Mark Mobius is one of the most famous Emerging Markets investors and right now he is bullish on Emerging Markets despite a huge rally in shares from late last year. Mobius turned bullish right as shares troughed and has remained so ever since.

Mobius likes the so-called ‘Frontier’ Markets more than the well established BRICs.  He mentions Kazakhstan, Romania, Kenya and Vietnam as examples. Below is a video of Mobius from the Telegraph, explaining that investors need to take a five-year view and be prepared for lower liquidity and extreme volatility (20 or 30% corrections) to profit.

Note that his reasons to be bullish are:

1. Money printing globally will underpin shares (a view Marc Faber also holds)
2. “Derivatives are not dead. There are $600 trillion worth of derivatives out there,” according to Mobius. As a result, leverage will goose returns supplied by the money printing.

Both of these are technical factors that do not speak to the underlying fundamentals.  It does suggest that government action may be the dominant force in markets for some time to come, a view espoused by Pimco’s Bill Gross.

The video runs just over five minutes.

Related posts:

• Mobius: Emerging market stocks are breaking out
• Marc Faber makes bullish comments on Bloomberg
• Marc Faber on passing the baton to emerging economies
• Whitney Tilson of T2 Partners, a new media darling, strikes a bullish tone
• Fred Hickey: Gold starts secular bull, tech ends secular bear

Below is a video released by the Kauffman Foundation about bloggers in the econ and finance space.  The video shows that our space is really catching on and garnering ever more readership and credibility.

This clip runs about 20 minutes and features Tyler Cowen and Mark Thoma, two well-known academics who also have top economic blogs. Two other favorite bloggers of mine, Paul Kedrosky and Yves Smith, are also featured.  Take a look.

Hat tip Real Time Economics.

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In the video below, William Black, a well-known Associate Professor of Economics and Law at the University of Missouri – Kansas City and former top regulator at of the Federal Home Loan Bank Board during the S&L crisis, holds court.

His basic premise: the bailouts have been a massive transfer of wealth from the middle class to the monied class.  He can be a very entertaining speaker.  Watch this video for a few interesting tales and ideas. It runs just under 100 minutes.

Dealbreaker says bank robberies are down, but Black has a different idea of what a bank robbery is. Catch his book “The Best Way to Rob a Bank Is to Own One” at Amazon.

Related posts:

• Black: Stress tests and the Big Lie
• Paul Krugman on the global economy
• Forstmann on Charlie Rose: easy money caused crisis
• Frontline – The Warning: Who Knew About the Looming Financial Crisis?
• A conversation with Peter Orszag on Charlie Rose

Update: These clips have sadly been removed from YouTube.

Clips from the 1987 PBS Film called Trader featuring famed investor Paul Tudor Jones are catching everyone’s imagination all of a sudden.  Is it that we are all secretly worried about a sock market crash?  Who knows.  It’s entertaining nonetheless and is a good piece of financial history.

I have to give you a fashion statement alert before you watch.  This is 1987 and, while I’m sure these guys thought they were pretty spiffy dressers, they’re looking a bit naff.  Check out the huge glasses, the suspenders and women with poofy hair. Kind of reminds me of “Wall Street”, “Working Girl” or “Bonfire of the Vanities.”

As for Jones, he’s filthy rich now.  But, he too took it on the chin during the recent credit crisis. Lately, things are going a bit better for him.

Here are the seven clips now on the net. Enjoy.

Related posts:

• “I want to be a corrupt official when I grow up”
• Louise Yamada: Sell stocks; Dow could be headed for 6000
• 1987
• Chart of the day: Dow Jones vs. Treasuries
• On BBC World Service talking autos at 2PM Eastern

Below is a very good hour-long interview I spied earlier today with Janet Tavakoli, the author of a new book ”Dear Mr. Buffett.”  Hat tip Zero Hedge.

I also linked out earlier today to a piece she wrote over at CNN on “What Wall Street owes you.”  Take a look.

Source

C-Span Q&A, 19 April 2009 Transcript

Related posts:

• Janet Tavakoli on fraud, derivatives, and bankruptcy
• Paul Krugman on the global economy
• Stephen Roach and Jim Grant: Video of credit crisis thoughts
• World Economic Forum: Experts voice their views on the economy
• George Soros: the credit crisis of 2008

I have highlighted comments by famed Columbia University economist Jagdish Bhagwati before (see “Jagdish Bhagwati: Obama is a protectionist”).  Bhagwati has since gotten with the program and sees Obama in a much more favourable light.  However, he is sceptical because Obama has not said boo about free trade.

Now Bhagwati is turning his attention away from trade, his specialty and talking inflation.  He’s not saying he’s 100% sure the U.S. will go into hyperinflation like some pundits.  But, in talks with the Financial Times Deutschland, he did make clear that he is worried about inflation. Nevertheless, he too warns of a 1937-style Armageddon if stimulus is withdrawn too quickly.  He goes into a lot of other topics as well, including the cozy relationship between Wall Street and Washington (singling out Tim Geithner in particular) and the lack of regulatory reform.

My translation of the German-language article is below.

The world renowned Economist Jagdish Bhagwati is not worried about financial markets – but he is worried about the risk of inflation.

The world renowned economist Jagdish Bhagwati has warned the governments in Germany and the United States about an erroneous assessment of inflation risks in their respective countries. Angela Merkel’s fears are "excessive", while the Americans have been reckless regarding the future risk of rising prices, said the Columbia University professor and Globalisation guru to FTD. "In the U.S., they underestimate the inflation threat: There are enormous amounts of money in circulation, but there have been no announcements for a clear exit strategy."

The Indian is world renowned for his defence of free trade and globalisation. Following the crisis, he argued that globalization in trade was a success, but, in the financial markets, it had failed.

Germany tends to be too cautious when it comes to supporting the economy, said Bhagwati. It is certainly "too early, now or in the next few months," to roll back stimulative measures just because medium inflation risks are present. A premature withdrawal would have disastrous consequences, according to Bhagwati, as we have seen in the past. "For a reversal, 18 to 24 months seems an appropriate time frame."

Bhagwati classified it as basically correct that Merkel is reacting to the fears of the population. "In the U.S., a concrete plan of how the stimulus will be taken back is completely lacking," the economics professor criticised. Even if the date for the withdrawal cannot yet be set, the government should demonstrate how they will proceed "as concretely as possible.”

The macro-economist showed scepticism about a third stimulus package. Laura Tyson, a key adviser to U.S. President Barack Obama, among others, has called for such a program. "As yet, not even all the money from the first package has been spent," said Bhagwati. Thus, spending more makes little sense. "The next delayed instalment of the first package will act like a third stimulus." The discussion underscored the lack of sensitivity to inflation risks. Much of the spending would be appropriated wrongly anyway, and corruption would creep in, the Columbia economist criticized. "The bulk of the money will be wasted."

The U.S. economic measure are less reason for hope for the world economy, according to estimates given by Bhagwati, than the recent signals from Asia: "In China and India huge bottlenecks in the infrastructure provide for substantial additional demand," said Bhagwati. That would help the rest of the world out of the crisis, including the United States. "In this respect I am optimistic that the crisis will no longer last for years."

In regards to the financial markets, the economist now has no more worries: "I would not step onto an aircraft carrier and declare that the war was over like George W. Bush once did – but I think we are on the right track."

Nothing has changed, in Bhagwati’s view, regarding the close link between Wall Street and politics. There is a lack of critical distance, which was one of the main causes of the financial crisis. "The reform of rating agencies is, thus, an urgent need," said Bhagwati. Moreover, he again called for the establishment of a financial market supervisory body of independent experts. Possible candidates [to head the body] would be Harvard economist Kenneth Rogoff, Fed Chairman Ben Bernanke and Deutsche Bank Chief Economist Norbert Walter.

Therefore, Bhagwati was critical about the new U.S. Treasury Secretary Timothy Geithner. He is considered closely allied with Wall Street. "I was not too excited about this staff selection," said the economist.

