Ford is my newest hero. Not only did they refuse to participate in the auto industry bailout, but they just posted a $2.3 billion profit for the second quarter. For the same quarter last year, they posted a $8.67 billion LOSS. Clearly, a big improvement.
Granted, the company is still experiencing problems. Revenue is down and is just now showing signs of recovery. North American operations are still generating losses. Ford expects to be back to permanent profitability next year due to its leaner and meaner organization, as well as consumer excitement over some of its new products.
Ford also appears to be gaining market share over its main US competitors, GM and Chrysler. This is likely the result of consumer uncertainty about the shaky future the bankrupt companies that are now being run by UAW.
It's also possible that many Americans are like me -- impressed by the one company that didn't take bailout money.
Fierce independence is an American value. It's right up there with baseball and apple pie. Americans are right to be impressed with Ford right now, and maybe that will translate directly into purchasing more Ford vehicles.
Thursday, July 23, 2009
Wednesday, July 22, 2009
TARP's Lack of Transparency
Yesterday, Neil Barofsky, the special investigator general for the Troubled Asset Relief Program (TARP), testified before congress about the status of the program. A couple of points were particularly troubling.
First, the potential liability of the TARP program is much higher than originally anticipated. Congress has authorized $643 billion for TARP (of which only $441 billion has been spent). But when you add in the liability assumed for the "toxic assets," the total taxpayer liability for the program in a worst case scenario is $23.7 TRILLION. Pretty scary.
Second, Mr. Barofsky complained that his recommendations for providing transparency for TARP are being ignored. Four of these ignored recommendations are:
First, the potential liability of the TARP program is much higher than originally anticipated. Congress has authorized $643 billion for TARP (of which only $441 billion has been spent). But when you add in the liability assumed for the "toxic assets," the total taxpayer liability for the program in a worst case scenario is $23.7 TRILLION. Pretty scary.
Second, Mr. Barofsky complained that his recommendations for providing transparency for TARP are being ignored. Four of these ignored recommendations are:
- Require TARP money recipients to report on what the money was actually used for.
- Treasury should report regularly on the value of its portfolio of TARP assets
- Disclose the identity of defaulting TARP borrowers
- Disclose all trading activity of TARP assets.
Thursday, July 16, 2009
The Independence of the Federal Reserve
There is a political storm brewing with regard to the independence of the Federal Reserve (aka The Fed). Some people correctly point out that the Fed is a tremendously powerful organization in our country, has a large influence over the economy, and as such, should have to answer to the people. The fact that the Fed has no oversight makes them nervous. Who is this "Fed" which has so much control over us, yet does not answer to us in any way?
The Fed is run by a seven-member Board of Governors. The Chairman (currently Ben Bernanke), vice-chairman, and the remaining five members are appointed by the President of the United States in staggered 14-year terms, one governor every two years. It was set up this way so that it could make decisions detached from political consideration. The Chairman serves a four-year term but can be re-appointed by POTUS as long as the total of 14 years is not exceeded. In any given presidential term, POTUS can only appoint two members of the board, making it impossible to stack it in his own favor.
The idea is that the Fed should be like the Supreme Court of the United States (SCOTUS), above the fray of politics. Each governor's job is secure for 14-years, which spans 7 congresses, more than two senate terms, and more than three presidential terms.
Like SCOTUS, its members are appointed by the President. But as one of the three branches of government, SCOTUS is subject to checks and balances. If SCOTUS does something really wacky, then it can be overruled by Congress (the people) via constitutional amendment.
The Fed is different. In a way, it's much easier to overrule the Fed than SCOTUS. The Federal Reserve does not exist in our constitution. It was created by Congress in the Federal Reserve Act of 1913 (at the encouragement of progressive icon Woodrow Wilson). As such, Congress has the power to change the Fed's charter if it gets out of line. But there's the rub. How do we know when the Federal Reserve is out of line? It operates within a shroud of secrecy, so no one ever really knows the nature and extent of its activities.
Many people are now calling for greater oversight of the Fed by Congress. We need to be careful, though, because this is a two-edged sword. Do we really trust politicians in Congress enough to have them influencing monetary policy without it being based on their own personal political concerns?
I think not.
The Fed should continue to be completely independent with regard to its monetary policy. They should do what they do based on their own best judgement, without any consideration to political consequences. However, once any decision is made and implemented, it should be part of the public record and open to bright sunshine pouring onto it. GAO should be able to do audits after-the-fact, and the American people should be able to know exactly what the Federal Reserve did on their behalf.
