New Geography

Tag: Financial Crisis

  • Layout for the Bailout: $3.8 Trillion and Counting

    Bloomberg.com reporters Mark Pittman and Bob Ivry are reporting a running total of the money the U.S. government has pledged and spent for bailouts and economic stimulus payments. The total disbursed through February 24, 2009 stands at $3.8 trillion; the total commitment is $11.6 trillion. The Federal Reserve is providing the largest share at $7.6 billion, followed by the U.S. Treasury $2.2 trillion and FDIC $1.6 trillion. The Department of Housing and Urban Development (HUD) and support for Fannie Mae and Freddie Mac, combined with purchases of student loans – bailout money that comes closest to directly bailing out Main Street – total only $760 billion – less than 7 percent of the total.

    The national debt currently stands at $10.8 trillion — versus an authorized limit of $12.1 trillion.

    Last week, U.S. Treasury Secretary Timothy Geithner got into a tiff with the rest of the world (denied by President Obama) by telling them that they should spend at least 2 percent of their GDP on their own stimulus packages.

    The U.S. commitment of $11.6 trillion equals 81 percent of U.S. 2008 gross domestic product (GDP). The $787 billion fiscal stimulus is 5.4 percent of GDP. Just the two-thirds of the stimulus that represents new spending (one-third is tax cuts) is 3.6 percent of GDP. Here’s what financial institutions in various countries got from U.S. taxpayers by way of the AIG bailout:

    Country

    Bailout Benefit

    US

     $   31.1

    France

     $   19.1

    German

     $   16.7

    UK

     $   12.8

    Switzerland

     $     5.4

    Netherlands

     $     2.3

    Canada

     $     1.1

    Spain

     $     0.3

    Denmark

     $     0.2

    Italy

     $     0.2

    Serbia

     $     0.2

  • Anger Could Make Us Stronger

    The notion of a populist outburst raises an archaic vision of soot-covered industrial workers waving placards. Yet populism is far from dead, and represents a force that could shape our political future in unpredictable ways.

    People have reasons to be mad, from declining real incomes to mythic levels of greed and excess among the financial elite. Confidence in political and economic institutions remains at low levels, as does belief in the future.

    The critical issue facing the new administration is finding useful ways to channel this disenchantment. We know popular anger can also be channeled in unproductive ways. It can serve to further a narrow political agenda – for example, Karl Rove’s cynical exploitation of the “culture wars” – or stir up a witch hunt against both real and perceived “threats,” as occurred during the McCarthy era. If this were Russia, there would be show trials and executions. We do not and should not do that – but we can still use populist anger to reshape our nation and make it stronger.

    In this respect, the Obama administration, criticized justifiably as too radical on some issues, has been far too timid. It has squandered much of the stimulus effort on maintaining fundamentally corrupt, even sociopathic, institutions like AIG or Citigroup. By taking direction from establishmentarians like Treasury Secretary Timothy Geithner, one of the original architects of the Bush financial bailouts, the current administration has seemed as complicit in condoning and even rewarding Wall Street’s transgressions as the last one.

    Populist rage creates the political support for taking far bolder steps against Wall Street. A good first step would be to allow the TARP-backed giant banks to come under some sort of federal control, or bankruptcy process, effectively wiping out the holdings of the financial malefactors and decimating any hopes for future bonuses. The public could then sell the remaining assets to the many well-run community and regional banks that invest in local businesses as opposed to the arcane paper favored by the Masters of the Universe.

    Radical financial reforms represent only part of the opportunity. China is using its stimulus to increase its competitiveness globally. So far, the Obama administration’s economic strategy, if it has one, has been selling the public on the chimera that highly subsidized “green jobs” and good intentions will save the economy. It has also rewarded what my old teacher Michael Harrington called “the social-industrial complex,” the massively growing education, health and social-service bureaucracy. President Obama needs to spend less time in photo ops at “green” factories and figure out how to drive the transformation of whole industries, like autos, steel, electronics and aerospace.

    In this sense, of course, the New Deal – particularly the Works Progress Administration and the Civilian Conservation Corps – provides some models. These programs used the unemployed to create new dams, electrical-transmission systems and bridges that boosted the nation’s productive power. Critically, such a program would target blue-collar workers – mostly male and heavily minority – hardest hit in the recession. As conservatives rightly note, the New Deal construction projects did not end the Depression, but they did give people purpose and skills as well as hope, while leaving us with a remarkable legacy of productive structures that inspire us with their affirmation of our national destiny.

    Sadly, the political operatives running the White House today may prefer to use the popular mood primarily to service their key political constituencies and boost their poll ratings. If they do so, they will have squandered a unique opportunity to implement changes that would benefit both the country and the middle class for decades to come. Public outrage is a terrible thing to waste.