Source

"USA unterschätzen Inflationsgefahr" – FTD

Related posts:

• Jagdish Bhagwati: Obama is a protectionist
• GDP: imports, inflation and local government are the story
• Kasriel: ‘greater risk for the global economy…is inflation’
• Does the US need a second stimulus package?
• Morgan Stanley warns of a new inflationary period

Here is a clip from the Daily Show with Jon Stewart that highlights Lenny Dykstra, the former baseball player turned financial guru.  To my mind, it really puts the bubble years into perspective.

By the way, I am a Boston Red Sox fan. And, in 1986, when the hated New York Mets beat us in the World Series, I was living with two Mets fans. Needless to say, I got a lot of stick, so Lenny Dykstra is not one of my favorite ball players.

Related posts:

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• Rosenberg: The Grinch who stole Christmas
• GM drops to 53-year low
• The new Star Trek film is here
• Marc Faber: “The feds poured the gasoline and lit the match. Now they’ve joined the fire department

I love this guy. If you are looking for a guy who is super bearish on the U.S., then David Tice is your man.  He sees unemployment at 15%, stocks well down from present levels and a serious Depression with a Capital-D in the offing.  In short, he’s talking about a financial and economic catastrophe.  Obviously, I don’t see things quite as starkly based on my previous comments. Nevertheless, he is refreshing to watch. Very entertaining.

Below is a recent clip from 2 Jul 2009 that I caught of him spinning his doomsday tale on Bloomberg.  I liked it so much I decided to post several videos of him from earlier appearances on Bloomberg which are below the first video.  He makes a lot of sense if you watch them in chronological order from bottom to top.

Enjoy.

12 May 2009

17 Apr 2009

05 Feb 2009

25 Aug 2008

9 Jul 2008

16 Apr 2008

06 Feb 2008

20 Nov 2007

Related posts:

• Marc Faber: “it’s very tough for a forecaster who was ultra-bearish to stay bearish”
• Getting bearish again
• A conversation about Prop. 8 with David Boies on Charlie Rose
• Stephen Roach is still bearish, no recovery until 2010
• Why I am bearish on the U.S. Dollar

Jim Cramer is not just calling a stock market bottom, but now he’s calling a housing bottom too.  In fact, he says go buy a house.  “Buy a house and buy Bank of America too?”  Cramer says: “This is patently obvious.”

Take a look and tell me what you think.  Personally, I know his stock picking record is dubious so I tend to dismiss this too. Hat tip Joe Weisenthal.

Related posts:

• Nationwide: U.K. house prices down 16.6%
• UK house prices up for third time in fourth month
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• Nationwide: U.K. house prices down 17.6% in year to Februay
• House prices in the U.K. up for first time since Oct 2007

I found this story and video of Bill Black on Tech Ticker (hat tip Larry Doyle). Basically, Black thinks the stress tests were a joke, a common theme heard from those in the know. Listen to what he says about a really difficult stress test we gave Fannie Mac ten years ago.

Results of the stress test brought a collective sigh of relief from Washington D.C. to Wall Street Friday, and stocks were rallying again on a growing sense the financial crisis has past. Don’t you believe it, says William Black, an Associate Professor of Economics and Law at the University of Missouri – Kansas City.

“It’s in the interest of the financial community to send this propaganda out,” Black says. “It’s remarkable not that they do it but that it still works.”

In other words, this isn’t the first time we’ve been told “the crisis is over” and that “banks are well capitalized” – and probably won’t be the last.

The professor and former financial regulator foresees another wave of foreclosures and future bank losses of more than $2.5 trillion vs. the government’s $599 billion estimate.

Simply put, the stress tests weren’t strong enough to be considered “wimpy,” Black says. Furthermore, Fannie Mae, Freddie Mac, AIG and IndyMac were deemed to have “passed” much more stringent government stress tests before their respective failures, he notes, recalling the grim history…

Related posts:

• Reinhart: Not everybody can be above-average in stress tests
• Ackman and Stigliz talk Stress Tests with Charlie Rose
• Bank by bank breakdown of stress test results
• Stress tests reveal Citi and BofA need more capital, but you knew that already
• What the stress tests reveal about Obama’s thinking on banks

Elizabeth Warren, the chair of the Congressional Oversight Panel to oversee TARP, goes ballistic in this interview with the guys from Tech Ticker. She gets right to the heart of what is wrong with the banking industry.  You can tell she is very passionate about this issue.

Take a look.  Below are the videos in two parts.  Also, see the attached article linked below.

Part I

Part II

Source

Americans’ Trust “Shattered” & CEOs Still in Denial, Elizabeth Warren Says – Tech Ticker

Related posts:

• Elizabeth Warren: “The big banks always get what they want”
• A conversation with Elizabeth Warren on Charlie Rose
• Blodget interview with “the man who destroyed my Wall Street career”
• Warren Buffett: Don’t expect miracles from Obama
• Independence Weekend Massacre: 7 banks seized

On Monday, I mentioned that the Asian Development Bank Fund was a clear sign that Asia was cutting loose from the west and looking to take care of things domestically.  WIlliam Pesek of Bloomberg News put out a piece this morning echoing those sentiments, but also adding a lot more background regarding the events leading up to the Asian Crisis in the late 1990s, which I think is relevant.  Below, are some relevant excerpts from the Pesek post with a link in the sources at the footer.  Afterwards, I will follow that with a 2005 piece from Marshall Auerback that runs on similar lines.

Pesek starts off:

The International Monetary Fund’s 1997 meeting has a special place in the hearts of many journalists.

There we were in Hong Kong, Asia’s economies crashing around us, watching George Soros duke it out with Malaysia’s prime minister. The billionaire described Mahathir Mohamad as a “menace to his own economy.” Mahathir labeled Soros, one of the speculators blamed for attacking Malaysia, a “moron.”

That brawl comes to mind as another big story out of the event comes full-circle. It involves an Asia-only bailout fund, Lawrence Summers and Timothy Geithner. Its implications will travel far and wide in the fastest-growing economic region.

The “Asian Monetary Fund,” so passionately derided by Summers and Geithner at the time, is back. There is little a crisis-plagued U.S. can do to stop Asia’s $120 billion foreign- exchange reserve pool. Its creation is the clearest sign yet that Asia is getting serious about combating the global crisis. Done right, it will bode well for the region’s outlook.

There is still a role for Soros and Mahathir in this story more than a decade later, and I’ll get back to them shortly.

In September 1997, Summers was deputy U.S. Treasury secretary and Geithner was just being sworn in as assistant secretary for international affairs. Today, they are director of the White House National Economic Council and Treasury secretary, respectively. Back then, Summers, Geithner and their boss, Robert Rubin, objected to Asia having a bailout fund.

Eclipsing the IMF

Their concern was that it would eclipse the IMF in the region and, by extension, the U.S.’s say in how Asia retooled economies. They feared doling out billions of dollars in aid with few policy-change strings attached would prove dangerous. And they got their way. That changed this week.

From 1997 to 1998, the IMF arranged about $100 billion of loans to Indonesia, South Korea and Thailand as currencies collapsed. In return, governments had to cut spending, raise interest rates and sell state-owned companies. The IMF’s policies needlessly deepened the turmoil.

During this global crisis, nations sought help from neighbors instead of borrowing from the IMF. Indonesia, for example, raised $5.5 billion of standby loans from the Asian Development Bank, World Bank, Australia and Japan, and increased the size of its currency-swap arrangements with China and Japan to bolster access to foreign exchange.