Then, if it turns out that they did something really wacky, we can pressure Congress to modify their charter to prevent that same sort of behavior in the future. This is America. Every nook and cranny of government must ultimately answer to the people.
The Fed is run by a seven-member Board of Governors. The Chairman (currently Ben Bernanke), vice-chairman, and the remaining five members are appointed by the President of the United States in staggered 14-year terms, one governor every two years. It was set up this way so that it could make decisions detached from political consideration. The Chairman serves a four-year term but can be re-appointed by POTUS as long as the total of 14 years is not exceeded. In any given presidential term, POTUS can only appoint two members of the board, making it impossible to stack it in his own favor.
The idea is that the Fed should be like the Supreme Court of the United States (SCOTUS), above the fray of politics. Each governor's job is secure for 14-years, which spans 7 congresses, more than two senate terms, and more than three presidential terms.
Like SCOTUS, its members are appointed by the President. But as one of the three branches of government, SCOTUS is subject to checks and balances. If SCOTUS does something really wacky, then it can be overruled by Congress (the people) via constitutional amendment.
The Fed is different. In a way, it's much easier to overrule the Fed than SCOTUS. The Federal Reserve does not exist in our constitution. It was created by Congress in the Federal Reserve Act of 1913 (at the encouragement of progressive icon Woodrow Wilson). As such, Congress has the power to change the Fed's charter if it gets out of line. But there's the rub. How do we know when the Federal Reserve is out of line? It operates within a shroud of secrecy, so no one ever really knows the nature and extent of its activities.
Many people are now calling for greater oversight of the Fed by Congress. We need to be careful, though, because this is a two-edged sword. Do we really trust politicians in Congress enough to have them influencing monetary policy without it being based on their own personal political concerns?
I think not.
The Fed should continue to be completely independent with regard to its monetary policy. They should do what they do based on their own best judgement, without any consideration to political consequences. However, once any decision is made and implemented, it should be part of the public record and open to bright sunshine pouring onto it. GAO should be able to do audits after-the-fact, and the American people should be able to know exactly what the Federal Reserve did on their behalf.
Then, if it turns out that they did something really wacky, we can pressure Congress to modify their charter to prevent that same sort of behavior in the future. This is America. Every nook and cranny of government must ultimately answer to the people.
Labels:
Ben Bernanke,
Federal Reserve,
Woodrow Wilson
Wednesday, July 15, 2009
Throwing off the TARP
J.P. Morgan Chase & Co. recently paid back $25 billion in federal bailout money that it had received via TARP, thus ending its brief stint of indentured servitude to the federal government.
The difference is quite striking. Now free of its vow to "honor and obey," J.P. Morgan Chase has stepped up its criticism of government proposals to impose new regulations on the derivatives market that many in the financial industry see as short-sighted.
A quick primer on derivatives may be helpful. In financial markets, the word "derivative" refers to any financial contract the derives its value from an underlying cash instrument (such as stocks, bonds, currencies, or commodities). There are three basic types of derivatives: 1) Futures and Forwards, 2) Options, and 3) Swaps.
Derivatives have received a bad rap recently because of the collapse of many derivatives constructed from mortgage-backed securities when the real estate bubble burst. The fact remains that derivatives are, for the most part, a good thing. They help reduce risk in financial markets, not increase it. Financial managers of corporations use derivatives to hedge against future uncertainty, which results in smoother earnings over time.
This is the crux of J.P. Morgan Chase's complaint. The Obama administration wants to force ALL derivatives to be traded via a central exchange, similar to a stock market. This would allow regulators to easily monitor the entire derivatives marketplace. The problem with this approach is that a significant portion of derivatives are one-of-a-kind contracts specifically designed to reduce a specific risk in a specific company.
The central exchange approach would be a logistical nightmare. Even if it were technologically possible, it would put a massive damper on the custom derivatives market. The seemingly honorable intent of the Obama administration is to reduce risk in the financial markets, but by damaging the attractiveness of derivatives in this manner, the perverse result could be an increase in risk, not a decrease.
J.P. Morgan Chase holds approximately $81 trillion (yes, trillion) in derivatives contracts. Clearly, they have a dog in this fight. They also have a great deal of expertise, which is demonstrated by the fact that they have paid back their TARP money and will be posting a profit this quarter. They know what they're talking about in this particular area. Maybe we should listen to them.
