Overvalued Credit and Minsky Moments

An excellent piece today by John Authers in the Financial Times, "Look to US for clues on whether sky is about to fall." It's not that he covers new ground, but he does a very good job of characterizing the current state of affairs. However, the piece falls just short of something you could share with a lay reader, which is a shame. As much as I like the phase "credit is overvalued," most people outside the markets need to be reminded that bond prices being high means interest rates are low. They take a borrower's viewpoint, and think of a static principal obligation, so "credit is too cheap," which can then be translated into, "Borrowers aren't demanding enough for the risk," would fit their perspective better.

I'll also grant him that the credit markets are vastly more precarious than the equity markets. However, I'm not certain that risk, or the perception of risk, isn't fungible. Markets move together to a greater degree than ever before. The credit markets were precarious before last week. The subprime meltdown was already underway. But the equity markets, for the moment, took the brunt of the damage.

He also has some pithy illustrative data, particularly of the magnitude of derivatives relative to the underlying instruments, and discusses the concept of a Minsky moment. Economist Hyman Minsky observed that creditors become more lax about lending standards during times of stability. He divided borrowers into three types: the upstanding sort that can pay principal and interest; speculative borrowers (or "units"), who can pay interest but have to keep rolling the principal into new loans; and "Ponzi units" which can't even cover the interest, but keep things going by selling assets and/or borrowing more and using the proceeds to pay the initial lender. Minsky's comment:

Over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight of units engaged in ­speculative and Ponzi finance.

What happens? As growth continues, central banks become more concerned about inflation and start to tighten monetary policy,

....speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently units with cash flow shortfalls will be forced to try to make positions by selling out positions. That is likely to lead to a collapse of asset values.

Ouch.

But again, it's hard to know where things stand. The markets that are most dodgy are generally the most opaque (not a good sign). But some of the apparent risks may be overstated. For example, Authers cites the fact that the "value" of swaps outstanding on a company's bonds can dwarf the total value of the bonds themselves many times over. But is that the notional amount of the derivatives (that is, the amount they are "insuring"), or their actual market value? The market value is small, sometimes very small, fraction of the face value. So while we may well have cause for concern, it's impossible to know how deeply concerned we should be.

From Auther's article:

It is time to switch fairy tales. For years, market talk has revolved around Goldilocks - shorthand for the belief that economic growth will be "not too hot, not too cold", and allow world markets to move ahead healthily without a big jolt.

After two weeks of heavy volatility, we have switched from Goldilocks to Chicken Little: is the sky about to fall on our heads? Are the many troubling aspects of the world markets going to be enough to generate a systemic collapse, taking the economy with it?

Whether or not this is likely, the fear of it has much to do with the volatility. So, if a Chicken Little event happens, how will it come to pass?

First, its roots would not be in China, or anywhere in the emerging markets, but in the world's continuing consumer of last resort - the US. It was US consumer discretionary stocks that led world markets during their recovery in the latter half of last year and emerging markets continue to rely in large part on their exports to the US. If the US economic motor is switched off for any reason, then the assets most affected by it - such as industrial materials and emerging markets stocks - stand to suffer most. But the problem would lie in the US.

Next, it is hard to come up with Chicken Little scenarios for the US stock market in itself. Some of the arguments US equity strategists have produced in the past few days look disingenuous. It is pointed out that price/earnings ratios for US stocks are well below their average for the past 10 years, for example - ignoring the fact that multiples are too high on a cyclically adjusted basis. But stocks are not in the grip of an absurd overvaluation, such as that of 2000.

That cannot be said for the credit market, where valuations look as over-stretched as equity valuations looked seven years ago. Until the recent turbulence, the extra "spreads" in interest that risky loans had to pay compared with relatively safe treasury bonds were at all-time lows.

Unlike equities, many credit instruments are recent inventions and do not have the lengthy history that provides guidance on what to expect in the future. Many decisions on lending that were once taken by banks are now effectively taken by the "invisible hand" operating behind the credit markets.

The growth of credit derivatives, which are opaque and often package debt of different qualities into one instrument, has added to the confusion. Hedge fund managers betting on a credit collapse point out that the value of derivative swaps related to a company's debt can easily outstrip the actual value of the debt many times over.

Thus, even though the derivatives market evolved to make it easier for lenders to spread their risks, a relatively small number of defaults could have a disproportionate impact.

Further, there is evidence that credit is overvalued, given the stage we have reached in the economic cycle. Research by Jim Reid of Deutsche Bank in London puts this in perspective. Particularly for high-yield bonds (where investors receive higher interest rates in return for taking a higher risk of default), credit has been persistently too expensive over time.

The valuations of low-quality "single-B" bonds are currently such that they will lose money compared with Treasuries unless their default rate over the next five years is better than for any previous five-year period over the past 30 years.

As the market has expanded drastically over that period, with many more companies gaining access, the probability in any case is that the default rate could be higher than has been seen historically. There are greater fears for lending to individuals. Americans spent more than they earned in 2005, for the first time ever, implying heavy borrowing.

They increasingly did so using adjustable rate mortgages, a new phenomenon in the US. There is no experience on what will happen to defaults when interest rates rise.

US banks are tightening their mortgage-lending standards at the fastest pace in 16 years, according to analysis by Odey Asset Management in London.

That in the past has been a leading indicator for an increase in defaults.

Greatest concern adheres to subprime lending - loans to people with bad credit histories. More than 25 subprime lenders have gone bust in the past few months. Such loans last autumn could be financed on the market for only 2.5 percentage points above the standard interbank lending rate. They now cost 14 percentage points more.

Do these problems put us in Chicken Little territory? George Magnus, economist at UBS in London, raises the possibility of a "Minsky moment". Named after the late US economist Hyman Minsky, this refers to the tendency for leverage to increase as long periods of economic stability make leverage easier to justify. This has happened.

As growth continues, normal lending discipline gives way to "Ponzi" structures - pyramid schemes where newinvestors are paid with money from exist-ing investors. These collapse when the supply of willing new investors dries up.

The "Minsky moment" comes, says Magnus, when "lenders become increasingly cautious or restrictive, and when it isn't only over-leveraged structures that encounter financing difficulties . . The risks of systemic economic contraction and asset depreciation become all too vivid." This is the worst-case Chicken Little scenario. Any new evidence that it will come to pass would lead to more market drama.

Gore, Carbon Offsets, and Misguided Thinking

Gregg Easterbrook, a fellow at the Brookings Institution, wrote an op ed piece in the New York Times, "Al Gore’s Outsourcing Solution" that makes a few valid observations. But his central recommendation, "America needs legislation capping carbon emissions here, but Congress should allow American companies and consumers to use investments in carbon offsets in China and India against those caps, where the bang for the buck is much higher," is patently wrong-headed.

The three big problems with this idea are how the offsets are counted, cheating (which is related to the first problem) and administrative costs. Now while Al Gore might be able to find groups that engage in carbon offsetting that is actually effective, the math for most programs is pretty dubious. Essentially, it's "sin now, repent at leisure." As the Center for Media and Democracy observed,

Carbon Trade Watch, a project of the Amsterdam-based Transnational Institute, recently released a report (pdf) critiquing offsets. "Offset companies give the idea that emissions are instantly 'neutralised' when in fact the supposed 'neutralisation' can take place over periods of up to a hundred years. Regular offsetting worsens the problem because the rate at which carbon emissions are 'neutralised' is far slower than the rate at which they are generated," warns Kevin Smith, the report's author.

Similarly, the Economist's Free Exchange, citing Anthony King, notes,

The public policy goal of those who worry about carbon emissions is for people to consume less bad energy. Whether people consume more good energy is beside the point. Trying to get other people to consume more good energy so that you can consume more bad energy is feeble-minded.

A personal "carbon offset" can be thought of as a self-imposed tax on the use of bad energy, accompanied by a subsidy of something else. The self-imposed tax is only constructive to the extent that it discourages the person from consuming bad energy. The subsidy is only constructive to the extent that it reduces carbon emissions somewhere else. Subsidizing good energy by no means ensures a reduction in the use of bad energy.

Even subsidizing the planting of a forest may not work. Although the trees will absorb carbon dioxide from the atmosphere, the planting itself may require the use of heavy earth-moving vehicles that emit pollution. Overall, adding forest in one spot may lead to a developer cutting down a forest in a nearby spot

The second problem is cheating. Even if an organization says it will grow trees (which per above we know is overrated), we have no idea if they are planting the same tree on behalf of five people.

The third problem, and this is particularly operative with the idea of carbon offsets for places like India and China, is administrative costs. The comparison to outsourcing is revealing. As we discussed in an earlier post, international outsourcing, aka offshoring, produces savings far lower than a simple comparison of labor cost savings would suggest. For example, when IBM looked at having some of its programming done in China, even thought the labor cost was 20% of that in the US, experts estimated the cost savings at only 15-20%. Why? The additional communication and coordination required. And that's when it's done with employees of the same company. It gets more complicated when using external vendors.

Now imagine what it would be like to have, say an official international program, with vendors of various sorts involved. A company would need to res each and choose which offset program to participate in. That takes time and money. The companies offering the offsets would have to package and market their programs (and perhaps have them qualified, if their was government involvement). That takes time and money.You'd need contracting, which means lawyers, as well as key people at the parties to a deal. More time and money. You'd need compliance and inspection (if not, you are inviting abuse)..... Easterbrook's "greater bang for the buck" quickly vanishes.

Dean Baker at Beat the Press has a minor "gotcha," namely that China isn't as ineffient an energy user on an overall basis as the US is (their horrific coal palnts and generally poor industrial practices are offset by our use of cars and large single family homes) if you measure their GDP on a purchasing power basis.

While Gore's personal carbon offsets might be effective, he's legitimizing a bad idea. A carbon or energy tax is a far more effective mechanism, but somehow the left has been cowed into promoting free market gimmickry instead.

From Easterbrook:

Last month, to the delight of many global-warming skeptics, it was revealed that Al Gore uses 20 times as much electricity and natural gas at his Tennessee house than the national average. Out of curiosity, I put the former vice president’s power bills and ZIP code through the home-emissions calculator of TerraPass, a company that sells “carbon offsets” — the promise to reduce greenhouse gases by the same amount your behavior increases them.

TerraPass estimated that the power use of a house equivalent to Mr. Gore’s causes 377,000 pounds of greenhouse gases annually. That is roughly the annual carbon emission of 20 Hummers. Next time you see Mr. Gore wagging his finger about the energy sins of others, picture a caravan of 20 Hummers driving to the Academy Awards.

A Gore spokeswoman told the press that the former vice president pays extra for wind energy, and buys carbon offsets. He’s not the only one: companies that sell such offsets are rising in popularity, and certificates for them were included in the stars’ Oscar night goodie bags. Soon not just individuals, but the entire United States, may be purchasing carbon offsets on a grand scale.

TerraPass charges $1,247.50 for one year of carbon offsets for a home like Mr. Gore’s, the price including a refrigerator magnet proclaiming the home “carbon balanced.” Initially I found it hard to believe anyone could counteract Mr. Gore’s prodigious energy lust for just $1,247.50, since planting about 20,000 trees would be required to neutralize even half his house’s carbon footprint.

But it turns out that TerraPass does its good works in part by covering landfills to prevent methane from seeping out. Since methane is a far more potent greenhouse gas than carbon dioxide, covering landfills is a cost-effective way to wrestle with global warming. I may be annoyed by Mr. Gore’s hectoring, but I’m not going to accuse him of hypocrisy on this one.

This all seems a classic example of economies of scale. Individuals can’t do anything about landfill methane. But a company like TerraPass can combine the resources of many to accomplish this task, allowing the person of good intent to use energy with no net contribution to the greenhouse effect. Whether companies marketing offsets really do reduce greenhouse gases is something for consumer reporters or the Federal Trade Commission to determine. Assuming the sellers do as promised, buying carbon offsets isn’t an exercise in guilt. It’s smart economics....

Current bills in the Senate — one sponsored by John McCain and Joe Lieberman, another by John Kerry and Olympia Snowe — would cut domestic greenhouse emissions to about the level of 1990....

But even if successful, the McCain-Lieberman or Kerry-Snowe bills would only slightly lower future atmospheric levels of greenhouse gases. That’s because Chinese carbon emissions are skyrocketing.

Since 1990, according to the World Resources Institute, American greenhouse emissions rose 18 percent while Chinese emissions rose 77 percent. China may pass America as the No. 1 emitter of greenhouse gases as soon as 2010. If current trends hold, by 2050 emerging nations led by China and India will emit twice as much carbon as the United States and Western Europe combined.

China’s emissions are soaring because the Chinese economy is nearly three times as “carbon intensive” as America’s, burning far more fossil fuel per unit of gross domestic product. Chinese coal-fired power plants are notoriously inefficient, consuming twice as much coal per kilowatt produced as American generating stations. They also run without the elaborate anti-pollution “stack scrubbers” found in Western power plants. And China opens a new coal-fired generating station every week to 10 days.

Here’s where offset economics come into play. Dollar for dollar, capital invested in greenhouse gas reduction would accomplish more if used to improve the efficiency of Chinese power plants than if spent in the United States. America needs legislation capping carbon emissions here, but Congress should allow American companies and consumers to use investments in carbon offsets in China and India against those caps, where the bang for the buck is much higher....

If our goal in legislating against carbon releases is not simply punishing the West and its power companies but truly trying to reduce the accumulation of greenhouse gasses in the atmosphere, the main event will be in the developing world. We must use the smartest possible economics, and that means investing in China and India.

Geo-Engineering for Global Warming

This week's Economist discusses "Plan B for global warming," which is to implement measures directed at cooling the earth's temperature.

It's an idea which is pragmatic (it acknowledges that collectively we aren't likely to take concerted enough action to stop, let alone reverse, the rising levels of greenhouse gases that are producing higher temperatures). But it's also fraught with risk. One of the problems with the recent Intergovernmental Panel on Climate Change's report is that weather is one of the most complicated modelling problems. And climate change is an even more complicated problem. We don't have enough computing power, let alone enough understanding. So even thought these ideas may sound compelling, and worth implementing, the second order effects are unknown, and may be significant. It's likely that their impact won't be evenly distributed, that atmospheric or ocean heat transport patterns could be disrupted, which could in turn produce dramatic local effects.

Science fiction fans will note that this is a precursor to terraforming, the process by which alien planets are altered to make them more fit for human life. It's a sad irony that the alpha version may be attempted on our own planet.

From the Economist:

If man is inadvertently capable of heating the entire planet, surely it is not beyond his wit to cool it down as well?....

Of all the schemes proposed, the most ambitious (and expensive) idea would be to place a giant sunshade in space at the inner Lagrange point, the position on the line between the Earth and the sun where the combination of centripetal and gravitational forces allows an object to maintain a constant position between the two. If the object is big enough, it could block out enough of the sun's rays to cool the Earth. Roger Angel, an astronomer at the University of Arizona, has suggested assembling a cloud of millions of small, reflecting spacecraft less than a metre across at this point, where together they would block out 1.8% of the sun's rays.

Dr Angel estimates that the total mass of the sunshade required would be around 20m tonnes. The shade would consist of individual craft around one metre across, put into position using a combination of magnetic launchers and ion propulsion. He believes the total cost of the project would be a few trillion dollars, or less than 0.5% of world GDP. Dr Angel admits that this is a somewhat far-fetched solution, and does not believe it would be attempted unless all other options had failed. But he has been given a small grant by NASA to explore the idea.

A less exotic approach, endorsed by Dr Crutzen, would be to spread tiny particles in the upper atmosphere to reflect the sun's rays. This effect has already been shown to work in nature: fine sulphate particles, called aerosols, ejected by large volcanic eruptions like that of Mount Pinatubo in 1991, have produced periods of global cooling. And sulphate pollution from industry had similar consequences, helping to balance the warming effects of carbon dioxide until the 1990s, when pollution controls in many regions had the perverse effect of increasing warming.

Ken Caldeira, a scientist at the Carnegie Institution, suggests that this idea might be more suited to local rather than global application, at least at first. The Arctic, for example, is among the regions most affected by global warming, and keeping the polar sea-ice frozen would be a good thing: white ice reflects more heat back into space than dark ocean, and the scheme would also save a few polar bears from drowning.

The most down-to-earth idea is that proposed by John Latham, a scientist at the National Centre for Atmospheric Research in Colorado. He suggests that blasting tiny droplets of seawater into the air would stimulate the formation of highly reflective, low-lying marine cloud. Simulations suggest this would have a substantial cooling effect. The question is how to do it economically. Stephen Salter of the University of Edinburgh has designed an unmanned vessel which would produce these clouds using wind power. Just 50 vessels, he reckons, each costing a few million dollars and spraying around 10kg (22lb) of water per second, could cancel out a year's worth of global carbon-dioxide emissions—though another 50 vessels would be needed every year until carbon-dioxide emissions were under control.

Dr Salter's ships would be much more precise than other geo-engineering schemes—“like an artist's paintbrush”, as he puts it. They could be deployed to the North Atlantic to cool the Greenland ice sheet during the northern summer and then migrate to Antarctica for the southern summer. Dr Caldeira even suggests that by cooling the sea, these ships could be used to combat hurricanes, since high sea-surface temperatures are linked to hurricane formation.

Other proposals include seeding the oceans to get them to absorb more carbon dioxide and building huge reflectors in desert regions to reflect sunlight back into space. This latter idea is impractical, says Dr Caldeira, who reckons that half the world's deserts would have to be covered. Indeed, most geo-engineering schemes sound half-crazy and tend to have both technical and aesthetic complications. Deliberately polluting the stratosphere would make the sky less blue, although sunsets would probably be prettier. Blocking out the sun would help to cool the planet, but it would do little to address other nasty side-effects of high carbon-dioxide levels, such as the acidification of the oceans.

Many greens oppose the whole idea in principle. Ralph Cicerone, president of America's National Academy of Sciences, has said that geo-engineering inspires opposition for “various and sincere reasons that are not wholly scientific”. But it does seem reasonable to worry that the illusory hope of a scientific fix might undermine the adoption of policy solutions, such as carbon caps and carbon quotas, designed to address the underlying cause of the problem. And then there is the danger of unintended consequences. Climate change is arguably an experiment which mankind has unwittingly found itself performing on the planet. To start a second experiment in the hopes of counteracting the first would be risky, to put it mildly.

Builders and Consumers Resist Greener Homes

A Reuters story, "U.S. struggles to build green homes," describes Americans' deep seated resistance to doing the right thing, energy-wise:

Regardless of the sales pitch, energy efficiency is an opportunity that Americans shun....

While gas-guzzling vehicles draw the most criticism, homes and businesses consume even more energy -- 40 percent of the U.S. total in 2005 versus 28 percent for transportation -- and provide the biggest potential for savings.