    This article originally appeared at Newsweek.

    Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

  • Story of the Financial Crisis: Burnin’ Down the House with Good Intentions and Lots of Greed

    Last week, the Chairman of the Federal Reserve, Ben Bernanke, told Congress that he didn’t know what to do about the economy and the repeated need for bailouts. This week, the Oracle of Omaha Warren Buffett, Chairman of Berkshire-Hathaway told the press that he couldn’t understand the financial statements of the banks getting the bailout money.

    This made it a daunting challenge the other day, when the Program Director for the Bellevue (Nebraska) Kiwanis Club asked me to talk to his group about the current state of the economy. Despite the many often outrageous examples of excessive greed and even criminality, the current debacle began with good intentions: provide opportunities for homeownership to a segment of the population that was historically left out.

    New credit rating systems had to be developed to take into consideration the fact that some immigrant groups prefer to live in extended families (multiple generations in one household). The individual income of any one may not qualify for a loan, but they would all be paying the mortgage. Yet, their family patterns meant assets are only held by the male head of household. That’s just one example, and there are many more. It’s just that banks and others came to realize that the existing systems were excluding people who would actually be very good borrowers. The original “subprime” borrowers were like the original “junk bond” companies – they didn’t fit the mold of a model credit customer. But among them were MCI and Turner Broadcasting – plus Enron and Worldcom, of course.

    Like junk bonds, the new mortgage product came to be abused by borrowers and lenders alike. This was made worse by developments that blurred the line between banks and brokers. Both parties participated in actions that allowed banks to have their in-house brokers sell off their mortgage loans to Wall Street in the form of bonds. This is called “originate and distribute”. The same bank wrote the mortgages, packaged the loans for sale and distributed the bonds to their clients – collecting fees at every stage.

    And here’s where greed entered the picture. The demand for these bonds completely outstripped the supply: senior management put pressure on the troops to write more mortgages and sell more bonds. The fees were pouring in from everywhere. The demand was so great that an average of 40% of the trades failed for lack of delivery – broker-dealers were selling more bonds than were issued. Each bond trade, whether or not there was a failure to deliver, resulted in a commission for the buying and selling broker-dealers. They didn’t have to tell the buyers that there was no delivery – the broker-dealers figured they could fix it later. This was the initial breakdown in regulatory oversight.

    The next one came when no one was watching over the credit rating agencies. According to a story on PBS (originally aired November 21, 2008), managers at Standard & Poor’s credit rating agency were pressured to give the bonds triple-A ratings in the pursuit of ever higher fees. (We’ve yet to learn all the details of the potential collusion between banks, brokers, rating agencies, etc., but more news is coming out all the time – stay tuned!)

    Along the way, it became clear that these investments in mortgage bonds were, in fact, risky – despite their triple-A credit ratings. That’s where the credit default swaps came in – credit default swaps (or CDS) are simply contracts akin to insurance policies. The bond holder pays a small premium up-front and they get all their money back if the bond goes into default which could happen, for example, if the homeowner owing the mortgage in the mortgage bond ends up in foreclosure. This was another idea with good intentions – it made the bonds more popular and sent more money back to the bank for more mortgages.

    The way the theory on structured securities was developed, if a bank can sell the mortgages they can use that cash to write more mortgages and so support local communities that need to expand housing opportunities. It should also disperse the risk, spread it around, so that some economic problem in one town, like a factory closing, won’t cause the local bank to go out of business. Losses on local mortgages would be spread out geographically, spread out over a large number of investors and over different types of investors (individuals, companies, pension plans, etc.) so that no one of them should suffer all the damage.

    Greed enters the picture again: instead of the CDS derivatives being sold only to the people who owned the bonds and only in a quantity equal to the value of the bonds that were issued, an unlimited number of swaps were sold. This is as if you have a $1 million home and someone sold you $20 million worth of insurance. The temptation to burn down the house was just too much. What you see now is arson. They are burning down “the house” to collect on the insurance. Except if it were your typical insurance it would be regulated and you would have to have “an insurable interest” in hand to buy the policy at all. This insures that there would be no more derivatives issued than there are assets. No, these CDS derivative contracts are completely unregulated and unmonitored.

    Sadly there were no video surveillance cameras in place when Wall Street was spreading around the gasoline and striking the match. Yet now we are stuck watching the house – and the economy – burn down.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

  • Cash, Not Pretense: An Entrepreneur’s Guide to the Credit Crisis.

