The Obama administration has mapped out a bold “new era of regulation,” said Damian Paletta and Jenny Strasburg in The Wall Street Journal. The regulatory reform, outlined last week by Treasury Secretary Timothy Geithner, would be the biggest overhaul of market rules since the New Deal. If approved by Congress, the rules would empower an independent super-regulator to monitor risks to the financial system and dramatically tighten oversight of hedge funds and private equity firms. The government would also oversee trading in credit default swaps and other risky derivatives. Most controversially, Geithner asked for the power to seize nonbank financial firms such as insurer AIG. Many Wall Street insiders “were quick to announce their opposition.” But facing popular outrage over bonus payments to AIG executives and other abuses, opponents of the muscular new approach will be lucky if they can even manage to limit a few provisions that they consider too intrusive, “such as making their trading records public.”
Obama is operating on the high ground here, said Clive Crook in TheAtlantic.com. House Minority Leader John Boehner was quick to call Geithner’s proposal for seizing financial firms “an unprecedented grab for power.” But there’s nothing unprecedented about it. The FDIC already has the power to take over failing banks and put them into a “pre-packaged bankruptcy.” It then restores the banks to financial health or merges them with more stable banks. Can anyone “intelligently oppose an FDIC-like resolution regime for AIG and other systemically important nonbanks?” The firm is the beneficiary of $173 billion in federal loans and guarantees. With that kind of money at stake, the feds have the right and the obligation to protect the taxpayers’ interest.
Unfortunately, there’s little reason to believe that government bureaucrats are up to this task, said Francis Diebold and David Skeel in The Wall Street Journal. Consider the saga of IndyMac, the troubled California mortgage lender. “It was not taken over by the FDIC until long after it was obvious it should be closed.” The delay cost taxpayers some $10 billion. Shortly after the IndyMac takeover last year, the FDIC brokered the sale of Wachovia Bancorp to Citigroup “at a lowball price.” When Wells Fargo snatched Wachovia away from Citi with “a vastly superior offer,” the FDIC “wound up with egg on its face.” The point is, the government is just not equipped to micromanage the financial world.
Ultimately, the tools we give regulators matter less than their willingness to use them, said The New York Times in an editorial. The financial crisis, “including what went wrong at AIG,” came about not because of some missing rule or regulatory agency. It happened because regulators, lawmakers, and executive-branch officials failed “to heed warnings about risks in the system and to use their powers to head them off.” Intoxicated by then-fashionable free-market rhetoric, they lost “the will to regulate.” Still, “tighter rules” would help, said USA Today. The current, creaky regulatory framework is a “patchwork of rules and agencies,” some of which date back to the Civil War. It’s way past time for a new system suited to “an era of computerized global trading and exotic financial instruments.”
Showing posts with label Financial Crisis of 2008-09. Show all posts
Showing posts with label Financial Crisis of 2008-09. Show all posts
Friday, April 10, 2009
Friday, November 7, 2008
Greenspan: The Oracle’s mea culpa
If there were any lingering doubts that free-market capitalism is dead, said The Dallas Morning News in an editorial, they were “blown to smithereens” last week by Alan Greenspan’s appearance on Capitol Hill. Greenspan, revered as the Oracle during his two-decade-long tenure as chairman of the Federal Reserve, came to Congress a humbled man, admitting sheepishly that there was “a flaw” in his economic philosophy. He’d spent his life, Greenspan testified, convinced that markets, and societies, work best when not fettered by government meddling and regulation. In the grip of this quasi-religious belief, Greenspan kept interest rates extremely low in the early part of this decade, creating a monstrous housing bubble, and opposed all attempts to regulate the trading of exotic financial instruments, such as the mortgage-backed securities at the heart of the current crisis. “I made a mistake,” Greenspan conceded, saying that the worldwide collapse of banks and financial institutions had left him “in a state of shocked disbelief.”
