Category: Economics

The Great Depression versus the Great Recession

One of the signposts at the beginning of 2012 is that the U.S. economy seems to be recovering. The troubles in the Euro-zone are still creating great uncertainty and people are still cautious. But manufacturing outputs are continuing to increase. I see “help wanted” signs starting to appear in business doors. (Feel free to disagree with this conclusion.)

One sign of trouble is that the unemployment rate is still very high. There are 6.6 million fewer jobs in the United States than there were four years ago. Some 23 million Americans who would like to work full-time cannot get a job.

Those of you following the macro-economic responses to 2008s Great Recession know that Ben Bernanke was a student of the 1930s Great Depression. One of the lessons he took away was that the Federal Reserve’s tightening of the money supply as a response to the economic conditions  helped cause the Great Depression. Bernanke took the opposite response at the beginning of the Great Recession and opened the monetary spigots wide open as a response to the woes of the financial sector in 2008.

Bernanke saved the banking system, but the economy is still stubbornly not creating new jobs.

The failure to create jobs is unlike any other post-WWII recession. Look at the percentage of job losses in this chart.  It’s not just a dramatic loss in jobs. There seems to be structural loss in jobs that the economy is not creating. You can see it in the numbers of the long-term unemployed.

It looks like something has changed in our economy.

Joseph E. Stiglitz, a man much smarter than me, has made some comparisons between the Greet Recession and the Great Depression in the December issue of Vanity Fair: The Book of Jobs. His theory is that the dramatic upheavals in the economy are a result of dramatic changes in the workforce.

Just before the Great Depression more than 1/5th of all Americans worked on farms. By comparison,today only 2% of Americans produce our food, plus a surplus to ship to other countries and to burn as fuel in our cars. Accelerating productivity before the Great Depression created a surplus of farm products, which lead to lower prices, which lead to a decline in farm incomes. Farmers had borrowed heavily to sustain production and were faced with the inability to pay back the banks. This swept the financial sector into the “vortex of declining farm income.” The 1930s America was moving from an agricultural economy to a manufacturing economy.

The parallel to 2008 is that the US economy has realized a tremendous increase in productivity in manufacturing. Contrary to popular opinion, American still has a robust manufacturing base. American manufacturing output has doubled since 1975.

We just don’t make as much of the same stuff as we did in 1975. Labor intensive products are made cheaper overseas. You won’t see the Made in the USA label very often on clothing, toys, and consumer electronics. It takes one third fewer people to manufacture twice as much stuff in America. Bruce Greenwald and Judd Kahn theorize that although the loss of jobs to overseas providers is significant, it’s the increase in productivity that caused most off the job losses in the manufacturing sector.

Andrew McAfee and Erik Brynjolfsson point out that the human workforce has to compete against the automated workforce of computers and machines. If a computer can do your job, then your job may be in danger. This is becoming increasing true in white collar jobs and not just manufacturing.

Stiglitz theory is that the cheap debt and rising home prices of the last decade allowed us to disguise the loss in jobs an income that came from the loss in manufacturing jobs. As a county, we were using our homes as piggy banks creating artificial demand. In 2008, the curtain was pulled back to reveal the true weaknesses in parts of the economy.

Perhaps it’s time to compare the abandoned farms of the 1930s to the abandoned homes of today’s Detroit.

What does this mean for compliance?

I’m not sure. Certainly, it will mean more changes. I expect we will continue to see changes in regulations and business practices as the government and industry grapple with the changes in the economy. We can already see in today’s Iowa caucus that the Republican presidential candidates most discussed topic is jobs. Politicians will continue to pin the blame on fat-cat bankers for quite a while. They make an easy target.

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Occupy the SEC

I will admit that I have been personally dismissive of the Occupy Wall Street movement and the splinter group of Occupy Boston that I pass by on the way to the office. Yesterday’s post on Occupy LEGO Land was an example. They lack a message and I personally think most of their message are off base. (Down with Evil Corporations)

One thing that caught my eye was infrastructure. Occupy Boston has a wooden street right down the middle of their tent city. There is a food tent and a legal tent. (There’s probably more examples of physical infrastructure.) That means collective decision-making and an allocation of resources. That means a community has formed from the mob of the 99%.

That collective decision-making can be seen in the General Assembly Meeting that happens every night. There is a participatory democracy, with everyone given a right to speak.

Why not take that model to the regulators? Why not make the Securities and Exchange Commission listen to the comments from everyone?

…What’s that?     … They do that?    … Where?