A quick re-cap then?  In 1997, Asia blew up.  The IMF got involved.  At the time, Tim Geithner and Larry Summers had prominent roles in making sure it was the IMF and not the ADB which was central to the process.  Now, in 2009, it is the U.S. which has blown up spectacularly and the U.S., with Geithner and Summers again in positions of authority, is in no position to dictate terms.  Hence the ADB monies.  The U.S. may have forgotten the Asian Crisis, but the Asians have not.  Marshall Auerback wrote a post 4 years ago reminding us that an Asian Monetary Fund was in development. Here is what he had to say with my highlighting for emphasis:

Even prior to the Asian financial crisis of 1997, the Japanese had begun to sell the idea of creating an Asian monetary fund to provide regional liquidity. Almost as soon as the trial balloon was launched, Washington shot it down with great force, sending Lawrence Summers, then Deputy Secretary of the Treasury to the region to make sure the message was not misunderstood. In spite of the subsequent travails experienced by the region, the idea apparently died a quick death.

Or did it? When Haruhiko Kuroda, former Japanese Deputy Minister of Finance for International Affairs, took over the helm of the ADB on February 1st of this year, he quietly began to promote the idea again. Kuroda has long been a strong advocate of an Asian Monetary Fund, an idea whose time may have come, given the increasingly low esteem with which the International Monetary Fund is held, particularly in emerging Asia, which has long been the world’s major savings repository.

It’s worthwhile looking again at the history of this venture: in the spring of 1997, before the onset of the Asian financial crisis, Japan and Taiwan had offered to put up $100 billion to help their fellow Asians cope with any potential fallout which might arise in the event of a precipitous withdrawal of short-term portfolio capital from their respective economies. The idea was killed by then-Treasury Secretary Robert Rubin and Deputy Secretary Summers, both of whom saw the idea as a threat to the monopoly of the IMF over international financial crises. The US Treasury in particular did not want Japan taking the lead in this area because Japan would not have imposed the IMF’s conditions on the Asian recipients, and as a policy objective for Washington, this almost superseded the importance of restoring the region to full economic health.

We all know what happened subsequently. Instead of forestalling global economic instability, the Treasury/IMF proposals helped make further instability inevitable. Ironically, the emerging markets’ crisis that ensued led to American policymakers developing a proposal very similar to that suggested by the Japanese in the first place. By November 1998, the Brazilian economy was so destabilised by volatile capital flows, that Secretary Rubin put together a $42 billion “precautionary package” to shore up Brazil, which had been the ostensible rationale underlying the initial Japanese proposal for the AMF.

Which does lead one to question the motives underlying Washington’s opposition to the original Japanese proposal. By killing off the idea of a competing Asian Monetary Fund, Rubin/Summers enabled the IMF to continue in its guise as an ostensibly “neutral” agency, thereby facilitating the implementation of the Treasury’s agenda whenever a financial crisis which required the IMF’s intervention arose. Of course, the “medicine” the IMF proffered had the ultimate effect of weakening pre-existing financial structures by imposing Western measures of financial restructuring, thereby giving Wall Street a huge stake in the subsequent “reform” agenda introduced: Basle capital adequacy ratios were to be applied. Highly indebted banks and firms were to be closed. Labour laws were to be changed to make it easier to fire workers, facilitating the closures. Regulations on foreign ownership were to be lifted in order to allow foreign banks and firms to buy domestic banks and firms, injecting needed capital and skills. All of which required lots of western style restructuring and “reform”, and who better to offer this than America’s finest investment bankers?

Somewhat similar measures were applied in a much narrower setting to solve the American savings and loan crisis in the late 1980s and early 1990s, and they worked. But it is one thing to undertake such reforms where real interest rates are very low and indebtedness not high (as in the United States in the late 1980s), and another to undertake them where both real interest rates and indebtedness are high. In these conditions such restructuring leads to closures and layoffs, with deflationary knock-on effects and more investor pullout. In short, the Fund’s initial insistence on fiscal contraction, cuts in aggregate demand, and large-scale institutional reform accelerated debt deflation.

This is why the IMF’s strategy for Asia ultimately failed in spite of widespread attempts revisionist attempts to take credit for the region’s subsequent economic recovery. In fact, in spite of the introduction of refinancing to the tune of US$110 billion, almost three times Mexico’s US$40 billion package of 1994–95 (the biggest in the imf’s history to that date), the crisis continued unabated: Asia’s currencies went into freefall by early 1998, leading to the Fund to call for even more interest rate hikes to arrest this process. Yet by May the deepening economic contraction, the rising unemployment and the fear of social unrest combined to produce a second wave of capital outflows and renewed falls in currencies and stock markets.

The Japanese themselves had long expressed disquiet with the IMF/Treasury measures forced on the afflicted economies in return for a financial bailout, fearing – rightly, as it transpired – that an overly conservative approach would push them into a full-blown recession. The financial mandarins in Tokyo wanted fiscal pumping and low interest rates so Asian exporters could trade their way out of the quagmire – and protect billions of dollars worth of Japanese investments in the region. Unfortunately, given the state of their own economy, Tokyo’s mandarins had comparatively little leverage and credibility to push their proposals more forcefully. It was the resumption of the collapse in May 1998 which finally forced Asian governments to begin to turn away from the initial imf strategy. They began to follow Japan’s remedies: bringing down interest rates and turning fiscal restriction into fiscal expansion.

In retrospect, it is clear that the Fund’s most serious error in policy was its failure to see the danger of calling for high real interest rates for Asian economies with high levels of private indebtedness. Unlike the Japanese, mandarins at the Fund failed to understand that high real interest rates, which are fairly well tolerated in Latin American countries where debt has historically been kept low by the 1970s legacy of hyperinflation, would be disastrously deflationary in Asian economies, characterised by a high savings/high debt structure.

Seen within this historic context, therefore, Mr Kuroda’s appointment as head of the Asian Development Bank is very significant, since he, along with his predecessor at the Japanese Ministry of Finance, Eisuke Sakakibara, was one of the major architects devising the original Asian Monetary Fund proposal, which was largely predicated on these Japanese policy prescriptions. Additionally, Kuroda is on record as expressing the Asian countries’ frustration that they lacked the proper voting power on the IMF to reflect their economic development over the past two decades. When he succeeded Sakakibara at the MOF, he noted: “The voting share and board representation of the Asian countries have been extremely limited. On the other hand, 37 per cent of the voting power in the IMF belongs to executive directors from Europe.” His comments largely reflected Asian frustration over the IMF as a “white man’s club” whose interests were increasingly at variance with those of the Far East. That the Japanese nevertheless openly put forward Sakakibara as a potential IMF President after Michel Camdessus’s retirement, knowing full well that his chances for acceptance were virtually nil, suggests that the country had an ulterior diplomatic motive: to demonstrate to the rest of Asia that it was best to disengage themselves from institutions which paid scant heed to the interests of the world’s largest savings bloc and thereby smooth the obstacles for the reintroduction of a regional lending facility like an Asian Monetary Fund.

Whilst the AMF proposal itself has ostensibly failed to gain any further traction in spite of the many manifest failures of the IMF since the Asian Financial crisis, the Asia Times has recently noted that in substance, if not in form, a less direct route toward the same objective has steadily been gain steam over the past several years:

“The AMF was generally greeted with scepticism and just as quickly vanished. But its legacy was felt in other ways. Despite US resistance, the 10 members of the Association of Southeast Asian Nations (ASEAN) linked their international reserves with Japan, China and South Korea in May 2000 as part of a currency swap framework that became known as the Chiang Mai Initiative. An Asian Clearing Union (ACU) has been functioning since 1975 to settle intraregional trade transactions in local currencies, and ASEAN has had a currency swaps arrangement since 1977 to deal with temporary international liquidity problems.