The U.S. Green Building Council says structures built to its standards can cut energy usage 20 to 80 percent using available technologies such as compact fluorescent lighting and high-efficiency building shells and water heating.

The Paris-based International Energy Agency, which advises rich governments, says more efficient use of energy can do far more to cut carbon dioxide emissions than either a shift to renewable energies or nuclear power in coming decades.

The problem is that builders and consumers don't want to change their habits, and lawmakers are reluctant to take them on. Consumers are eager to spend on glitzy amenities, but aren't willing to pay more for more energy-efficient homes unless the payback is rapid, meaning less than three years, when prototype energy saving homes show four-year recoupment.

This failure reveals a lack of political will and personal responsibility. It's always easier to build things to be environmentally efficient from the outset than to retrofit, but the incentives aren't there to induce most builders to convert to more energy efficient designs, particularly if the end buyers aren't so keen. Legislators and regulators have been willing to impose costs and restrict freedoms when it comes to product liability, requiring safety belts, air bags, the use of child seats. Despite considerable industry opposition and lukewarm consumer support, these rules have been passed. Why should collective safety be any different than individual safety? In fact, in that case, there is a much stronger argument for intervention.

So how do you change behavior? One method is building codes. Another, as we have discussed before, is an energy or carbon tax. This would not only change the payback on investing in energy savings, but would change behavior on other fronts. It isn't just the design and the construction of the homes that's a problem, it's also the very fondness for dispersed single family residences. Higher energy prices would induce some to favor housing in denser locations, with shorter commutes, and around the margin would also favor multi-family dwellings.

And there is PR and the media. The American culture glorifies conspicuous consumption, and it is reinforced on TV, in magazines, and in movies. Now it's hard to compete with the power of advertising, but perhaps being green could be spun as an elite consumer positions (to a degree, that's already true) and being "not green" could be depicted as being uncool.

Finally, there are the evangelicals. Many of them are adopting a pro-environment stance. They represent a lot of buying power. Why hasn't someone figured out how to harness them?

Can We Believe in Science?

Not to worry, I have not become a creationist. But each era has had firmly held beliefs about how the world works that have been displaced by later theories.

The article below is a mundane but nevertheless important example. Some Danish scientists have questioned the long-held belief that nerve signals are electrical, since electrical impulses would generate heat. They are instead exploring the theory that nerves may instead use sound waves.

The reason I raise this (aside from the fact that it's geeky) is that it exhibits the tenuous state of knowledge in what ought to be fairly well settled scientific realms. So if we can't have confidence in what we know there, it's even more of a stretch to trust any theory asserted in the social sciences.

From CBC News, "Scientists say nerves use sound, not electricity:"

The common view that nerves transmit impulses through electricity is wrong and they really transmit sound, according to a team of Danish scientists.

The Copenhagen University researchers argue that biology and medical textbooks that say nerves relay electrical impulses from the brain to the rest of the body are incorrect.

"For us as physicists, this cannot be the explanation," said Thomas Heimburg, an associate professor at the university's Niels Bohr Institute. "The physical laws of thermodynamics tell us that electrical impulses must produce heat as they travel along the nerve, but experiments find that no such heat is produced."

Heimburg, an expert in biophysics who received his PhD from the Max Planck Institute in Goettingen, Germany — where biologists and physicists often work together in a rare arrangement — developed the theory with Copenhagen University's Andrew Jackson, an expert in theoretical physics.

According to the traditional explanation of molecular biology, an electrical pulse is sent from one end of the nerve to the other with the help of electrically charged salts that pass through ion channels and a membrane that sheathes the nerves. That membrane is made of lipids and proteins.

Heimburg and Jackson theorize that sound propagation is a much more likely explanation. Although sound waves usually weaken as they spread out, a medium with the right physical properties could create a special kind of sound pulse or "soliton" that can propagate without spreading or losing strength.

The physicists say because the nerve membrane is made of a material similar to olive oil that can change from liquid to solid through temperature variations, they can freeze and propagate the solitons.

The scientists, whose work is in the Biophysical Society's Biophysical Journal, suggested that anesthetics change the melting point of the membrane and make it impossible for their theorized sound pulses to propagate.

Tax Code Writing Outsourced to Tax Shelter Designers

You can't make this stuff up.

The link in the story from Washington Monthly, "'It's the Fox Designing the Henhouse'," points to a New York Times article, "I.R.S. Letting Tax Lawyers Write Rules."

David Cay Johnston reports today that the IRS is outsourcing its writing of tax rules to the very lawyers and accountants who create tax shelters and exploit loopholes for the superrich:

John D. Graham, the official appointed by President Bush to streamline the federal rule-making process and give private interests a greater voice, said even he was surprised by the I.R.S. plan.

"Whoever's pen the first draft comes out of has a big advantage," said Dr. Graham, who ran the Office of Regulatory and Information Affairs for the White House before becoming dean last week of the graduate school at RAND, the nonprofit research organization.

....A single word, sometimes one letter, can change the meaning of a rule: "must" or "may"; "and" versus "or"; "could" or "would."

....In recent years there has been a quickening pace of moves to outsource the actual work of regulation, hiring contractors to write the rules. Now the I.R.S. is proposing that outside experts do it at no charge, opening up the possibility that some firms providing the draft would be working on behalf of an individual, business or association seeking to plant a favorable nuance in a rule.

What an outrageous thing to say. I'm sure all these guys are doing this work for free merely out of a sense of pro bono altruism and a desire to make sure our tax rules are clear and consistent. I really don't know where Johnston gets off implying that they might be trying to plant "favorable nuances" that they can later take advantage of.

Anyway, the IRS says this is just a pilot project limited to "technical and noncontroversial issues." So I'm sure there's nothing to worry about. And certainly no reason for the Democratic Congress to restore cuts in IRS staffing so that they can once again write their own rules and audit the rich with the same zeal they audit the working poor. Why, that would be tantamount to class warfare, wouldn't it?

"Why Can't Shareholders Be Trusted to Set CEO Pay?"

Um, because Barney Frank is making their case?

This great post from Dean Baker at Beat the Press makes a simple and persuasive argument:

Representative Barney Frank has proposed a law that would require corporations to have non-binding polls of their shareholders on CEO compensation packages. According to Marketplace Radio, the opponents of this measure claim that shareholders have diverse interests and aren't in a position to properly assess CEO compensation.

It would be helpful if the media teased this one out a bit further -- the shareholders aren't qualified to determine the pay of their top employee, but the insiders (a corporate board that usually owes their position primarily to the CEO) somehow can be trusted to act in their interest.

The media also portray this as a government intervention into the corporate sector. Of course, this is nonsense. The corporate sector is a creation of the government (individuals can have partnerships, legal corporations are a creation of the state), the question here is about setting the right rules. The government already imposes a long set of rules for corporate governance, including rules on disclosure of financial data and also rules ensuring that the rights of minority shareholders are protected. The issue here is whether it is necessary to change the rules to ensure that CEOs do not abuse their insider power to get exorbitant compensation packages. (I discuss this issue in a chapter of the Conservative Nanny State.)

Hedge Funds Bigger Players Than Investment Banks in Treasuries

The Financial Times reported today, in a page one story, "Funds take firm grip on US Treasuries,"

Big hedge funds have recently grabbed such a large share of trading in US Treasury bonds that their activity is eclipsing many of the investment banks which have traditionally dominated the market.

This falls in the category, "I know this isn't good, but I can't tell you why."

Or more accurately, I can give some reasons, but since I don't trade Treasuries, I am certain to be missing some important nuances, enough that a participant can pick at details. Nevertheless, I believe the theory is valid.

Investment banks and big commercial banks have Treasury trading desks. That means they have taken upon themselves an obligation (of sorts, it isn't a contractual obligation), to make a market, that is, stand willing to buy and sell Treasuries. They will post prices on an interdealer trading system. Many transactions can be executed electronically; larger trades (and the size varies by the particular issue, since some bonds are more liquid than others) need to be confirmed with a trader. Big trades are likely to be done at a price slightly off the screen price. Note these are terribly crude generalizations.

Access to the interdealer screens has been considered to be an advantage; it gives better insight into where the market is than the Bloomberg screens. And the advantage has increased now that these systems are now trading platforms.

Now hedge funds have obtained the same informational footing as the market makers, they have no obligation to make a market, and according to the Financial Times story below, they trade in bigger volumes than the market makers. Seems that they have the upper hand. If I were a market maker, I think I would be less likely to risk capital in a market like this, since it has become a less attractive business proposition now that the hedge funds run the show.

This may not matter most of the time. The Treasury market is so liquid that market makers being more chary likely won't have any discernible impact. But in the bad old days, when bond firms were macho and could make real money, some firms prided themselves in making a market even in adverse circumstances: very big trades, very volatile markets. One can imagine we'll see less of that sort of thing.

The FT story continues:

Citadel, the Chicago-based fund, is now estimated to account for more than 10 per cent of trading in the most liquid Treasuries, according to market participants with knowledge of the fund’s activity.

The surge in the significance of hedge funds has arisen partly because Citadel and others are increasingly using computer-driven trading models that make trades very frequently to exploit tiny differences in prices, generating high volume.

The shift indicates the degree to which the arrival of such electronic trading is now reshaping financial markets.

Benn Steil, an academic who works at the Council for Foreign Relations, said: “Once hedge funds start accounting for this much of the market, it is hard to know what to call them – they are not really bank customers any more.”

It is difficult to calculate accurately the proportion of the market represented by hedge funds since they do not release figures on their trading flows. Meanwhile, the two platforms that dominate electronic trading in liquid Treasuries – BrokerTec and eSpeed – are reluctant to discuss individual clients’ activity.

However, in recent months Citadel and other funds have offered some data to financiers in Europe, because they are seeking to join MTS, the dominant platform for trading eurozone government bonds, whose membership is currently limited to banks.

In the Treasury market, hedge funds and other big users are already connected directly to “inter-dealer” trading systems managed by eSpeed and BrokerTec, a unit of Icap.

The data suggest that Citadel accounts for at least 10 per cent of trading flows on eSpeed and BrokerTec, which in turn are believed to account for about two-thirds of trading flows in the most frequently traded Treasury instruments .

Citadel declined to comment.

Two decades ago, the banks designated as “primary dealers” in Treasuries accounted for around 80 per cent of all trading in the inter-dealer market.

However, one trader now estimates that this proportion has roughly reversed.

The shifts in the Treasury market is now fuelling debate in Europe, since hedge funds such as Citadel are now seeking to gain direct access to MTS, so that they can execute computer-driven trading strategies in European bond markets too.

Why Director Independence May Not Be All It's Cracked Up To Be

The blog Conglomerate pointed us to a paper, "The Fetishization of Independence," by one of its one-time writers, Usha Rodrigues, Assistant Professor of Law at the University of Georgia. They argue it is a "great" paper. I'm not sure I'd go that far, but is well documented and certain to cause a lot of debate. It will (hopefully) sharpen thinking about what makes for a good board, and good oversight. You can download it here (there's a bit of fuss in registering, but no cost).

Her core argument is:

Behind all these rules lurks the belief that, by closing off all conceivable connections to management, rulemakers can create the ideal board. As discussed....this presumption has led to the modern ascendancy of the supermajority independent board, one free from ties to the corporation. I will argue that this move fetishizes independence, by viewing outsider status as a proxy for excellence as a corporate agent. I will also argue that this approach is both wrong and counterproductive.

She claims that good directors are hard to find, so the constraint of independence makes the process even harder, and that even if there were a large pool of director talent, the independence requirement is counterproductive.

I don't buy her first argument. It is true that companies complain they find it hard to find directors, but the problem is in part, if not entirely, self-created. The involvement of search professionals has led companies to set overly exacting standards for who should be a director (and let's face it, making the search more difficult justifies the headhunter's fees). The same condition, of setting the bar for hiring well in excess of what is necessary for good performance, also exists with top, and increasingly routine, corporate jobs.

Companies are increasingly looking for the "out-of-central-casting" director, one with excellent management experience and a great Rolodex. It's the people with the Rolodexes that are in short supply. Corporations would do better to move to the model of venture capital, and have an advisory board in addition to the board of directors. Members of the advisory board would have comparatively few duties, so the time requirements would be far less (and the liability would be minimal), so they could be involved with more companies. Unfortunately, that approach would represent a radical change in corporate governance, so it's likely not to be viable except at relatively small companies.

Similarly, in support of her first argument, she claims that directors' and officers' insurance premiums have been rising. That is plain wrong. They have fallen, considerably, since the implementation of Sarbanes Oxley.

Nevertheless, her second argument, is more persuasive, although I found her detailed argument could lead to a different conclusion than her summary above. She cites studies that show that having independent directors hasn't led to better outcomes. These studies are very few in number, so it is hard to have confidence in their findings.

The best part of the paper is a very lengthy discussion, from various perspectives, of the approach towards independence taken under Delaware law, which is more situational, than Sarbox, which is rule based. Sarbox famously has missed cases, like UnitedHealth, where directors had financial connections to other enterprises tied to the CEO. Similarly, board members often have ties to corporate officers through common charities, clubs, or membership on other boards.

Rodrigues argues that Delaware law is better able to deal with situations like these. It distinguishes between "interest," when an individual has a clear financial stake in a situation, versus "independence" when he may be beholden to the company, its officers, or other key participants.

Now not being a legal expert, the big question I have is if the Delaware notion of independence is more useful and germane, why was it ineffective in preventing the accounting scandals of 2002 that led to the passage of Sarbox? The number of companies was sufficiently large (29) that a fair number of them must have been incorporated in Delaware.

Perhaps the problem isn't what she argues, that independence (as defined by Sarbox and even under Delaware law) is overvalued, but that it can't be achieved under current corporate practice. The slate of directors is nominated by management. Presumably, directors want to continue as directors. It's prestigious and pretty well paid. That very fact makes them hopelessly beholden to management and therefore ineffective overseers.

NeoCons Celebrate Their Lack of Interest in Facts and Common Sense

Normally I try to limit my excursions into politics to items that have some relationship to finance, but I can't resist certain juicy stories. And this one comes from an economics blog, Brad DeLong's Semi-Daily Journal, so I suppose I have an excuse.

The specter of an entire room of grown men giving a standing ovation to the patent nonsense below is really astounding. Did someone spike the wine? Oh no, I forgot. This is the American Enterprise Institute listening to one of its own.

And the history citation below shows that it was the Crusaders, and not the Muslims, who created the bad blood between Christianity and Islam.

This is DeLong's post, "Bernard Lewis Makes His Bid for the Stupidest-Man-Alive Prize:"

Has Bernard Lewis always been this stupid, and did I just not notice?

Washington Wire - WSJ.com: Bernard Lewis drew a standing ovation from a packed house of conservative luminaries Wednesday night in a lecture that described Muslim migration to Europe as an Islamic attack on the West and defended the Crusades as “a late, limited and successful imitation of the jihad” that spread Islam across much of the globe. Lewis gave the nearly hour-long speech at the annual black-tie dinner of the American Enterprise Institute after receiving the group’s Irving Kristol Award. Among the attendees were Vice President Dick Cheney, Supreme Court Justice Clarence Thomas, former United Nations Ambassador John Bolton and ex-Pentagon official Richard Perle. Notably absent was I. Lewis “Scooter” Libby....

The 90-year-old Lewis, seen by some as the intellectual godfather behind the administration’s decision to invade Iraq, warned in his lecture that the West — particularly Europe — was losing its fervor and conviction in the face of an epochal challenge from the Islamic world. The Islamic world, he said, was now attacking the West using two tactics: terrorism and migration....

Lewis, author of “The Arabs in History” and “Islam and the West”, among many other books, also gave a ringing endorsement for the ill-fated Crusades, which spanned two centuries starting in 1095, when various European armies tried to regain the “Holy Land” for Christendom. –Neil King Jr.

The better judgment on the crusades was given by a much smarter and wiser man, the late Steven Runciman:

A History of the Crusades: Volume III: The Kingdom of Acre and the Later Crusades (Cambridge: Cambridge University Press: 0521347726): Seen in the perspective of history, the whole Crusading movement was a vast fiasco.... The Crusades had nothing to do with... access to the stored up learning of the Muslim world..... [I]t was Sicily rather than the lands of Outremer that provided a meeting place for Arab, Greek, and Western culture.... The Crusades were not the only cause for the decline of the Muslim world... [but] the intrusive Frankish state was a festering sore that the Muslims could never forget. As long as it distracted them, they could never wholly concentrate on other problems.

But the real harm done by the Crusades was subtler... the effect of the Holy War on the spirit of Islam. Any religion that is based on an exclusive Revelation is bound to show some contempt for the unbeliever. But Islam was not intolerant in its early days.... The Holy War begun by the Franks ruined these good relations. The savage intolerance shown by the Crusaders was answered by growing intolerance among the Muslims.... By the time of the Mamelukes, the Muslims were as narrow as the Franks.... The Muslims enclosed themselves behind the curtain of their faith; and an intolerant faith is incapable of progress.

The harm done by the Crusades to Islam was small in comparison with that done by them to Eastern Christendom...

Renewed Interest in Hedge Fund Regulation

There was a great flurry of activity last year when many hedge funds either sought to comply with new SEC registration requirements that applied to all but fairly small hedge funds, or reorganized themselves so as not to qualify (either by having long lock-ups, or by reorganizing themselves offshore). But it all came to naught when the SEC's authority was challenged successfully in court (the ruling hinged on the definition of who the client is. The SEC had sought to invoke its authority under the Investment Company Act of 1940, which excludes advisers that have fewer than 15 clients in the preceding 12 month period. The court agreed with the plaintiff's argument that the "client" is the fund the hedge fund manages, not the end investor. No hedge fund manages as many as 15 funds).

The SEC had said they would seek legislation to secure the needed supervisory powers, but with a Republican commissioner, and a hands-off posture at both Treasury and the Fed, this appeared to be more face-saving talk than a serious intention.

Support is coming from an unexpected quarter, as reported in CFO.com, "Sen. Grassley Seeks Hedge-Fund Rule:"

Breaking ranks with the Bush Administration and apparently with the Securities and Exchange Commission itself, Sen. Chuck Grassley has proposed legislation that would require most hedge funds to register with the SEC.

The amendment would narrow the exemption "that is currently used by large, private pooled investment vehicles to avoid registering with the Securities and Exchange Commission," stated Grassley, the ranking Republican member of the Senate Finance Committee.

Grassley's measure would amend the Investment Advisers Act of 1940, which exempts advisers from registering with the SEC if they have fewer than 15 clients in the preceding 12-month period and who don't present themselves to the public as investment advisers.

Since last June, when the D.C. Circuit Court of Appeals overturned an SEC rule requiring most hedge fund advisers to register with the commission by Feb. 1, 2006, hedge fund advisers have been able to define the word "client" as the hedge fund itself, rather than the investors who own shares in it. Thus, an adviser serving two hedge funds is exempt from registration—even if the funds have many more than 15 investors.

