bizzXceleration: Performance, Value and Profit

A Little History Review: Debt Since WW2

 These potential reforms are important only insofar as we a) mitigate the chances of it happening again, b) we maintain a healthy, vibrant and contributory financial sector while c) doing away with the socionomic dysfunctions that almost destroyed the economy. The root of all this are debates over the level and role of debt financing in the economy so we thought we'd review a little history to put things in context. To address that we built two sets of composite charts from the Fed data on money flows and the results make interesting viewing. In the UL sub-chart current dollar debt (our estimates) grew from about $2.5T to about $31T from 1945-2008; and contrary to current headline and political mythology that's not Federal debt that's the largest portion, it's Households and Businesses. Our post-war prosperity was built on a sea of it. In the LL chart though you can see the structural shifts where relatively speaking Federal debt was shrunk while Financial sector debt grew enormously. These shifts are highlighted on the right-hand sub-charts as multiples of GDP where total debt grew from 1.6X GDP to slightly over 3.5X! More interestingly Household and Business Debt grew steadily until the '80s when it jump-shifted, and then did so again in the '90s and '00s. Bear in mind who was making that debt available - which leads to the most startling growth. Financial debt grew 0.01X to 1.18X of GDP, or about 1,163%!!! In addition to pointing out that it was post-deregulation that we began drowning in debt but in fact, contrary to popular political mythology, Federal debt was steadily paid down until the Reagan administration when it ballooned again, then was paid down during the Clinton years only to be re-built during BushII. Not what you normally would think, eh?

Relative Debt Growth 

The second chart shows the normalized relative growth and highlights many of these points from a different perspective. All these charts are built around cumulative % growth from 1945 to 2008 and show the relative, normalized, growth of each of the major sectors. As you can see in the UL growth in Finance debt outstanding completely swamps all other sectors, which is why the other charts break things out separately. The LL sub-chart shows the major sectors, excluding Finance, the UR shows Finance by itself and the LR sub-charts shows Household debt along with growth in Credit Cards and Mortgages.

Here's the fundamental questions these charts raise in our minds: 

1) What's the appropriate level of debt for a healthy economy? We'd suggest something more in line with the points reached around the mid-80's, except for Finance.

2) If that's true what kind of regime will be required to evolve back to that point? How long might it take to get there? Is it feasible and what happens if it's not?

3) If Banking and Finance need to return to their roots (not say 0.01X of GDP but something on the order of .25-.5X, ala the 1980's, what kind of Industry will we have? Is it even possible? Is it politically feasible given the heartfelt opposition of the Industry to even modest reforms?

Fighter's Go to Your Corners: the Prospects for Reform

Ah, there's the rub, as they say. It's not an accident that the President made a speech directly to Wall St. on this topic nor that Summers, Blair and Shapiro were addressing the Georgetown University seminar on Financial Reform about the same time, nor that a whole slew of regulatory changes were being announced by the Fed, et.al. during the same time period. We've have to say that the agencies, the Administration and Congress are headed for the mats, as Sonny Corrleone would put it over this. And should be. But that kind of warfare does no one any good - it may simply be the best alternative that we're all left with. We'll continue to argue that after loosing (destroying) almost a decade's worth of funny-money profits it's even in the Industry's own evident self interest to proactively and constructively participate in re-shaping the regulatory and legislative framework. Larry Summer's Georgetown speech laid out the Administration's framework pretty clearly, as well as explaining the reasons and intents. Five major principles were laid out:

1) Capital Adequacy for systemically important institutions (which also implies no more off balance sheet green curtains)

2) Resolution Authority - in other words the end of TBTF (to big to fail). As Larry put it we don't ever want to find ourselves again where we were with FNM, FRE, LEH, AIG and MER with no institutional recourse.

3) Regulatory Arbitrage - no more shopping among regulatory agencies for the best deal, and that especially includes international comparison shopping (if you don't think that was an important part of the recent G-20 meetings think again).

4) Regulate Systemically - no more regulatory "prudentially" single institution by institution but ask what impact the collective will have. Think of it as the end of "we will assimilate your distinctiveness and make it ours".

5) Consumer Protection - need a separate authority to focus on the health and well-being of the consumer instead of letting those concerns get swamped by concern for the financial health of financial institutions. That (hopefully of course) means the end of predatory lending practices or exploitative credit card marketing and management.

And the Alternative?

Summers pursued a great analogy when he compared changing the regulatory framework to how we deal with Automotive Safety issues. For many decades the theory of auto safety was that it was the responsibility of individual drivers. But as more and more vehicles got on the roads with higher and higher performance cars we had an "epidemiological" problem - that is there were more and more unecessary deaths because cars were changing faster than humans evolve. By comparison then do we continue to let the death toll mount or do we do something?