At a surveillance level, the Executives’ Meeting of East Asia and Pacific Central Banks (EMEAP) was set up in 1991 to monitor financial market developments and exchange information on perceived threats. More recently, Thailand has instigated an Asian Bond Fund as a part of the Asian Cooperation Dialogue, with the objective of developing domestic capital markets and reducing reliance upon speculative inflows from abroad…"

In the meantime, Japan has been polishing up the AMF formula and, reverting to its traditionally more pragmatic approach, has shifted the battleground to the diplomatic front. Two years ago, the ADB launched a scathing attack on the IMF’s role in the global financial architecture by floating the idea of ‘credible emergency financing from official sources, with less strings’. In language that clearly was aimed at Asia’s central bankers and monetary chiefs, the institute’s Japanese dean, Masaru Yoshitomi, called for ‘collective measures to restore systemic currency stability, including joint interventions’.

Simultaneously, Kuroda’s predecessor at the ADB, Tadao Chino, began to challenge the World Bank’s function as the final arbiter of global development policy by setting the agency on a more independent footing. ASEAN countries have given warm, if qualified, support for monetary union, even awarding the ADB Institute a contract several years ago to conduct regular surveillance of the members’ economies, in a pointed intrusion into the IMF’s turf.”- (“Asia’s Answer to the IMF”, Alan Boyd, Asia Times, Feb. 19, 2005)

It is understandable why Washington would continue to resist the notion of an Asian Monetary Fund. As things stand right now, in spite of the significant contraction in bond yields since the late 1990s, western investors continue to extract huge risk premiums from the entire emerging markets universe as a quid pro quo for the provision of their capital. This is manifestly perverse, especially when one considers that the ultimate source of much of that liquidity is Asia. All of the nations of Asia continue to run large current account surpluses, the proceeds of which are funnelled back into the US Treasury market, where the savers obtain a yield of less than 5 per cent, in a country which is now the world’s largest debtor nation, suffering the twin diseases of a declining currency and higher inflation (both of which are eroding the real value of the Asian creditors’ respective investments).

By contrast, even leading Asian conglomerates (whose products are readily gobbled up by the American consumer) are forced to pay several hundred basis points above the yield of Treasuries. The Western investor or banker is extracting a wholly unmerited premium, whilst the US continues to trade on its reserve currency and safe haven status to subsidise its over-consumption and perpetuate the country’s growing financial imbalances.

It’s a great deal for Washington and readily explains the Treasury’s violent opposition to an Asian Monetary Fund (or anything else that would disrupt the existing status quo, such as restrictions on capital account mobility). But must the world’s largest creditor bloc continue to act from such a position of weakness, which is more apparent than real? The aggregate net creditor position of Asia dwarfs its indebtedness. The domestic markets are rapidly maturing and will soon be in a position to replace the American consumer (who must surely retrench if the US is ultimately to come to grips with its own debt disease).

The actions by Asia’s leading policy makers suggest an implicit (albeit belated) recognition that they have been getting a raw deal from the existing global financial architecture and are taking incremental steps to redress the current imbalance. To be sure, historic rivalries, notably between China and Japan (manifesting themselves most recently over Taiwan) may slow the development of an AMF. It is also probable that the Bush administration will likely go out of its way to exacerbate this rivalry and thereby frustrate the development of competing multilateral agencies, which would invariably weaken Washington’s influence in the region.

But in spite of these periodic setbacks, the trend appears clear. The day is moving closer where an Asian Monetary Fund will become a reality. It is particularly noteworthy that the idea continues to be pushed by Japan, America’s staunchest ally in the region. Tokyo’s embrace of Washington only goes so far. Ironically, if (as we suggested last week) America ultimately repudiates existing obligations to its (largely) Asian foreign creditors, it will simply catalyse this process and likely ensure the AMF’s swift arrival, in spite of ongoing efforts to render this idea stillborn since 1997. The world is full of such rich ironies: In Iraq, America has long expressed opposition to the formation of Shiite-dominated theocracy, yet the recent elections suggest that this is about to become an impending reality. So too, the inexorable logic of current economic policy making may yet introduce outcomes – such as the introduction of an Asian Monetary Fund – completely at variance with Washington’s oft-expressed preferences to the contrary. In any event, time is definitely not on the side of the existing status quo.

My view here is this: the Great Unravelling has been a blow to every nation in the global economy.  The U.S., Europe, Africa, Asia, Latin America, Canada, they have all suffered.  But, Asia is de-coupling.  Mind you, I am not saying they are literally about to separate from the West and embark on their own growth path.  No, the ties are too strong.  Nevertheless, the West is weak, particularly the United States.  No one from the IMF is dictating terms in Asia today. Nor will they for the foreseeable future.  The die is cast.  The United States badly overplayed its hand in the 1990s.  Asia senses it is weak, overburdened with debt and depression.  This is therefore their opportunity to break free and I believe Asia will use it.

(Also see related posts: China warns that the west’s quantitative easing is inflationary and Breaking news: China has been secretly stocking up on gold)

Source

Summers, Geithner Are Silent as IMF Loses Grip: William Pesek – Bloomberg

Related posts:

• Asia is de-coupling
• New Zealand in recession: who’s next in Asia?
• Stephen Roach: Downturn in Asia less severe, but recovery later
• Jim Jubak joins the inflation made in Asia crowd
• Big Mac Index: Europe overvalued, Asia undervalued

For a moment forget that Mark Mobius is talking his own book.  He suggests in the video below that we are in the early stages of a new bull market for emerging markets. He does not suggest that it will be off to the races from the word go, however. Mobius thinks we are base-building right now.

Mobius is primarily buying stocks with P/E ratios of under ten, of which there are many in the emerging markets. He sees Hong Kong-listed Chinese stocks as the number one place to go (remember that Chinese stocks were decimated in 2008). He favors Brazil, Turkey and Russia as well.

Now, Mobius was making the same comments back in December and I was skeptical. Nevertheless, many emerging markets had their lows in November and December (much earlier than most of the larger Western markets, where lows were registered in March). They have not looked back in the last 5 months.

Related posts:

• Mobius: Still bullish on Emerging Markets
• Sprint: an example of stocks beaten down in the bear market
• The market is moving. You should be too.
• Louise Yamada: Sell stocks; Dow could be headed for 6000
• Selling the good news does not a bull market make

Berkshire Hathaway’s Annual Meeting is this coming Saturday 2 May 2009 in Omaha, NE at the Qwest Center (details in pdf here).  Given the financial turmoil and all of the hubaloo around Berkshire’s credit rating, it should be a very interesting affair.

In conjunction with the Annual meeting, Berkshire CEO Warren Buffett’s son Peter is hosting a unique event, a discussion really, where he talks about his life and upbringing.  Details are below.

Peter’s ‘Concert and Conversation’ serves as an entertaining and informative look into the life of a man with a very unique upbringing. His open discussion about the lessons he’s learned as the son of one of the most noteworthy investors of our time and its effect on creating the man he’s become, acts as a true testament that life is never a straight road. The evening will include live performances of selections from Peter’s album releases including his latest, Imaginary Kingdom, punctuated with videos from his film/television work and philanthropic activities.

EVENT DETAILS:
An Evening of Concert and Conversation with Peter Buffett
WHEN: Saturday, May 2nd at 7:30 pm
WHERE: The Rose, 2001 Farnam Street, Omaha, NE
TICKETS: $42, with $25 of the cost being tax deductible
http://rosetheater.org/season-events.asp

Related posts:

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• Barron’s: an interview with Peter Schiff
• Forstmann on Charlie Rose: easy money caused crisis
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• Some tidbits about stimulus, recovery, and the Great Depression

Irrespective of whether one thinks the stress tests used to test the U.S. banking system is a sham (10% unemployment is not a worst-case scenario), the fact of the matter is these tests MUST show some differentiation in order to be credible.  Vincent Reinhart, a former Fed official now at the AEI, makes this case in the video below with Bloomberg News.

Most of us have fixed on whether the stress tests will be credible or not.  In order to be credible, there will have to be stress test winners and losers. Now, mind you, the government has to be very careful about the stress exercise hurting some institutions, so it will tread carefully. This is very much a political exercise. So, having heard Reinhart voice his view, my question is whether the winners and losers will be picked based on real financial differentiation or based on other more political factors.