The difference is quite striking. Now free of its vow to "honor and obey," J.P. Morgan Chase has stepped up its criticism of government proposals to impose new regulations on the derivatives market that many in the financial industry see as short-sighted.
A quick primer on derivatives may be helpful. In financial markets, the word "derivative" refers to any financial contract the derives its value from an underlying cash instrument (such as stocks, bonds, currencies, or commodities). There are three basic types of derivatives: 1) Futures and Forwards, 2) Options, and 3) Swaps.
Derivatives have received a bad rap recently because of the collapse of many derivatives constructed from mortgage-backed securities when the real estate bubble burst. The fact remains that derivatives are, for the most part, a good thing. They help reduce risk in financial markets, not increase it. Financial managers of corporations use derivatives to hedge against future uncertainty, which results in smoother earnings over time.
This is the crux of J.P. Morgan Chase's complaint. The Obama administration wants to force ALL derivatives to be traded via a central exchange, similar to a stock market. This would allow regulators to easily monitor the entire derivatives marketplace. The problem with this approach is that a significant portion of derivatives are one-of-a-kind contracts specifically designed to reduce a specific risk in a specific company.
The central exchange approach would be a logistical nightmare. Even if it were technologically possible, it would put a massive damper on the custom derivatives market. The seemingly honorable intent of the Obama administration is to reduce risk in the financial markets, but by damaging the attractiveness of derivatives in this manner, the perverse result could be an increase in risk, not a decrease.
J.P. Morgan Chase holds approximately $81 trillion (yes, trillion) in derivatives contracts. Clearly, they have a dog in this fight. They also have a great deal of expertise, which is demonstrated by the fact that they have paid back their TARP money and will be posting a profit this quarter. They know what they're talking about in this particular area. Maybe we should listen to them.
Labels:
Bailout,
Derivatives,
Financial Crisis,
TARP
Tuesday, July 14, 2009
Reflections on a Trillion Dollar Deficit
Yesterday the Treasury Department announced that as of the end of June, this year's federal budget deficit exceeded one trillion dollars. And the fiscal year doesn't end until October 1. Remember, this is the deficit we're talking about, not the total debt. So in the last nine months we've added an entire trillion dollars to the debt that we are passing down to our children and grandchildren.
To put this in perspective, in just the last nine months we have added nearly 10% to the ten trillion dollar national debt that taken 233 years to accumulate. Not only does this deficit represent the highest deficit ever recorded in terms of dollars, but it also represents the highest percentage of gross domestic product (13%) since the end of World War II. The spending is expected to accelerate over the next few months, with government sources anticipating the final deficit this year to exceed 1.8 trillion dollars.
What are they thinking?
There are only four ways to pay for deficit spending: 1) Borrow money by issuing government bonds; 2) Print more money; 3) Raise taxes; 4) Cut other spending. Let's take a quick look at each of these approaches.
Borrow Money. This is what the government has been doing this year. They have been able to sell bonds to companies and foreign governments in order to bankroll the deficit. Ultimately, however, this will lead to rising interest rates because the fed will eventually have to increase the interest rates on the bonds in order to attract new customers. Rising interest rates will have a devastating impact on the real estate market, which has already taken its fair share of lumps.
Print Money. This a very dangerous option. If the government prints money to pay its bill, the result will be high inflation, putting the country into a prolonged economic malaise like we had in the 1970's. The other effect will be a loss of worldwide confidence in the dollar, possibly impacting its status as the world's reserve currency.
Raise Taxes. This is a short-sighted solution. Economically, tax increases are contractionary. This means that raising taxes historically stifles economic growth. A recent exception to this was the Clinton tax hike, where tax increases were followed by economic growth. This was likely due to the fact that the tax hikes occured during the internet boom, which fueled tremendous economic growth entirely unrelated to the tax increase. Of course, that growth turned out to be the tech bubble which burst at the end of Clinton's second term. There is wide agreement that tax increases during a recession are a bad idea and would ultimately prolong the recession by preventing both businesses from growing and jobs from being created.
Cut Spending. This is the logical place to look to solve the problem. Our trillion dollar deficit was generated by the two stimulus packages, the first by Bush and the second by Obama. As long as we stop doing more stimulus and do not add any more expensive new legislation, such as health care reform, next year's budget deficit naturally will be much lower.