One thing the Industry is under-estimating outside the Beltway or NYC is the depth and breadth of public anger. One could argue we saw similar outrage after the Tech Bubble burst with Enron, Worldcom, et.al. and the outrage petered out. The difference though, this time, is those actions didn't threaten society. Last June we were at a conference on the future of corporate governance and one session, focused on improving Board decision-making, was taken over by one gray-haired gentleman's anger at the breeches of fiduciary trust by the Finance Industry. Bear in mind this was a couple of hundred people all of whom were executives, board members or consultants with decades of experience. If they were so anger as to loose control what does the rest of the country think.

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Readings

In Fed We Trust: Ben Bernanke's War on the Great Panic

Pulitzer Prize winning editor of the Wall Street Journal details how Ben Bernanke single-handedly came to the rescue of the U.S. economy to prevent a second Depression.  Wessel claims that Bernanke's response effectively made the Federal Reserve the 4th branch of government.

U.S. Job Seekers Exceed Openings by Record Ratio Despite signs that the economy has resumed growing, unemployed Americans now confront a job market that is bleaker than ever in the current recession, and employment prospects are still getting worse.Job seekers now outnumber openings six to one, the worst ratio since the government began tracking open positions in 2000. According to the Labor Department’s latest numbers, from July, only 2.4 million full-time permanent jobs were open, with 14.5 million people officially unemployed.And even though the pace of layoffs is slowing, many companies remain anxious about growth prospects in the months ahead, making them reluctant to add to their payrolls.Though layoffs have been both severe and prominent, the greatest source of distress is a predilection against hiring by many American businesses. From the beginning of the recession in December 2007 through July of this year, job openings declined 45 percent in the West and the South, 36 percent in the Midwest and 23 percent in the Northeast. Shrinking job opportunities have assailed virtually every industry this year. Since the end of 2008, job openings have diminished 47 percent in manufacturing, 37 percent in construction and 22 percent in retail. Even in education and health services — faster-growing areas in which many unemployed people have trained for new careers — job openings have dropped 21 percent this year. Despite the passage of a stimulus spending package aimed at shoring up state and local coffers, government job openings have diminished 17 percent this year. Job Openings vs Seekers

FDIC: "Credit quality declined sharply" for Shared National Credits A record $447 billion in assets were classified as substandard, doubtful, or a loss, almost triple the peak following the 2001 recession. As a percent of commitments, the current 15.5% of loans "classified" far exceeds the previous peak in 1991 of just under 10% of loans.Also, according to the FDIC, nonbanks held 47 percent of classified assets despite owning only 21.2 percent of the SNC portfolio. American Banker has an excellent quote: Large Syndicated Loans Going Bad

Strauss-Kahn Says Crisis Consequences Will Last Long Time International Monetary Fund Managing Director Dominique Strauss-Kahn said the worst financial crisis in seven decades will have long-term consequences.“We will still have rising unemployment at least for a year,” Strauss-Kahn said via videolink in an address to the Yalta European Strategy Conference from Washington. “From this point of view, the crisis isn’t over. It is too early to claim victory, even that we have avoided the worst situation. The consequences will be there for a long time.”The so-called Group of 20 should expand “a little bit” to be more effective, Strauss-Kahn suggested, adding that the organization cannot exclude from its discussions “one billion people from Africa.”The Group of 20 nations at a meeting in Pittsburgh on Sept. 25 agreed to a global economic strategy aimed at a more balanced recovery for industrial and emerging countries. The G-20 also agreed to boost the clout of emerging economies at the IMF to recognize some countries’ growing importance.

A Rich Uncle Is Picking Up the Borrowing Slack  THE United States government is borrowing money like never before. The national debt rose by more than a third over a one-year period, far more than it ever did at any time since World War II.In the past, when the government became a heavy borrower, there was talk about crowding out private borrowers. But this time, interest rates have remained low and no one seems to be worried about that.The reason is simple: Rather than crowding out the private sector, Uncle Sam is now standing in for it. Much of the government borrowing went to investments in financial institutions needed to keep them alive. Other hundreds of billions went to a variety of programs aimed at stimulating the private economy, including programs that effectively had the government pick up part of the cost for some home buyers and some auto buyers.This week, the Federal Reserve published its quarterly report on debt levels in the economy. While Uncle Sam borrowed more, others borrowed less. The accompanying chart shows that total domestic debt — the amounts owed by individuals, governments and businesses — climbed just 3.7 percent from the second quarter of 2008 through the second quarter of this year. That is the smallest increase since the Fed started these calculations in the early 1950s.Moreover, domestic debt declined in the second quarter, falling 0.3 percent to $50.8 trillion. The figures are not seasonally adjusted, making quarter-to-quarter comparisons risky, but it was the first such decline since the first quarter of 1954, when total debt was less than $500 billion.Over the 12-month period, nonfinancial businesses increased their debt by just 1.3 percent. Since that number is well below the interest rate most of those companies pay, it indicates that they paid back more in old loans than they took out in new ones.Until this recession, the idea that American individuals would ever cut their overall debt levels seemed as likely as an August snowfall in Miami. But that was before the bottom fell out of the housing market, something that Florida condo developers had considered to be equally unlikely. Annual Growth Rate of Total Debt