Under the SEC's rule, advisers had to count "shareholders, limited partners, members, or beneficiaries" as clients.

To date, 335 advisers have withdrawn in the wake of the Circuit Court decision, SEC spokesperson John Nester told CFO.com, while another 113 have withdrawn for assorted business. Seventy advisers have registered with the commission since the ruling. Nester said the SEC "declined immediate comment" on Grassley's proposed amendment.

In the June Circuit Court ruling, Goldstein v. SEC the judges decided that the rule was "arbitrary." While SEC Commissioner Christopher Cox said that the decision left a "gaping hole" in its ability to register and inspect hedge funds, the commission chose not to appeal the ruling.

Further, the SEC, as part of the President's Working Group on Capital Market chaired by U.S. Treasury Secretary Henry Paulson, has agreed not to pursue more regulatory power over hedge funds.

Filed on Wednesday by Grassley, the amendment would empower the SEC to require all investment advisers to register except for those who:

• Have $50 million or less in assets under management;

• Have fewer than 25 clients;

• Don't hold themselves out to the public as investment advisers;

•And manage the assets of fewer than 15 investors, regardless of whether the investors make use of the advisers' services directly or through a pooled investment vehicle like a hedge fund.

Grassley filed the measure as an amendment to S.4, the 9/11 homeland security bill now being debated by the full Senate. The senator said the amendment is relevant to the larger bill because reports have shown that there are terrorist links to hedge funds.

What is interesting is that there appears to be growing support for hedge fund regulation. It is increasingly being recognized that pension funds and other large institutions invest in hedge funds, and therefore the little guy, and not just sophisticated investors, are exposed. Consider the suprisingly populist tone of this commentary from MarketWatch, "History lesson." It overstates the problem of hedge fund fraud, but nevertheless highlights the need for more transparency:

There were a lot of dark days in 1929: Black Thursday, Black Friday, Black Monday and Black Tuesday, the last being the worst day for the stock market. But it wasn't until four years later that any securities law was passed to protect investors.

The Securities Act of 1933 was the first law enacted by Congress to regulate the securities markets. It required securities registration and disclosure. Prior to 1933, the thinking was that other civil laws governed behavior, such as fraud and manipulation, and no specific laws were needed to address the securities industry.
I know, you ponder that and scratch your head. But it seems we haven't learned a thing from history.

People are using that exact same rationale today to argue against hedge-fund regulations. Decades from now, people will be looking back on us, as we do on the Roaring '20s, scratching their heads and wondering why rules weren't in place to protect investors. The writing is on the wall, and it isn't in invisible ink: a major hedge-fund-related meltdown is coming.

A major insider-trading case involving three hedge funds and several Wall Street firms came to light last week. Other cases of hedge-fund fraud have popped up in Denver, Greenwich, Conn., and a slew of other places around the country.
And the ripple effect is global: there are an estimated 9,000 hedge funds with more than $1.4 trillion in assets. That's a pretty good number of funds -- the mutual fund industry has about the same number -- and a pretty significant amount of assets, about 20% of the total U.S. stock market value.

Yet, regulators are drumming their fingers on their desks: "What to do? What to do...?"

Registration is not enough
Sen. Charles Grassley, R-Iowa, announced an amendment this week that would require hedge-fund advisers to register with the Securities and Exchange Commission. Grassley said he's offering the legislation because a federal appeals court last year overturned an SEC rule requiring advisers to register with the agency.

"My amendment gives Congress a good opportunity to say there should be greater transparency with hedge funds," Grassley said. "Today the average Joe has a stake as pension funds are invested in hedge funds."

That's an understatement: Pension funds, banks and insurance companies are the backbone of the investment industry. These institutional investors have more assets invested in the capital markets than any one else. They also have more money invested in hedge funds than anyone else.

But registration of hedge funds isn't enough. There is a duty for public officials to protect and serve the public; they're not. Hedge funds managers are the most rogue group of people we've seen since the Robber Barons. Hedge funds can literally change the economic landscape of this country. And there is very little accountability for their actions....

Trust is a must
Trust must remain in the capital markets. When it's breached, as we saw last week when confidence weakened on the heels of a decline in the Chinese stock market, investors flee. Even one of the financial industry's own trade groups is concerned about investor trust being corrupted.

"Our organization is deeply troubled about the impact these ethics-related allegations have on investor trust," said Jeff Diermeier, president and chief executive of the CFA Institute in Charlottesville, Va., about the insider-trading case brought to light last week. The CFA Institute is the home of chartered financial analysts who make up a big portion of the investment management industry.

To be sure, not all hedge funds are risk-oriented. Some have very staid investment management techniques. But, like they say, it only takes a few bad apples...
"We approach this with the knowledge that proper training and attention to ethics at an individual level, with continuous reinforcement, is part of the answer," Diermeier said about solving the problem of investment schemes.

Unfortunately, a more heavy-handed approach is needed: the hedge fund industry needs to get slapped into shape. Regulators need to examine and understand exactly what hedge funds are -- and provide oversight accordingly. Letting them remain in the shadows of Wall Street only threatens us investors with dark days ahead.

Housing Recovery? What Housing Recovery?

One long-standing skeptic about the housing market is Nouriel Roubini of RGE Monitor. You have to sign up for premium content to get his full story (he does give you an initial free peek), but you can get the drift of the gist from his synopsis, "The housing market is still far from bottoming out:"

Last summer I predicted that the current housing recession would end up being one of the worst in decades (see here and here and here). I elaborated these views in a wide series of long blogs and clearly pointed out already last summer that sub-prime mortgages would be a serious weak link in mortgages but that all of the mortgage market would eventually come under stress. At that time the consensus was talking about a housing “slowdown”. When it became obvious that the housing was not in a slowdown but in a severe recession the consensus spin moved to the view – that even Greenspan supported last fall – that the housing recession was “bottoming out”. The evidence for such “bottoming out” was between thin and non-existent, especially as both starts, completions and new home sales kept on falling; the only things that were rising in the comatose housing market were cancellations and an unprecedented glut of unsold new and existing homes.

To counter the prevailing view that housing is bottoming out my colleague Christian Menegatti and I just wrote and published a new long detailed analysis of the housing market titled “The US Housing Recession is Still Far from Bottoming Out”....We come to the conclusion that the current housing recession will indeed be one of the worst ones in decades and that, even in the most optimistic scenario of a soft landing for the US economy, the housing market is still very far from bottoming out. Of course, if a recession were to occur this year, the housing recession would be even more bleak than our already very negative benchmark scenario.

To be balanced rather than panicky or alarmist we decided to title the paper as “The US Housing Recession is Still Far from Bottoming Out”. But yesterday when our paper was published Mr. Tomnitz.- the CEO of DR Horton (the second largest home builder in the US) - loudly declared that housing will “SUCK” for all of the 12 months of 2007. He prefaced that remark by saying – almost comically – that he “did not want to be too sophisticated” but that housing sucks and will suck all of 2007 (“I don’t want to be too sophisticated here, but 2007 is going to suck, all 12 months of the calendar year”)....

Now even Greenspan – who last fall repeated the deluded consensus that housing was bottoming out – is speaking about a possible recession this year. Coming from a man whose Delphic words were usually so cryptic that you did not know whether he was talking about the economy or the weather, the fact that the Maestro repeated the dirty R-word three times in the last week should be a signal that he is now real worried about a recession....

Yale economics professor, author of "Irrational Exuberance," takes a more measured tone than Roubini but is similarly downbeat about housing. From BusinesWeek, "The Bubble Guru's Take On Housing:"

Looking at our national home-price index [the Standard & Poor's/Case-Shiller Home Price Indices], it appears that the boom is over. [Prices] had been rising at an accelerating rate from the late 1990s through 2004. Since then the rate of increase has been decelerating.

We're going through a peak. There hasn't yet been a big price decline, like 20%. For instance, out of the 20 major cities in the country the biggest drops are in Detroit and Boston, which are down 5.9% and 5.1%, respectively. I think there's a good chance home prices will be down 10% to 30% over the next five years.

Similarly, the weakness in housing has become so widespread that it is affecting employment in related industries. From MSNBC, "Weak housing market weighs on job growth:"

Since the middle of last year, a downturn in the U.S. housing market has taken its toll on a wide group of people and companies, clobbering homebuilders, condo flippers, borrowers with weak credit, lenders who oversold loans, and just about anyone with a home for sale.

Now the housing slump is hitting yet another target: housing-related jobs, a list that includes everyone from the people who build and sell houses to makers of appliances and furnishings.

That's a sharp contrast to the height of the housing boom in 2005-06, when the industry was responsible for creating some 25,000 to 50,000 new jobs every month, according to Mark Zandi, chief economist at Moodys.com.

“In the recent months it’s been laying off workers at a pace of 25,000 to 50,000 per month,” he said. “And I think the next couple of quarters we’ll start seeing job losses of between 50,000 and 75,000 per month. ... I think the housing market is going down a whole other notch.”

Update as of 1:30 a.m.: Felix Salmon's blog makes, in his post "How convincing is Roubini's argument that the housing recession will only get worse?" a critical reading of Roubini's paper. It does sound as if Roubini's efforts to make his assessment, which seems to be largely anecdotal and impressionistic, into something more rigorous, doesn't work. But Salmon himself says Roubini could still well be right, his simple point is his charts don't prove his case.

The most persuasive point, and inherently the data isn't available to support it, is that there appears to be a considerable overhang in the housing market. So even if prices stabilize, the backlog coming on to the market makes the prospect of recovery any time soon less likely.

Palast: New US Attorney an Unindicted Felon?

For those who may not know about him, Greg Palast is an award-winning journalist who does major investigative pieces for the BBC. He's also an unapologetic Old Leftist, and has a strident writing style, but he delivers the goods.

One of his areas of focus is voter fraud in the US. He broke the story in the UK about the disenfranchisement of blacks in the 2000 Presidential elections in Florida. Felons are not permitted to vote in Florida, and the voter rolls were scrubbed of black-sounding names (think twice when you name your girl Latisha) that bore any resemblance to a felon's name. 90,000 blacks were removed from the voting lists. Take 90,000 voters x 30% turnout x 90% propensity of blacks to vote Democrat, and you get over 24,000 more votes for Gore, far more than the 3000 or so disputed ballots that seemed to determine the outcome.

The story ran overseas in December, when the election was still in dispute. But no US media organization ran it until Michael Moore put it in the introduction to his book, "Stupid White Men," in 2002. Only then did the Washington Post consider it to be newsworthy.

It remains to be seen whether Palast's latest piece will get traction here. Timothy Griffin, appointed as US Attorney for the Eastern District of Arkansas, is allegedly the mastermind of a Republican National Committee program to challenge 70.000 voters in minority districts (below you can read about the document trail). Challenging voters on a large-scale basis using race as the criterion is a felony. Griffin said he was not willing to go through a Congressional confirmation process, but somehow was able to bypass that thanks to the Patriot Act.

Here is Palast's report, "Bush’s New US Attorney a Criminal?:"

There was one big hoohah in Washington yesterday as House Judiciary Chairman John Conyers pulled down the pants on George Bush’s firing of US Attorneys to expose a scheme to punish prosecutors who wouldn’t bend to political pressure.

But the Committee missed a big one: Timothy Griffin, Karl Rove’s assistant, the President’s pick as US Attorney for the Eastern District of Arkansas. Griffin, according to BBC Television, was the hidden hand behind a scheme to wipe out the voting rights of 70,000 citizens prior to the 2004 election.

Key voters on Griffin’s hit list: Black soldiers and homeless men and women. Nice guy, eh? Naughty or nice, however, is not the issue. Targeting voters where race is a factor is a felony crime under the Voting Rights Act of 1965.

In October 2004, our investigations team at BBC Newsnight received a series of astonishing emails from Mr. Griffin, then Research Director for the Republican National Committee. He didn’t mean to send them to us. They were highly confidential memos meant only for RNC honchos.

However, Griffin made a wee mistake. Instead of sending the emails — potential evidence of a crime — to email addresses ending with the domain name “@GeorgeWBush.com” he sent them to “@GeorgeWBush.ORG.” A website run by prankster John Wooden who owns “GeorgeWBush.org.” When Wooden got the treasure trove of Rove-ian ravings, he sent them to us.

And we dug in, decoding, and mapping the voters on what Griffin called, “Caging” lists, spreadsheets with 70,000 names of voters marked for challenge. Overwhelmingly, these were Black and Hispanic voters from Democratic precincts.

The Griffin scheme was sickly brilliant. We learned that the RNC sent first-class letters to new voters in minority precincts marked, “Do not forward.” Several sheets contained nothing but soldiers, other sheets, homeless shelters. Targets included the Jacksonville Naval Air Station in Florida and that city’s State Street Rescue Mission. Another target, Edward Waters College, a school for African-Americans.

If these voters were not currently at their home voting address, they were tagged as “suspect” and their registration wiped out or their ballot challenged and not counted. Of course, these ‘cages’ captured thousands of students, the homeless and those in the military though they are legitimate voters.

We telephoned those on the hit list, including one Randall Prausa. His wife admitted he wasn’t living at his voting address: Randall was a soldier shipped overseas.

Randall and other soldiers like him who sent in absentee ballots, when challenged, would lose their vote. And they wouldn’t even know it.

And by the way, it’s not illegal for soldiers to vote from overseas — even if they’re Black.

But it is illegal to challenge voters en masse where race is an element in the targeting. So several lawyers told us, including Ralph Neas, famed civil rights attorney with People for the American Way.

Griffin himself ducked our cameras, but his RNC team tried to sell us the notion that the caging sheets were, in fact, not illegal voter hit lists, but a roster of donors to the Bush-Cheney reelection campaign. Republican donors at homeless shelters?

Over the past weeks, Griffin has said he would step down if he had to face Congressional confirmation. However, the President appointed Griffin to the law enforcement post using an odd little provision of the USA Patriot Act that could allow Griffin to skip Congressional questioning altogether.

Therefore, I have a suggestion for Judiciary members. Voting law expert Neas will be testifying today before Conyers’ Committee on the topic of illegal voter “disenfranchisement” — the fancy word for stealing elections by denying voters’ civil rights.

Maybe Conyers should hold a line-up of suspected vote thieves and let Neas identify the perpetrators. That should be easy in the case of the Caging List Criminal. He’d only have to look for the guy wearing a new shiny lawman’s badge.

Environmental Advocates Hire Investment Banker in Energy Deal

In a very interesting turn of events, Environmental Defense, the group that negotiated for some environmental concessions to win its support for the leveraged buyout of TXU, the Texas utility, by Texas Pacific Group and KKR, has engaged boutique investment banking firm Perella Weinberg.

The New York Times, in the story, "Environmental Group Behind the TXU Deal Hires a Banker," summarizes the state of play:

One of the nation’s largest and most influential environmental groups, Environmental Defense, has hired Perella Weinberg Partners, the boutique investment bank, to advise it as the group takes on an unusual role in the middle of the $38 billion buyout of TXU, the Texas energy giant.

Two weeks ago, Environmental Defense helped negotiate environmental terms of the buyout deal that the Texas Pacific Group and Kohlberg Kravis Roberts & Company struck with TXU, including concessions to reduce coal-fired plants and carbon emissions limits.

With the addition of Perella Weinberg, Environmental Defense appears to be signaling that it wants an even more powerful seat at the bargaining table with TXU and its suitors....Over the next several weeks, TXU will be seeking higher bids for the company from rival suitors as part of a provision in its deal with Texas Pacific and Kohlberg Kravis that allows it to test the market for better offers.

While Environmental Defense negotiated and blessed that deal, it could switch allegiances to support another set of suitors should one present an even more environmentally friendly plan.

We were skeptical of how genuine Texas Pacific's and KKR's intentions really are (see "Green Spin in TXU Buyout Bid"). Cancelling the eight power plants was a pragmatic economic decision; the green spin was gravy. But having not only a seat, but savvy representation at the table, will help keep the successful buyers (whoever they are) honest.

And the arrangement is a plus for the bankers. Perella Weinberg has a roster of star talent, but to date has few deals closed, so taking a high profile assignment (admittedly for less-than-usual fees) is a smart PR move. Perhaps more importantly, it may represent a new effort by M&A bankers to regain their status as trusted counsel. The widespread use of the auction process initially was a boon to bankers, since the industry had an accepted playbook that brought buyers to a deal on a set schedule, and was effective at garnering top prices. Unfortunately, it also made the mechanics of how to do a deal transparent to corporate buyers, and over time devalued the role of the banker, and also led companies to handle routine transactions on their own.

The deal is likely to be tested on other fronts. As we noted, and the New York Times discusses in a separate story, "With Coal Plans Cut Back, Texas Faces Energy Gap," that what is making this deal environmentally friendly is the cancellation of plans to construct 8 coal fired plants. Unfortunately, Texas needs the energy:

Texas faces a big hole in its electricity production, since the country’s second-most-populous state also happens to be one of the fastest growing because of immigration and the rise in riches from the recent increase in oil and gas prices.

That hole just got bigger as the TXU Corporation, the state’s biggest utility, scrapped plans for eight new coal-fired plants under a deal it has agreed to with potential new owners. The deal has delighted many environmentalists, but it has also stoked one Texas-sized problem.

Unless new generation is built quickly from some source, Texas energy production in 2009 will fall below reserves recommended by the state operator of the power transmission grid for guaranteeing smooth operations during peak periods of high heat.

Sources believe that Texas won't be able to obtain enough energy to fill the gap from renewable sources soon enough. The most likely near-term candidates are gas and nuclear power.

The Carry Trade and Global Imbalances

A fine post on Seeking Alpha, "What Good is the Carry Trade?" by Tim Iacono, takes a stab at the impact of the alleged unwinding of the carry trade (we have though it played a fairly big role in the upheaval of the last week plus, but no one can tell for certain) and the role of cheap credit.

Many have defended what economists describe as "global imbalances," the massive flows of capital from China, Japan, and other high-savings nations into the US and other countries with chronic trade deficits (any country's fund flows have to be offsetting, so a country with a trade deficit must run a capital account surplus, that is, must import capital, i.e., sell domestic assets to foreigners to pay the trade deficit).

The other way to characterize this pattern is to see the trade deficit as the result of America's chronically low savings rate. America must import capital to fund needed investment and government deficits because domestic savings aren't large enough to fund them. That leads to capital imports, which produces a trade deficit.

Martin Feldstein, Harvard economics professor and president of the National Bureau of Economic Research, describes the situation in a Foreign Affairs article, "The Return of Savings":

The savings rate of American households has been declining for more than a decade and recently turned negative. This decrease has dramatically reduced total national savings despite a rise in corporate saving. In 2003 and 2004, the combined net savings of households, businesses, and government were only about one percent of gross national income -- the lowest level in at least 50 years.