That's the beauty of it. We don't even need to actually cut spending to solve the problem. All we need to do is prevent Congress from enacting any new spending. Unfortunately, over the last several years, Congress has not demonstrated any ability whatsoever to fiscally reign itself in. In fact, the current Congress has shown itself gleefully willing to approve any and all new spending, no matter what the cost, as long as it carries the emergency misnomer of "stimulus."
They just need to take a deep breath and put away the checkbook for a while. The economy will recover just fine without them.
To put this in perspective, in just the last nine months we have added nearly 10% to the ten trillion dollar national debt that taken 233 years to accumulate. Not only does this deficit represent the highest deficit ever recorded in terms of dollars, but it also represents the highest percentage of gross domestic product (13%) since the end of World War II. The spending is expected to accelerate over the next few months, with government sources anticipating the final deficit this year to exceed 1.8 trillion dollars.
What are they thinking?
There are only four ways to pay for deficit spending: 1) Borrow money by issuing government bonds; 2) Print more money; 3) Raise taxes; 4) Cut other spending. Let's take a quick look at each of these approaches.
Borrow Money. This is what the government has been doing this year. They have been able to sell bonds to companies and foreign governments in order to bankroll the deficit. Ultimately, however, this will lead to rising interest rates because the fed will eventually have to increase the interest rates on the bonds in order to attract new customers. Rising interest rates will have a devastating impact on the real estate market, which has already taken its fair share of lumps.
Print Money. This a very dangerous option. If the government prints money to pay its bill, the result will be high inflation, putting the country into a prolonged economic malaise like we had in the 1970's. The other effect will be a loss of worldwide confidence in the dollar, possibly impacting its status as the world's reserve currency.
Raise Taxes. This is a short-sighted solution. Economically, tax increases are contractionary. This means that raising taxes historically stifles economic growth. A recent exception to this was the Clinton tax hike, where tax increases were followed by economic growth. This was likely due to the fact that the tax hikes occured during the internet boom, which fueled tremendous economic growth entirely unrelated to the tax increase. Of course, that growth turned out to be the tech bubble which burst at the end of Clinton's second term. There is wide agreement that tax increases during a recession are a bad idea and would ultimately prolong the recession by preventing both businesses from growing and jobs from being created.
Cut Spending. This is the logical place to look to solve the problem. Our trillion dollar deficit was generated by the two stimulus packages, the first by Bush and the second by Obama. As long as we stop doing more stimulus and do not add any more expensive new legislation, such as health care reform, next year's budget deficit naturally will be much lower.
That's the beauty of it. We don't even need to actually cut spending to solve the problem. All we need to do is prevent Congress from enacting any new spending. Unfortunately, over the last several years, Congress has not demonstrated any ability whatsoever to fiscally reign itself in. In fact, the current Congress has shown itself gleefully willing to approve any and all new spending, no matter what the cost, as long as it carries the emergency misnomer of "stimulus."
They just need to take a deep breath and put away the checkbook for a while. The economy will recover just fine without them.
Labels:
Deficit,
Financial Crisis,
Stimulus,
Taxes
Monday, July 13, 2009
Financial Literacy and the Financial Crisis
Nearly 7,000 high school seniors completed the latest financial literacy survey in 2008. The results were not encouraging. The average score was 48%, representing a solid failure and the worst performance of high school seniors to date (Source: Jump$tart Coalition).
When we also consider the students that drop out and never make it to senior year, we can clearly see that well over half of our young people entering adulthood are unprepared to effectively manage their own finances and make informed financial decisions. This cannot be good. It would be naive to think that the dismal state of financial literacy among today's young adults does not have wider economic consequences.
The most obvious consequence that comes to mind is the current financial crisis. Blame for the collapse of the financial markets has been laid at the feet of many people, groups, agencies and organizations, including: Wall Street financiers, members of the executive and legislative branches of government, mortgage lenders, mortgage guarantors (like Fannie Mae), and even borrowers. Certainly a strong case could be made against each of these potential culprits.
Lurking beneath all of these causes, however, is the most insidious one of all - financial illiteracy. With so many of America's young people unable to pass a basic financial literacy test, is it any wonder that they became victims of questionable lending practices?
Few would argue with the fact that it was the subprime mortgage crisis that started the financial chain reaction that ultimately resulted in our current economic situation. But what caused the subprime mortage crisis? The subprime mortgage industry owes its existence to the Community Reinvestment Act (CRA) which was originally created in the 1970's. Its purpose was a noble one - to help encourage more widespread home ownership by disadvantaged households that might normally have difficulty qualifying for mortgage loans. These mortgage loans given to people who would typically be denied due to credit risk issues are called subprime loans.
