SECRETARIA DE ESTADO DE ECONOMÍA,

MINISTERIO DE ECONOMÍA Y HACIENDA

SECRETARÍA GENERAL DE POLÍTICA ECONÓMICA Y ECONOMÍA INTERNACIONAL SUBDIRECCIÓN GENERAL DE ECONOMÍA INTERNACIONAL

CUADERNO DE DOCUMENTACION Número 86-23º (alcance) ¡Feliz año 2009!

Alvaro Espina Vocal Asesor 30 Diciembre de 2008 (14 horas)

CD 86-23º de alcance 30 de Diciembre de 2008 [A] “Los sistemas de propiedad no son autónomos, sino que dependen en su definición de toda una constelación de procedimientos legales, civiles y penales. La evolución de la legalidad tampoco puede ser contemplada como algo derivado del sistema de precios. Los jueces y la policía deben ser remunerados, pero el sistema mismo desaparecería si estos agentes tuvieran que estar vendiendo en cada momento sus servicios y decisiones. De modo que la definición de los derechos de propiedad, basados en el sistema de precios, depende precisamente de la no-universalidad del sistema de precios y de propiedad privada. El sistema de precios no es universal, y probablemente en un sentido profundo no puede serlo. En la medida en que es un sistema incompleto debe estar complementado por un contrato social, implícito o explícito”. [B] “Con independencia de nuestras teorías omnicomprensivas acerca del mercado, los economistas debemos reconocer que hay bienes que podrían ser comprados y vendidos, pero que no lo son. Pueden aducirse muchos ejemplos. Las decisiones judiciales y los votos no pueden ir hacia el mejor postor. Los individuos no pueden renunciar a ciertos derechos legales. Los valores que se ofrecen a la venta en el mercado tienen que respetar, entre otras, la regulación sobre transparencia: no está permitido ofrecer valores sin proporcionar esa información, incluso cuando lo que se notifica al comprador es que tales valores no respetan la regulación. Cuando se me pregunta si la razón para que estas mercancías potenciales se vean universalmente impugnadas es que comercializarlas violaría [los derechos de] la persona, mi respuesta resulta menos clara. Más que con la preservación de la integridad individual, muchas de estas impugnaciones parecen relacionadas con la operatividad del sistema social...... El mercado es un sistema; la política, otro. El uso del mercado y de su lenguaje para hablar de política conduce a resultados que ofenden nuestra intuición; e igual sucede cuando el mercado emplea el lenguaje político. Contemplar los problemas políticos desde la perspectiva de cualquier otro sistema suele conducir a conclusiones insatisfactorias. La multiplicidad de sistemas de control en el mundo real probablemente no resulta accidental.” Kennet J. Arrow1

1

Kenneth J. Arrow: [A] “Gifts and Exchanges”, Philosophy and Public Affairs, 1972, 1-4, pp. 343-362; [B] “Invaluable Goods”, Journal of Economic Literature, 1997, Vol. 35, nº 2, (Junio), pp. 757-765.

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Tras Estocolmo: Los números de Krugman Tras regresar de recoger el premio Nóbel, Krugman le ha echado las cuentas a Europa. Si cada país emprende por separado un plan de reactivación –lo que, al paso que van las cosas, se presentará como algo inexorable, por mucho que arrastren sus pies los más recalcitrantes- por cada euro gastado por el Estado sólo se conseguiría un crecimiento del PIB de 0,73 euros; y por cada euro de déficit –y deuda- en que incurriera el Estado sólo se conseguiría un crecimiento del PIB de 1,03 euros2. Conclusión: a los estados europeos no les sale a cuenta embarcarse en planes de expansión por separado, porque en general los resultados son muy inferiores al esfuerzo realizado (fundamentalmente, porque más de una cuarta parte del esfuerzo expansivo de cada país enriquece a los vecinos, vía aumento de importaciones, ya que, en promedio, cada euro de crecimiento del PIB implica un aumento de 0,4 euros en las importaciones). Ahora bien, si estos planes se coordinan y se adoptan todos al mismo tiempo, por cada euro gastado por los estados europeos se obtiene un crecimiento del PIB europeo de 1,18 euros y por cada euro de déficit –y deuda- en que incurren los estados se consigue un crecimiento del PIB europeo de 2,23 euros (o sea, la rentabilidad obtenida por cada euro de deuda contraida es del 123%, reduciendo el apalancamiento). La razón de esta diferencia es que de los 0,4 euros de importaciones, 0,27 euros van hacia importaciones intracomunitarias, mientras que sólo 0,13 son extracomunitarias. Estas son las paradojas de los beneficios derivados de la acción colectiva. Claro que, como explicaba Mancur Olson, alguien puede tener la tentación de hacer de gorrón, o de viajero sin billete (free-rider). Para ello, sólo tiene que arrastrar un poco los piés hasta que los demás países adopten sus planes de expansión, lo que beneficiaría también al crecimiento del rezagado, a través del tirón sobre sus exportaciones, sin 2

La formulas empleadas para estimar el multiplicador del gasto expansivo (dY/dG) y el impacto del déficit sobre el euro (dY/dD) son: dY/dG = (1-m)/[1 - (1-m)(1-t)c]; y dY/dD = (1-m)/[1 - (1-t)(1-m)c - t(1-m)], en las cuales c y m son las propensiones marginales al consumo y a importar, y t la presión fiscal marginal. En los cálculos, m = t = 0,4; c = 0,5.