Related posts:

• Black: Stress tests and the Big Lie
• Stress tests reveal Citi and BofA need more capital, but you knew that already
• What the stress tests reveal about Obama’s thinking on banks
• BofA, Citi, Wells and GMAC biggest losers in stress test leaks
• Meredith Whitney: Regardless of stress tests, banks will still need more capital

Paul McCulley of PIMCO made a few comments back in March which caught my attention.  Given how well banks are doing this earnings season, I thought it relevant to quote him here.  The essence of his remarks was this:

• Deleveraging is a self-reinforcing vicious cycle brought upon by the Paradox of Thrift.  In order to stop this downward deflationary spiral, we need the political will to socialize losses from which privatized gains have already been made.  While this socialization of losses is unseemly and maddening, it is wholly necessary.

Personally, I don’t buy it.  McCulley is talking his own book. It is a self-serving statement.  Nationalization or stuffing bondholders are equally good ways of stopping this spiral. Nevertheless, here is what he had to say:

The present crisis, in textbook terms, is a case of the dual, mutually reinforcing maladies of the Paradox of Thrift and the Paradox of Leverage. In many respects, they are the same disease: what is rational at the individual citizen or firm level, notably to increase savings out of income or to delever balance sheets, becomes irrational at the community level.

If everybody seeks to increase their savings by consuming less of their incomes, they will collectively fail, because consumption drives production which drives income, the fountain from which savings flow. Likewise, if everybody seeks to delever by selling assets and paying down debt, or by selling equity in themselves, they can’t, as the market for both assets and equity will go offer-only, no bid.

Both of these maladies require that the sovereign go the other way, (1) dis-saving with even more passion than the private sector is attempting to increase savings, thereby maintaining nominal aggregate demand and thus, nominal national income; and (2) becoming the bid side for the levered private sector’s offer-only markets for assets and equity. It really is that simple, at least on paper, as Keynes and Minsky wisely taught.

The problem with the desirable textbook solution is that it suffers from constrained political feasibility. Actually, dealing with the Paradox of Thrift is practically much easier, even if less critically important, than dealing with the Paradox of Deleveraging. While Congress may belly-ache and wrangle incessantly about the precise size and composition of fiscal stimulus packages, it is safe to say that but for a few wing nuts, we are all Keynesians now in the matter of cracking the Paradox of Thrift.

In contrast there is limited political consensus for using the sovereign’s balance sheet and good credit to break the Paradox of Deleveraging. Put differently, while we may all now be Keynesians, we are not all Minskyians. What is ineluctably needed involves socializing the losses of a banking system – both conventional banking and shadow banking – after the spectacular winnings of the Forward Minsky Journey were privatized. It simply doesn’t sit well politically. In fact, it stinks to high heaven.

Thus, to quote my partner Mohamed El-Erian, we must contemplate a scenario in which the economically desirable solution is not politically feasible, while that which is politically feasible may not necessarily be economically desirable. Last Sunday, on 60 Minutes, Ben Bernanke addressed this nasty reality directly when he said that perhaps the most severe risk we face is the lack of political will.

In my view, the Geithner-Summers-Bernanke bailouts are very much a case of socializing the losses, as bank earnings this quarter attest. So McCulley is getting his wish. Let’s see whether this method of dealing with the crisis has longer-term benefits.

Source
The Thinking Behind the Stimulus and Bailout Programs – Paul McCulley

Related posts:

• The $1 trillion deficit: has Bill Gross gone crazy?
• Doubling down at AIG
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Below you can watch a video clip of Congressional Oversight Chairperson Elizabeth Warren’s introductory remarks at a hearing today on Capitol Hill. Afterward, Treasury Secretary Tim Geithner responds in a 10-minute open statement.

Related posts:

• Weekend Video: A Conversation with Tim Geithner at CFR
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• Did Tim Geithner blow it?
• Geithner and Summers consolidate power

Despite the fact that I can envisage a cyclical upturn this Winter, the menace of bank writedowns is ever-present. One analyst who has been particularly prescient on warning on this front is Mike Mayo, now working at Calyon. Below David Faber of CNBC talks about a recent prediction by Mayo that writedowns will be even worse than the Great Depression. Given the title of this site, I’m sure you realize I sympathisize with this point of view.

Related posts:

• Citi’s writedowns in colorful bar charts
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• Deutsche Bank and HBOS hit by writedowns

Back in February I posted an article called “The bullish argument for the global economy” highlighting Goldman Sachs’ Chief Economist Jim O’Neill’s bullish view for the economy. O’Neill believed in February that a economic rebound was certainly possible due to fiscal and monetary stimulus. Paul Kasriel has made similar arguments.

While I do agree that fiscal and monetary stimulus have been great and may induce a cyclical rebound, I wanted to point out that he mentioned the Philly Fed Survey and the ISM surveys as potential leading indicators of recovery.

Both surveys are out and they have not been extremely robust.

Released on March 2nd, the ISM was marginally higher last month. But, with 50 as the border to recession, a PMI reading of 35.8 is deeply recessionary.

The Philadelphia Fed’s March Business Outlook Survey came out today and this is what it said (bolding mine):

The region’s manufacturing sector continued to contract this month, according to firms polled for the March Business Outlook Survey. Indexes for general activity, new orders, shipments, and employment remained significantly negative. Employment losses were substantial again this month, with over half of the surveyed firms reporting declines. Firms continued to report declines in input prices and prices for their own manufactured goods. Most of the indicators of future activity suggest that the region’s manufacturing executives expect declines to bottom out over the next six months, but the firms’ employment forecasts suggest continued weakness.

Indicators Reflect Further Contraction

The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, edged higher, from -41.3 in February to -35.0 this month. Last month’s reading was the lowest since October 1990. The index has been negative for 15 of the past 16 months, a period that corresponds to the current recession (see Chart). Continued weakness was evident in all of the broad indicators this month. The survey’s current new orders index declined nearly 10 points, to -40.7, its lowest reading since July 1980. The shipments index increased six points, but this follows a record low in February. The survey’s current inventory index declined precipitously this month, from -24.3 to -55.6, its lowest reading in the history of the survey.

Basically, the Philly Fed’s survey was big fat bust. No matter, the market is up nearly 160 points as I write this. So, is this a harbinger of good things to come or should I expect Jim O’Neill to change his tune?

Sources
February 2009 Manufacturing ISM Report On Business® - ISM
March 2009 Business Outlook Survey – Federal Reserve Bank of Philadelphia

Related posts:

• Philly Fed: Business outlook shows ‘notable improvement’
• Philly Fed survey points to manufacturing rebound
• ISM: U.S. manufacturing contracting slower
• ISM: U.S. Manufacturing sector growing again
• U.S. ISM manufacturing survey hits 28-year low

I have the same misgivings about the Public Private Partnership Investment Program that Paul Krugman does. However, I still think it could work in conjunction with all of the other stimulus being applied (at least in inducing a cyclical rebound, which seems to be the goal). Krugman does not. Watch the video to see his reasoning.

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• Tim Geithner defends bailout plan on “Meet the Press”
• Are Citi and BofA gaming the Geithner Plan already?
• Did Tim Geithner blow it?
• Chanos: I warned Brown and Geithner of financial calamity

Merrill’s Economic Research team has been top notch for years under the leadership of Richard Bernstein and David Rosenberg.  Unfortunately for Bank of Aerica, these two gentlemen are jumping ship now that Merrills has been taen over by BOA.  I look forward to hearing more from them in their new roles elsewhere.

David Rosenberg, is leaving Bank of America Corp. He will join Gluskin Sheff & Associates in Toronto, Bloomberg reports.

Mr. Rosenberg, who attracted a large following in North America for his meticulous, lengthy, always-engaging and sometimes searing research on the markets and global economy, is leaving less than a year after Bank of America bought Merrill Lynch & Co.