Actually, the SEC allows anyone to submit comments on their proposals.  Take for example the hundreds (thousands?) of comments the SEC received on Definitions Contained in Title VII of Dodd-Frank Wall Street Reform and Consumer Protection Act. Anyone can submit a comment by sending a letter, using the web, or sending an email.

Will they listen? I assume they read each and every comment letter. The participatory democracy of a few hundred campers on the Greenway does not scale to the complex economy of a few million. Regulators need to choose among competing interests that protect the public, yet give the regulated the guidance they need. Everyone’s voice can still be heard.

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Occupy LEGO Land

As the #OccupyWallStreet protests grew, it was inevitable that the movement would spread in unusual ways. That includes plastic toys.

“We must not be LEGO ‘lands’
— We must be a LEGO NATION.”

#OccupyLegoLand is a Facebook Fan Page that gives voice to LEGO minifigures. Like Occupy Wall Street, they are battling on many fronts: working in horribly exploitative conditions, war, bankers, and the release of the new iPhone.

#OccupyLegoLand aims to rebuild the world, brick by brick.


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Carried Interest and Obama’s American Jobs Act

The tax treatment of carried interest has been eyed as a revenue source off and on for the past few years. It’s back in the sights of the administration in the new American Jobs Act.

Subtitle B – Tax Carried Interest in Investment Partnerships as Ordinary Income

Section 411 – Partnership Interests Transferred in Connection With Performance of Services.
Current law allows service partners to receive capital gains treatment on labor income without limit, which creates an unfair and inefficient tax preference. This section would tax as ordinary income, and make subject to self-employment tax, a service partner’s share of the income of an investment partnership attributable to a carried interest because such income is derived from the performance of services.

Section 412 – Special Rules for Partners Providing Investment Management Services to Partnerships.
To the extent that a service partner contributes “invested capital” and the partnership reasonably allocates its income and loss between such invested capital and the remaining interest, income attributable to the invested capital would not be recharacterized. This subtitle would be effective for taxable years beginning after December 31, 2012.

Full text of the American Jobs Act on WSJ.com

Germany, Sub-Prime Mortgage Backed Securities, and Scatology

Michael Lewis continues his around the world tour of the 2008 financial crisis from the view of Germany: It’s the Economy, Dummkopf!. The story in the September issue of Vanity Fair seems to be all about excrement. We heard that there were big chunks of the mortgage securities business that were terrible. There is the famous email describing the Timberwolf as on sh*tty deal.

Lewis did great job offering some insight from Ireland, Greece, the Iceland. In this story he seems distractedby feces and Nazis. The biggest insight I took away was:

At bottom, he [Dirk Röthig, of the German financial institution IKB] says, the Germans were blind to the possibility that the Americans were playing the game by something other than the official rules. The Germans took the rules at their face value: they looked into the history of triple-A-rated bonds and accepted the official story that triple-A-rated bonds were completely risk-free.

IKB and many of the other German banks thought they were getting a good return on the mortgage-back securities with little risk, but were actually getting a sh*tty deal. I get it. But I think he belabors the metaphor.

Michael Lewis could write about the economics of a paper bag and I’m sure it would be interesting story to read. In fact, I paid for a subscription to Vanity Fair just because of his articles. This one came up a bit short. Maybe he just thought the underlying story was not interesting enough so he spiced it up with lots of stories about German scatology. He layers in some Jewish alienation in Germany for some spice in his the discussion of feces.

It’s the Economy, Dummkopf! is still worth reading and still offers a few great insights into the 2008 financial crisis.

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Popping the Irish Bubble

In compliance, you need to learn from your mistakes so you can prevent future problems. There were many mistakes that lead to the 2008 financial crisis, not just in the United States, but also abroad. Michael Lewis wrote The Big Short, taking a look at the Unites States financial crisis and has written great stories on the financial crises in Iceland and Greece.

His latest story in Vanity Fair focuses on the troubles in Ireland: When Irish Eyes Are Crying.

He makes this one look easy. Ireland’s banks made too many bad real estate loans and the Irish government foolishly guaranteed the obligations of the Irish banks.

Lewis quotes Theo Panos, a London hedge fund manager: “Anglo Irish was probably the world’s worst bank. Even worse than the Icelandic banks.” The bank faced losses of up to 34 billion euros. A big number, but the sum total of loans made by Anglo Irish was only 72 billion euros. This one Irish bank had lost nearly half of every dollar it invested.

The signs of an immense real estate bubble sound obvious. A fifth of the Irish workforce was employed building houses and the construction industry had become a quarter of the country’s GDP. As for prices, since 1994 house prices in Dublin had risen more than 500 percent. As a measure of affordability, rents had fallen to less than 1 percent of the purchase price. Your $833 in rent would be for a home with a sales price of a $1 million.