    Compared with most businessmen, 41-year-old Charlie Wilson has some reason to like the economic downturn. President of Salvex, a Houston-based salvage firm he founded in 2002, Wilson has seen huge growth in the bankruptcy business over the past year. It is keeping his 10-person staff, and his 55 agents around the world, busy.

    But the credit crunch still creates headaches for Wilson. With loans hard to secure, many would-be customers cannot bid on the merchandise in his inventory. “We are booming with more deals because people are defaulting,” Wilson notes, “but the buyers are gun-shy because they can’t get the money to pay.”

    So what do you do in these circumstances? Charlie Wilson is taking a back-to-basics approach. Rule No. 1: Stay away from people who rely on credit, not cash. This means private companies – including many outside the U.S. – are often better customers than larger, but now cash-strapped, public ones. “The further away I get from Wall Street, the better I feel,” Wilson says.

    Cheap is the new hip. Focus on cutting costs and streamlining operations. Don’t spend money on unnecessary employees or hard infrastructure; use the Internet wherever possible. It helps, Wilson says, to be located in an affordable building and in a place, like Houston, where taxes, regulatory costs and rents are generally cheap. “I work out of a Class C building,” he says, “and now everyone thinks it’s sexy.”

    Expand your range of customers. Look for new customers who have cash resources and access to markets that are still growing. This has led Wilson to look outside the U.S, to places like India or China, where many companies still have cash and see the current crisis as a great opportunity for bargain hunting.

    These three trends – the growing importance of cash, cost cutting and expanding one’s customer base – are defining entrepreneurial response to the credit crash. All three trends can be seen in the strategies of entrepreneurs who are focusing on burgeoning, often cash-oriented immigrant markets.

    Consider the success of La Gran Plaza, a massive Latino-themed shopping center on the outskirts of Ft. Worth, Texas. Not so long ago, La Gran Plaza was a failing suburban shopping center. Now it’s thriving, but only after being regeared to service the cash economy of the local Latino community. Similar success can be seen elsewhere in the country, even in Southern California, which has been hard-hit by the recession but where ethnic malls and supermarkets continue to thrive.

    Some urbanists, like scholar Richard Florida, maintain that the post-crash environment favors densely populated (and very expensive) cities like New York. But in fact, it may make more sense for entrepreneurs concerned with costs to work out of places like Houston, or even the Great Plains states, where local governments are more business-friendly. And everything, from housing to energy, tends to be less expensive.

    Indeed, over the past few recessions, the basic pattern has been that cities come into the downturns late and stay in them longer. In the last decade, many big cities have become very dependent on Wall Street and asset inflation. In 2006, for instance, financial services accounted for a remarkable 35% of all of New York City’s wages and salaries, compared with less than 20% 30 years earlier.

    So it seems likely that the credit crisis will hit pretty hard in those places most addicted to credit – places like New York, San Francisco and Chicago. This occurred early 1980s, the early 1990s and will occur again now. It might even be worse this time around. The federal takeover of the banks will mean lower salaries and bonuses, which will make such places less attractive to ambitious young people. If you are limited to $250,000 a year, it’s much easier to “get by” in Charlotte or Des Moines than it is in Manhattan.

    The biggest hope for New York, Los Angeles and other big cities lies with immigrants and the fact that lower property prices could keep some talented individuals from migrating elsewhere. But the one expensive big city really well-positioned for the credit crunch may be Washington, D.C., since it “creates” its own credit. As key financial decision making shifts to the capital, we can expect to see some financial-industry titans (and their retainers) spending more time in, or even moving to, the capitol. Washington, it’s time for your close-up.

    Beyond the beltway, the credit crunch will eventually benefit places with lower costs of living – including Houston. High rents, strong regulatory restraints and prestige spending make little sense in a cash-short environment. Now, fancy high-rise offices in elite areas are an albatross for even the strongest business.

    The remade economy may hold some much-needed good news for hard-hit sun-belt markets. Some places, like Phoenix, may be poised for a comeback. “Phoenix is paying for being overbuilt, but [lower] prices will attract people back,” explains local economist Elliot Pollack. “The fundamentals that drove the growth are still here with the return of lower costs – the ease of doing business, lower taxes and the attractiveness of the area.”

    But the real winners may be the people now leaving big companies to start new firms. Unburdened by bad habits developed in the bubble, they will be able to fit their business models in lean times. Many won’t mind being in an un-fancy building or neighborhood. Whether they are forming new banks, energy companies or design firms, they will need to do it more efficiently – with less overhead, smarter use of the Web and less pretension.

    “People are watching their companies go under. You get three vice-presidents who get laid off but know their business,” Wilson says. “They start a new company somewhere cheap that is more efficient and streamlined. These are the companies that will survive and grow the next economy.”