Mr. Rosenberg moved to Merrill Lynch’s New York office from Toronto to become chief North American economist in the early 2000s, travelling back and forth between the two cities.

Not afraid to speak his mind, he was one of the first economists to warn of a housing bust in the United States and the ensuing financial market and consumer spending collapse. He has been relentlessly bearish in recent years.

Merrill, meanwhile, has moved to make its analysts less accessible to the media. Bank of America is also wrestling with merging the staff and cultures from the two firms.

Richard Bernstein, chief U.S. quantative strategist, is also leaving Bank of America Corp. a company spokeswoman said.

Mr. Bernstein, 50, will start his own money management company after leaving in mid-April, and Mr. Rosenberg, plans to leave in mid-May.

“The wisdom and counsel that David and Rich provided clients, analysts and our businesses have enriched our franchise,” a spokeswoman at Bank of America said.

Gluskin Sheff is a highly respected independent brokerage catering to high net worth individuals. 

Source
Economic guru David Rosenberg returning to Canada – Financial Post

Related posts:

• David Rosenberg: This is the Great Depression II
• Rosenberg thinks U.S. market may Test March lows
• Bernstein: America is turning Japanese
• Richard Bernstein: Once a huge market bear, now a bull
• Quote of the Day: David Rosenberg

Recently, I have highlighted the comments of a number of investing gurus, most of whom are fairly positive on the market. This includes Jeremy Grantham, Marc Faber, Bill Fleckenstein, Fred Hickey, Marty Fridson and Steven Leuthold (Louise Yamada is a notable exception).  However, when it comes to the global economy, the situation is much murkier, the likes of David Rosenberg at Merrill Lynch/BofA have made the case for continued economic weakness in the United States.

The standard bearer of the global-economy-is-weak-and-needs-rebalancing theme is Morgan Stanley Asia head Stephen Roach. And he is not a tad bullish on the global economy.

The world is moving into the second wave of the financial crisis, which will be symbolized more by the deterioration in the global business cycle than the financial market itself, said Stephen Roach, chairman of the Hong Kong-based Morgan Stanley Asia.

“I think the second wave will be driven by the weakening of profitability of corporations around the world and that will have a negative impact on their ability to pay back loans to banks and other financial institutions,” said Roach in an exclusive interview with Xinhua at Morgan Stanley Asia’s headquarters.

The first wave came about through the so-called subprime crisis, sparking a broadly based and severe recession in the world economy, he said.

Out of the recession, now comes further weakness in loans outstandings by financial institutions, which will have further negative impact on the earnings of the financial institutions.

“So I think the second wave is just beginning, which reflects more the impact of global business cycle than the credit market contagion itself,” said the chairman.

GRIM OUTLOOK FOR WORLD ECONOMY IN 2009

Roach noted that the world economic recession is not bottoming. “I think there’s more to come in terms of the weakness of the world economy.”

“When the year is finished, I think 2009 will represent the first decline for an entire year in world GDP we have see since the end of World War II,” he said.

Roach said that the drops of the global economy in the last three quarters of the year may not be as severe as in the early months of 2009, but the global economy is going to keep declining.

“There is weakness across the world. Every major developed economy is in recession. We’ve never seen that before,” he said.

And most large developing countries, including China, are either slowing very sharply or they are too in recession.

“This is a synchronous downturn in the global economy. There is quite a great deal further to go in my opinion,” he said, adding that unemployment will keep increasing for the better part of the final three quarters of 2009.

The world economy may bounce up a while by the end of the year, as there had been very steep decline in most economies in the fourth quarter of 2008 and equally steep drop in first quarter of 2009, he said.

“So statistically, you can get a positive increase in some point in the remaining three quarters, but that will be short-lived,” he said.

In large part, the global economy will be in a contraction mode through the end of this year, possibly, in the early of next year, he said.

The article goes on to present Roach’s view on major risks for 2009, as well as the Chinese growth story. But, the long and short of Roach’s view is that a weak global recovery will not begin until 2010.

Details at the link below.

Source
Stephen Roach: World moving into second wave of financial crisis – Xinhua

Related posts:

• Stephen Roach: Downturn in Asia less severe, but recovery later
• Stephen Roach sees a W-shaped recovery for China
• Stephen Roach and Jim Grant: Video of credit crisis thoughts
• Stephen Roach is talking double dip again
• Stephen Roach has a bone to pick with Congress

This video from the Charlie Rose show should give one a fairly complete view of most of the relevant finance and political issues surrounding the AIG situation. (hat tip Calculated Risk)

Participants include bank analyst Meredith Whitney and Gretchen Morgenson of the NY Times, and Carol Loomis of Fortune. Why is Hank Greenberg in this panel? It seems incongruous since most of these problems happened while he was the head of AIG. Very strange.

Related posts:

• A conversation about the growing fiscal deficit on Charlie Rose
• Jeremy Grantham: “Pull the trigger”
• A conversation with Robert Caro on Charlie Rose
• A conversation with Pete Peterson on Charlie Rose
• A conversation with Peter Orszag on Charlie Rose

The large bonuses at AIG have sparked yet another wave of revulsion amongst American taxpeayers.  And rightfully so.  This company has cost taxpayers $170 billion and counting and yet the bonuses of the same individuals complicit in the losses is still to be paid due to contractual obligation.  While Ben Bernanke, Larry Summers and others have expressed their contempt for this state of affairs, I suspect there will be consequences down the line.

Below is the crux of the problem as detailed in the New York Times:

The American International Group, which has received more than $170 billion in taxpayer bailout money from the Treasury and Federal Reserve, plans to pay about $165 million in bonuses by Sunday to executives in the same business unit that brought the company to the brink of collapse last year.

Word of the bonuses last week stirred such deep consternation inside the Obama administration that Treasury Secretary Timothy F. Geithner told the firm they were unacceptable and demanded they be renegotiated, a senior administration official said. But the bonuses will go forward because lawyers said the firm was contractually obligated to pay them.

Austan Goolsbee, staff director of the president’s Economic Recovery Advisory Board, on Sunday detailed Mr. Geithner’s reaction.

“He stepped in and berated them, got them to reduce the bonuses following every legal means he has to do this,” Mr. Goolsbee said on “Fox News Sunday.” “I don’t know why they would follow a policy that’s really not sensible, is obviously going to ignite the ire of millions of people, and we’ve done exactly what we can do to prevent this kind of thing from happening again.

The payments to A.I.G.’s financial products unit are in addition to $121 million in previously scheduled bonuses for the company’s senior executives and 6,400 employees across the sprawling corporation. Mr. Geithner last week pressured A.I.G. to cut the $9.6 million going to the top 50 executives in half and tie the rest to performance.

The payment of so much money at a company at the heart of the financial collapse that sent the broader economy into a tailspin almost certainly will fuel a popular backlash against the government’s efforts to prop up Wall Street. “There are a lot of terrible things that have happened in the last 18 months, but what’s happened at A.I.G. is the most outrageous,” said Lawrence H. Summers, President Obama’s chief economic adviser, during an appearance Sunday on ABC’s “This Week With George Stephanopoulos.” “What that company did, the way it was not regulated, the way no one was watching, what’s proved necessary — is outrageous.”

Yesterday, I had an e-mail exchange with a number of financial and economics professionals in which we discussed the AIG bailout and the specific issue of these large bonuses. One comment which I found particularly noteworthy came from Bill Black, a well-known economist from the University of Missouri-Kansas City. Bill is well versed in both the legal and financial sides of these affairs. Below is a short bio:

Bill Black is an Associate Professor of Economics and Law at the University of Missouri – Kansas City (UMKC). He was the Executive Director of the Institute for Fraud Prevention from 2005-2007. He has taught previously at the LBJ School of Public Affairs at the University of Texas at Austin and at Santa Clara University, where he was also the distinguished scholar in residence for insurance law and a visiting scholar at the Markkula Center for Applied Ethics.