This sharp decline in saving has had important implications for the United States and for the global economy. It has reduced productivity-enhancing net business investment in the United States to less than four percent of GDP and made the United States increasingly dependent on capital from the rest of the world to finance that investment. At the same time, the decreased national savings rate -- and the increase in consumer spending that it implies -- has induced a rise in U.S. imports. Those imports have contributed to the growth of output and employment in many countries around the world.

The downward trend in U.S. household saving will likely soon be reversed. In the long term, a substantial rise in household saving will have a positive effect on the U.S. economy. But the initial effects will pose problems for the United States and its trading partners. If these effects are not managed well, the result could be declines in output and employment and a corresponding rise in U.S. protectionism.

Feldstein is, in essence, saying that he doesn't regard the current situation as sustainable. But it has persisted so long that many have become complacent about it, a complacency that parallels the widespread complacency about risk that evaporated last week.

Iacono make a more immediate point: that despite attempts to defend it, the carry trade creates financial instability and fails to channel capital to good uses. Remember, in Japan's bubble years, the country's excess liquidity went to overpaying for foreign assets and to dubious domestic projects, like theme parks in the boonies. In this iteration. other people are doing the buying on behalf of the Japanese, but their choices don't look all that much better.

From Iacono:

Much of the blame for last week's shellacking of financial markets around the world has been attributed to the "unwinding" of the Yen "carry trade". That is, when hedge funds and other financial institutions closed out investment positions funded by money borrowed at low rates of interest from Japan....

Spurred by a recession warning from Alan Greenspan and the plunge in the Shanghai Composite index last Tuesday, carry trade profits were promptly taken, resulting in the sale of stocks, commodities, currencies, probably a few paintings, and who knows what else.

The after-hours plunge of over $20 in the price of gold on the New York Access market last Tuesday is being attributed, at least in part, to the sale of more than six tonnes of gold bullion by the streetTRACKS Gold ETF (GLD), a trading vehicle that has apparently become quite popular with hedge funds and other speculators.


The price of the metal had fallen only a dollar or two when the COMEX closed at 1:30 PM, but as of 4:15 PM, the gold ETF had lightened its load by a couple hundred thousand ounces. Clearly, there were few buyers for the supply being liquidated.

Similarly, high-yielding currencies in countries such as New Zealand and South Africa plunged as foreign currency positions, funded by the carry trade, were liquidated.

For the rest of the week, the rout was on for equity markets around the world, margin calls were made, and forced selling ensued.

The highly leveraged bets of hedge funds using cheap money denominated in the lowest yielding currencies once again wreaked havoc with financial markets.

When Rates Were Low in the U.S.
Not more than a few years ago, in the aftermath of the bursting of the U.S. stock market bubble when the short-term interest rate was only one percent, the U.S. Dollar was the preferred funding source for the carry trade.

There was great trepidation in mid-2004 when former Fed Chairman Alan Greenspan, a staunch backer of hedge funds over the years, began his "baby step" interest rate normalization campaign that eventually saw short-term rates climb 425 basis points.


Though many expected some sort of disaster, there were few problems. However, interest rates rising at a snail's pace over a two year period emboldened borrowers around the world and at the top of the list of confident punters were buyers of real estate in the U.S.

Many of these loans are now going bad.

If not for the carry trade would interest rates in the U.S. have been raised at a faster pace avoiding some of the most egregious practices of the last two years in the U.S. housing market?

No one will ever know, but all of this prompts the question, "What Good is the Carry Trade?"

In comments on Tuesday in Greenwich, Connecticut, Assistant Treasury Secretary Anthony Ryan noted that, "few groups are more adept at identifying opportunities and moving capital around the world than those managing hedge funds."

But do they have to do it with money borrowed from countries with weak economies?

This distorts the entire exchange rate picture and only benefits hedge fund managers and their investors. There is no discernible improvement in the "allocation of capital" - it's just "asset shuffling".

More Bubbles
It seems that all the carry trade really accomplishes is a further "bubbleization" of the world economy. Some hedge funds will reap huge profits and others will fail disastrously. Some rich investors will get a little richer and some will lose out. Some pension funds will have huge surpluses and some will have to resort to plan "B" to fund retirements.

Meanwhile, emerging economies struggle to survive the torrent of carry trade money and markets become more volatile.

There is an enduring idea that if the "the market" sets the price of currencies, equities, commodities, and other assets, then this is somehow better. The market knows best. But if "the market" is dominated by hedge funds with easy access to cheap money, this can be more destabilizing than beneficial...

Speculators have always played an important role in financial markets, but why must they be provided with such easy access to cheap money?

Senators Criticize Credit Card Companies

Although I must confess to not being a close observer of the Washington scene, even at my remove, it's crystal clear that the Democrats haven't been willing to take on Bush frontally. Polls show widespread opposition towards Bush's Iraq policies, and all the Dems are willing to put forward is a wimpy two sentence non-binding resolution expressing disapproval of the surge. They made no effort to cut off the war's air supply by restricting funding. Admittedly, the Democrats don't have the numbers to beat a veto, but their tactics reveal a lack of resolve, of toughmindedness. A no-holds-barred fight over the budget would weaken Bush and embolden his critics.

Instead, Democrats (and Republicans who are sensitive to the change in popular sentiment) are going after safer targets. And bank credit card pricing is about as safe as you can get. A MarketWatch story, "Senators criticize credit-card fees," reports on hearings before the "Permanent Subcommittee on Investigations of the Homeland Security and Governmental Affairs Committee."

Now what is interesting is this group is not a subcommittee of the Senate Banking Committee (see here for a list of subcommittees). Furthermore, its chairman, Carl Levin, is not a member of the Banking Committee.

One can specualte as to what this means in terms of Senatorial politics (is this group trying to end run Banking? Steal its thunder? Pressure it into taking more aggressive action than it is now contemplating? Or is this actually supportive?) Irrespective of the internal and jurisdicitonal dynamics, this says the heat is on the credit card industry, and isn't abating any time soon.

Now in fairness, this process has a long way to go. We are merely at the finger-waving and name calling stage. No legislation is pending. If the industry has any sense, it will rein its pricing in. However, I don't see the industry doing much more than window dressing and ending the most egregious practices. If you've gotten used to 30+% interest rates, it's really hard to go back to the mere low 20s.

From MarketWatch:

Both regulation and legislation are needed to stop abusive credit-card practices, the chairman of a powerful Senate subcommittee said Wednesday, adding that credit-card companies have to be reined in. Senators criticized excessive fees and penalty interest rates, and spoke about the need for improved disclosure at a hearing of the Permanent Subcommittee on Investigations of the Homeland Security and Governmental Affairs Committee.

"Even if someone had questions about the amount of interest on a bill, most consumers would be hard pressed to understand how the amount was calculated, much less whether it was correct," said U.S. Sen. Carl Levin, D-Mich. "But by nickel-and-diming tens of millions of consumer accounts, credit-card issuers reap large profits."

Levin, subcommittee chairman, said the Government Accountability Office has found that disclosures from the largest card issuers were "often written well above" the eighth-grade level at which about half of American adults read. Further, the report indicated that popular credit cards have interest rates of more than 30% for holders who pay late or exceed a credit limit....

Increased credit-card use has contributed to more household debt, according to the GAO. The credit-card debt owed by an average U.S. household more than doubled to $2,200 in 2004 from about $1,000 in 1992, according to the Board of Governors of the Federal Reserve System.

The funny bit is how totally flatfooted the bankers' responses are:

"Our approach to the market is shaped by competition," said Bruce Hammonds, president of card services for Bank of America Corp. Hammonds said customers want flexibility, and that fee disclosure is not as straightforward as producing the nutritional information for a can of soup.

"Shaped by competition." That's an interesting justification. That appears to translate into, "We look to our competitors to see how much we can get away with." And the can of soup idea was a dangerous gauntlet to throw down. If the SEC can require clearer financial filings and more transparent fee disclosure for securities, which are more complicated (or ought to be) than credit cards, the industry can do much better.

Richard Srednicki, chief executive of Chase Card Services, added that risk-based pricing, which can result in higher payments from consumers, is "integral" to the credit-card industry. "We need risk-based pricing to manage our business," he said.

In other words, we reserve the right to lend to people who really shouldn't be borrowers, provided we can charge enough.

These lame responses says the industry isn't taking this salvo terribly seriously, otherwise they would have hired a PR firm to script better answers. And they may be right, it isn't serious.....yet.

But if we see an economic downturn, and the newspapers feature more stories of middle class people who fall into a debt trap due to unfortunate circumstances, the pressure on credit card issuers will intensify, and Congress may decide to do more than merely point fingers.

Links Between China's Military and Economic Strategy

Robert Reich has an interesting post today, "Why China Announces Military Buildup the Same Week Paulson Visits," about how China is pursuing inter-related economic and military strategies in its drive to become a superpower.

Although much of what Reich says is cogent, I disagree with one point, namely, that "America's indebtedness to China gives the U.S. huge leverage over China -- if we allowed the dollar to fall, China would lose a bundle."

That is just plain wrongheaded. If the dollar were to fall sharply, it's true that "China" would take large losses. But who exactly would feel the pain? My impression (and forgive me for not being clearer about the facts) is that the Chinese banks are making foreign bond purchases. Chinese banks aren't like banks here. They have been propping up dodgy former state-owned companies (although apparently their balance sheets are somewhat improved by virtue of the very worst businesses being closed). Admittedly, the banks have been implementing modern banking techniques, like credit scoring, but lack of transparency makes us question whether things have improved as much as the officialdom would like us to believe.

In 2006, Ernst & Young released a study, which according to the Economist, in a story titled, "A muffled report," estimated the total amount of non-performing loans at $911 billion, over 5 times as large as government estimates. This led to a firestorm of criticism and E&Y had to retract the report. Yet the Economist stressed that the analysis captured recent loans that were omitted from other reports, and by implication, was probably more accurate.

So what would it mean to these banks, say if the dollar fell by 30%? Not as much as you would think. They aren't on mark to market accounting. Their income from their US bonds would fall 30%. That's not a small number, but these are banks that make loans to domestic companies that can turn out to be complete writeoffs (or worse, they get no income and have no hope of repayment, but have to keep extending credit, although we are told those practices are a thing of the past).

Now presumably, in the end, depositors would be affected and their income on savings would go down somewhat (remember, their domestic loan book is much larger than their US bond purchases). So what? This is a country that has non-existent pollution control, to the point where tens of millions of people live on rivers loaded with carcinogens. Prisoners sentenced to death are rumored (and there is supporting evidence) to have their organs harvested while they are still alive. Beijing recently imposed a rule where citizens could only own one small dog, so non-conforming pets are seized in house raids and killed. And not humanely, either. Believe me, the citizenry endures a lot worse on a routine basis that mere financial losses.

No. our influence over China is that we have a lot more nukes than we do, and the only sizable navy. Only the US can move troops in large numbers. We dream if we think our economic standing carries much weight with China. The might even regard us as foolhardy to have let so much of our manufacturing go overseas (after all, it was in the end the superior production capacity of the US that enabled the Allies to win World War II). And foolishly, we are outsourcing more of our chip manufacturing to China (Taiwan is the biggest single foreign fabricator, which may explain China's keen interest in reasserting control). Trade in advanced technology products is heavily weighed in favor of China.

But those not-very-competent Chinese banks may be our salvation. As the Economist story noted, "[T]here is little sign that the banks themselves have fundamentally changed their behaviour and become rational lenders." Japanese banks' inability to make sensible loans (they too saw themselves as an arm of industry, and were capable only of asset-based, not cash-flow, lending) led first to a bubble, then a collapse, then years of little growth because it was politically and culturally unacceptable to liquidate weak enterprises (the increase in unemployment was feared to be too destabilizing).

From Reich:

China announced this week that it’s planning to increase military spending 18 percent this year this year – its largest military boost in almost a decade – to $45 billion, making it one of the largest defense spenders in the world. That’s not much when compared to America’s military budget of more than $600 billion this year, but it’s large enough – and following so closely on the heels of China’s successful test of an anti-satellite missile – as to spook the Pentagon. What’s going on?

One clue is that China’s announcement of its military buildup comes the same week Treasury Secretary Hank Paulson is scheduled to visit, presumably to continue pressing China to raise the value of its currency in light of the huge and growing trade imbalance with America.

You see, for China, economic security and military security go hand in hand. Both are part of the same strategy to make China a superpower. Maintaining its current 10 percent yearly growth rate necessitates reliable supplies of oil, natural gas, and other raw materials from all over the world; as well as the latest technologies. And China also needs growing export markets to absorb its increasing production, and provide jobs to the tens of millions of its people migrating from the countryside.

All this, in China’s view, necessitates being able to play power politics with both Middle-East and Russian oil producers, when and if tensions arise over energy supplies. And China needs to be able to flex its muscle with Japan, Europe, and America in the competition for energy and other critical raw materials – as well as continue to have access to technologies these nations possess. And it needs to keep its access to these hugely important markets.

Power politics in today’s world doesn’t require the direct exercise of military power so much as the capacity to pressure other major powers indirectly – for example, credibly threatening to use force against Taiwan, or selling advanced weapons systems to oil-rich or raw-materials-rich developing nations, or, in the case of North Korea, becoming the source of food and weapons.

Sound familiar? China is not inventing this strategy of combining economic power with military power. It’s following in the footsteps of the nation that wrote the play book on how it’s done – the United States.

That’s why China’s military announcement was timed to coincide with Hank Paulson’s visit. Some in the U.S. think China has been able to buck American pressure to revalue China's currency because China is becoming our major creditor. Not true. America's indebtedness to China gives the U.S. huge leverage over China -- if we allowed the dollar to fall, China would lose a bundle. No, the real reason China has been able to hold the line against American pressure is China's growing influence around the world. Its military strategy is a part of this, and it's why Paulson’s economic mission will get nowhere.

Microsoft Vs. Google Spat on Copyright

It's generally good fun to see large companies have a go at each other in the press, but the latest one is not (yet) as gratifying as one might hope, mainly because neither player has landed a blow.

In yesterday's Financial Times (oddly the salvo was not picked up in the US until today, relatively briefly in the Wall Street Journal), a first page story, "Microsoft attacks Google on copyright," commented on Microsoft's fierce criticism of Google's cavalier attitude towards intellectual property:
Microsoft on Tuesday launches a fierce attack on Google over its “cavalier” approach to copyright, accusing the internet company of exploiting books, music, films and television programmes without permission.

Tom Rubin, associate general counsel for Microsoft, will say in a speech in New York that while authors and publishers find it hard to cover costs, “companies that create no content of their own, and make money solely on the back of other people’s content, are raking in billions through advertising and initial public offerings”.

Mr Rubin’s remarks, presaged in an article in Tuesday’s Financial Times, come as Google faces criticism and legal pressure from media companies over services allowing users to search online for books, films, television programmes and news. Viacom, the US media group, instructed YouTube, which Google owns, to remove 100,000 clips of copyright material.

The Authors Guild and a group of publishers backed by the Association of American Publishers have separately sued Google for making digital copies of copyrighted books from libraries without permission.

Mr Rubin will tell the AAP’s annual meeting that Google’s decision to take digital copies of all books in various library collections, unless publishers tell it not to, “systematically violates copyright, deprives authors and publishers of an important avenue for monetising their works and, in doing so, undermines incentives to create”.

Now it is truly odd for Microsoft to be mounting this attack. There aren't any pending negotiations or lawsuits between the two companies that would make this a bone of contention. This is thus a PR effort.

But again, it is difficult to understand what Microsoft expects to accomplish from this initiative. Curry favor with makers of print and media content? Perhaps, but what will count to them is not speechifying, but the terms of any deals offered to them. Talk is cheap. And Microsoft's record on patents isn't great. For example, Microsoft was ordered in 2003 to pay a fine of $521 million to Eolias Technologies for unauthorized use of intellectual property. And Microsoft has just been ordered to pay $1.52 billion to Acatel-Lucent to infringement of patents related to MP3 compression.

Am I missing something here? Patents are intellectual property, just like copyrights. And because Microsoft is a fierce opponent in the courtroom, the scuttlebutt in tech circles is that there are many developers who have suffered from IP infringement at Microsoft's hands, but lacked the resources and intestinal fortitude to take them on.

Eric Schmidt, Google's CEO, took an interesting tactic by not dignifying Microsoft's criticism with a direct reply. He took the line that his critics (e.g., Microsoft) were shills for big media companies (undercutting Microsoft's aligning itself with the creative little guys). From the FT, "Google chief dismisses criticism from rivals,"

Eric Schmidt, chief executive of Google, yesterday shrugged off criticism being heaped on the internet company by rivals and some media companies over its approach to copyrighted content, dismissing it in barbed comments as a form of negotiation.

"The kinds of comments you're referring to [criticising Google] are in the context of a business negotiation," Mr Schmidt told investors at a Bear Stearns conference.

"I have learned that, as part of being a player in the media industry, the way one negotiates is everything is leaked and you're sued to death. So the lawsuits . . . appear to be in the course of doing normal business," he said, adding this might reflect the preponderance of lawyers in the media industry.

"It is not normal in the technology industry, I can assure you," he added.

Mr Schmidt's comments follow a fierce attack on Google by its rival Microsoft over its "cavalier" approach to copyright. Tom Rubin, associate general counsel for Microsoft, earlier accused Google of exploiting books, music, films and television programmes without permission.

A number of book publishers have sued Google for making digital copies of copyrighted books from libraries without permission. In addition, a number of media companies have stepped up pressure on Google to remove their video content from the popular video sharing site YouTube as negotiations to license the content and share advertising revenues have stalled.

Among the companies facing difficult negotiations with Google are Viacom, CBS and NBC Universal. The discussion started last year after Google paid $1.6bn to acquire YouTube, the most popular online video sharing site.

Google has unquestionable been aggressive about getting content on its servers. It's a bit of a force majeur approach: let's take a position first, and talk price later. That does give them quite a bit of leverage in any negotiation (if you can even call it that).

But Schmidt takes an interesting second strategm in positioning the criticism not as having a foundation, but as being media company negotiating tactics. The funny thing is while that may not play in the world at large, it actually has an element of truth.

Having worked on Wall Street, and having clients in a variety of industries, my experience is that, with perhaps the exception of top litigators, media industry types are hands down the most tenacious and skilled negotiators. And those skills are held broadly in the industry, not by a few individuals. It's part of the air they breathe.

Professionals from other industries who think they are good negotiators are routinely bested by media types. Look how Microsoft was hosed by cable companies. It made a $1 billion investment in Comcast and a $5 billion investment in AT&T mainly to get them to use Microsoft software in their cable set-top boxes. That's an awfully steep price to get a seat at the table, and it does not appear to have given Microsoft an iota of commercial benefit.