    This article originally appeared at Forbes.

    Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

  • Compensation Confidential

    The salary of the chief executive of a large corporation is not
    a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.
    John Kenneth Galbraith

    What would Galbraith have said about the AIG bonuses?

    When AIG CEO Edward Liddy said the bonus payouts helped retain “the best and the brightest,” he revived a theme that has been common throughout the modern era of executive compensation: an arithmetic correlation between money and talent. Lost on Mr. Liddy, and indeed on much of Wall Street, was the fact that the term was used by David Halberstam to characterize the intellectuals who led us to war and failure in Vietnam. Sweet irony.

    I have been silent witness to the growth of executive compensation entitlement syndrome for the last ten years as a sometime ghostwriter for a prominent company in the field, which shall remain nameless (they pay infinitely more than newgeography.com, and may want to hire me again). This week seems the appropriate moment to share the lessons I learned about the behavioral underpinnings of today’s financial industry bonus crisis.

    1) The seeds of each new scandal in executive pay are sown in the wake of the last one. Remember stock options? They came into vogue in the early 1990s when executives awarded themselves bonuses for laying off vast numbers of workers, rationalizing that they had raised profit margins and deserved a payoff. Congress decided that compensation in excess of $1 million would not be tax deductible to the corporation unless it was geared to performance. As we have learned over and over, performance can be cut to order conveniently when options or other incentives vest. This is what one economist called “the invisible hand of Alexander Portnoy, not that of Adam Smith.” When I began working in executive compensation, CEOs chose which options to cash based on which vintages from a multiyear portfolio were in the money at a particular time.

    And if the resulting tax bill was too high? The stockholders would pick up the tab. Even Apple was caught backdating options for Steve Jobs. Regulators were — and are — perpetually one barn door behind the horses. Who knows what well-intended remedies will be born of the current crisis?

    2) CEOs are as peer conscious as any high school clique, but better paid. Executive comp consultants refer to the Lake Woebegone Effect. To wit, if your pay isn’t above average, or well above average, the board is admitting to the world that you are sub-par…and we wouldn’t want that, would we? So comp committees and their consultants have to find schemes whereby CEO pay keeps rising, perks keep rising, and the water level in Lake Woebegone goes up accordingly until it overflows its banks. If a CEO at a competitor in your industry category is in the 75th percentile, you have to be in the 80th or 90th. World-class management, like a designer accessory, is a function of the price tag.

    3) CEOs are risk averse. They want their money upfront, to justify the risk of taking the new job and the headaches that go with it. Once seated, management finds ways of locking in wealth. The turnover in these jobs is massive. Five years after the Mergers & Acquisitions boom of 1989-91, fewer than half of CEOs who had received sizable recruitment bonuses were still in place (figures courtesy of The Wiley Book of Business Quotations).

    Earlier in this decade, I interviewed a dozen or so CEOs for a Wall Street publication, which deemed them exemplars for a new economic age. Two years later almost all of them were on a list of CEOs who had been indicted or were otherwise disgraced. Of course, the pay levels that justify the risk of failure look a lot like the rewards for success to the rest of us. The bigger scandal comes when the initial contract ink is dry, and they start to manage the company in a way that makes the shareholders feel like they deserve to earn their enormous compensation. That’s when they take risks, as AIG did when the bosses saw the company’s Triple-A credit rating sitting on a shelf and decided to put it on the street in the form of Structured Products.

    What they failed to do was something the barbershop down the street from me, in its capacity as a “number hole”, always remembered to do. If the action was too heavy on a number, they’d lay it off on another bookie…er, banker. Who will hedge the hedgers now that AIG is circling the bowl?

    4) CEOs hate their jobs, mostly. That’s why you have to pay them extra for doing the jobs they are already paid to do, only better. Look, I wouldn’t want to do it either. Corporate jobs are good when business is good and soul-destroying the rest of the time. That was true at my level and I’m sure it’s true at the top, too.

    Come to think of it, even when things were apparently going well, I saw the body language; I heard the mental gymnastics, the ethical contradictions, and the hairsplitting. When you have what comp consultants call “line of sight” for the whole company, you see that it’s a rare event when everything is going well. You make your numbers by selling assets and hope that the problems stay out of the newspapers. But when things are rotten, and they have been rotten for a long time, it’s no wonder that CEOs take everything they can: apartments, jets, club dues, sports tickets, million-dollar furnishings, a piece of the M&A action, stock buybacks, and $440,000 spa weekends complete with manicures and hair styling. They’re like hookers going through a john’s wallet while he’s in the shower. And successful or not, they feel they’ve earned it.