He was also litigation director of the Federal Home Loan Bank Board, deputy director of the FSLIC, SVP and General Counsel of the Federal Home Loan Bank of San Francisco, and Senior Deputy Chief Counsel, Office of Thrift Supervision. He was deputy director of the National Commission on Financial Institution Reform, Recovery and Enforcement.

And this is what Bill had to say about the AIG situation (I have bolded the bits I find most significant):

This is the consequence of six things on the Treasury end of things:

• (1) the failure to use Chapter 11 bankruptcy/pass-through receivership to deal with deeply insolvent financial institutions,
• (2) the failure to expose, and to the extent possible, remedy through restatements the massive accounting fraud that AIG was/is engaged in that triggers the bonuses,
• (3) the failure to bring criminal charges against the control frauds,
• (4) the failure of Treasury as negotiators — they had all the leverage when they bailed out AIG and could have conditioned the aid on at least the VP tier and above giving up their bonuses,
• (5) the weakness of Treasury’s current lawyers who, if press reports are accurate, couldn’t think of any way for the U.S. government to take effective action against what it reportedly views as a scandal, and
• (6) (and I haven’t seen this discussed) why was Treasury blind-sided by this? It confirms that they did not conduct even the most obvious due diligence on AIG’s assets and contingent liabilities. Given what we know about the lack of due diligence by AIG on underlying assets, particularly nonprime paper, this confirms exactly how dangerous Treasury is to the the nation. It is also consistent with the concern that it faces such a critical staff shortage, particulary in the relevant skills (which the folks it hires from Wall Street lack). I doubt that they have five senior officials that have ever reviewed loan files for a living or conducted meaningful due diligence (which requires cracking the loan files).

On the AIG end we see the perverse incentives of keeping the senior level folks on that caused the crisis. They have every incentive not to be honest about the true extent of the losses. They know the place is dead (hopelessly insolvent) and have strong incentives to loot the corpse, e.g., through bonuses. They do not alert Treasury sufficiently in advance even to bonuses that they should know will be perceived as scandalous (though another problem with keeping these failed elites in power is that they are clueless about the reaction of normal people). They do not work to limit bonuses, e.g., by being honest about past accounting fraud. I believe when the facts come out that we will find that they did not make criminal referrals on the prior senior officials that led AIG’s accounting fraud (which would have given AIG and the Treasury a far stronger legal basis for refusing to pay bonuses that were “earned” via accounting control fraud.

I don’t oppose bonuses that are actually earned through long term performance. That is not the case with the AIG bonuses. We can offer well designed performance pay if we use bankruptcy or receiverships.

Bill’s argument is testament to the problems associated with nationalization as practised in the U.S. during this credit crisis. In effect, we are seeing private gain and socialized loss-writ large. To the degree that Citigroup or Bank of America or any other large institution is being nationalized, should we expect any different at those institutions?

I have been in favour of pre-privatization as a policy remedy in this crisis.  At a minimum, this episode should make clear that a pre-packaged or managed bankruptcy administered by the government would be superior to this ill-considered and attempted arms-length transaction at AIG.  My short-hand for this divide is “bankruptcy/pre-privatization vs. propping up zombie banks.” Propping up zombie banks while refusing to prosecute any illegal activities is likely to invite a negative populist response as I indicated in my recent post “Where are the perp walks?” In my view, the Obama Administration may well come to be viewed as an enabler of these events unless it can demonstrate a credible willingness to prosecute financial service criminal activity and end the ability of incumbent management to control likely insolvent institutions.

I will finish off my commentary with a snippet from a post by James Kwak on the Baseline Scenario, which gets right to the heart of this divide in policy options.

I think there are three main positions in this debate:

• A1: The banking system is broken. Banks need to get rid of their toxic assets and they need more capital. The solution is for the government to buy their toxic assets at a high price (or insure those assets) and to give them lots of cheap capital.
• A2: The banking system is broken. Banks need to get rid of their toxic assets and they need more capital. The solution is for the government to take them over, transfer off their toxic assets, recapitalize them, and (when possible) sell them back into the private sector.
• B: The banking system is basically sound and will recover if we give it some time. In the meantime, the government should give the banks just enough money and intervene as little as possible to keep them afloat until asset prices recover.

The big divide is not between A1 (Rajan) and A2 (Simon and me). In both cases, you end up with a healthy banking system, at significant taxpayer expense. (A2 should be somewhat cheaper because it wipes out the shareholders, but I agree with Rajan that it is dramatically cheaper only  if the government is willing to restructure some of the liabilities.)

The big divide is between both of these and B, the position of the Bush and Obama administrations – both of which rejected aggressive measures in favor of just-in-time, just-big-enough bailouts. Now the government is conducting stress tests on an industry it has already said is adequately capitalized, and will follow that with a public-private asset-buying program that tries to split the difference between paying real market value and paying enough to keep the banks happy. I’ve quoted these exact words before, but here’s Krugman again: “The actual plan seems to be to keep the banks semi-alive by implicitly guaranteeing their liabilities and dribbling in money as necessary, all the while proclaiming that they’re adequately capitalized — and hope that things turn up.”

Now, let’s say you agree that something more needs to be done. Then you have to choose between A1 and A2. A2 is the one people typically call “nationalization.” But which is more consistent with a capitalist system: protecting the creditors who lent money to a failed bank, the shareholders who invested in a failed bank, and the managers who failed . . . or firing the managers, wiping out the shareholders, and maybe, if possible without triggering collateral damage, forcing some of the creditors to take some losses? Which one better approximates the incentives you want in a free market?

UPDATE: 637PM EDT – Bill Black has a post up on Huffington Post along with Tom Ferguson, Rob Johnson and Walker Todd that is a must-read about this issue. How to Stop AIG’s Bonuses. And Yves Smith also chronicled the email exchange with Bill Black and has her own take, “Wiliam Black Savages Treasury’s Conduct on AIG”

Sources
A.I.G. Paying $165 Million in Bonuses After Federal Bailout – NY Times
Nationalization and Capitalism – James Kwak

Related posts:

• Bankruptcy expert says ‘not at all’ possible for quick Chrysler bankruptcy
• Did JP Morgan cause Lehman’s bankruptcy?
• FAS 157 and the significance of distress versus bankruptcy
• Last bankruptcy tonight: America West Bank
• Citigroup talks with US Government as bankruptcy looms

By now you have heard that Warren Buffett’s bets on GE, Goldman, and Swiss Re and his derivatives positions have earned him a downgrade from Fitch Rating Agency.  Below is the Fitch statement.  I have highlighted the key sections:

Fitch Ratings has downgraded the Issuer Default Rating (IDR) and senior unsecured debt ratings of Berkshire Hathaway Inc. (NYSE:BRK/A) as follows:

–IDR to ‘AA+’ from ‘AAA’;

–Senior unsecured debt to ‘AA’ from ‘AAA’.

Fitch has concurrently affirmed its ‘AAA’ Insurer Financial Strength (IFS) ratings on BRK’s insurance and reinsurance subsidiaries. The Rating Outlook for all entities is Negative. See full list of rating actions below.

Today’s actions are part of a broader review of insurance and financial services company ratings being conducted by Fitch, which includes taking a fresh look at various risk factors and criteria application in light of the current stressful economic environment. Related to this ongoing exercise, which has resulted in numerous insurance and other financial services sector downgrades in recent weeks, Fitch believes that ‘AAA’ ratings are not appropriate at the holding company level for financial-oriented enterprises given significant market volatility and correlation of risks under stress, recently observed throughout the global economy.

With respect to BRK, Fitch views the company’s potential earnings and capital volatility derived from its large, unhedged market exposures as inconsistent with the stability required at the ‘AAA’ level. Such exposures include large, concentrated equity investments, as well as exposure to the equity and credit markets through various derivative contracts. Fitch views BRK’s investments in a wide variety of retail, service and manufacturing companies as mitigating this exposure somewhat, but Fitch does not view BRK’s degree of diversification as sufficient to offset these concerns at the ‘AAA’ level.