That's a long-winded way of saying that tech companies haven't fared too well in media-land, and Google paying $1.6 billion for YouTube and having its value severely diminished by having Viacom and other media companies insist Google remove copyrighted content says Google may be learning the hard way.

So the irony is that the big content owners may still do well against Google. Ironically, it's the little guys that Microsoft is standing up for (but will not stand with) that are likely to get the short end of the stick.

But back to the spat. The FT felt it important enough to weigh in with an editorial, "The rights and wrong of Google content":

Google now faces a backlash from publishers that make the professional “content” – from films to television programmes and books – on which it relies. They argue that Google is playing fast and loose with the intellectual property of others in order to attract users to its services. Viacom, the US media company, has told Google to remove 100,000 clips from its YouTube service which have been uploaded by users without Viacom’s permission.

Into this battle has stepped Microsoft, which is trying to catch up with Google’s strength in internet search....It must be fun for Microsoft, accustomed to defending its own dominance of personal computer software, to have a David-like dig at the internet’s Goliath. But what it says must be taken with a pinch of salt. Not only is it profiting from search-related advertising itself, but it is not clear that it has better technology for copyright enforcement than Google. It wants to be seen as the publishers’ friend but its commitment has yet to be fully tested.

But Microsoft is chiselling at Google’s weak spot. Too often, the latter has demonstrated insensitivity verging on technological arrogance towards owners of content. That is exemplified by its initiative to scan millions of books, both in and out of copyright, from libraries into its Book Search service. It displays snippets of copyrighted works to those who use the service unless the publishers of the works get in touch to ask it to desist.

Google is being sued by a group of publishers, including subsidiaries of Pearson, the owner of the FT, over Book Search. It claims that it is acting within legal provisions governing the fair use of copyrighted content. The issue will be decided by the US courts, but Google is making enemies by insisting it will scan copyrighted material unless publishers “opt out” of having their works treated in this way.

Blather about it being in the public interest for the world’s information to be made searchable is beside the point. The principle goes deeper than copyright law. Companies, especially powerful ones, cannot get away with riding roughshod over the wishes of smaller enterprises just because it suits them. Microsoft has discovered that painfully over the years. Now it is Google’s turn.

Surprisingly Strong Words from Martin Wolf

As you may well know, Martin Wolf is the Financial Times' award winning economics editor and their lead economics commentator. He is thoughtful, measured, articulate, and takes far greater pains than many of his peers not to overstate his data.

So it was stunning to see at the top of the home page of the FT's website, a link to Wolf's Wednesday piece, "How long will the markets be able to defy gravity?" The actual title to the article was only marginally less grim, "Equities look overvalued, but where is the turning point?"

It's not that I disagree with Wolf. Quite the contrary. I have argued that the whistling-in-the-dark confidence of a lot of American financial commentators is overdone. Worrisome events are still playing themselves out – the Bank of Japan intervening to keep the carry trade from unwinding further, the subprime debacle, interest rates on the bonds of investment banks spiking upwards due to losses on their CDO holdings. Moreover, the fundamental outlook for the US economy is poor. The current high level of corporate earnings appears unsustainable, and despite brave talk, the housing market looks to be getting worse rather than better. But I have toned down my views because (let's face it) the regulators and the market participants are trying to talk the market back up. Everyone wants this genie back in the bottle. It is possible they will succeed, not this month, but over the course of the next two or three months.

Wolf, by contrast, does something more intelligent, more difficult, and in the end more valuable than trying to foresee, even in a general way, the trajectory of the markets. He instead takes a long view of valuation and global economic conditions, and argues, persuasively, that equities are still considerably overvalued. But he is not about to call a turn (he views last week as a mere blip) but discusses some of the factors, most notably the weak conditions in the US housing market, that might precipitate a change.

Is the market turbulence of the last week telling us something or is it no more than “a tale told by an idiot, full of sound and fury, signifying nothing”? Some analysts are prepared not only to explain day-to-day movements in markets, but to predict them. I am neither clever enough for the former, nor rash enough for the latter. I am prepared, however, to make four statements: first, a period of market volatility is welcome; second, core equity markets do look overvalued; third, that this does not appear to be the case is due to the extraordinary condition of the world economy; finally, the big question is how long those conditions will endure.

Any long period of market stability encourages speculation. Taken to excess, such risk-taking, particularly when fuelled by huge amounts of borrowing, can create significant instability. At a time when asset markets are generally buoyant and risk premiums low, the need for a reminder of riskiness is valuable. It is far better, as natives of San Francisco must know, to suffer a series of mini-earthquakes than a long period of calm, followed by a huge one. Similarly, euphoria in markets is dangerous. From time to time it needs to be punctured, before bubbles reach the proportions seen in Japanese markets in 1990 and US markets in 2000.

The corrections we have seen in important stock markets are modest: last week, Standard & Poor’s 500 index fell by 4.4 per cent and the MSCI world index by 4.5 per cent. But could this be the start of something bigger? One way of addressing this question is to examine the valuation of the most important market of all, that of the US.

The chart, taken from data prepared by London-based Smithers & Co, shows the actual and the cyclically adjusted price-earnings ratio of the Standard & Poor’s composite index since 1881. The cyclically adjusted measure follows the method of Professor Robert Shiller of Yale university: it is the ratio of stock prices to the moving average of the previous 10 years’ earnings, deflated by the consumer price index. The picture shows that the actual p/e ratio is now very close to its long-run mean of just over 15. The most recent cyclically adjusted p/e ratio, however, is 26.5, or about two-thirds above its long-run average. It is not as astronomically high as in 2000, but it is very high, by historical standards.

What is going on? The answer is that the US – and, indeed, most of the world – has experienced an enormous surge in corporate earnings. The chart shows real earnings per share and the average of the previous 10 years’ real earnings per share. What emerges is the cyclicality of earnings. What also emerges is the scale of the recent surge: in real terms earnings rose by 192 per cent between March 2002 and December 2006. But real earnings also rose by 170 per cent between December 1991 and September 2000, before collapsing in the ensuing months: in March 2002 real earnings of the companies in the index were only 19 per cent higher than at the previous trough, over a decade before.

It is always a mistake to confuse a cycle with a trend. In the case of corporate earnings, it is worse than a mistake, it is a huge blunder. The intense cyclicality of corporate earnings is the most important reason why the unadjusted p/e ratio is a worthless indicator of value. The question one has to ask is whether they will be sustained or fall back again, as they have done in the past.


Over the past 125 years, real earnings of companies in the index have grown at only 1.5 per cent a year – lower than in the economy as
a whole, because the index is always underweight in new and dynamic companies. Over the past quarter century real earnings have grown at an annual rate of 3 per cent. The annual growth of 25 per cent seen since the most recent trough will not last. On past experience, it is far more likely to turn negative.

If we are to assess when that might happen, we have to recognise that the buoyancy of corporate profitability is just one of several extraordinary features of the world economy. Here are a few others: dynamic and now widely shared growth; low real interest rates on risk-free securities; low inflation-risk and credit-risk premiums and so low nominal interest rates; huge current account “imbalances”; and low inflation, in spite of big rises in prices of commodities, especially oil.

This combination explains many phenomena in financial markets. The borrowing by private equity funds to buy corporate assets is just one.

Some of what we see is also surprising. This is particularly true of the association of rapid global economic growth and high profitability with low real interest rates and little concern about inflation. A world such as this is one in which one would have expected high real interest rates and worries about inflation, not the opposite.


So what is going on? Several answers emerge: monetary policy credibility, the great achievement of central banks over the past quarter of a century; globalisation of world markets in goods, services and capital; the incorporation of China into the world economy; the almost fixed Chinese exchange rate and consequent downward pressure on dollar prices of manufacturers; the shift of world income to two groups of high savers – the east Asians and, more recently, the oil exporters, and the consequent emergence of a huge savings surplus in these countries; the role of governments as accumulators of US dollar liabilities, especially treasury bonds; the role of the US as borrower and spender of last resort; and the rapid growth of US productivity.

All this together has generated the conditions for stable economic growth. But how long will the happy times last?

The dangers ahead look big. One is that markets will overreach themselves, so generating a destabilising correction. Another is a reduction in excess savings outside the US and a tightening of world interest rates. Another is a slowdown in US productivity growth. Yet another is a shift in global monetary conditions that threatens the soaring profitability of the US financial sector. But the biggest risk is that the end of the US property boom will persuade US households to tighten their belts at last, thereby ending the US role as the world’s big spender before the big savers are prepared to spend in turn.

We can be confident that profit growth will not continue at recent rates. But a sharp reversal, though possible, may not be imminent either. The economic risks are evident and the market does look expensive. But I would not dare to forecast a turning point. Forecasting is for far cleverer and braver people than I am.

On Regulating Hedge Funds

Mark Thoma on Economist's View, sums up his view in his headline, "Kenneth Rogoff: German Leaders Are Right About Hedge Fund Transparency and Regulation". Rogoff takes issue with Paulson's dismissal of the idea of making hedge funds more accountable.

It's odd that Paulson even thinks he had a vote on this issue, since the Treasury is not a regulator, but one supposes as a former Wall Street chief (oh, and of a firm that has been accused of being more a hedge fund than a market maker) he feels entitled to an opinion. Oh, but of course. He was a member of a committee that made a solidly pro-industry set of recommendations (ironically, he joined the group as head of Goldman, but the report got an extra boost since it was issued after Paulson went to Treasury).

Paulson has almost made it sound as if Europeans are trying to rein in one of America's most successful new industries (he might well have recycled Rumsfeld's "old Europe" charge if Rumsfeld himself hadn't gone by the wayside).

Now the regulator that has the most reason to worry about hedge funds, namely the Fed, actually made statements that would seem to argue for more oversight. From a January 11, 2007 speech by the president of the Federal Reserve Bank of New York, Tim Geithner:

The global financial system is in the process of very dramatic change. The changes of even just the last five years are extraordinary, in terms of the size, and strength, and scope of the major global firms, the role of private leveraged funds, the extent of risk transfer and the increase in the size of the derivatives market, the change in the structure of the credit market, the increase in and changes in the pattern of cross border financial flows.

These changes, and others, seem likely to have made the financial system both more effective in moving capital to its most productive use and more stable and resilient over time. But they do not, of course, mean the end of systemic risk in financial markets. They could in some circumstances work to magnify rather than mitigate stress. Central banks, supervisors and those running the major private financial institutions need to continue to work to ensure that what Jerry Corrigan calls the “shock absorbers” in the financial system—capital and liquidity and the operational infrastructure—are sufficiently strong and robust to withstand economic and financial conditions more adverse than we have seen in the recent past.

Although Geithner doesn't come out and say it, one has the impression that he is acknowledging that the pace of innovation has been so rapid, and the nature of the changes so far reaching, that the regulators don't have a good handle on the institutions themselves or on the risks they might be collectively creating.

That alone would seem to make more disclosure, at least to the supervisory bodies, a priority. But even if that could be achieved, the Fed has limited resources and many other responsibilities, particularly inspecting banks. Thus a more transparency, and more regulation, could produce a double benefit. Regulation, while it might limit some business opportunities and increase costs, would presumably also curtail some exterme behavior, such as excessive leverage, that could endanger counterparties. More transaprency would enable investors, consultants, rating agencies, and counterparties, to have a better picture of the risks, and come up with better ways of measuring and monitoring risk. It would allow the marketplace to serve a quasi-regulatory function, and enable the Fed to build on this understanding.

But no. For some reason beyond my comprehension (perhaps campaign conribution) the Fed and the other regulatory bodies are staunchly pro-industry, rather than taking the more traditional role of balancing the needs of the companies and their customers.

From Rogoff's piece, "Hegemony Through Hedge Funds" (apologies if the link doesn't work, I was having trouble with it just now):

The recent volatility in global capital markets should give pause to those who say German leaders, who have been arguing for greater transparency in global hedge funds, are just sore losers.

American and British policymakers, in particular, say the German whining is nonsense, and that hedge funds, along with other New Age financial entities such as private equity firms, are key innovators in today’s global economy.

This debate is ... clouded by a healthy dose of national self-interest. With New York and London the centres of global finance, the United States and Britain have enormous profits at stake. So it is convenient for them to downplay the likelihood that risks to the world’s financial system will be spread more evenly than the benefits.

German leaders, by contrast, must reckon with a populace that is deeply resistant to rapid change, particularly when it involves job cuts. Many German workers believe, as one trade unionist recently lamented, that takeovers are being driven by a philosophy of "buy it, strip it and flip it"....

The big question is whether this Wild West mentality poses broader risks to the global financial system, particularly given circumstances where a large number of firms are all collectively making the same bet. If they lose, a long string of bankruptcies can cut deeply into banking systems...

At the moment, the most glaring weakness is the so-called "yen carry trade". Hedge funds have borrowed hundreds of billions of dollars at ultra-low interest rates in Japan, and invested the proceeds in countries such as Brazil and Turkey, where interest rates are high.

As long as the yen remains weak, this investment strategy will be a money machine. But if the yen appreciates sharply, as it easily could given Japan’s huge current account surplus, some hedge funds will suffer huge capital losses and the yen carry trade will implode.

And while today’s main risk is the yen, in a couple months it could be something completely different. So pressure outside the US and Britain to put the hedge fund industry on a tighter regulatory leash is hardly surprising. The Germans, for example, want to reduce risk by forcing hedge funds to adhere to stricter reporting requirements.

The funds respond to such proposals by arguing that if they are required to reveal their investment strategies, they will lose their incentive to innovate, and a recent US government report — a multi-agency effort headed by Treasury Secretary Hank Paulson (formerly of Goldman Sachs) — supports that position.

Greater regulation would be a mistake, the report argues, because the global economy’s best defence against systemic risk is the exercise of common sense and "due diligence" by each and every person who invests or interacts with hedge funds.

In other words, the US is telling investors to carry their own guns, because, as in the Wild West, there might not be a sheriff around to help. But frankly, as we are reminded by recent events, it is hard to see how at least a small increase in transparency can hurt. The Germans, in chairing the G8 this year, should not surrender on this issue. ...

What Is Greenspan Up To? (Part 2)

Curiouser and curiouser. Greenspan uses the "R" word in Hong Kong, and the Chinese stock market goes down 9% the next day. Now the sequence of the two events might have been pure coincidence (the main cause for the Chinese sell off was the announcement that the powers that be were going to tighten margin lending to cool off the overheated stock market), but one can believe that Greenspan's comments might have heightened nervousness in other markets and fuelled the fire. And now, as the Financial Times tells us ("Greenspan risks new row with Fed") he's done it again, although almost assuredly with less dramatic results (note that, as of the early a.m., this story is not on the Wall Street Journal's website).

As you doubtless recall, Bernanke had a scheduled appearance before Congress, which gave him the opportunity to reassure the markets, and Greenspan backpedaled somewhat, saying recession was "possible" rather than "probable."

Now I had gotten on my high horse when I read Greenspan's remarks, which was right before the markets started their dive:

It is singularly odd (one might even say out of line) for a former Fed chairman to intrude on the turf of the current Fed chief. So why is Greenspan making predictions about the US economy, ones that seem to be at odds (at least in tone) with Bernanke's?

I cited Dean Baker's theory, which was that Greenspan was trying to position the coming recession as an inevitable end of a cycle, rather than the result of the housing bubble he helped create coming to an ugly end.

It may simply be that Greenspan has an insatiable appetite for the limelight. Or as others have speculated, his remarks may be financially motivated. He gets paid very large amounts of money to speak, plus he has a book coming out. Never hurts for someone like him to maintain profile, right?

But this second go at Bernanke seems almost pathological. In a Bloomberg interview, he clearly feels free to make comments about the economy, even though his status as former Fed chairman means they will be treated more seriously than perhaps they should be (remember, the Fed has access to lots of information from its member banks that isn't public). And in an interview with a news service he talks about seeking anonymity!

It was Clinton that made it acceptable for former top level government officials to take highly-paid public speaking gigs and seven figure book advances. Before that, former presidents never did anything so, ahem, common. Even people like Kissinger, who did maintain his profile, did so discreetly, by sitting on a few corporate boards, doing very highly level consulting, and speaking very selectively.

Similarly, Paul Volcker, who undertook a considerable financial sacrifice to stay at the Fed until he was satisfied inflation was under control (it was widely known that his wife was terribly ill and he was having trouble paying for her treatments on his salary) did not hurry to sell his services to the highest bidder once he left the Fed. And he never commented on the economy, the banking system, or Fed policies after he left office. The contrast between his behavior and Greenspan's couldn't be starker.

Here is the latest chapter:

Alan Greenspan risked stirring renewed controversy on Tuesday when he told the Bloomberg news agency that there was a “one-third probability” of a US recession this year.

The former Federal Reserve chairman’s comments are starkly at odds with the relatively upbeat assessment made by Ben Bernanke, his successor, in testimony to Congress last week.

Mr Greenspan’s latest remarks come barely a week after he told investors in Hong Kong that he thought a US recession this year was “possible”. The earlier comments spread quickly through the investment community, spooking investors and contributing to turmoil in financial markets.

Following a global sell-off in equities and other assets, Mr Greenspan was forced to clarify his statement, declaring he had said that a recession this year was “possible” but not “probable”.

The markets appeared to take Mr Greenspan’s latest comments in their stride but the remarks show he has decided not to keep quiet in the light of the past week’s experience, highlighting a dilemma for Mr Bernanke.

The Fed chairman is inclined to think it is not Mr Greenspan’s fault the market takes his comments so seriously. Moreover, such is the respect and goodwill towards Mr Greenspan within the Fed, as well as in markets globally, that there would be little benefit for Mr Bernanke in being seen to clash publicly with him.

However, the apparent second-guessing of the Bernanke Fed’s economic view by its former chief risks adding to the volatility and undermining the current chairman’s efforts to establish his authority in the markets.

Mr Greenspan on Tuesday told Bloomberg he was “surprised at this recent episode”. He said: “I was aware of the problem that if I stayed public I could make it difficult for Ben. For the most part it has worked. I was beginning to feel quite comfortable that I was fully back to the anonymity I was seeking.”

He said there were signs that the US’s economic expansion was ageing. “We are in the sixth year of a recovery. Imbalances can emerge as a result,” he said.

Mr Bernanke has not put any figure on the likelihood of a US recession this year. However, his public remarks suggest that, while he feels there may be some chance of a hard landing so painful that it results in negative growth this year, the likelihood of that is much less than one in three.

Mr Greenspan’s interview overshadowed a speech by Mr Bernanke later in the day, in which he called for new legislation to tighten controls on Fannie Mae and Freddie Mac, the government-sponsored mortgage finance institutions.

Mr Bernanke said their portfolios “represent a potentially significant source of systemic risk”. He suggested that the two institutions should only keep on their books loans that promoted low-cost housing.

Is Right Wing Nuttiness Finally Backfiring?