As long as the subprime market remained relatively small, there was no danger to the overall economy. In the last ten years, however, these loan programs were heavily pushed by groups like Fannie Mae, who would buy up the questionable loans, guarantee them, and then package and sell them off to Wall Street at a profit. They were making lots of money doing it, and heavily lobbied both Republicans and Democrats in Congress to make sure they could continue the practice unrestrained.
But who were the borrowers? For the most part, they were the financially illiterate, who due to lack of financial education, were unable to make informed decisions about how much house they could really afford, if any. Since they lacked the tools to understand the level of risk they were taking, they were inclined to believe whatever they were told by their lender, missing the obvious fact that as soon as their adjustable rate started to increase, they would be forced into mortgage default.
The supply of subprime loans was high during this period due to the fact that the loans could be easily sold by lenders to Fannie Mae at a profit (and with no risk to the lender). It was so profitable that any lender would have been doing a disservice to their stockholders by NOT participating.
The demand for subprime loans, however, was driven by financial illiteracy. If as a society we had done a better job educating our young people in basic financial principles and budgeting, then there would have been many fewer borrowers willing to enter into these excessively risky mortgage contracts.
Free markets work very well when all parties are well-informed and educated. Prosperity inevitably follows a well-functioning free market. As such, financial illiteracy represents perhaps the greatest threat to capitalism that we have yet encountered. It is therefore incumbent upon parents, businesses, teachers and local officials to ensure that the next generation is better educated than the current generation to make wise personal finance decisions.
When we also consider the students that drop out and never make it to senior year, we can clearly see that well over half of our young people entering adulthood are unprepared to effectively manage their own finances and make informed financial decisions. This cannot be good. It would be naive to think that the dismal state of financial literacy among today's young adults does not have wider economic consequences.
The most obvious consequence that comes to mind is the current financial crisis. Blame for the collapse of the financial markets has been laid at the feet of many people, groups, agencies and organizations, including: Wall Street financiers, members of the executive and legislative branches of government, mortgage lenders, mortgage guarantors (like Fannie Mae), and even borrowers. Certainly a strong case could be made against each of these potential culprits.
Lurking beneath all of these causes, however, is the most insidious one of all - financial illiteracy. With so many of America's young people unable to pass a basic financial literacy test, is it any wonder that they became victims of questionable lending practices?
Few would argue with the fact that it was the subprime mortgage crisis that started the financial chain reaction that ultimately resulted in our current economic situation. But what caused the subprime mortage crisis? The subprime mortgage industry owes its existence to the Community Reinvestment Act (CRA) which was originally created in the 1970's. Its purpose was a noble one - to help encourage more widespread home ownership by disadvantaged households that might normally have difficulty qualifying for mortgage loans. These mortgage loans given to people who would typically be denied due to credit risk issues are called subprime loans.
As long as the subprime market remained relatively small, there was no danger to the overall economy. In the last ten years, however, these loan programs were heavily pushed by groups like Fannie Mae, who would buy up the questionable loans, guarantee them, and then package and sell them off to Wall Street at a profit. They were making lots of money doing it, and heavily lobbied both Republicans and Democrats in Congress to make sure they could continue the practice unrestrained.
But who were the borrowers? For the most part, they were the financially illiterate, who due to lack of financial education, were unable to make informed decisions about how much house they could really afford, if any. Since they lacked the tools to understand the level of risk they were taking, they were inclined to believe whatever they were told by their lender, missing the obvious fact that as soon as their adjustable rate started to increase, they would be forced into mortgage default.
The supply of subprime loans was high during this period due to the fact that the loans could be easily sold by lenders to Fannie Mae at a profit (and with no risk to the lender). It was so profitable that any lender would have been doing a disservice to their stockholders by NOT participating.
The demand for subprime loans, however, was driven by financial illiteracy. If as a society we had done a better job educating our young people in basic financial principles and budgeting, then there would have been many fewer borrowers willing to enter into these excessively risky mortgage contracts.
Free markets work very well when all parties are well-informed and educated. Prosperity inevitably follows a well-functioning free market. As such, financial illiteracy represents perhaps the greatest threat to capitalism that we have yet encountered. It is therefore incumbent upon parents, businesses, teachers and local officials to ensure that the next generation is better educated than the current generation to make wise personal finance decisions.
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