulatory reform unfortunately has been highly partisan. The Democrats, urged on by President Obama, for the most part support a comprehensive bill, while virtually all Republicans appear to be strongly opposed to the bill in its current form, claiming primarily that it imposes too much and unnecessary government intervention in our financial markets.

As someone who spent a career in corporate, government, international and investment banking, what do I think?

I think a relatively comprehensive reform bill will eventually be approved with a few changes from the current draft to convince a small number of moderate Republicans to vote in favor. However, a lot will depend on the outcome of the pending SEC lawsuit against Goldman Sachs. It seems to me that the SEC will have difficulty proving fraud in a court of law, although it's likely that jurors and the presiding judge will conclude Goldman did not behave ethically in how they handled their activities cited in the case.

In view of the high costs and distractions of a possibly lengthy trial and the negative publicity likely to come out, it would not be at all surprising if the SEC and Goldman settle before a trial. In such a settlement Goldman no doubt would have to pay a substantial fine (which they can easily afford) and acknowledge that, while they felt strongly they were not guilty of outright fraud, they in retrospect should have handled the transaction involved differently, with more transparency. The Obama Administration and SEC would most probably prefer a trial, if they felt very confident they could win in court and also that it could be concluded in a reasonably short period of time, but I suspect that's not what they will conclude.

In the end I think Goldman will come out OK and continue to be a dominant player in our financial markets, we will have a reform bill approved into law, and the lawyers, accountants and associated lobbyists representing all the players will make out like bandits.

Angelides' Financial Crisis Inquiry Commission will deliver their report in December and it will be highly critical of Wall Street and the senior management and boards of directors of the major commercial banks and other financial institutions who were active in real estate lending over the past several years. Furthermore, a high and disturbing level of blatant partisanship in Congress will continue and average Americans will continue to feel very unhappy with both Wall Street and the majority of our elected politicians.

Sunday, April 11, 2010

Agricultural/Farm Subsidies

Given our large federal government budget deficits and very high national debt level, which I've commented on in recent posts, it is definitely appropriate to look carefully at how and where we can reduce spending. It's not difficult to identify the answers, but largely for political reasons, it seems to be very difficult to get needed results. While the amounts involved are relatively small, one of many logical places to cut spending is for agricultural and farm subsidies.

In his first national address to a joint session of Congress in February last year, President Obama stated that approximately $5 billion of subsidies to large agribusinesses that don't need them were "wasteful" and should be eliminated. I agree with him, but I'm not sure that's happened yet. From 2003 to 2006 millionaire farmers reportedly got $49 million in subsidies, but it's not clear whether those have been stopped. My understanding is that subsidies of all types to this industry totaled $23 billion in 2005 and as much as $44 billion last year.

These subsidies represent unnecessary spending and are also often harmful to U. S. exports, which adversely affects our trade deficit or surplus with other countries. According to a report in the Wall Street Journal a few days ago, federal subsidies to U. S. cotton growers has allowed Brazil, under the rules of the World Trade Organization (WTO), to impose new tariffs on 102 U. S. products affecting approximately $1 billion in U. S. exports and thousands of American jobs. In an effort to get Brazil to delay imposition of the tariffs the U. S. government apparently has just proposed to Brazil that we make a $147 million payment to Brazilian cotton growers who compete with American growers in certain export markets. This is stupid! We as taxpayers would then be subsidizing U. S. growers as well as Brazilian growers.

We should eliminate all subsidies to the industry and negotiate an end to subsidies by our competitors abroad in coordination with the WTO. It is true that many smaller, less efficient family farms may find it hard to survive if subsidies are ended. That would be unfortunate for them. However, with knowledge of subsidies soon terminating, farmers would be very motivated to make needed changes to improve their financial prospects, by changing crops, becoming more efficient, acquiring more acreage, or even merging with another nearby farmer, similar to what other smaller businesses operating today in challenging operating environments are often needing to do. To facilitate transitions for these farmers, and as warranted by specific circumstances, the subsidies could be terminated gradually over a period of two or three years.