The downgrade also recognizes that even the most senior obligations at the holding company level are deeply subordinated to policyholder obligations at the regulated insurance and reinsurance company subsidiaries. Fitch notes this point is not new, but rather reflects Fitch’s view on appropriate weighting given to this risk in the current environment and at the current rating level.

BRK’s ratings also continue to reflect Fitch long-standing concerns with respect to ‘key man’ risk in the form of the company’s chairman, Warren Buffett. Fitch views this risk as unrelated to Mr. Buffet’s age, but rather Fitch’s belief that BRK’s record of outstanding long-term investment results and the company’s ability to identify and purchase attractive operating companies is intimately tied to Mr. Buffett. In current application of its criteria, Fitch does not view this concentration as consistent with an ‘AAA’ rating.

The ‘AAA’ IFS ratings of BRK’s insurance subsidiaries continue to reflect their strong capitalization and competitive positions, and underlying underwriting results. Fitch notes that at their current levels, BRK’s IFS, IDR and senior unsecured ratings continue to be among the highest in Fitch’s rating universe.

Fitch’s current ratings on BRK assume that the company is likely to continue to aggressively deploy its cash and capital as the potential for ongoing difficult economic and capital market conditions persists and companies look for investors with strong balance sheets to provide funding. Fitch would view this deployment as consistent with BRK’s long-standing opportunistic investment style although it adds an element of fluidity to BRK’s profile. Over the last six months BRK has agreed to purchase CHF3 billion of 12% preferred shares in Swiss Re, and has purchased $5 billion of 10% preferred shares in Goldman Sachs, and $3 billion of 10% preferred shares in General Electric. Additionally, in early 2008, BRK formed a financial guarantor to insure tax exempt bonds issued by states, cities, and other local entities and by year-end (YE) 2008 the company had written $595 million of financial guaranty premiums.

In 2008, BRK’s total shareholders equity declined by 9.5% to $109 billion. Major components of the change in equity included a $15 billion (after-tax) decline in BRK’s net unrealized gain on investment securities, largely tied to declining equity markets, partially offset by $5 billion of net income. Net earnings were down from over $13 billion in 2007 and represent a six-year low for the firm.

BRK’s 2008 earnings also included $3.3 billion (after-tax) of non-cash mark-to-market losses on equity index put contracts the company has written with a notional value of $37 billion as of YE 2008. These contracts include equity index put option contracts on four indexes, including three indexes outside of the United States. BRK has also written credit default swap (CDS) contracts on various high yield indexes, state and municipal bond issuers, and single name corporate issuers with notional amounts of $30 billion as of YE 2008.

While the contracts’ recent mark-to-market losses are large, the agency believes that the ultimate economic effects, while uncertain, are likely to be significantly less than indicated by the marks. Favorably, the equity index put contracts were generally written with strike prices equal to the then current index value, had a weighted average maturity of 13.5 years at YE 2008, and are exercisable only at maturity. The CDS contracts appear to be well-managed with reasonable contract and per issuer limits. Additionally, few of the contracts have collateral positing requirements. At YE 2008 BRK had posted $550 million of collateral related to these contracts, a small amount for a company with BRK’s liquidity profile.

BRK uses a reasonable amount of financial leverage in its capital structure and at YE 2008 its consolidated debt-to-total capital ratio was 25%. BRK’s consolidated debt is derived from three sources; debt issued or guaranteed by the holding company, debt issued by the company’s finance and financial products subsidiaries, and debt issued by the company’s utilities and energy subsidiaries.

When evaluating BRK’s financial leverage at the parent level, Fitch generally excludes debt issued by BRK’s utilities and energy subsidiaries from its analysis since the agency believes that these subsidiaries have the ability and intent to fund this debt without parent support. In contrast, Fitch includes debt issued by BRK’s finance company subsidiaries that is guaranteed by BRK. Much of this debt is issued to fund loans and receivables, with these assets ‘matched’ against the debt balances. Given the current difficult economic environment and pressure on asset values, Fitch believes “matched” debt poses additional risks to those posed in the past.

The Negative Outlook reflects uncertainty surrounding the ultimate effect of the current financial market conditions on BRK and its insurance company subsidiaries. These uncertainties include potential further equity market declines and the affect they would have on BRK’s vast equity portfolio and capitalization, as well as the adverse effect of general economic conditions which are likely to pressure BRK’s earnings over the next 12-to-18 months.

For its current review, Fitch received from BRK’s management certain non-public information regarding BRK’s derivative exposures. However, Fitch does not regularly meet with BRK management, and does not believe the extent of interaction meets that required for Fitch to consider its ratings on BRK and its subsidiaries to be fully interactive. Fitch’s ratings on General Reinsurance Corporation (GenRe) and its direct and indirect subsidiaries, is the result of an interactive process between GenRe and Fitch in which Fitch regularly meets with Gen Re management and has received non-public information from the company.

Fitch has taken the following rating actions:

Berkshire Hathaway, Inc.

–IDR downgraded to ‘AA+’ from ‘AAA’.

Berkshire Hathaway Finance Corporation (BHFC)

–IDR rated ‘AA+’;

–$1.5 billion 5.11875% notes due Jan. 11, 2011 downgraded to ‘AA’ from ‘AAA’;

–$1 billion 4.6% notes due May 15, 2013 downgraded to ‘AA’ from ‘AAA’;

–$1 billion 5% notes due Aug. 15, 2013 downgraded to ‘AA’ from ‘AAA’;

–$1.5 billion 4.125% notes due Jan. 15, 2010 downgraded to ‘AA’ from ‘AAA’;

–$500 million 4.20% notes due Dec. 15, 2010 downgraded to ‘AA’; from ‘AAA’;

–$700 million 4.75% notes due May 15, 2012 downgraded to ‘AA’ from ‘AAA’;

–$750 million 5.125% notes due Sept. 15, 2012 downgraded to ‘AA’ from ‘AAA’;

–$500 million 4.5% notes due Jan. 1, 2013 downgraded to ‘AA’ from ‘AAA’;

–$950 million 4.625% notes due Oct. 15, 2013 downgraded to ‘AA’ from ‘AAA’;

–$400 million 5.10% notes due July 15, 2014 downgraded to ‘AA’ from ‘AAA’;

–$1 billion 4.85% notes due Jan. 15, 2015 downgraded to ‘AA’ from ‘AAA’.

GEICO Corporation

–IDR downgraded to ‘AA+’ from ‘AAA’;

–$150 million 7.40% senior notes due July 15, 2023 downgraded to ‘AA’ from ‘AAA’.

General Re Corporation

–IDR downgraded to ‘AA+’ from ‘AAA’;

–$150 million 9% senior notes due Sept. 12, 2009 downgraded to ‘AA’ from ‘AA+’;

–Short-term IDR affirmed at ‘F1+’;

–$500 million commercial paper program affirmed at ‘F1+’.

Fitch has affirmed the ‘AAA’ IFS ratings of the following companies with a Negative Rating Outlook:

–Government Employers Insurance Company;

–General Reinsurance Corporation;

–General Star Indemnity Company;

–National Reinsurance Corporation;

–General Star National Insurance Company;

–Genesis Insurance Company;

–Genesis Indemnity Insurance Co.;

–Fairfield Insurance Company;

–National Indemnity Company;

–Columbia Insurance Company;

–National Fire and Marine Insurance Company;

–National Liability and Fire Insurance Company;

–National Indemnity Company of the South;

–National Indemnity Company of Mid-America;

–Wesco Financial Insurance Company.

Fitch’s rating definitions and the terms of use of such ratings are available on the agency’s public site,www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch’s code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the ‘Code of Conduct’ section of this site.

Source
Fitch Downgrades Berkshire Hathaway to ‘AA’; Affirms ‘AAA’ IFS; Outlook Negative – Business Wire

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