On the Contrary

What is on everybody’s mind, the Economy, was the focal point of discussion this Sunday morning, but the discussion was more political than policy based.  On Meet the Press we had Lindsey Graham and Chuck Schumer laying out familiar political positions.  Yawn.  The round table discussion was a little more interesting in that they included Liaquat Ahamed, the author of Lords of Finance, who raised the issued that back in the 1920’s the failure of a major European bank was really the beginning of the Great Depression.  He raised the issue of the collapse of the Eastern Europe Economies and the fact that while we are looking inward, this is a global crisis and focusing on saving us may not save us even if we do all the right things.

On GPS we had an eclectic group led by Niall Ferguson (Assent of Money) who was arguing that our expanding of the deficit to solve the slow down in our own country will actually exacerbate the problem as it robs capital from the rest of the world.  What they didn’t tell us was that if that is the case, what is the way forward.  David Frum was trying to make the point that this wasn’t the Republican’s fault.  I do think they made a very valid point that the real problem is global, but decisions on how to solve it, whether in China or America, is political and thus locally focused.  Meanwhile John McCain is railing against the earmarks in the budget (less than 3%) as though this is our problem.

Reliable Sources took on the real issue of whether the press and CNBC were trying to use instantaneous market fluctuations as unfair evaluations of the President’s policies.  The answers were sadly predictable based upon the pundit’s political persuasion.  The automaton from the Washington Times (conservative Washingtown voice) thought it was just fine, while the rest of the pundits thought we may need to step back and wait and see.  She (the Washington Times blogger) even tried to play down the Jon Stewart satire of CNBC’s financial predictions that went bust (See Two Pieces of Wisdom from Jon Stewart).  Sad that politics blinds us to our own failures in logic, myself excluded of course.

So what have learned?  Not much.  Apparently most Americans are looking for a quick fix in America for a global problem that will probably get much worse before it bottoms out.  What we really need is to understand just how serious the problem is, that the problem and the solution are global, and a general agreement on the way forward.  The political arguments we are having are the cart before the horse when we should first listen to dueling economists and historians so we understand the problem. What we are getting now is moderate steps in one direction, amid political arguments that we are all tired of.  When the Sunday shows start bringing in historians and economists, maybe then the political babble will end and we can have a rational discussion about the way forward.

For what it is worth here is my two bits:  Ignore the Republicans.  Doing what Herbert Hoover did in 1929 is not a way forward.  They are locked in their political ideology and their ideas, or lack thereof, are a result of mental constipation.  It is a global problem, but I am not sure that the U.S., even if we knew the correct solution, could bring the EU and China along.  The one example we have of getting out of this is the Keynesian solution, which is deficit spending.   When we did massive borrowing to run World War II, we did it all internally by borrowing from our own citizens.  The conventional wisdom is that we will be borrowing from the Chinese this time and they may redirect their money to their own problem, forcing us to raise interest rates to get the required cash.  Unless you haven’t noticed things are getting very bad in China and unrest is quite possible.

Having said that, we could always print money which causes inflation, which if things get bad enough, may not be such a bad idea since inflation forces people to buy things since they need to spend their money before it is devalued.  At any rate I think we need to proceed with the Obama solution which has three legs; stimulus, banks, and housing, only much more aggressively.  As Tom Friedman wrote in one of his columns when he described the scene in Jaws where one of the major characters (Richard Dryfus) sees the shark for the first time and tells the boat captain, “we need a bigger boat”.  Well, we need a bigger stimulus package.

The next stimulus package will be about the size of the last one, but forget the tax cuts and focus on investments that will create jobs that will be about the economy of the future.  That would be infrastructure, education, energy, and climate.  We need to get that in place right now and the only infrastructure spending would be either repairing what has to be repaired or new green transportation systems.  Continuing to build transportation systems that are petroleum centric is counterproductive.