Like with the example of the cotton growers mentioned before, ending the subsidies should enable us in many cases to be more competitive with U. S. exports, including agricultural products, as foreign governments reduce or eliminate tariffs on imported U. S. products.

The large agribusinesses as well as the family farmers have a very well organized and effective lobby in Washington to protect their subsidies. The lobbyists are well compensated and, as one would suspect, their representatives and senators in Congress are well supported by substantial campaign contributions. Legislation to end subsidies will therefore be quite difficult, and we frankly shouldn't be optimistic about prospects, at least in the near term. As with many of these political issues, sustained pressure, compelling arguments, and patience from the voters and the media will be required.

Saturday, April 3, 2010

Healthcare Reform - More Thoughts

It was disappointing, but not surprising, that no Republicans voted for the historic bill President Obama signed into law last week. The Republican leadership, headed by House Minority Leader John Boehner of Ohio and Senate Minority Leader Mitch McConnell of Kentucky, put a lot of pressure on their more moderate and, in some cases, possibly wavering members to withhold support for ideological, pragmatic, as well as political reasons.

While Boehner was greatly overstating the impact of the bill when he repeatedly said it was a "government takeover of healthcare," there is no question its approval into law and implementation would significantly increase the federal government's role. There is also no question that at $940 billion over ten years its cost is very high, and one can certainly question whether the country can afford it, given our weak and recovering economy, large budget deficits and high national debt. It's also not at all certain that this law will contribute to the sizable level of deficit reduction claimed by Obama.

Politically, of course, Boehner and his colleagues saw defeat of this bill as a major means to seriously damage President Obama and enhance the prospects for big gains by Republicans in the November mid-term elections for both congressional and various state governor races including in California. The Democrats, led aggressively by Obama, took a big political risk by pushing such a controversial, complex and expensive bill through Congress on a highly partisan basis. They are betting on the majority of Americans agreeing by November that the healthcare law, despite its high cost and limitations, is nevertheless the right course for the country.

At its core the political debate was between cost and coverage. The Republicans were primarily seeking much lower costs and cost containment measures, where the bill was relatively weak, while Obama and the majority of Democrats in Congress were prioritizing greater coverage for uninsured Americans and more security for those who are already insured. The expectation is that the new law will provide for some level of healthcare insurance coverage for 32 million Americans who currently are uninsured. That, as I understand it, is where most of the law's cost comes from.

I would have liked to see a more credible rough breakdown of the 32 million uninsured people in terms of their general circumstances. How many of them could probably have afforded to purchase coverage, but chose not to, perhaps because they are reasonably healthy and decided to wait until they were older and more liable to need care. How many, if any, are illegal immigrants? However, given the large number of unemployed, the high volume of home foreclosures and under water mortgages, my assumption is that the great majority were legal resident Americans who genuinely felt they could not afford to purchase any coverage.

Furthermore, I may be wrong, but my strong suspicion is that it has been difficult for many Americans to find a simple, basic healthcare insurance policy they would be eligible for having relatively limited but acceptable coverage at a very affordable cost. How many of the 32 million fall into this category?

Conclusions? Much more attention to cost containment measures will be needed over the next several years as the law's implementation proceeds. There's a lot of noise from Republicans about repeal of the law and gaining exemption for states pushing for that. But several legal scholars believe their chances for success are poor. We'll have to wait and see what happens in the November elections, but there's a great deal at stake and no doubt the campaign fervor will be very high on both sides. This was a big, badly needed victory for Obama and the Democrats. If the economy continues to improve and the current official 9.7% unemployment rate is able to fall to 9.4% or 9.5% by early November, which is no sure thing, the Democrats will probably hold their own in the coming elections.

However, it's also likely that if the healthcare reform law is poorly implemented and if the economic recovery falters, and the unemployment rate remains where it is or gets worse, then Democrats will most probably face a very tough time in November, possibly even losing control in the House, worsening Obama's prospects for any bipartisan support on new legislation for the last two years of his elected term in office. Stay tuned.