G-20 Unites on Bank Rules, Aligning Policy as Focus Moves Away From Crisis  Group of 20 leaders built on the common front they forged in fighting the financial crisis to chart a shared path toward a more stable banking system and a stronger global economy.President Barack Obama and his counterparts ended their Pittsburgh meeting yesterday promising to “raise standards together” to ensure banks restrain pay and build up capital buffers. They also established a peer-review process to monitor individual efforts to rebalance economies and to hand emerging nations a greater say in managing world growth.“There is much more work to be done, but we leave here today more confident and more united in the common effort of advancing security and prosperity for all of our people,” Obama told reporters after hosting his first summit.Enacting the proposals may prove difficult. Banks buoyed by rising stock prices may resist or find a way around the new regulations; countries may ignore policy advice from others and the G-20 itself may be too unwieldy to deliver on its goals.“The G-20 has to prove itself,” said Simon Johnson, a former chief economist of the International Monetary Fund. “They need to establish legitimacy and get things done.”A lot is at stake. While the international economy is showing signs of recovering from its worst recession since World War II, pockets of weakness remain, especially in the U.S. and other industrial countries. Demand for U.S. durable goods unexpectedly fell in August and loans to households and companies in Europe grew at the slowest pace on record, data showed yesterday. European and U.S. stocks posted their biggest weekly declines since July.

 Barney Frank Talks Back Are we lucky that we're not in a second depression? Not lucky -- it took a lot of hard work. There was a three-step process. From last September to spring of this year, we were just trying to dig out of that hole. We have avoided a worse disaster. You don't get reelected by saying, "Things would've been worse without me." Now we're in the phases of making things better and putting down rules so it doesn't happen again.What's the most important part of financial regulation? Limiting securitization. I believe the single biggest issue here is that people invented ways to lend money without worrying if they got paid back or not by securitizing the loan. When I was younger, the theory was if you had a high risk tolerance, you went into stocks. If you were safe and stodgy, you bought debt. But debt became the volatile aspect here.Should the administration have started on financial regulation sooner? No! They were busy. I understand the media always wants to have bad things to say. But they were working on undoing where we were. They were working to put liquidity back. The problem was that 2008 took longer to end than we thought it would. It didn't really end till April of 2009. The early months of the Obama administration were spent trying to dig out of the hole. Let me ask you a question. What harm came from waiting? The argument is that you won't get as much regulation because the banks are stronger now.That's nonsense. But you are implicitly acknowledging that nothing bad has happened. We didn't need to worry about excess. We had to worry about minus. We worried about getting things back to normal. Now that things are getting back to normal, we can worry about excess. But I believe we will have regulations in place well before we reach that point.

The Mortgage Machine Backfires WITH the mortgage bust approaching Year Three, it is increasingly up to the nation’s courts to examine the dubious practices that guided the mania. A ruling that the Kansas Supreme Court issued last month has done precisely that, and it has significant implications for both the mortgage industry and troubled borrowers.The opinion spotlights a crucial but obscure cog in the nation’s lending machinery: a privately owned loan tracking service known as the Mortgage Electronic Registration System. This registry, created in 1997 to improve profits and efficiency among lenders, eliminates the need to record changes in property ownership in local land records.Dotting i’s and crossing t’s can be a costly bore, of course. And eliminating the need to record mortgage assignments helped keep the lending machine humming during the boom.Now, however, this clever setup is coming under fire. Legal experts say the fact that the most recent assault comes out of Kansas, a state not known for radical jurists, makes the ruling even more meaningful.

• New Rules Coming On Oct. 1, new rules adopted by the Federal Reserve will go into effect, requiring greater diligence on the part of mortgage lenders and brokers.

 Fed Didn't Bark at Loan Abuses Under a policy quietly formalized in 1998, the Fed refused to police lenders' compliance with federal laws protecting borrowers, despite repeated urging by consumer advocates across the country and even by other government agencies.The hands-off policy, which the Fed reversed earlier this month, created a double standard. Banks and their subprime affiliates made loans under the same laws, but only the banks faced regular federal scrutiny. Under the policy, the Fed did not even investigate consumer complaints against the affiliates."In the prime market, where we need supervision less, we have lots of it. In the subprime market, where we badly need supervision, a majority of loans are made with very little supervision," former Fed Governor Edward M. Gramlich, a critic of the hands-off policy, wrote in 2007. "It is like a city with a murder law, but no cops on the beat."Between 2004 and 2007, bank affiliates made more than 1.1 million subprime loans, around 13 percent of the national total, federal data show. Thousands ended in foreclosure, helping to spark the crisis and leaving borrowers and investors to deal with the consequences.Congress now is weighing whether the Fed should be fired. The Obama administration has proposed shifting consumer protection duties away from the Fed and other banking regulators and into a new watchdog agency. That proposal, a central plank in the administration's plan to overhaul financial regulation, is opposed by the industry and faces a battle on Capitol Hill.Sub-Prime Loan Origination Distribution