For the banking system, ditherating is not an answer.  The fear of a domino effect must be overcome (or ameliorated) and we have to identify and remove the bad debts out of the system (along with the present management structure).  Investors, bondholders, and taxpayers must all share in this burden (read pain).  Whether this is some form of the bad bank/good bank scenario or nationalization, it must be done quickly.  One aside here:  One guest on GPS raised the issue of class anger in the United States.  We let the rich get richer because we believe the lie that we would all profit and they squandered everything.  It will be imperative that those who profited from our downfall are seen to pay dearly in fixing the system or there will be rioting in the streets.

Finally the same medicine is going to have to happen in the mortgage industry.  Decide on a reasonable interest rate for all loans, say 4%-5% and establish it.  Then re-evaluate the market worth today of the property and reset the principle balances.  Use a liberal value assuming some middle ground between the present principle balance and a realistic actual worth.  Those that can qualify for these new loans, then fine.  Those that can’t get foreclosed on.  Waiting for the marketplace to do this under foreclosures just extends our problems.  Note that this is almost a double-edged sword because once this is done, much of the banking problem settles at what those toxic assets are really worth and what the federal government should insure them for.  This not only settles the worth of the Collateral Debt Obligations (CDOs) but the Credit Default Swaps (CDSs) and allows us to estimate the real worth of these investments.

Okay, maybe these ideas are a little naïve considering the complexity of the problems, the interconnectiveness of our economies, and the impact of global problems, but why aren’t we having this discussion instead of endless discussion about what is politically possible instead of what needs to be done and making it politically possible?

As much as I see this as a global crisis, and although we need to stay engaged and try to work with the EU and China to solve the problems, the real place where our actions can make a difference is at home.  The critical issue is that this must be our focus and we need to get on with it, aggressively.  Any other delay or Republican obstructionism, and we are doomed. Note there is a bright side.  If we have a global depression, Iran won’t be able to afford nukes, North Korea will starve, and Al-Qaeda will be broke.  This says to me it is really time to start solving our own problems instead of saving Iraq and Afghanistan from themselves by emptying out our treasury.

Vine:   Well, I lied or more accurately, I forgot.  There is work in the vineyard before pruning.  As noted in the picture taken Wednesday morning, winter is not through with us yet.  The snow was gone in the afternoon, but the rain continuous and I will have to repair some erosion damage in the lower vineyard.  This year in the steep sections I may bite the bullet and install some drainage lines.  The soil is soft now and digging in red dirt is one of my most cherished activities.  The other chore is to retie all the vines, which is not as bad as it sounds.  For the trellis vines (Syrah) the cordons (horizontal runs) have all been retied with a little device called a Max Tapener .  It looks like a giant staple gun and it wraps the tie-tape around the cordon and wire and then staples the tie-tape together.  With some practice you can get a nice tight tie and it cuts the time for performing this task to about 10% of what it would usually take.  The ones I did last year held up fairly well last year so I will continue testing this product.  I am sure some traditionalists will tell me this won’t work, but I am just one guy with only so much time.  I also need to adjust the trunk ties so that they are loosened to prevent binding as the plant grows.  Hopefully if the rain stops I will have this done prior to pruning.  Then all I have to do is clean up and burn pruning debris when that little task is complete.  See, isn’t growing grapes romantic?

By the way I watched “Bottle Shock” and it was truly a fun movie to watch.  Buried in the love story and the wine competition in France was a story about terroir and love of the plant itself.  My favorite quote in the movie was that the vineyard is fertilized by the footprints of the grower in the vineyard.  So true.  Say what you want, to grow great grapes is a labor of love, not technical ability, although it does help.  They got several things very right in this movie:  Growing grapes and making great wine requires a respect for your terroir, hard work, and great art.  A fine wine is a confluence of these three attributes.