    To be sure, they buy back their humanity with good works, a form of plenary indulgence, as I learned first hand the last time my mother was sent to the emergency room. En route, on the car radio I had listened to the Senate Banking Committee questioning Lehman Brothers chairman Richard S. Fuld. When I arrived, I noticed a plaque on the wall of my mother’s ER cubicle. The space had been donated by Mr. and Mrs. Richard S. Fuld.

    This is the curse of the managerial class, particularly the financial managerial class, and one of the sorry phenomena of our current situation is that everything is financial. Everything is worth what the financial chieftains say it’s worth for as long as they can get away with it. They don’t love the product, the process, or the people. They love the pay package, the perks, and the power. They love the action. When Bear Stearns was melting down, its CEO was incommunicado at a bridge tournament. Isn’t that a bit like a busman’s holiday? What happened to their brains? They hold their breath and search for the greater fool. The best and the brightest, indeed.

    Henry Ehrlich is author of Writing Effective Speeches and The Wiley Book of Business Quotations. He is currently working primarily with companies that are trying to fix the health care mess. Piece of cake.

    Photo by David Shankbone

  • Digging into AIG bonuses and other aid recipients

    On Sunday March 15, 2009, American International Group, Inc. revealed the identities of some of the beneficiaries of about half of the nearly $180 billion the US government has committed ($173 billion actually paid out so far) to support the ailing international financial giant. As we now know, AIG sold credit default swaps (CDS) that paid off if the market value of some bonds fell. (I use the term “bond” here generally to refer to the alphabet soup of CDO, CLO, MBS, etc. – all of which are debt that is sold to the public.) Most CDS only pay off if the borrower fails to make payments – something that hasn’t happened in the case where AIG is making payments. The geniuses at AIG – and we know they are geniuses because they earned $165 million in bonuses for the effort – took on completely unknown risks for, apparently, insufficient premiums, resulting in the need for an emergency $85 billion loan last September from the Federal Reserve Bank of New York (courtesy of my buddy Tim Geithner) to “avoid severe financial disruptions”… as if that worked!

    Whatever. So, now AIG is letting us know who got our money: $22.4 billion for payouts on the CDS and $27.1 billion to buy the bonds underlying the CDS (so some of the CDS could be cancelled). That’s about $50 billion so far for derivatives – no one knows how much more they’ll need. Here’s a summary by the country where the recipients are based:

    Country

    CDS
    Payout

    US

    $16.0

    France

    $13.3

    German

    $8.1

    Switzerland

    $3.3

    UK

    $2.0

    Canada

    $1.1

    Netherlands

    $0.8

    Scotland

    $0.5

    Spain

    $0.3

    Denmark

    $0.2

    Numbers in billions. $4.1 billion paid to “other” not included here. Numbers won’t total to $49.5 billion due to rounding.

    There was also $12.1 billion paid to US municipalities (states, cities, school districts, etc.) – where states invested, for example, bond proceeds prior to expenditure. In those cases, the municipalities invested in assets with guaranteed rates of return (another genius idea at AIG!). The bigger numbers belong to the states that had recent large bond issues – for example, $1.02 billion to California which has yet to distribute a dime of the bond money raised for stem cell research (due to on-going litigation).

    AIG took $2.5 billion for their own business needs – like the bonuses? The $165 million bonuses were just for the London-office that specialized in selling those very special CDS. Total bonuses paid were $450 million for all the geniuses at AIG – the AIG who made $6.2 billion in 2007 and lost $37.6 billion in the first 9 months of 2008!

    The most interesting bit, perhaps, are payments of $43.7 billion to securities lenders – those stock and bond holders who lend out their shares to enable short sellers. This means that AIG borrowed stocks so they could short sell them – make an investment that paid off only if the prices fell. (If you don’t know what short selling is, here’s a five minute video that explains it in a light-hearted way.) Bottom line – it gave AIG incentives to push down market prices. And their announcements and actions at the end of 2008 certainly achieved that goal. Way to go, geniuses!

  • Buffett Update: Downgrade from Oracle to Seer?

    A day or so after he was on CNBC, Warren Buffett went on Bloomberg Television and told them that he’ll continue to sell derivatives contracts. He’s getting deeper into investments that he has called “financial weapons of mass destruction.” Apparently he’s betting that there will not be a crash (which would require a payout) in corporate junk bonds, muni bonds or stock markets in the UK, Europe and Japan. Here’s the punch line: his stock is up 17.2% since he started talking!