Greenspan still doesn’t get it, said Tim Rutten in the Los Angeles Times. His error, he told Congress, was assuming that the “self-interest of organizations, specifically banks,” would keep them from engaging in stupid and corrupt financial trading. The flaw in this theory, as any kindergartner could have explained, is that a bank is a building, not a person. The fateful decisions to buy and sell billions of dollars of dubious derivatives were taken not by banks but by people who work at banks, whose rational self-interest told them accurately that with a little fancy paperwork they could retire at 29 and move to Tahiti. These executives and traders had no loyalty to the companies that employed them, nor did they care about long-term consequences of their wheeling and dealing. That was obvious to nearly everyone—everyone, that is, without Greenspan’s “ideological blindness.”
That’s a bit too harsh, said Zachary Karabell in Huffingtonpost.com. Unlike the parade of Wall Street execs who’ve told Congress that the destruction of their companies just wasn’t their fault, Greenspan was “genuinely contrite” and at least “took responsibility for his mistakes.” In fact, there was actually something “sad and noble” about Greenspan’s testimony, as if, at 82, he was delivering one last lesson for the world—not about interest rates or housing bubbles, but about the danger all of us face when we allow our ideas to harden into ideologies that we don’t dare question.
Greenspan still doesn’t get it, said Tim Rutten in the Los Angeles Times. His error, he told Congress, was assuming that the “self-interest of organizations, specifically banks,” would keep them from engaging in stupid and corrupt financial trading. The flaw in this theory, as any kindergartner could have explained, is that a bank is a building, not a person. The fateful decisions to buy and sell billions of dollars of dubious derivatives were taken not by banks but by people who work at banks, whose rational self-interest told them accurately that with a little fancy paperwork they could retire at 29 and move to Tahiti. These executives and traders had no loyalty to the companies that employed them, nor did they care about long-term consequences of their wheeling and dealing. That was obvious to nearly everyone—everyone, that is, without Greenspan’s “ideological blindness.”
That’s a bit too harsh, said Zachary Karabell in Huffingtonpost.com. Unlike the parade of Wall Street execs who’ve told Congress that the destruction of their companies just wasn’t their fault, Greenspan was “genuinely contrite” and at least “took responsibility for his mistakes.” In fact, there was actually something “sad and noble” about Greenspan’s testimony, as if, at 82, he was delivering one last lesson for the world—not about interest rates or housing bubbles, but about the danger all of us face when we allow our ideas to harden into ideologies that we don’t dare question.
Friday, October 31, 2008
What goes up must come down
For more than 400 years, financial ‘bubbles’ and panics have shaken empires and altered history. It’s happening again with the housing bubble. Why don’t we ever learn?
What is a financial bubble?
Bubbles are a market phenomenon in which something’s value is inflated far beyond its intrinsic worth. They are probably as old as commerce itself, though the first outbreak of market delirium identified as a bubble was the Dutch Tulip Bubble of 1636–37. A few decades later, the British government tottered after hundreds of thousands of Brits went broke investing in a South American real estate boom. In the 1800s, countless Americans lost their shirts speculating on railroad stocks. The 20th century brought the most destructive bubble of all—the credit-fueled stock speculation of the Roaring ’20s that ended in the Great Depression. More recently, the U.S. has been rocked by the Internet bubble of the late 1990s and this decade’s housing bubble, which ushered in today’s worldwide financial crisis. In fact, bursting bubbles led to nearly all 11 recessions the U.S. has suffered since the end of World War II.
Do all these bubbles have anything in common?
They’re all outbreaks of what historian Charles Mackay called “the madness of crowds.” (See below.) Take the tulip bubble. In the early 1600s, a mysterious virus infected many of the Netherlands’ tulip bulbs, which suddenly started producing brightly colored flowers with unusual streaks and whorls. A craze for the flowers developed, and during the winter of 1636, many Dutch started trading promises—futures contracts, essentially—to buy or deliver tulip bulbs the following spring. Prices rose furiously. One eager buyer traded his house for a single bulb; another swapped 12 acres of land. The outlandish prices brought in even more traders seeking easy riches, and initially, prices rose as new buyers surged into the market. But promises to deliver bulbs outnumbered the actual supply, and as spring approached, many people who had contracted to deliver bulbs couldn’t fulfill their obligations. Contracts to buy the bulbs were suddenly worthless, and the market crashed.