Wine:    Last Saturday (remember that Saturday is my day to try to make a great meal at home) I broke out my new All-Clad slow cooker and decided to make Pappardelle Bolognese.  I have a slow cook cookbook and this looked really good.  Veal is a little hard to find, but I finally found some and followed the recipe (Williams-Sonoma Slow Cooking).  It slow cooked for about 8 hours and I added mushrooms which may have been a mistake.  When we finally served it with multi-grain bread, salad, and Dunamis (Narrow Gate Vineyard (Rhone Blend)) I was somewhat disappointed in that it was rather bland.  I think I should have cooked down the mushrooms and removed the excess moisture before I added them to the Bolognese.  But with some extra salt, pepper, and parmesan cheese (and a little hot sauce), it picked up nicely.  I highly recommend the Dunamis as it is a very distinctive blend of Grenache, Mourvedre, and Syrah and you can try it at Narrow Gate Vineyard. Narrow gate (Frank Hildebrand) utilizes a very eco-friendly growing style and does mostly whole berry fermentation, gently extracting the tanins and other flavors out of the grape.  It is a delicious wine and I highly recommend it.  Should I add that the wines produce in this area by winemakers such as Frank are of exceptional quality and price.  Wine Spectator hasn’t figured that out yet with their fixation on the costal areas of California.  Carpe Diem.

I think most people understand that banks may have a problem and they won’t lend, increasing the problems our economy is facing, but there is no real understanding of the “problem”.  So I thought that in my simple minded way I would take on the economic-babble and try to turn it into plain English.  I, of course, will oversimplify, probably to the point of actually making sense.  When you listen to the economic-babble, what gets lost are some fairly simple concepts wrapped in some deeply established conventional wisdom about free markets inculcated through years of dreary study.  As a structural engineer I liked to use terms like transverse loads and horizontal force resisting systems to hide some fairly simple concepts and always look serious so I could earn the big bucks.  It is part and parcel of the mystic of being a professional.

Okay, what is wrong with the banks and why won’t they lend money?  Because they don’t have any!  Wait, you say, what about the $350B we gave them?  Well it costs a lot of money to pay bonuses and continue with all those off-site conferences.   People are depressed with only getting six figure bonuses and motivation seminars in Vegas and Santa Monica with concerts by Chicago are not cheap.  Do you have any idea what an open-bar for 3000 costs?  Besides, corporate jets don’t run on water you know.

Seriously, they really don’t have any money because all that money they were taking in with your deposits they invested in CDOs (Collateralize Debt Obligations- Securitized Mortgages sliced and diced) to earn the maximum interest to pay for all the free services they offer you, the return on your money market accounts, and all those great bonuses.  As if those ATM fees weren’t enough.  In order to make your accounts liquid (funny how economist like to refer to cash flow as something that runs through you hands), i.e., the ability to cash you out when you want, they have to have cash on hand.

They have to borrow that money since the real money they got from you and stockholders is invested to earn them profit for what they are doing.  So when other banks look to loan them money, they want to know that their loan will be secured by the assets the bank holds so that if stuff happens, they can get their money out.  It has to be secured by the assets of the bank.  Ah and there is the rub.

If those assets are only worth about 20¢ on the dollar, your dollar that they invested in CDOs, that means that the banks liabilities exceed their assets. If things get tougher or there is a real run on the bank (people want their cash), the bank will collapse because they can’t sell the assets to cover this demand much less borrow it from anyone else.  You and anybody who loaned them money and invested in their bank will lose.  That is why the banks are holding on to the money the Fed gave them.  It improves their balance sheet and staves off the wolves.  They won’t loan it to you even if you are a good bet because they may need it to cover a run, bonuses or off-site motivation seminars.  How do you think they keep those really smart guys on their payroll that make those bad investments in the first place?

Worse, is that each of the banks also holds loans from each other.  This interconnectedness means that if one collapses, meaning their loan payback is now worthless; it impacts all the other bank’s viability.   Now comes the transparency thing.  Nobody knows who owns what and how much of a bank’s net worth is based upon these “toxic” assets.  So everybody is holding their cards close to their bodies and hanging on to their cash.