One robin does not make a spring, and one incident of over-the-top vituperation that is roundly denounced, even by people on the same team, does not yet indicate a shift in sentiment. But we can hope a little.

Yesterday I wrote a post on the anger of the right. By happenstance, it was shortly after Ann Coulter's characterization of John Edwards as a "faggot". Apparently that was finally going too far. Even MarketWatch, not exactly the most politically minded news outlet, felt compelled to denounce her (and the piece by Jon Friedman, "Ann Coulter's the Paris Hilton of political coverage" is well done).

When I read that comment, I actually started pondering as to how one might respond to it. Jon Stewart could do it vastly better, but the high concept was to suggest that if what Coulter said was true, here we have in Edwards the conservative Christian model of the perfect faggot, someone who had overcome his homosexual impulses and was successfully living with a wife and children, and despite intense press interest, had never been caught in a leather bar. How dare she renounce such a shining example of reformed faggotry?

So I basically came to the same conclusion as Friedman. You can't treat these people seriously. But it might be more fun, and more effective, to take their kookiness at face value and see where you can go with it.

From Friedman:

Ann Coulter, the raging right-wing author, has become the Paris Hilton of political coverage. Even among her most rabid red-state fans, she has become a cartoon character -- and journalists should treat her like one.

It's no longer enough for journalists to shake their heads in amazement at her most recent verbal atrocity. Since Coulter's already a bad joke, why not depict her wearing a dunce cap? Her quotes could begin to appear in a special section called "Coulter's Latest Stupid Comment."

Hilton will do anything to appear on gossip venues, like Page Six or Gawker, as a way to stay in the news and burnish her hard-earned rep as America's most outrageous party girl. Likewise, Coulter will do anything to enhance her dubious image as America's most outrageous pundit. The more we rip her, the more her books sell and the prices for her speeches go up.

It wasn't nearly enough for Coulter to mock the Sept. 11 widows. (Her previous low-water mark at desperately trying to steal attention from serious people.) Last week, she felt compelled basically to call presidential candidate John Edwards -- a Democrat, of course -- a "faggot" at the Conservative Political Action Conference.
Edwards' team called the comment "a shameless act of bigotry." Representatives for Republican candidates John McCain, Rudy Giuliani and Mitt Romney distanced themselves far from Coulter's sensibility.

As Slate columnist Jack Shafer pointed out Monday (relying on a file from the Washington Monthly), Coulter has a long history of mocking Bill Clinton, welfare recipients and Vietnam veterans, among others.

She went too far this time. Coulter already is regarded as being foolish; I suspect that she'd love to be considered outright dangerous. But she is too goofy to accomplish that goal. She's in danger of becoming obsolete, the most cutting description of all.

The subhead to Shafer's column in Slate was, "Why the press can't ignore her." I disagree: We can ignore her. We should ignore her. What possible value does Coulter contribute to any reasonable discussion? The Associated Press imposed a ban on Paris Hilton "news" last month, lifting it when she was stopped by police for driving with a suspended license.

Coulter is not only boorish; she is also out of touch. As someone who professes to understand national politics, she should've understood that the November 2006 elections underscored the changing times in the United States.

As the countdown to 2008 goes on, political commentators who want air time should heed the lesson of Coulter. The media seem to grasp that Americans no longer seem to want red-meat candidates at all costs.

The more we rip Coulter, the more her books sell and the prices for her speeches go up....Yes, I know -- I'm playing Coulter's little game simply by writing this column. I'm giving her more attention.

Comic Relief (Bush and Democracy)

I trust you will enjoy this. The Brits carry off deadpan so much more successfully than we do.

It's the Fundamentals (Stupid)

We aren't saying that the market upheaval of last week was caused by fundamentals. It's hard ex post facto to attribute an unwinding to any one event, or set of events, and in this case, there are many possible culprits. If we had to attribute it to any simple set of causes, it would be a tightening of liquidity in key markets (per below), and the spike up in the VIX, meaning there was a sudden increase in volatility expectations (that is, for whatever reason, a bunch of investors woke up and realized the complacency was way overdone).

On the liquidity front, Larry McDonald tells us in "About Recent Financial Turbulence" at Seeking Alpha that

One trigger for the recent turbulence in stock markets was a stepping up of efforts to withdraw liquidity from the world economy. In the weeks and days leading up to the breakdown:

One trigger for the recent turbulence in stock markets was a stepping up of efforts to withdraw liquidity from the world economy. In the weeks and days leading up to the breakdown:

* The People’s Bank of China raised reserve ratios on financial institutions to 10%, the fifth hike since mid-2006
* The Reserve Bank of India raised reserve ratios by 0.5% to 6.0%, the second since December
* The Bank of Japan raised its central rate from 0.25% to 0.50%.

China and India are expected to continue tightening in response to inflationary pressures. Indeed, the China Economic Review says analysts expect reserve ratios in China to go as high as 11.5% in 2007. And analysts expect more hikes in India given domestic inflation of 6.5% and forecasted GDP growth of 9.2% (highest rate in 18 years).

Now (as I have said) what is going to keep markets unsettled for longer than the optimists hope are the weak fundamentals. Normally, markets can brush off middling and mixed fundamentals because, on average, economies show more growth months than low or non-growth months by a considerable margin. So blindly betting on the bull case is pretty safe.

But what happens from time to time is the market gets ahead of itself, valuation wise. That can lead to short-term downturns and profit taking. Again, the smart bulls wait until the correction seems to be losing steam and take advantage of the buying opportunity.

When you have overvaluation and generally lousy fundamentals, however, the dynamic is different. Valuations need to settle down to a much lower lever before the market can begin a sustained rise. And the fundamentals look pretty poor. Barry Ritholtz, in another Seeking Alpha piece, eviscerates a cheery story by James Pethokoukis, "Don't Use the Market to Predict a Recession," in US News & World Report by taking apart each of the supposedly encouraging indicators that Pethokoukis cites:

What are the hopeful pleas of the soft landing proponents? Consider this short list, and our counters:

1) Corporate America remains healthy

The good news is that corporate balance sheets are the best they have been in years. The bad news is that matters a lot less than you would think. The lift under major corporate strength has been earnings -- which have been decelerating for quite some time now, and are likely to get worse, not better in the near future.

The strength there is somewhat deceptive. A vastly disproportionate amount of S&P500 earnings have come from Oil & Material companies. As the economy slows, that will slip. We also see a lot of M&A/Private Equity driving the Financial sector. A shift in Psychology is underway, and that is likely to look different if this selloff accelerates. Third, a lot of financial engineering has occurred. Share buybacks are responsible for about a third of earnings gains. Bottom line: S&P500 earnings remain a lot more vulnerable than most people realize.

Then there's the profits at a cyclical peak: Earnings cannot grow faster than GDP + inflation indefinitely. As we have pointed out before, this profit cycle has been driven by cheap labor, cheap money, and tax breaks -not organic demand.

2) The GDP report wasn't all bad

That's true: 2.2% isn't zero.

However, it is not 3.5%, either. And it's trending lower. Even more importantly, it does not reflect the thesis that helped the markets power higher from December through February: That growth was reaccelerating, that the soft patch was behind us, that a soft landing might not even be necessary due to the robust economic environment.

That turned out to be dead wrong: Housing is already in a recession, as is Autos and most Manufacturing that is not cheap dollar export dependent. Durable goods have been weakening along with Housing, and Business Investment - which the Bulls have been forecasting for 3 years - is near a 3 year low, with more weakness likely on tap.

The "contained sub-prime debacle" and the "not dependent on housing consumer" turned out to be Fairy Tales - like Goldilocks herself.

3) Jobs remain key

It's stunning that this keeps getting trotted out, but let me repeat it in CAPS for those who have have somehow missed it: THIS HAS BEEN THE WORST JOBS RECOVERY IN POST WAR HISTORY.

We've mentioned this repeatedly over the past 3 years, most recently here and here.

4) Federal taxes keep pouring in

Temporarily true, primarily due to a number of factors and one time events.

But if you want to get closer to where "the rubber meets the road," have a look at State and Local tax receipts. They are in near crisis mode in many places, as Income gains, and Hiring and Consumer Spending are all off of where they should be at this point in the cycle. Productivity gains are clearly a double edged sword this cycle also.

For The Liscio Report's prior take on State Tax reciepts plummeting, see #3 here.

Note we agree with Barry on corporate earnings, but for different reasons. Earnings quality has been terrible, independent of the trend. Much more accounting gimmickry, even with Sarbox, and a good deal a result of either unsustainable or damaging cost cutting (ie, it's really disinvestment, starving future quarters to look good now). It looks like companies are starting to have to pay the piper.

Our Vote for a Name for Last Tuesday

Dealbreaker.com put out a call for a name for terrible Tuesday, "Wanted: What Should We Call Last Tuesday?"

I guarantee my recommendation will never win, so I haven't even bothered to submit it. But I vote for Groundhog Day. Not in the traditional sense of Punxsutawney Phil serving as rodent weatherman.


No, I mean in the sense of the Bill Murray movie, where he wakes up and has to keep reliving the worst day of his life, which happens to be Groundhog day, over and over until he gets it right. The markets, at least for the last week, seem to be stuck in a loop and like Bill Murray, aren't able to get past last Tuesday. Hope they learn their lesson soon.

The Fed Favors Its Friends

So much for our belief in the independence of the Fed. Cactus at Angry Bear has done a series of analyses on money supply growth in the months preceding an election, his latest being, "The Fed, Presidential Elections, and Coincidence – Part 5." When the Fed chair is of the same party as the incumbent, money supply growth is accommodate; when from the opposing party, money growth isn't just lower than normal, it's negative.

The interesting corollary of this work is that it shows that the Fed can do a very good job of managing growth on a short-term basis.

Before you take exception, I suggest you follow the link and read his spreadsheets (you would be taking issue with a serious economist, the kind that does wonky models, and he's already up to five posts on this topic). Here is an excerpt from his latest:

[T]he following chart, reproduced from an earlier post shows that the increase in real M2 per capita every month is higher in years in which a Presidential incumbent from the same party as the Fed chair runs for re-election than in other years. By contrast, when an incumbent is running for re-election but he is from a different party than the Fed chair, the growth in real M2 per capita is not only lower every month than in other years, it is also negative.


I’ve also produced tables (see the same link as above) showing that the fed funds rate, which the Federal Reserve controls directly, has similar very clear-cut behavior: when a “friend” is running for re-election, the fed funds rate is unusually low, and when an “enemy” is running for re-election, the fed funds rate is unusually high.

A cynic might conclude from this that the Fed helps its friends by making money cheap and easy to benefit its friends, yet tight and expensive to hurt its enemies.

Now, some readers have objected. They point out this can be coincidence. The Fed may well be reacting properly to conditions in the economy. Let us consider that argument in more detail. If the Fed is behaving impartially, to get the clear-cut results we see in real M2 per capita and fed funds rate, the Fed needs a reason to slow down the economy when an incumbent from the other party is running for office, and it needs a reason to try to jump start the economy.

Put another way, for this to be a coincidence, for the Fed to be operating properly, when an “enemy” is running for re-election, the economy has to be growing quickly, and when a “friend” is running for re-election, the economy has to be faltering. (Take another look at the table above – the table doesn’t exactly brook a middle ground.)

On the other hand, a cynic such as myself would disagree. The cynic would say – the loose money supply in the last column… that will cause rapid growth. Similarly, the tight money supply in the second to last column… that will cause growth to slow.

This makes for a testable hypothesis, H0: Fed acting properly v. H1: Fed acting improperly. So… what does happen with growth? The table below shows the growth rate in real GDP per capita per quarter. (Unfortunately, the data is not available monthly).


What do we see? Well, in the three quarters leading up to an election, real growth per capita is fastest precisely when the Fed’s friends can use the help. And in two of the three quarters leading up to an election, growth is slowest precisely when the Fed’s enemies can use the extra weight dragging them back. In the quarter, growth is almost at its slowest, missing by a mere 0.02%!

Note also… when growth is fastest in column 4, it is usually quite a bit faster than in other columns – there is little room for confusion on the Fed’s part, and simply insisting that the Fed was working with preliminary data seems a stretch.

What about in the quarter in which the election takes place? What explains that? Well… elections take place about a third the way through that quarter. Thus, the Fed has the time to reverse course. In fact, after at least a year of improperly tight money, it has to loosen up to prevent a recession, and after at least a year of improperly loose money, it has to tighten up to prevent runaway inflation.

Sure, the data is limited, but when the same results are obtained several ways, appealing to coincidence gets less and less likely. I’ll be honest, I managed to convince myself last week. But if any of you still need convincing, in the next day or two, I’ll look at the coincidence question again, from a different direction, this one involving both cause and effect of Fed behavior.

The Anger of the Right

An article in The Guardian online by Kevin Baker, "The right kind of anger," seeks to probe the psyche of the right, specifically its fondness for vitriolic anger. Baker observes that the Anne Coulters of the world are back to their old slash and burn ways, despite the fact that those very same tactics didn't save them in the run up to last November's elections.

It's a worthwhile line of inquiry, and one the Democrats ought to consider seriously. The appalling thing about Coulter and Limbaugh and all the other wingnuts isn't that they say crazy things. It's that there is a big audience for this sort of craziness. It somehow resonates with some people and reinforces their beliefs.

The left, for the most part, has stayed above the fray and refused to stoop to this level of discourse, partly because it is such a mis-match with their identity, and part because they believe anyone nuts enough to fall for this sort of thing won't be swayed.

Maybe. But I have a feeling that the fallback position of appalled liberals, which is to ignore this sort of thing and hope it will pass, is a mistake. One doesn't necessarily have to stoop to the level of the kooks to respond. The failure to reply is read as an admission that you have no response, therefore the charge is accurate. Look at the damage that was done to Kerry by his silence. He looked weak, and to some, he looked guilty too.

Baker reads the current anger of the right as the product of failed policies in Iraq. He points out that the right has, from the Cold War onward, advocated extreme aggression as the answer to most geopolitical problems. The conservatives finally got to execute on their plan, and it turned out to be a disaster, so they are lashing out.

But the tone, and even the content, is pretty much the same as when the neocons were riding high. Baker's point is interesting but it doesn't explain the repetition of now-failed tactics (anger didn't help them in the Congressional elections) nor does it explain where it came from in the first place.

Psychologists have studied the question of what predisposes someone to be conservative or liberal, as recounted in a New York Times article, "Across the Great Divide: Investigating Links Between Personality and Politics." Some observations are cringe-making (conservatives are neat, liberals are sloppy), while other observations, for example, that liberals are more open, particularly regarding change; conservatives place considerable stock in tradition and loyalty, seem both more valid and more useful.

The reliance on anger, just like the reliance on fear, may be an attempt to push voters into their reptile brains (this was an observation made by Adrianna Huffington). Once you get people operating from there, they are immune to reason, hence immune to liberals.

But why is the anger button so easy to hit in conservatives? Is it anger that others no longer follow the rules (well, their rules) of how to raise children, how to conduct themselves in marriage, even how to behave in public? Liberals are genuinely puzzled about the fuss about gay marriage; I wonder if conservatives are so overwrought because it is a focus for their upset about the breakdown of traditional families. Is it anger over how things are changing so quickly? About America's decline in the world (and the fact that it is non-Caucasians that will be on top soon?)

If I were Howard Dean, I'd take a couple of million dollars of party money and hold a ton of focus groups. I'd get some good actors/improvisors, and cast some to play the Michael Savagehttp://www.nytimes.com/2007/02/12/arts/12part.html?ei=5070&en=30504c571638ba4c&ex=1173243600&adxnnl=1&adxnnlx=1173149270-BpNwOJT11/U0mSwx+LYLQA/Anne Coulter part, and others to play people responding to them. I'd run various types of responses to typical anger tactics again and again before carefully chosen center and center-right groups to see what kind of attacks are worth answering, and what sort of responses are most effective. This is too important to go on guesswork and gut.

From Baker:

The American right is angry again. Ever since it narrowly lost control of Congress last November, American conservatives have taken to lashing out in all directions.

Within weeks of the election, rightwing publications were vilifying the authors of the Baker-Hamilton report on Iraq as "surrender monkeys" and Israel-bashers. New books by movement intellectuals such as Dinesh D'Sousza and Bruce Bawer blame jihadist successes on, respectively, American popular culture and European appeasers. No less an authority than William F Buckley Jr, the longtime dean of the modern conservative movement, fulminates against "Defeatocrats" and "Vertebrate-challenged Europeans". And then there was Ann Coulter's tirade at this weekend's CPAC conference: "I was going to have a few comments on the other Democratic presidential candidate John Edwards," Coulter said towards the end of her speech. "But it turns out you have to go into rehab if you use the word 'faggot', so I - so kind of an impasse, can't really talk about Edwards."

What is going on? The right used to be able to take a punch. Its exemplar was Ronald Reagan, who shrugged off two failed runs for the presidency and made it to the White House by inventing conservatism with a smiley face. That aw-shucks grin could stretch wide enough to cover up everything - from contra death squads to the world's largest banking scandal. Reagan fundamentally altered the way the right presented itself to the world, transforming the clench-jawed negativity of Barry Goldwater and George Wallace into a sunny, optimistic faith in rugged individualism.

Reagan's cheerful chiding of liberals morphed into a vulgar but spirited style of political taunting under the likes of Rush Limbaugh and Newt Gingrich. Their brand of ridicule was originally so over the top that it often seemed to be satirizing itself, like professional wrestling, while still getting its core message across - a brilliantly effective way of taking down ponderous liberals in an America of all irony.

So why has the right reverted to its old, perpetually angry style of politics? I suspect the creeping disgruntlement has to do with the fact that conservatives have at last been confronted with the realities of their policies in Iraq.

Consider: For more than sixty years now, or ever since the start of the Cold War, the right has insisted that every major international dilemma could be solved merely by the application of American might and will. The Chinese Communists were to be vanquished by "unleashing" Chiang Kai-shek from the island of Formosa; the Korean War could be won by General MacArthur's suggestion to create "a belt of radioactive cobalt" between China and North Korea by dropping some fifty atomic bombs there. The Soviet occupation of Eastern Europe was to be "rolled back". Castro should have been removed by an American invasion, but failing that President Kennedy should have followed the advice of several of his Joint Chiefs of Staff and used the "opportunity" of the Cuban Missile Crisis to hit both the Soviets and the Chinese with a surprise, atomic attack. Vietnam should have been reduced to the proverbial "parking lot" or at least, according to Goldwater in the 1964 campaign, had its Ho Chi Minh trails cut with nuclear devices. Iran is once again being subjected to George W Bush's scabbard-rattling, and on and on.

Always and forever the right's response to a problem, anywhere in the world, has been to hit it with a two-by-four. This may have once been mere campaign foaming, but somewhere along the way American conservatives made the always fatal mistake of believing their own rhetoric. Under Bush, the right had the opportunity to act on its long-stated worldview for the first time, unfettered by any effective opposition. The results lie broken all around it, in the bloody chaos that is today's Iraq.