There was a tight link between the Irish banks and Irish real estate. Lending to construction and real estate has risen from 8% to to 28% since 2000.

The Irish government stepped in to help save the banks from their poor underwriting and poor investments. Instead of merely standing behind the deposits at the Irish banks, the government guaranteed all of their obligations. Investors who were looking to dump bonds issued by the banks for pennies on the dollar, were rewarded for holding on to them.

There are plenty critics of TARP and the bailout of the US banks. But it was a significantly smaller intervention than what happened in Ireland.

It’s worth your time to take a few minutes and read When Irish Eyes Are Crying.

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Frontline Investigates Bank of America and the Government’s Role in the Banking System

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Tuesday night is the premiere of Frontline’s latest report: Breaking the Bank. The report is supposed to include high-profile interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain and will reveal the story of two banks at the heart of the financial crisis and their rocky merger. It may also look at the implications of the government’s new role in taking over (“nationalizing”?) the American banking system.

“The bets were huge and risky—billions of dollars on the housing market. The upside was undeniable—superbanks reaped billions of dollars, dominated the landscape, and gobbled up competitors. Then the bottom dropped out—the massive losses on Wall Street nearly broke the banks. In the worst crisis in decades, brand name banks are on the brink. Now as the federal government implements an unprecedented intervention in the industry, FRONTLINE goes behind closed doors to tell the inside story of how things went so wrong so fast and to document efforts to stabilize Wall Street. Veteran FRONTLINE producer Michael Kirk (Inside the Meltdown) untangles the complicated financial and political web threatening one particular superbank-Bank of America.”

UPDATE: The full version of the program is now available for viewing online: Breaking the Bank.

Here is a preview:

If you missed them, the Frontline reports on Inside the Meltdown and the Madoff Affair were wonderful and worth your time to watch. They are available online:

Iceland’s Meltdown

iceland-flag

With all of the focus in the United States on the collapse of Bear Stearns, AIG, Lehman Brothers, and Merril Lynch, we may be a bit myopic in not noticing other issues around the world. Iceland stands out as a country that has really run into trouble. As Michael Lewis wrote in Wall Street on the Tundra: “Iceland instantly became the only nation on earth that Americans could point to and say, ‘Well, at least we didn’t do that.’”

The collapse has been so big that Iceland is abandoning its own currency to join the European Union. Until the collapse, Iceland had little interest in joining the EU. They do want the bureaucrats in Brussels messing with their fishing. Iceland put some excellent regulatory controls on fishing that have lead to stable fish populations and rich fishermen.

They failed to do the same with their financial system. They ended up having fisherman quitting the sea to engage in currency trading.

There are lots of lessons to be learned from a compliance and risk management perspective.

Legend has it that Joe Kennedy cashed out of the stock market when his shoeshine boy gave him stock tips. Maybe a warning sign should be fishermen engaging in currency trading. We saw similar events in the U.S. as people quit their jobs to be real estate entrepreneurs. I heard a success story from an acquaintance who told of buying a house for 100, putting in 10 and selling it for 120. I didn’t have the heart to tell him that house prices has risen by 15% during that same time frame. A rising market makes everyone look like a genius.

As Michael Lewis points out “One of the hidden causes of the current global financial crisis is that the people who saw it coming had more to gain from it by taking short positions than they did by trying to publicize the problem.” You saw that with Iceland’s collapse and you saw that with the collapse in the United States. The most publicity shined on Goldman Sachs for its profits in September 2007 made from shorting mortgage positions. I am sure that there were quite a few mortgage originators who knew they were peddling garbage. But they had no incentive to stop the income coming from origination fees.

The three biggest banks in Iceland, a country of only 310,000, made loans totaling over 850% of Iceland’s Gross Domestic Product.  Only 1/5 of the loans were in Iceland’s currency. They instead borrowed from their banks in cheaper currencies such as yen and Swiss francs. To compare, the balance sheet of Britain’s banking system was at 450% of GDP and the US at 350%. Clearly, carrying too much debt is a problem. Especially when their are few alternative sources of capital besides more debt.

Iceland’s debt load increased from 200% of GDP in 2003 to almost 1000% in 2008. That is an enormous growth curve. Even steeper than the rise of housing prices in the United States.

Economic cycles are part of human nature. We overbuy into good times and oversell in bad times. It easy enough to look back a few years to the Dot-Com bubble focusing on market share and eyeballs at the expense of the bottom line.

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