People really thought tulips could make them rich?
It sounds silly. But that’s the nature of bubbles—frenzied speculators part with common sense in their “irrational exuberance’’ for the next big thing. In the mid-1800s, new U.S. railroad companies were working to link markets that had never before been connected, thus revolutionizing commerce. Millions of Americans borrowed money to buy shares in railroad companies, and stock prices soared. But the steep costs of building the railroads proved too much for many companies, and several collapsed, ruining investors who planned to repay their loans out of their stock profits. The Internet bubble of our own time was remarkably similar.
In what way?
Investors were so excited about the potential, they lost sight of reality—hope triumphed over reason. Take the notorious case of Webvan, a company that delivered grocery orders placed over the Internet. On the day Webvan went public in 1999, its stock market value soared from $375 million to $8.5 billion—one of the best opening days of any stock in history. Webvan could never deliver enough groceries to justify that value, and the company went bankrupt in 2001. But it wasn’t just faith in the Internet that led speculators to bid up Webvan’s price. They also had faith that other people believed even more fervently in the Internet’s potential. In short, people who paid a foolish price for Webvan and hundreds of other Internet firms figured they could always find a greater fool to pay an even higher price. And many did, compounding their folly by buying their shares with borrowed money. Eventually, of course, the bubble burst.
What does borrowed money have to do with it?
Without borrowed money, there likely would be no bubbles. That’s because bubbles first inflate when credit is easy to obtain, and pop when credit tightens. During the stock bubble of 1929, for instance, many investors bought shares with borrowed funds. When prices started to fall in October 1929, investors rushed for the exits, hoping to sell their shares while they were still worth more than their loans. But because everyone was selling at once, stock prices plummeted, leaving many investors with debts they couldn’t repay. Many U.S. banks were among those investors. Hearing about the banks’ losses, depositors rushed to withdraw their funds, starting a bank run that caused thousands of banks to collapse.
Is something similar happening today?
In many ways, yes. The housing bubble first started to inflate when interest rates fell to 1 percent after the 2000 dot-com crash. Banks happily granted mortgages to almost anyone who could fill out an application. Millions of borrowers bought houses they really could not afford, figuring they could sell at a profit if they got in a pinch. It wasn’t such a far-fetched idea—in much of the U.S., housing prices had risen steadily since the late 1970s. But prices eventually hit a peak and started to fall, and the inevitable stampede for the exits began. As in 1929, says finance professor Lawrence Kryzanowski, people thought “the good times were going to go on forever. And then very quickly, they stopped.” History provides one consolation, however: Just as every boom inevitably comes to an end, so does every recession.
The madness of crowds
Many economists believe that people tend to make rational financial decisions. But the recurrence of bubbles suggests that greed, emotion, and peer pressure can overwhelm rationality. When we see friends and neighbors making big bucks trading dot-com stocks or flipping McMansions, we want in on the action. For a while, as everyone joins the party, rising prices become a self-fulfilling prophecy. But then comes a seemingly minor event that reverses the psychological polarity, turning endless optimism into bottomless panic. (In the case of the housing bubble, it was one big bank’s announcement in March 2007 that it was experiencing higher-than-expected losses on its mortgage holdings.) The same herd mentality that drove people to crowd into the market now drives them to flee the market en masse. Falling prices then become the self-fulfilling prophecy, and the panic feeds on itself, sweeping aside caution, common sense, and historical memory. Super-investor Warren Buffett has seen it happen over and over again through the years. “What we learn from history,” he likes to say, “is that people don’t learn from history.”
What is a financial bubble?