This is the end of the line for the right's free ride, for its long insistence on the application of military might, first, last, and always, without having to worry about the aftermath. As a result, the right has drifted into confusion, baffled about how to react to a world that does not, after all, respond to its bidding. In its childlike regression to the movement's early years, conservatives have once again decided simply to throw a tantrum and rail against their ever-expanding list of enemies, at home and abroad. And why not? We have all disappointed them terribly.

Market Fatigue ("This Time It's the Same")

Here it is, Sunday evening. The Asian markets are opening down.

I don't know about you, but I am already tired of the events of last week. They don't appear to be ending anytime soon, despite the attempts at reassurance by various people in positions of authority. And no, I didn't take a beating.

It's just that it was obvious to know what to think a couple of weeks ago. Risky assets in every market one could conceive of were trading at almost no premium to tame ones. US consumers had been spending more than they earned for two consecutive years. Money supply growth in the US and other major OECD countries has been running well in excess of population and GDP growth. Even though corporate earnings in the US appear to be high, earnings quality is poor and a considerable portion comes from cost cutting and defacto disinvestment. Central bankers have admitted they do not fully comprehend the brave new world of finance, with its proliferation of risk transfer techniques and leverage on leverage. The US housing recovery appears tenuous. The carry trade had sucked up so much capital that it was badly distorting the price of the yen.

I could go on, but you get it. It was easy to see that there was a big disconnect between the widespread complacency and what was actually happening. It was easy to see that things had to change.

But now that that investors have been shocked awake, it's hard to see what the trajectory will be. There has been a good bit of brave talk, "the only thing we have to fear is fear itself" sort. We have Alan Abelson's view (courtesy Barry Ritholtz's Big Picture):

Nothing better illustrates how vivid an impression Tuesday made on ordinary Janes and Joes than the marked change in their sentiment as registered by the American Association of Individual Investors: to 39.6% bearish and 36.6% bullish, from 53.9% bullish and 22.3% bearish the previous week.

By contrast, the Wall Street seers remain stoutly upbeat. The conventional view (wisdom is too fine a word for it) among strategists of various shapes, sizes and dispositions is that the market was obviously overheated and primed for a shakeout.

They didn't bother to offer it, but the implicit excuse for not sounding the tocsin before the big break was they were too busy crooning on about Goldilocks, the global savings glut and the sea of liquidity as guarantors of the Dow climbing to (insert here the wild number that makes you happy). In any case, no need to fret....

The almost universal conviction is that Tuesday's plunge was not the start of a full-fledged bear market. Even the savviest sage we know, who has been unequivocally skeptical for a spell now, thinks the odds are against it being the start of a bear market. He reckons there's one more big move up likely and, after that, perhaps a few month hence, stock prices will begin their journey to the nether depths.

Perhaps. But we wonder. That virtually everyone agrees that Tuesday wasn't the start of a bear market strikes us as more than reason enough to suspect it just might be.

Oddly, while Abelson's reading is consistent with the tone in the business media, it conflicts with other surveys. Another poll, courtesy hedge fund newsletter Opalesque) of hedge fund managers, is much more bearish (admittedly it goes out only over the next month):

Greenwich Alternative Investments, LLC released today its market sentiment indicators for U.S. equities, the U.S. Dollar and the U.S. Treasury 10-year Note.

The majority of the managers continue to remain bearish on the S&P 500, as 62% expect U.S. equities to end March lower vs. 23% higher and 15% unchanged. February proved to be a difficult month for the U.S. Dollar, and 70% of the managers expect the Dollar to continue moving lower vs. 15% unchanged and 15% higher. Finally, the dramatic run up in the U.S. 10-year Note has left the group with a divided outlook for March, as 46% anticipate 10-year prices will advance, 31% remain unchanged and 23% move lower.

The Greenwich Alternative Investments Macro Sentiment Indicators are based on the outlook of hedge fund managers employing a macro view and who manage, in aggregate, in excess of $30 billion in assets. The purpose of the indicators is to reveal how these managers believe the S&P 500, the U.S. Dollar and the U.S. Treasury 10-year Note will perform over the current month.

So, in contrast to the Barron's picture, this isn't a simple "retail is panicked, the smart money is staying in" story. Some of the pros (and if you believe the hedge fund mythology, the smartest of the pros) are pessimistic too.

A lot of the factoids that make the case that the markets will recover fairly soon are comparisons to past downturns. Note that most of this is technical analysis, the financial world's version of astrology. And notice how it is invoked more widely at times like now, when markets are jittery than otherwise, in much the same way that psychics are more popular when times are bad.

Of course, in the long run, the markets will almost assuredly recover. But the arguments we are hearing for recovery sooner rather than later are all variants of "this time will be the same."

It's funny how many times we've heard "this time is different" when bull markets get toppy. Being contrarian by temperament, we are also skeptical of "this time will be the same."

So how is this time different in ways that might affect how things play out?

1. The Fed has little wriggle room. Investors have gotten used to the "Greenspan put," but with all the money supply growth of recent years, which has helped fuel the housing bubble and the excess liquidity that has in part gone into risky assets, it doesn't appear Bernanke can apply much stimulus. Although the last batch of unemployment numbers weren't pretty, the Fed is worried about overheating. But that concern may have been a cover that would be acceptable to a Democratically-controlled Congress when the real issue may be "we can't take the dollar down any further." Our continuing to enjoy the right of seigniorage, which permits us the luxury of issuing debt in our own currency, is that we can't trash the dollar.

In our humble opinion, the economy is in danger of tipping into stagflation.

2. There may be systemic risk. There has been a lot of hand wringing about hedge funds and the leverage they use. However, the real issue isn't whether a hedge fund, or two, or twenty, collapses. It's whether they damage important financial players. And note that many (most?) of the big financial firms, meaning the investment banks, have large proprietary trading desks, and are large market makers. There are at least two areas of the global markets looking seriously dodgy right now: the yen carry trade (which is unwinding even more as of this a.m. in Japan) and the CDO market, in which the investment banks made rich fees in packaging CDOs, but often retained a piece of the most speculative part of the deal. Bloomberg reported last Friday evening that the CDO-linked bonds of major Wall Street firms like Goldman, Merrill, Bear Stearns, and Morgan Stanley, were trading at junk levels, a dramatic decline in a short period of time. Now that may be an overreaction. But it also might not be.

The way one of these firms might be hurt is by an unwitting double (or triple) exposure to the same risk. Consider CDOs. If the investment bank bonds mentioned above are now correctly priced, it says these firms have already taken big losses. Now imagine hedge funds that have big CDO exposures going under. Goldman, Morgan Stanley, and Bear Stearns are the three largest prime brokers by a considerable margin. They might take further writeoffs if their clients couldn't make margin calls. And if there were rumors that any Wall Street firm had taken really large CDO or prime brokerage losses, you could imagine a flight to quality across all credit markets, which would leave the large investment banks with further losses (I don't care what anyone says about hedging positions. If you are a market maker, it is well nigh impossible not to be net long on your trading desks).

Now again, I am not saying any of these firms would go under. Quite the contrary. But the specter of any major Wall Street institution taking a large hit would produce distress in the markets, perhaps even short-lived panic.

3. The fundamentals don't look good. Prevailing P/E ratios of close to 20 with long bond rates near 5% (these were pre-correction levels) says you believe robust growth is ahead. Query where that could possibly have come from. As we have harped on before, consumers are overextended, corporate profits aren't what they appear to be either. Whether the economy does reasonably well in 2007 depends more than it ought to on housing (particularly now, it could either feed on the concerns created by the market or counter them). But the prospects aren't encouraging, as Nouriel Roubini report in his post, "Summary: Hard Landing Recession Ahead:"

# New home sales collapsed 16.6% in January. On the heels of a 14.4% fall in housing starts in January it is clear that the housing recession is worsening.
# Cancellation rates – as reported by major home builders - are now in the 30 to 40% range
# The stock of new and existing unsold homes is still rising in absolute and relative terms; so the glut of empty housing is increasing.
# Home prices fell in December according to the S&P/Case-Shiller Index; and home prices are unchanged on a year over year basis. The OFHEO price index – out this week – showed still some price appreciation in Q4 relative to Q3 (1.1%). But even that index shows that the rate of price increase deceleration has been massive in 2006. And even the NAR data on home prices show a price fall in 2006 and in the last month.
# Construction spending fell more than expected in January (-0.8%). More importantly, not only was residential spending down, but non-residential construction was flat (0% change) in January. That is consistent with Q4 GDP figures showing falling real non residential investment.

The only good news is if things are as bad as Roubini says, maybe the Fed will believe it's safe to lower interest rates. Oh, but I forgot. We still have that problem of not being able to trash the dollar....

This adds up to a rougher ride for a longer time than anyone wants to believe. Let's hope I'm wrong on this one.

How Income Inequality Changed: Clinton Vs. Bush

This is a fascinating little bit of analysis in, of all place, Mother Jones, where James Galbraith gives us "Bush's Beltway Boom." In it, he describes how the people at the top of the food chain (the top 1% that everyone is getting so upset about) has changed in the Bush years from the Clinton years. In essence, a lot of the wealth gains in the late Clinton days were tech related while in the Bush era, Beltway counties that showed the greatest income gains.

Now as much as the depiction of "who gained and lost" is generally true, there is a bit of legerdemain here. Truly obscene amounts of money were made by the lucky few who cashed out at the right time in the dot-com frenzy, and by some of the service providers (for example, Morgan Stanley analyst Mary Meeker made over $10 million a year for a while and didn't go to jail either). Except for people who hold options on Halliburton stock, partners at the Carlyle Group, and a few top lobbyists, it seems unlikely that people in the DC orbit can make the same dough as top people in the tech arena. But perhaps I am misinformed.

The "Democrats gave us tech, the Republicans gave us pork" dichotomy that Galbraith give us is overdone. The last bit about the Republicans is true, the first part is more complicated.

The irony with the tech boom is that the Democrats did the most they could for it by staying out of its way. That is of course contrary to the image that the Republicans like to convey. And the frenzied phase that led to the great increase in wealth in Silicon Valley, well I don't know if I'd hold that up as a shining example of capitalism (but again, it looks not too bad next to the no-competing-bid outsourcing that has grown under Bush). The Greenspan-fuelled dot-com bubble looks, in retrospect, more like wealth transfer than wealth creation. But it did leave us with some pretty cool toys.

From Galbraith:

The rise of the Democrats brings some much-needed attention to the issue of income inequality, but while most observers focus on how income is distributed among people, it is also revealing to look at the distribution across places. This measure of income inequality, calculated using tax data recorded by county, actually declined quite sharply after 2000. Why? Because it tracks, with uncanny precision over more than 30 years, the nasdaq stock index. After declining in the early 1970s, both indices rose almost steadily until they reached an all-time peak in 2000; both fell thereafter.

In other words, income inequality in the United States has been driven by capital gains and stock options, mostly in the tech sector. This is what separates that mysterious top .01 of 1 percent from the rest of us: They're the people who run Google, Oracle, and eBay.

County data confirm this: The big income winners in the late 1990s were concentrated in just four counties—Santa Clara, San Francisco, and San Mateo in California (all in the environs of Silicon Valley), and King County in Washington (Microsoft)—as well as in Manhattan, the home of the bankers who made it happen. Take the big tech counties out, and the rise in inequality between counties in the late 1990s disappears. And, of course, while these counties were big winners through 2000, they became the big losers in the Bush Bust.

Though the tech bust reduced inequality in America, it doesn't follow that only rich places lost out, still less that only poorer places gained. In fact, there was one group of counties that did exceptionally well in the first four Bush years. Guess what? They're concentrated around Washington, D.C. Of the top 10 gainers from 2000 to 2004, three are Washington neighbors (Fairfax, Montgomery, and Baltimore), and one is D.C. itself. Among the top 35 gainers, there are five more counties in the immediate vicinity. Conversely, none of the top 50 losers are near the capital.

This should remind us that the Democrats under Clinton fostered a private-sector investment boom, fueled by technological optimism and foreign money. In economic terms, Al Gore really did invent the Internet, in a way; his cheerleading (and Clinton's, and Greenspan's) steered money into that nascent boom. True, certain citizens got very, very rich. But the tech boom was also good for most of the rest of us: We had nearly full employment, rising wages and productivity, and little inflation; we also got a lot of fiber-optic cable, cheap phone calls, and fast video games.

Bush inherited a bust. He fought it by cutting taxes, with a strong tilt toward the rich; together with low interest rates, this fostered a vast housing boom, now deflating. Much of that housing was high-end, as any visitor to the posher suburbs can tell. And though it was stronger in some places than others, it was widely diffused. Was this the right use of resources? Not in my book. But all that construction did keep the economy going when it might otherwise have tanked.

Bush's other big policy was to increase government spending, above all on the military. Who profits? Private contractors, consultants, Beltway bandits. And the epicenter was Washington and its suburbs, home to not only the Pentagon, the cia, and the National Security Agency but also, not coincidentally, defense contractors such as Lockheed Martin and General Dynamics

The Wealthy More Exposed This Time

An interesting report in the weekend Wall Street Journal, "A Risky Profile," by Robert Frank, argues that the very wealthy (ah, our favorite top 1%) have taken on more risk and therefore were likely, as a group, to have taken a bigger hit last weak than the wealthy of the past.

Now in a way, this is seriously good news. Someone had to be buying all those crazy risky instruments. Frank tells us the rich were participants, and in addition, were also bigger users of leverage than heretofore. Otherwise, it would all be in the hands of pension funds, endowments, insurance companies, and other financial institutions. Glad to know the rich are pulling their weight.

The uber-wealthy were always the preferred targets for hedge funds. But in the last few years, institutional investors have been piling in with both feet. So the more interesting question, which Frank's piece doesn't answer (and in fairness, it may be well nigh impossible to develop the data) is who is holding the risky assets, and in what proportion to their total net assets? That will tell you how seriously exposed various types of investors truly are.

But institutional investors are relative return investors. If markets go down, oh well, that's too bad, but what they care about it how they performed relative to a benchmark. The wealthy are absolute return investors. Losses bother them more than the pros. So the other interesting question is how this will affect the consumption patterns of the wealthy. Presumably, we'll see weaker art auction prices and less demand for high end real estate, particularly vacation properties (note these are typically lagging indicators, so they may not weaken for a while). How much it will affect routine luxury good sales is an open question.

Please take note of one factiod. The story mentions that, "The nation's richest 1% controlled 51% of the country's individually held stocks in 2004, the latest period measured. That was up from 41% in 1989." That seems to support the idea that income and wealth disparity are increasing, a fact bitterly disputed by Alan Reynolds (see here and here for some examples).

From Frank:

Today's rich have expanded their fortunes and lifestyles in large part by turning to highly risky investments. In the search for ever-higher returns, they've doubled their holdings in hedge funds and other "alternative investments," and poured their money into stocks while draining down cash. At the same time, they've dramatically increased their debt.

"The wealthy have taken on much more risk than they had 10 or 20 years ago," says Steve Henningsen, a partner at Wealth Conservancy, a Colorado wealth-management firm. "They're probably more exposed to more risk than the average investor because they've been the ones buying all these fancy debt products, hedge funds and other investments that their advisers told them to buy."....

Consider stocks. The nation's richest 1% controlled 51% of the country's individually held stocks in 2004, the latest period measured. That was up from 41% in 1989...

In 2002, the last time markets fell significantly, financial millionaires -- or those with at least $1 million in investable assets -- lost $200 billion of their total wealth of $7.6 trillion. That represented 2% of their wealth. Yet today, they're exposed to risks far less understood than stocks or bonds.

Since 2002, financial millionaires have more than doubled their exposure to hedge funds, private equity and other so-called alternative investments, according to Merrill Lynch and Cap Gemini. (Those investments now make up more than 20% of their portfolio.) They also have increased their exposure to stocks by 55%. Meantime, they've cut their holdings of cash and bonds, the two most stable investments. Their exposure to real-estate has stayed the same.

Today's wealthy also rely more on borrowed money. The nation's richest 5% held $1.67 trillion in debt, up fourfold from 1989. A large part of that is mortgage debt, but wealth experts say some of the funds have also gone into risky and higher-yielding investments, such as hedge funds. Since hedge-funds themselves are highly leveraged, the double-borrowing could make for a rapid fall should hedge funds start to implode.

While the rich employ sophisticated advisers, sometimes they don't steer their clients to the safest investments. "A lot of the wealthy have leveraged up their house to put money into hedge funds or do the Japan carry-trade because they could make more than their costs of borrowing," Mr. Henningsen said. "That desire for yield could come back to haunt them."

Granted, some rich investors have started to pare back their risk, anticipating a downturn....On the whole, however, advisers said most clients are staying put.

At the same time, the appetite for risk among the wealthy for even more exotic markets -- such as wine, art and other collectibles -- shows no sign of slowing. On Wednesday, the day after the Dow plunge, Sotheby's auctioned off bottles of wine from the private cellar of Baroness Philippine de Rothschild. The auction fetched $2.2 million -- more than double the estimate.

"The Death of the PC"

No, I didn't say that. Daniel Eran, in a post "Can Apple Take Microsoft in the Battle for the Desktop?" at his blog Roughly Drafted, did (it's a heading to one of the sections of the piece).

A few days ago I posted "The Sun is Setting on Microsoft," and got a comment that, along with directing obscenities at one of the writers I quoted, said I was lying when I reported that I knew people who planned to switch to Mac once their PCs needed to be replaced (for example, one person has already changed his household computers, his own business PC is the last to go).

Why is this so hard to believe? Walter Mossberg, the Wall Street Journal's well regarded technology editor, has been saying for the last year or two that anyone buying a new computer should seriously think about getting a Mac. He has also said that Macs are a better deal on a price/performance basis. That's a strong endorsement from someone who has no axe to grind, and until recently, had been a staunch Microsoft loyalist.

This article from Eran takes the argument one step further, and cites a lot of data. The piece is long (I've spared you a lot of the computer industry history) but well done. He argues that Microsoft is making the same mistakes that Apple made in the early to mid 1990s, most important in letting its market dominance go to its head and neglecting product development as a result. Further (and this is the interesting bit) he shows that Apple has been targeting the most profitable parts of the market, such as high-performance, high end desktops, and laptops. When you look at Apple's profit margins, they are considerably higher of other computer makers.

Now of course, this isn't an apples to apples comparison (no pun intended) since the Apple results include iPod and iTunes sales, and those (certainly iTunes) are probably higher margin than the computer business. Dell is really a hardware company, and so doesn't have the higher margins of software (remember, the OS is bundled into the Mac). But the comparison to HP has some merit, since HP also has some very high margin businesses (printer ink and corporate computer consulting).