So with all this uncertainty, we have dollar constipation.  Now the way to solve the problem is to make the banks solvent again.  one way is to stop the mortgage crisis, stem falling housing prices to shore up the value of these “toxic” assets.  But that is a whole other story that I will take up later and just threw it in here to make the point that all of this is interconnected.  The other option is to increase their cash.  Secretary Paulson tried this by giving them $350 billion and it turned out not to be enough by a whole bunch.  Meanwhile taxpayers are wondering why they need to bail the banks for these bad decision on investments and want some protection on their money. The reason is that if all these banks domino, the net worth of the United States goes in the dumper and we as a country collapse.  But the concern about some return on taxpayer funding is a valid one.

Now the obvious solution is to nationalize the banks.  What this accomplishes is that the banks, now backed by resources of the federal government guaranteeing the worth of these assets, no longer fear a run, are recapitalized and can loan freely in an attempt to get back on their feet.  The government takes on and “insures” the liabilities of the banks and in an ownership role, can change management and benefit if the banks and their assets rebound.

But now comes the convention wisdom that governments just screw up markets.  This ignores the reality that the FDIC does this kind of thing all the time, but hey, when did facts and reality count for anything?   This belief in government bad, private ownership good is the result of all that dreary learning necessary to get your PhD in economics.  So here come all the exotic plans to recapitalize the banks while protecting the taxpayers where the government doesn’t really own the banks and it is left in private hands.  These go something like this and these are grossly over simplified.  There are multiple variations to either limit government control or try to change the heads banks win, tails taxpayers lose scenarios of anything less than nationalization:

• Insurance – The government insures the banks assets so that private capital will then feel secure enough to recapitalize these institutions (selling stocks and bonds).  Downside – banks keep their existing management that got us where we are and the government takes all the risk with no pay back.  If the assets collapse taxpayers are on the hook, if they rebound, the banks gain.
• Good Bank/Bad Bank – In this case the government establishes a “bad bank” that takes the bad assets off the hands of the bank leaving them capitalized to get back to work.  Downside – same as above, and the money to buy off all those assets comes from taxpayers.  If the assets (housing prices) come back, the government may recoup some losses, but that depends on the price the government initially pays for these assets.  Banks don’t want to admit the real price of these assets in today’s markets so this one is unlikely
• Continuing to Capitalize the Banks through preferred stock – This is basically what TARP did but has been adjusted recently.  It buys stock that is “preferred” in that they get a guaranteed return on the sock of 5%-8%, but have no voting interest.  The banks can then choose to convert this preferred stock to common stock getting out of the burden of the dividends, but then giving the government voting interest in running the bank.  Considering the price of most banks stocks and the cash needed, this would actually nationalize the banks without calling it nationalization.  Downside – While it infuses cash, it probably is not enough and requires Congress to authorize more, and it skirts the ownership issue leaving bad management in place unless the bank opts to turn itself over to the Feds.  If you really want to have your eyes roll back in you head, clink on this link to understand the details of this type of investment (The Baseline Scenario).

Note that all these solutions have one thing in common:  Don’t violate the conventional wisdom that these banks should remain in private hands.  Those private hands did a bang up job so far.  So for the short term they need to lose their license for running banks.  In my mind the uncertainty in the market is never going to be solved by the conventional wisdom of putting on a happy face and letting banks dangle.  We need to identify the problem, nationalize them, sell off their good assets, and re-privatize them as markets improve as smaller entities.  In a sense reboot the whole system and get the pain out of the way.

Most addicts understand that before recovery, you have to hit bottom or you are not ready.  The conventional wisdom is that we need confidence in our system so people will start spending again.  But we have not hit bottom so we will make the changes necessary to really correct our present situation.  Republicans still think Ronald Reagan applies and until they face reality, we are going nowhere.  That is why this obvious solution is still going to be a hard fight.  Until then, nationalization is a dirty word.  Or for the wingnuts, be afraid, the black helicopters are coming to take over our country.  First it’s the banks, then it will be national health care.  I say bring it on.