Bubbles are a market phenomenon in which something’s value is inflated far beyond its intrinsic worth. They are probably as old as commerce itself, though the first outbreak of market delirium identified as a bubble was the Dutch Tulip Bubble of 1636–37. A few decades later, the British government tottered after hundreds of thousands of Brits went broke investing in a South American real estate boom. In the 1800s, countless Americans lost their shirts speculating on railroad stocks. The 20th century brought the most destructive bubble of all—the credit-fueled stock speculation of the Roaring ’20s that ended in the Great Depression. More recently, the U.S. has been rocked by the Internet bubble of the late 1990s and this decade’s housing bubble, which ushered in today’s worldwide financial crisis. In fact, bursting bubbles led to nearly all 11 recessions the U.S. has suffered since the end of World War II.
Do all these bubbles have anything in common?
They’re all outbreaks of what historian Charles Mackay called “the madness of crowds.” (See below.) Take the tulip bubble. In the early 1600s, a mysterious virus infected many of the Netherlands’ tulip bulbs, which suddenly started producing brightly colored flowers with unusual streaks and whorls. A craze for the flowers developed, and during the winter of 1636, many Dutch started trading promises—futures contracts, essentially—to buy or deliver tulip bulbs the following spring. Prices rose furiously. One eager buyer traded his house for a single bulb; another swapped 12 acres of land. The outlandish prices brought in even more traders seeking easy riches, and initially, prices rose as new buyers surged into the market. But promises to deliver bulbs outnumbered the actual supply, and as spring approached, many people who had contracted to deliver bulbs couldn’t fulfill their obligations. Contracts to buy the bulbs were suddenly worthless, and the market crashed.
People really thought tulips could make them rich?
It sounds silly. But that’s the nature of bubbles—frenzied speculators part with common sense in their “irrational exuberance’’ for the next big thing. In the mid-1800s, new U.S. railroad companies were working to link markets that had never before been connected, thus revolutionizing commerce. Millions of Americans borrowed money to buy shares in railroad companies, and stock prices soared. But the steep costs of building the railroads proved too much for many companies, and several collapsed, ruining investors who planned to repay their loans out of their stock profits. The Internet bubble of our own time was remarkably similar.
In what way?
Investors were so excited about the potential, they lost sight of reality—hope triumphed over reason. Take the notorious case of Webvan, a company that delivered grocery orders placed over the Internet. On the day Webvan went public in 1999, its stock market value soared from $375 million to $8.5 billion—one of the best opening days of any stock in history. Webvan could never deliver enough groceries to justify that value, and the company went bankrupt in 2001. But it wasn’t just faith in the Internet that led speculators to bid up Webvan’s price. They also had faith that other people believed even more fervently in the Internet’s potential. In short, people who paid a foolish price for Webvan and hundreds of other Internet firms figured they could always find a greater fool to pay an even higher price. And many did, compounding their folly by buying their shares with borrowed money. Eventually, of course, the bubble burst.
What does borrowed money have to do with it?
Without borrowed money, there likely would be no bubbles. That’s because bubbles first inflate when credit is easy to obtain, and pop when credit tightens. During the stock bubble of 1929, for instance, many investors bought shares with borrowed funds. When prices started to fall in October 1929, investors rushed for the exits, hoping to sell their shares while they were still worth more than their loans. But because everyone was selling at once, stock prices plummeted, leaving many investors with debts they couldn’t repay. Many U.S. banks were among those investors. Hearing about the banks’ losses, depositors rushed to withdraw their funds, starting a bank run that caused thousands of banks to collapse.
Is something similar happening today?
In many ways, yes. The housing bubble first started to inflate when interest rates fell to 1 percent after the 2000 dot-com crash. Banks happily granted mortgages to almost anyone who could fill out an application. Millions of borrowers bought houses they really could not afford, figuring they could sell at a profit if they got in a pinch. It wasn’t such a far-fetched idea—in much of the U.S., housing prices had risen steadily since the late 1970s. But prices eventually hit a peak and started to fall, and the inevitable stampede for the exits began. As in 1929, says finance professor Lawrence Kryzanowski, people thought “the good times were going to go on forever. And then very quickly, they stopped.” History provides one consolation, however: Just as every boom inevitably comes to an end, so does every recession.