He does go overboard on some of his comments ("the imminent goring of Windows Mobile by the iPhone" although I for one do think the iPhone will do very well), his conclusions are reasonable (and do not depend on his occasional bits of hyperbole!).

I'd be delighted to hear any reasonable comments on or objections to Eran's observations, but mere flames are not acceptable. There are plenty of usenet groups for that. Slashdot also picked up on Eran's piece, so you can find a lot of heated chat there.

From Eran:

Some analysts are nostalgic for the days when they could appear intelligent merely by gushing about everything from Microsoft. They felt safe in recommending everything the company released, knowing that there were no real alternatives, and that anything the company could deliver would more or less have to be purchased.

All their advice and analysis helped to create the general illusion that Microsoft was divinely fated to succeed, and that no rival could ever hope to challenge the company. That illusion helped to reinforce the real power wielded by Microsoft as the dominant vendor of PC desktop operating systems.

Maintaining that illusion was as important to Microsoft as a properly running propaganda machine is to a banana republic dictator. As power begins to falter, maintaining an illusion of strength becomes increasingly important.

Ironically, the desperate measures that are frequently taken to sustain such an illusion often serve to distract from the real problems that need to be fixed and subsequently cause greater damage.

The Ghost of Past Failures
Microsoft certainly isn't the first tech company to stumble in a grand way. Apple fell from its position as a leader in the tech industry in the 80s to being "hopelessly beleaguered" within a decade.

In Apple's case, the company began making serious mistakes during a decade of limited competition leading up to 1995. Once a real competitor appeared, Apple was not only also woefully unprepared for the challenge, but also stumbling in the delivery of its own plans.

Had Windows 95 never arrived, Apple would still have had plenty to worry about; its future plans were uncertain, its product strategies were unfocused, and its System 7 software had grown obsolete....

[T]here has been one CEO of Microsoft since 1984: Steve Ballmer....

That means Ballmer really has nobody to blame for the problems Microsoft is now experiencing. Some of those problems are very much like Sculley's Apple under the direction of Gassée: a reliance on high prices and low product innovation to stretch the company's existing, threadbare assets while arrogantly ignoring the competition.

Competition Makes Companies Stronger
Just like Apple in 1990, Microsoft appeared untouchable in 2000. In reality however, both companies had really been softened by the lack of strong competition, and were so intoxicated by the praise of market analysts that they ignored brewing threats that were soon to develop into formidable rivals....

Apple also didn't count on Microsoft offering much of a threat, since the company's Windows product had been an embarrassing joke until 1990, and was still laughably behind.

Apple wasn't prepared for Microsoft's Windows 95, followed by its four paid updates that were released over the next five years. That lack of preparedness, exacerbated by poor governance, lead to major troubles for Apple within just a few years.

The analysts that had previously celebrated the company were quick to turn on it, and discount every effort the company made to recover. Increasingly, analysts compared Apple to Microsoft--a very different company with an entirely different business plan.

The Turning of Tables
In 2000, Microsoft Windows was still a poor product, but it had replaced DOS on hundreds of millions of PCs, and was strong competition to the ten year old operating system that Apple was still trying to sell.

When Windows 2000 shipped, Apple's efforts to sell Mac OS 9 and its delayed attempts to deliver Mac OS X similarly appeared laughably behind the times.

It was Microsoft that wasn't ready when Mac OS X Jaguar was delivered in 2002; it offered many of the key features intended for Microsoft's Longhorn, expected in 2003.

Apple then rapidly delivered Panther in 2003, Tiger in 2005, and then moved Tiger to Intel in 2006. Meanwhile, Longhorn hadn't gone anywhere but back to the drawing board.

Now that Windows Vista has finally shipped, critics are panning it as being an overpriced, unnecessary upgrade. Customers who have been waiting for Vista to ship have taken the opportunity to investigate the Mac, which not only offers a better product now than Vista, but also promises a further leap beyond Vista later this year with the release of Mac OS X Leopard.

This All Happened Before
Ballmer's incredulous confusion as to why Vista upgrades are not taking off sounds eerily similar to how Apple's executives refused to acknowledge the threat of Windows 95 as Mac sales slowed.

Ballmer has repeatedly dismissed Apple as a competitor, recently stating, “Remember, when you're the little tiny niche guy who owns about 2 percent of the worldwide market, you can be cute one time and it helps you grow.”

That was his brilliant response when asked by BusinessWeek about Apple’s high profile ad campaign calling attention to the security and reliability problems in Windows in comparison to the Mac.

Back in the mid 90s, it was Ballmer’s Windows 95 getting all the attention, while Apple’s Copland and Taligent projects fell apart. Apple revealed that it really had no alternative plans and started looking.

After finally delivering the disappointing Vista--which is regularly compared to Apple’s two year old Mac OS X Tiger--Microsoft has yet to admit any mistep. Instead, it talks about nebulous plans for the next version of Windows, which might be delivered in a few years.

Microsoft avoids direct comparisons with Apple and pretends there is no competition it needs to answer.

A Painful Vistula
Many of the pillars promised for Longhorn were stripped from Vista in order to have something to ship four years after it was originally promised. Even so, reviewers have described Vista as “beta quality” and recommend waiting on Vista until Microsoft ships its first service pack.

Many companies have put off buying Vista entirely. The US Federal Department of Transportation has put an indefinite moratorium on purchases of both Windows Vista and Office 2007, stating in a memo:

...there appears to be no compelling technical or business case for upgrading to these new Microsoft software products. Furthermore, there appears to be specific reasons not to upgrade.

As PC sales continue through the year, Microsoft will be able to claim that an increasing number of users are "buying Vista," which ships with new PCs. However, many businesses are buying new PCs and installing their own software images, commonly Windows 2000. Some have only recently moved to the six year old Windows XP.

When Apple reports additional sales of Macs, it actually means more active users of the latest Mac OS X....

A Better Product Mix
Windows enthusiasts like to recount Apple's long static 2% share of the worldwide market for all computer systems. However, Apple is no Dell or HP. Apple sells systems targeted at profitable portions of the PC market:

higher end Mac Pro workstations and Mac Book Pro laptops for creative professionals
complete, simple iMac, MacBook and Mac mini systems for consumers
entry and mid level workgroup servers and RAID units

Conspicuously missing from that lineup is anything like the volume loss leader PCs sold by HP, Dell, and no-name PC makers: the $600 systems that are stripped down to include just the core components needed to run Windows.

Those boxes offer scant profits, so they come with minimal support and are packed with adware and vendor junk that attempts to sign up users for additional security, anti-virus, and other services....

The Death of the PC
Consumers are increasingly interested in laptops, where differences in quality are more obvious.

"In the U.S. market, the focus continues to be on the transition from desktops to notebooks, with notebook growth being the sole bright spot while desktop shipments continued to decline.” - Bob O’Donnell, IDC, Oct 2006.

....Consumers are willing to pay more for better laptop hardware because of its perceived value and potential for resale. Vista is non-returnable, non-transferable, and has zero resale value. It should be no surprise that there is little consumer demand for paying hundreds of dollars for such a software upgrade.

That’s forcing Microsoft to push more activation restrictions in Windows Vista, killing the same pirate market that has helped prop up the Windows monopoly. While Microsoft struggles to force its user base to pay for a half-baked upgrade, Apple is finding lots of new customers willing to pay for premium hardware.

The Cream of the Market
Microsoft makes no premium from sales of higher quality PC hardware; it supports HP and Dell in their crusade to profit from selling more units of e-waste more often.

Overall market share numbers capture the vast scale of PC disposability, but do not reflect the product profitability that comes from building a better quality product.

While Apple is cited by Gartner and IDC as selling around 5% of all the computers in the US, it isn't obvious that Apple's 5% share is the cream of the market; it’s actually worth more than the same or larger percentage shares held by rivals.

There were 9.8 million Macs sold in the last two years, up from 6.2 million in the previous two year period. Those numbers don't compare with the stunning volume of PCs shipped by HP and Dell--which each sold 38 million PCs in 2006 alone--but Apple's profits do.

In the forth quarter of last year, HP and Dell combined sold 10 times as many PCs as Apple in the US, earned 5.5 times as much revenue as Apple, but together only ended up with 2.2 times as much net income as Apple.

In other words, Apple earned nearly half as much net income with its 5% share the market as HP and Dell together, with their combined 55% share of the US PC market: $1 billion for Apple vs $2.2 billion for HP and Dell together!

Adding in third place PC maker Gateway makes things look even better for Apple, because Gateway actually lost money all year, despite shipping more PCs than Apple and capturing a larger percentage of market share.

A large chunk of Apple's profitability comes from the iPod and other consumer electronics. Those sales are increasingly directing consumers to the Mac, and will help float the company through downturns in PC sales....

Being independent from Microsoft actually helps Apple tremendously; the rest of the industry’s reliance on Microsoft hamstrings them from effectively competing with Apple....

The End of a Monopoly
Combined with the dominance of the iPod over devices using Microsoft's PlaysForSure, the imminent goring of Windows Mobile by the iPhone, and the shift of support across the industry from Windows to Linux in servers, the days of Microsoft's monopolistic grip on the desktop are winding down.

Apple doesn't have to take a majority share of the desktop market to win, it only needs to take the most valuable segments of the marketr, nimbler, and less expensive rivals....

Is Apple big enough?
One remaining bit of illusion is that Apple simply can't compare to the heavyweights that control the industry because of its "small market share." A comparison of Apple's market capitalization--the value of the company assigned by investors in the market--helps to explain why Apple can't be ignored.

"Shift Happens"

This attention-getting video clip is a bit of futurist forecasting, with emphasis on demographic and information technology-driven changes.

I just wonder how poor old human beings, with our ape brains, are going to cope. Just consider the havoc created by one technological advance: cheap, reliable, non-intrusive birth control, as in The Pill. Forty years later, we still haven't adapted. Female reproductive control means women have better access to work of all kinds and can have real careers, women have more money, men have more competition, women don't have to put up with marriages that don't suit them (note even if the guy filed for divorce, the cause may well be the woman's refusal to be compliant and subservient), ergo higher divorce rate and all these new complicated child rearing arrangements and family structures. If you believe the New York Times Style pages, what women want seems to change every 10 years, which means we haven't reached a new equilibrium yet.

The factiod I found most striking was the one on how many jobs people will have over their working life. For most adults, the workplace is our main community. Changing jobs is a high stress event. Similarly, starting a new job, even if it is one you sought, is also hard psychologically. But if this forecast is correct, a change in degree will be a change in kind. Jobs will be so transient that many people won't invest in forming relationships at the office.

And humans do need relationships, even casual ones. It's part of our wiring (the limbic brain, to be precise). Primates and babies that don't get enough nurturing early on either die or are highly disturbed. And it's not as if we can switch off these needs once we exit infancy (although they do become less intense as we are better able to care for ourselves).

It seems this brave new world will require lots of Prozac.

Fuel Efficiency Standards Vs. Gas Tax

A great post, "CAFE Standards," from James Hamilton at Econbrowser on how fuel efficiency standards (technically, corporate average fuel efficiency, or CAFE) work and their effects in practice. He in turn cites research by Marc Jacobsen, an economics PhD at Stanford.

I found it useful to understand a bit more about how these standards are applied, particularly since the popular press generally glosses over these details.

Econbrowser provides a very good summary of the paper, but let me highlight the key points:

• "Almost all the profit impact of CAFE is borne by domestic firms." Japanese automakers are already fuel-efficient; tightening the standards doesn't affect them. The European car makers pay fine rather than changing their cars.

• CAFE costs six times as much as gas taxes for the same amount of fuel use reduction.

Why the continued reliance on CAFE, if it is so inefficient? Because the costs aren't visible to the consumer, while gas taxes would be. Better to do something that pretends to solve the problem, but doesn't annoy voters, than do something effective that might force people to change behavior. Except this strategy, ironically, does hurt Detroit automakers, and so is detrimental to some American workers.

From Econbrowser:

Featuring prominently in the new energy plan from President Bush is a call for changes in the corporate average fuel efficiency (CAFE) standards that the Administration claims could reduce U.S. gasoline consumption by 5% over the next 10 years. Here are some of the reasons I'm not thrilled by that suggestion.

CAFE standards are based on the premise that auto manufacturers and consumers are making inappropriate decisions about the kind of vehicles that get produced. The clearest way to motivate this from an economic perspective would be to suggest that there are costs to using gasoline beyond those paid directly by consumers, such as a geopolitical cost when the U.S. relies on imported oil or possible consequences for the world climate. But if that is the motivation, an economically more efficient way to accomplish the objective would be to tax the gasoline use itself so that the after-tax price paid by consumers completely reflects whatever these true costs are deemed to be. This has the benefits of providing an incentive not just to purchase more fuel-efficient cars, but also to encourage more fuel conservation in the use of the existing fleet through such measures as driving slower, driving less, or getting more of the existing mileage from the more fuel-efficient vehicles. And it allows consumers and firms the maximum flexibility to figure out how to do this in the least disruptive way.

When you force consumers to buy something other than their first choice, the consequences may not be quite what the policy-maker originally envisioned. One example sometimes given is the shift to SUVs. Because the initial CAFE standards were different for "light trucks" as opposed to "cars", one way Detroit responded to CAFE was to create a new supersized vehicle that in practice is used the way a "passenger car" used to be, but that wasn't similarly regulated. A second example of a possible unintended consequence of tightening CAFE is that if American cars no longer have the characteristics sought by consumers, they will buy more imports.

There is an interesting new study of this by Mark Jacobsen, an economics Ph.D. student at Stanford whom we're trying to persuade to join our faculty at UCSD. Jacobsen notes that auto producers generally fall into one of three groups, as exemplified by Toyota, Ford, and BMW in the diagram below. The fleet of a Japanese producer like Toyota usually has an average fuel economy that is higher than the existing CAFE standard, meaning that a modest increase in the standard would not affect them directly. European producers like BMW fail to meet existing CAFE standards, and choose to just pay the fine that is required for any company that fails to comply. The third group is the U.S. producers like Ford, who feel that violating the CAFE standards would expose them to unwanted publicity, litigation, or further undesirable legislation, and therefore stay just inside the standard. It is thus the U.S. auto producers who do the adjusting when CAFE standards are tightened.



Jacobsen builds a detailed model of the American new and used car market based on the choices consumers make between different kinds of cars. His simulations suggest that one consequence of tightening CAFE standards is an increase in the number of imported cars and a decrease in the fuel efficiency of those cars. Essentially the European producers have an advantage over the American producers in being more willing to flaunt their violation of the CAFE standards, and the Japanese producers have the advantage of selling enough compact vehicles to be allowed to expand less-efficient models such as the Acura. Thus, people who like bigger cars end up buying more of them from the importers when the standards are tightened.

Overall, Jacobsen estimates that a one-mile-per-gallon increase in the required average corporate fuel efficiency would increase the average fuel-efficiency of all new cars sold by 2.5%. However, since most of the older cars would still be on the road, Jacobsen estimates that during the first year, total U.S. gasoline consumption would decline by only 0.8%. He estimates the costs of this 1 mpg tightening of CAFE would be $20 billion in the first year, with these first-year costs shared about equally between U.S. consumers and producers. For comparison, Jacobsen claims that a gasoline tax could accomplish the same first-year effect at an efficiency cost of significantly less than $1 billion.

Over time, the fuel savings from tightening CAFE would of course increase, but even after 10 years, Jacobsen concludes that that a gasoline tax could accomplish the same thing at 1/6 the cost.

Although it is hard to motivate CAFE from sound economic principles, somehow it has political staying power. The public evidently sees the costs associated with CAFE as borne by "somebody else" whereas they know they pay the gasoline taxes themselves. But here's another possible proposal that might be suggested by Jacobsen's research. Why not start decrying the fact that some of those foreign companies are failing to comply with our existing CAFE standards, and claim that what we need to do is get more serious about enforcing these, and raise the payment required per vehicle of any company that fails to meet the standards? In practice, this would amount to either raising the tax on BMWs, or forcing the European importers to sell some more fuel-efficient vehicles. Ford and GM would be spared, as long as they continue to stay within the existing standards.

Maybe not a proposal that an economist would love. But a politician might. And it seems that's the name of the game here.

Greener Vehicles Possible Now

Roland Piquepaille's Technology Trends, in his post "Super-green minivans possible today," picks up on a Mercury News story that discusses what amounts to a low-emissions minivan, one that meets the stringent California requirements for 2016. Except this car hasn't been built yet:

According to the Mercury News, the Union of Concerned Scientists (UCS) has designed a super-green minivan. The Vanguard is a vehicle concept that could cut greenhouse gas emissions by 40 percent and exceed California's 2016 global warming standards. This minivan, which only exists as a computer simulation, would use existing technologies and could run on a gasoline-ethanol blend. Such a vehicle would only "cost $300 more than one of today's minivans, but it would save an owner $1,300 over the lifetime of the vehicle." Of course, as UCS is not a car maker, it's hard to know if such a concept will really be used by the automotive industry....

While the Vanguard concept has been only really applied to the design of a minivan, its features can also be used in other vehicle classes to cut their greenhouse gas emissions by more than 40 percent. Below is a picture showing three classes of vehicles and the reduction of global warming pollutants which could be obtained. From top to bottom are a minivan, a compact pickup truck and a large truck.

It's going to be interesting to see whether this story is picked up and how it is spun. The issue isn't whether the minivan and its cousins will work. I guarantee you that MIT students could fabricate the vehicle in a month.

The important thing about these computer designs is that they throw the gauntlet down to the auto industry and show by making use of technology already in use, they could produce much more fuel efficient cars, even in large sizes.

However, note the question is not really making the new computer model into a car. The car is a proof that you can do a lot more with what you have. If the auto industry can't (or won't) produce something like the proposed vehicle, they probably could ascertain which established emission-reducing technologies have the biggest bang for the buck, and start incorporating them.

But the weak point of the scientists' argument is focusing on a particular design and suggesting pricing. Anyone who has looked at new tech products will tell you that assumptions about scale economies in manufacturing are pretty speculative. If they choose to, the carmakers could easily raise doubts about the Union of Concerned Scientists' cost assumptions, and use that to discredit the underlying premise.

The reason I am skeptical about Detroit's willingness to make a sincere effort to advance new energy-efficient technologies is that I did some work on advanced batteries many years ago (California and 11 Northeastern states had set a target that a certain percentage of autos sold had to be zero emission, meaning battery driven). Now the legislation was poorly conceived (how do you mandate sales mix?). But it was also clear in dealing with the automakers (and I was working with a potential investor, mind you, we had not drunk the Kool Aid) that although they were spending a good deal of money on research and prototypes, it was simply to stave off criticism. Their real investment of energy (no pun intended) was in killing the legislative initiatives, which they did.

But if stories like this don't reach a broader audience, they won't even have to go that far.