    Berkshire Hathaway shares peaked last year at $147,000 each when Buffett was buying energy companies. The price is so very high because they have a policy of never paying dividends. Therefore, all the company’s earnings are put back into investments. If you tried to use a standard finance model to determine the appropriate price for these shares, the answer would be “infinity” because you can’t divide by $0 dividends. Anyway, two months after the peak, the shares were in the tank – relatively speaking – at $77,500 per share. By the end of the week before his TV appearances, the shares were even lower, at $72,400. The day of the CNBC interview: Berkshire Hathaway shares closed at $84,844 – a cool 17.2% gain. Remember, this is the man who said he is fearful when people are greedy and greedy when people are fearful.

    On March 12, Berkshire Hathaway lost its triple-A credit rating from Fitch Ratings because of potential losses from those derivatives. Not that we should believe everything Fitch says – Fitch is among the credit rating agencies that gave triple-A ratings to subprime mortgage bonds, and look what happened to those investments! For what it’s worth, Fitch gives Berkshire a “negative” outlook, meaning another cut is possible within a couple of years. The two other big ratings agencies, Moody’s Investors Service and Standard & Poor’s, still rate Berkshire triple-A.

  • We Need a New Oracle

    Warren Buffett was on CNBC for three hours on March 9, 2009, dishing out his wisdom. All this fanfare despite having lost $24 billion in value last year, and handing the title of Richest Man in the World over to Bill Gates. Buffett made multiple references to “war” in describing the current financial crisis.

    There are several problems with Buffett’s comparison of the current state of the economy to war, as pointed out in this story in the Omaha World-Herald, which ran the day after the interview. What we are seeing is less like war – in which an outside enemy attacks you – and more like arson, except the people who burned down the house are now collecting the insurance too!

    Warren Buffett – the widely revered Oracle of Omaha, where I live – is one of those who built the boom in the capital markets and are benefiting from the bust. No surprise then that Buffett whose primary business vehicle is Berkshire Hathaway, a financial holding company, supports the bailout of financial institutions. Their business includes, among others, property and casualty insurance and a financial holding company. When Senator Ben Nelson (D-NE) told me that he talked with Warren before voting for the first bailout package, I button-holed him after lunch and gave him an ear full.

    Of course Buffett was in favor of the bailout – his companies directly benefited as did the investments made by his companies. He put $5 billion into Goldman Sachs preferred stock with a 10% dividend – a substantially better rate of return than the US government got on our $10 billion bailout, er, I mean “investment.” Berkshire Hathaway was the largest shareholder in American Express Co. when they received $3.4 billion from Uncle Sam.

    Buffett appeared on CNBC a year ago (March 3, 2008). At that time he was forthcoming about the risks Berkshire Hathaway was taking. He told CNBC at the time that he had “written 206 transactions in the last three weeks” which were default swaps on municipal bonds – the financing used by cities and states to fund everything from building schools to general obligations.

    Buffett bragged that “the municipality has to quit paying” before any losses would have to be covered. This gives him incentive for another payout from Uncle Sam in addition to the Wall Street bailout – he also has incentive to support the stimulus package. If the cities and states default on their debt, then Buffett (Berkshire Hathaway companies) would be on the hook to make good on the full value of the bonds. At that point in March 2008, after just 3 weeks of investing, Buffett said he made $69 million in premiums for guaranteeing payment on $2 billion of municipal bonds. The primary insurer received about $20 million, an amount significantly less but that carries more risk. If that doesn’t seem to make sense, then you understand – the pricing of risk and premiums did not make sense. This systematic irrationality was also a contributing factor to the current financial mess.

    The scheme of buying and selling bond payment guarantees is very much dependent on rising asset prices (and no recession), just like any Ponzi scheme. Describing his investment strategy in March 2008, Buffett clearly said that what he and the other insurers in this market are “hoping for is new money.” He even admitted that getting new money was preventing he and others in the market from having to “totally face(d) up to the mistakes that they’ve made.”

    By now, Bernie Madoff has shown you how a Ponzi Scheme falls apart in a down market. In the 2008 interview, Buffett gave us a preview of what keeps him awake at night. Cities and states don’t go broke very often, but when they do “it could be contagious.” Luckily for Buffett, the Congress – “the best Congress that money can buy”, according to Sen. Kennedy – voted to send “stimulus” money to the cities and states.

    In fact, Buffett wouldn’t have to pay on any of those bonds unless the primary bond insurer went broke, too. That primary bond insurer is Ambac Financial Group, Inc. Ambac is the first to pay in the event of default on the municipal bonds that Buffett is guaranteeing. If any of the bonds go bad, Ambac has to pay the bondholders. If Ambac got into financial trouble Buffett said he would “be out trying to help them raise money” – otherwise Berkshire Hathaway would have to pay off the bonds. Now, in March 2009, Buffett talks about the economy going over a cliff while Ambac teeters on the edge of junk bond status. When it falls, it could take Berkshire Hathaway with it. The table below shows what happened to Ambac’s credit rating between Buffett’s two appearances on CNBC.