The madness of crowds
Many economists believe that people tend to make rational financial decisions. But the recurrence of bubbles suggests that greed, emotion, and peer pressure can overwhelm rationality. When we see friends and neighbors making big bucks trading dot-com stocks or flipping McMansions, we want in on the action. For a while, as everyone joins the party, rising prices become a self-fulfilling prophecy. But then comes a seemingly minor event that reverses the psychological polarity, turning endless optimism into bottomless panic. (In the case of the housing bubble, it was one big bank’s announcement in March 2007 that it was experiencing higher-than-expected losses on its mortgage holdings.) The same herd mentality that drove people to crowd into the market now drives them to flee the market en masse. Falling prices then become the self-fulfilling prophecy, and the panic feeds on itself, sweeping aside caution, common sense, and historical memory. Super-investor Warren Buffett has seen it happen over and over again through the years. “What we learn from history,” he likes to say, “is that people don’t learn from history.”
Crisis moves from Wall Street to Main Street
What happened
President Bush said this week he was open to taking additional steps to stimulate the flagging economy, amid new indications that the U.S. is sliding into a deep recession. A slew of downbeat earnings reports and a steep jump in unemployment claims convinced policymakers and investors alike that the financial crisis had extended beyond Wall Street and was battering the “real economy.” The Bush administration reversed itself and voiced support for a new economic stimulus package, as did Federal Reserve Chairman Ben Bernanke. Congressional Democrats quickly got to work producing a $300 billion package with new infrastructure spending, unemployment benefits, and Medicaid assistance to states. Congress plans to hold a special session after the election to take up the legislation.
Following a stock market rally that reflected widespread relief that the credit crisis was easing, stock indexes plunged as corporations reported dramatically lower sales and earnings. Construction equipment giant Caterpillar called the economic contraction “the worst we’ve seen in years.” Internet portal Yahoo! announced it would lay off 1,500 workers, and thousands of other layoffs were announced by Merck, PepsiCo, and other companies. “This is an equal-opportunity recession,” said Cathy Paige of temporary-staffing supplier Manpower. “Everyone is feeling it.”
What the editorials said
The Fed chairman knows which way the wind is blowing, said The Wall Street Journal. With a Barack Obama presidency looking increasingly likely, “Bernanke all but submitted his job application” to Obama by endorsing the interventionist, Democratic approach to fiscal “stimulus.” A “tougher” Fed chairman would refrain from “meddling in campaign tax-and-spending debates” right before an election, but Bernanke has opted for self-interest over principle.
Washington’s inclination to intervene is admirable, said USA Today, but the public would be better served if policymakers let the recession play out. It may sound “harsh,” but “recessions are as necessary to prosperity as are recoveries.” Growth can resume only after the economy is purged of its excesses. There’s room for limited steps to ease the downturn’s impact on the most at-risk Americans, but expensive new programs that add to the soaring deficit “could do more harm than good.”
What the columnists said
Welcome to “the Great Incomprehensible Recession of 2008,” said Steven Weisman in The New Republic. “The only thing easy to understand” about the mess we’re in is that panic is everywhere, from the stock exchange to the halls of Congress. Nearly everything else is comprehensible only to “a priesthood of experts.” As Washington moves beyond short-term fixes to consider long-term reforms, the first priority “must be to make the entire global financial system more transparent, comprehensible, and accountable.”
Too bad that’s not the Democrats’ main concern, said James Capretta in National Review Online. The stimulus measures that the Democrat-led Congress will take up in November represent the first step backward toward “the failed liberal policies of the 1960s.” Those policies, with their “large expansions of federal entitlements and explicit efforts to redistribute income,” will foster dependence on government and stifle initiative and innovation.
Washington has its priorities, I have mine, said Warren Buffett in The New York Times. And that’s to “buy a slice of America’s future at a marked-down price.” One rule has guided all my investment decisions: “Be fearful when others are greedy, and be greedy when others are fearful.” Right now, fear is coursing through the markets, knocking down the prices of some of the world’s soundest companies to levels not seen in decades. Those companies “will be setting new profit records five, 10, and 20 years from now.” I’m positioning myself now to share in those profits, and so should you.
What next?