    Timeline of Ambac Credit Rating Slide

    Date Event
    3/3/2008 Buffett appears on CNBC discussing investment scheme relative to Ambac
    3/12/2008 Moody’s confirms Ambac’s Aaa rating; changes outlook to negative
    4/24/2008 Moody’s reiterates negative outlook on Ambac’s Aaa rating following earnings announcement
    5/13/2008 Moody’s says worsening second lien RMBS could impact financial guarantor ratings
    6/4/2008 Moody’s reviews Ambac’s Aaa rating for possible downgrade
    6/19/2008 Moody’s downgrades Ambac to Aa3; outlook is negative
    9/18/2008 Moody’s places ratings of Ambac on review for possible downgrade
    11/5/2008 Moody’s downgrades Ambac to Baa1; outlook is developing
    3/3/2009 Moody’s reviews Ambac’s ratings for possible downgrade
    3/9/2009 Buffett appears on CNBC; no discussion of Ambac

    Acting selfish and self-serving is what got us into this mess in the first place. We’ve been witness to bloated executive compensation in the face of lousy corporate performance. We’ve seen mega-billionaires living lavish lifestyles for years on the proceeds of Ponzi schemes and fraud. Maybe it’s time for a new Oracle, in Omaha or elsewhere, because this one has been giving us bad advice.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

  • Why The Stock Market Matters

    My father was a career enlisted man in the United States Air Force. I was in the third or fourth grade when he graduated from high school. My mother graduated from high school after I was married. My dad worked for several companies after his Air Force career. He was working for Disney when he died. My mother worked part time in child care from time to time.

    I tell you this to show that this is not a wealthy family. When my dad died, my mother received the standard Disney benefits. My guess is that those benefits were more generous than average for American business, but not extravagant.

    My mother put the death-benefit funds at a bank trust department. They invested the funds in a portfolio that is standard for widows. Some of the funds were put in fixed securities. Some were invested in stocks that were considered safe. These funds, along with some fixed income securities, represent her liquid assets. Her only other assets are her survivor’s share of my father’s pensions, and a small condominium.

    What has happened to her portfolio? Let’s look at the Dow for an indication. The Dow peaked at 14,164.53 on October 9, 2007. It was down to 13,264.82 by the end of 2007. It was only 8,776.39 at the close of 2008. Today, Monday, March 09, 2009, the Dow closed at 6,547.05.

    Since its high, the Dow has lost 53.79 percent of its value. It lost 33.84 percent of its value in 2008. So far this year, it has lost another 25.40 percent. These are huge losses.

    If we apply this year’s average daily loss, we are less than three days from a Dow value of 6,422.94. This was the value of the Dow at the closing on December 4, 1996, the day before Greenspan gave his famous quote on the market’s irrational exuberance. Remember that? It was a very long time ago. We’ve lost more than a decade’s gain in a remarkably short time.

    When asked about the stock market, President Obama dismissed it as unimportant: “You know, the stock market is sort of like a tracking poll in politics,” he said last week. “It bobs up and down day to day, and if you spend all your time worrying about that, then you’re probably going to get the long-term strategy wrong.” It is just a guess, but I’m thinking that if his poll numbers had declined over 25 percent this year, he’d be spending some time worrying.

    A friend of mine dismisses the stock market losses as paper losses. He claims that the firms, factories and other assets still exist. I don’t buy that. If that is the case, why would we have mark-to-market rules? The fact is that many assets have vanished. They are gone. Many more are reduced in value. Certainly, today’s present value of future earnings — the fundamental source of stock value — is far below what it was on October 9, 2007.

    Wealth has disappeared, and that disappearance has serious consequences to real people. Which brings me back to my mother: The combined impact of stock and real estate values has caused her net worth to fall over 50 percent. She’s half as wealthy as she was just a short time ago. That is a problem for her, and it is a problem for America.

    Economists are notorious for disagreeing. However, the belief that people spend out of wealth is about as close to a consensus as one can find. My mother will confirm that belief with her actions. The children and grandchildren will get smaller gifts on their birthdays and at Christmas. She will travel less. She will eat out less. She’ll cut her spending.

    There will be other impacts. My siblings expect an inheritance, and that inheritance is a significant portion of their wealth. Right now, with the inheritance being less than half of what it was, their wealth is down a lot. That means they’ll be spending less. That is a problem for America.