President Bush said this week that he’ll host an economic summit, beginning on Nov. 15, at which leaders of the world’s biggest economies will consider coordinated efforts to combat the global slowdown. The announcement cheered European leaders, “who’ve already forced the U.S. hand on key design elements of the financial rescue effort that’s currently underway around the world,” said John D. McKinnon in The Wall Street Journal. European leaders are “hoping that a politically weakened Bush administration will be more likely to accept their ideas at the summit.”
President Bush said this week he was open to taking additional steps to stimulate the flagging economy, amid new indications that the U.S. is sliding into a deep recession. A slew of downbeat earnings reports and a steep jump in unemployment claims convinced policymakers and investors alike that the financial crisis had extended beyond Wall Street and was battering the “real economy.” The Bush administration reversed itself and voiced support for a new economic stimulus package, as did Federal Reserve Chairman Ben Bernanke. Congressional Democrats quickly got to work producing a $300 billion package with new infrastructure spending, unemployment benefits, and Medicaid assistance to states. Congress plans to hold a special session after the election to take up the legislation.
Following a stock market rally that reflected widespread relief that the credit crisis was easing, stock indexes plunged as corporations reported dramatically lower sales and earnings. Construction equipment giant Caterpillar called the economic contraction “the worst we’ve seen in years.” Internet portal Yahoo! announced it would lay off 1,500 workers, and thousands of other layoffs were announced by Merck, PepsiCo, and other companies. “This is an equal-opportunity recession,” said Cathy Paige of temporary-staffing supplier Manpower. “Everyone is feeling it.”
What the editorials said
The Fed chairman knows which way the wind is blowing, said The Wall Street Journal. With a Barack Obama presidency looking increasingly likely, “Bernanke all but submitted his job application” to Obama by endorsing the interventionist, Democratic approach to fiscal “stimulus.” A “tougher” Fed chairman would refrain from “meddling in campaign tax-and-spending debates” right before an election, but Bernanke has opted for self-interest over principle.
Washington’s inclination to intervene is admirable, said USA Today, but the public would be better served if policymakers let the recession play out. It may sound “harsh,” but “recessions are as necessary to prosperity as are recoveries.” Growth can resume only after the economy is purged of its excesses. There’s room for limited steps to ease the downturn’s impact on the most at-risk Americans, but expensive new programs that add to the soaring deficit “could do more harm than good.”
What the columnists said
Welcome to “the Great Incomprehensible Recession of 2008,” said Steven Weisman in The New Republic. “The only thing easy to understand” about the mess we’re in is that panic is everywhere, from the stock exchange to the halls of Congress. Nearly everything else is comprehensible only to “a priesthood of experts.” As Washington moves beyond short-term fixes to consider long-term reforms, the first priority “must be to make the entire global financial system more transparent, comprehensible, and accountable.”
Too bad that’s not the Democrats’ main concern, said James Capretta in National Review Online. The stimulus measures that the Democrat-led Congress will take up in November represent the first step backward toward “the failed liberal policies of the 1960s.” Those policies, with their “large expansions of federal entitlements and explicit efforts to redistribute income,” will foster dependence on government and stifle initiative and innovation.
Washington has its priorities, I have mine, said Warren Buffett in The New York Times. And that’s to “buy a slice of America’s future at a marked-down price.” One rule has guided all my investment decisions: “Be fearful when others are greedy, and be greedy when others are fearful.” Right now, fear is coursing through the markets, knocking down the prices of some of the world’s soundest companies to levels not seen in decades. Those companies “will be setting new profit records five, 10, and 20 years from now.” I’m positioning myself now to share in those profits, and so should you.
What next?
President Bush said this week that he’ll host an economic summit, beginning on Nov. 15, at which leaders of the world’s biggest economies will consider coordinated efforts to combat the global slowdown. The announcement cheered European leaders, “who’ve already forced the U.S. hand on key design elements of the financial rescue effort that’s currently underway around the world,” said John D. McKinnon in The Wall Street Journal. European leaders are “hoping that a politically weakened Bush administration will be more likely to accept their ideas at the summit.”
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