    This sort of wealth destruction is happening to families across the country. It is happening to rich families and to families that are far from rich. The Dow has declined an average of about 50 points a trading day this year. Millions of American families, responding to the steady erosion of wealth, are cutting back their spending plans. This feedback from the stock market to the economy will likely swamp any stimulus plan.

    The message is clear. The stock market matters. Its freefall must be halted before the recovery can begin.

    Bill Watkins, Ph.D. is the Executive Director of the Economic Forecast Project at the University of California, Santa Barbara. He is also a former economist at the Board of Governors of the Federal Reserve System in Washington D.C. in the Monetary Affairs Division.

  • How the Financial Crisis Threatens Localism

    By Richard Reep

    As in many places, the poor economy is forcing many families in affluent Winter Park, Florida to make some necessary adjustments. One of the most basic adjustments relates to shopping for food and staples. In better times, Winter Park was ruled by two Publix supermarkets and a Whole Foods. Grocery-cart conversation among friends became a common event; now this smooth, middle-class lifestyle pattern has been disrupted.

    Hard times are driving people to less intimate settings, largely to Wal-Mart and other discount stores, whose offerings and management are largely interchangeable between places. In this way hard times could be shifting the pendulum swing away from localism and towards globalism. For now, Wal-Mart’s globalism offers the advantage of low prices, overcoming the disdain that many in Winter Park expressed at this store; for it is the antithesis of Winter Park’s treasured shopping culture epitomized by Park Avenue, a quaint strip of unique boutiques. Even if you did buy those steaks at Wal-Mart, you didn’t exactly advertise the fact at your dinner party.

    Winter Parkers had thought that their basic food needs had been comfortably institutionalized. As neighborhood touchstones go, Publix is Florida’s gold standard. Winn-Dixie, Albertson’s, and other competition paled in comparison to the customer loyalty that Publix brought. Their brands weren’t much different, and neither were their prices. There was just something about that kelly green logo that inspired people to integrate Publix into their own personal culture and lexicon.

    For years, this chain has built a loyal following in Florida. Good customer service, great store brands, convenient and quality stores all contributed to their preeminence in the grocery market, and allowed them to expand in the Southeast. Today, however, Publix is challenged by its own reputation, and has become vulnerable to competition as local shoppers tighten their pocketbooks.

    Winter Parkers had two choices between their Publix: Hollyanna and Lakemont. The brand veneer, both in content and in form, was subtly bent to suit local tastes. People referred to their favorite as “my Publix”, and even when the Baldwin Park Publix opened in 2003 closer to many folks, their loyalty with their particular store kept them from going to the Baldwin Park store. (Its architecture doesn’t help; this storefront might have been designed by Albert Speer).

    Suddenly, however, Publix faces real competition from stores that traditionally do not overlap with its market share. This Lakeland-based company, which boasts an excellent reputation, finds itself now with both emptier parking lots and smaller cash register totals. What’s going on here?

    At the Lakemont Publix, the organic produce area has grown, in direct response to hip, organic Whole Foods up the street. Whole Foods, however, is suffering mightily in this economy – who needs $8.00 strawberries? If you are skeptical about this, a tour of their largely deserted parking lots and front entry areas on Sunday afternoon, when grocery shopping is near-peak, can be quite telling.


    Whole Foods has some great parking spaces right near the front door, and the entry area, usually clogged with shoppers, seemed to be nearly desolate. A few students sat at the bistro tables tapping on laptops; not the usual rich scene for this upscale store.

    Publix at Lakemont also had some great parking spaces right near the front door, and an even more desolate entry area. In fact, where are the Girl Scouts?


    Where have all these people gone? The answer lies up State Road 436 to the left, ladies and gentlemen – Wal-Mart! Parking near the front…forget it. At the entry, a line of people going in and full shopping carts coming out! And the Girl Scouts are smart enough to realize that this is where the local culture is going these days! Is Wal-Mart the new Publix?

    As everyone is frantically re-tooling their own personal economy, Wal-Mart has become the grocer of choice for more and more of Winter Park. Are the prices really lower? A little bit. Will Publix adapt to the new, changing times to meet this challenge? For this 79-year-old Florida-based grocery store chain, and all its loyal (but more loyal to their checkbooks) customers, we certainly hope so.

    The buying power of globalism continues to disrupt and shift local patterns. As Wal-Mart, Costco, and others compete in this New Economy, local and regional chains need to react quickly to gain back their customer base, or they will find themselves in for a difficult struggle to regain lost ground.

    Richard Reep is an Architect and artist living in Winter Park, Florida. His practice has centered around hospitality-driven mixed use, and has contributed in various capacities to urban mixed-use projects, both nationally and internationally, for the last 25 years.