2

incurrir en el más mínimo gasto o riesgo, robando el empleo de los demás y mejorando el equilibrio relativo de sus cuentas públicas y su balanza externa a cuenta de los desequilibrios de los demás. Gráfico I

No es difícil adivinar que el país con más fuerte tentación de no pagar billete es Alemania, cuyo crecimiento es precisamente el que más depende de las exportaciones3. Pero ¿qué sucedería si nadie hiciese nada? Pues sucedería que el PIB caería a plomo, pero lo haría menos en los países que más importan (como España, que importó de Alemania 47.631 M. €, siendo su octavo socio comercial, pero sólo exportó 20.687 M. €, ocupando el puesto 14º). 3

Según el Instituto federal de estadísitica: “Germany’s economy is very much export-oriented and hence also export-dependent. At the same time, due to scarce natural resources Germany also depends on imports – in particular, in the energy sector (mineral oil, natural gas). In 2007 Germany exported goods worth 965.2 billion euro and imported goods worth 769.9 billion euro. Thus, both exports and imports reached their highest-ever level. The foreign trade balance achieved a “record surplus” of 195.3 billion euro.” Véase: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Navigation/Statistics/Au ssenhandel/Aussenhandel,templateId=renderPrint.psml__nnn=true (con el gráfico adjunto)

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En cambio, el presunto gorrón sería el más perjudicado. Mientras el dólar se apreciaba respecto al euro, Alemania se permitía el lujo de actuar como lastre, tanto en materia de planes de expansión europeos, como esperando que el BCE no bajase los tipos al ritmo adecuado (con los sindicatos alemanes volcados en congelar sus salarios reales y reducir los salarios relativos para ganar posición competitiva, como vía para conservar el empleo4). Gráfico II

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GROSS MONTHLY EARNINGS IN THE 3RD QUARTER OF 2008: +3.0% TO EUR 3,105

“A full-time employee in the industry or in the service sector in Germany earned an average gross EUR 3,105 per month in the third quarter of 2008. That was 3.0% more than in the third quarter of 2007. In the former territory of the Federal Republic, average gross monthly earnings amounted to EUR 3,224 (+2.9%), in the new Länder EUR 2,355 (+3.4%). Over the same period, the consumer price index rose by 3.1%; hence, its increase was by 0.1 percentage points larger than that of all-German earnings. ”Véase: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Navigation/Statistics/Ve rdiensteArbeitskosten/Bruttoverdienste/Bruttoverdienste.psml

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Probablemente el exceso de confianza de la dirigencia económica alemana en lo invulnerable de su economía, por estar orientada hacia la exportación -orientación que recibió un impulso definitivo tras la adopción del Euro, que triplicó el superavit de la balanza, como se observa en el Gráfico III-, proviniera estos últimos meses de la depreciación del Euro respecto al dólar y el yen (debido a la búsqueda compulsiva de seguridad y a la inversión del carry-trade respecto al yen). Lo que pasa es que en ese estúpido frente de guerra (“crass warfare”, en palabras de Krugman), a frau Merkel (nein-Merkel) el tiro ya le está saliendo por la culata, porque el racaneo monetario de monsieur Trichet5 está disparando de nuevo la cotización del euro frente al resto de monedas. El viernes 19 de diciembre el euro ya cotizaba a 1,47 dólares y a 0,95 peniques, y Brad Setser vaticinaba a corto plazo la paridad con la libra y la recuperación del tipo de cambio record a 1,6 dólares. Es dudoso, sin embargo, que el descenso de la competitividadprecio de las exportaciones alemanas denominadas en dólares modifique la actitud de los dos guerreros teutónicos, ya que dos terceras partes de las exportaciones y siete de cada diez euros importados provienen de la Unión Europea (aunque, la suma de las exportaciones a EEUU y Reino Unido significaron en 2007 el 15% del total, como se observa en el gráfico II, y otro 11% se dirigía hacia Asia, de donde provenía el 17% de las importaciones –ocupando China ya la tercera plaza con un 7%-, mientras que los dos grandes países anglosajones sólo remitían el 11,6% de las 5

Obsérvese la ironía que emplea Brown Brothers Harriman recomendando a “Mr. Trichet” que siga cuidándose de mantener el euro fuerte (para mejor conveniencia del resto del G10 y para estupefación de todos los observadores avisados, tras comprobar la revaluación del euro en 17%/15%/12% respecto a dólar/libra/yen durante las últimas semanas). En el colmo de la burla, el analista afirma que, aunque los tipos ya deberían encontrarse cerca de cero, es de prever que el BCE, con su proverbial parsimonia, sólo llegue a esa situación allá por febrero. La cosa promete ser un verdadero festín para las exportaciones hacia Europa y el arbitraje carry-trade: http://www.bbh.com/fx/index.php/fx2/entry/10543/?qoMenuLink=Q1%202009. Pero, para entonces, la economía europea se encontrará prácticamente paralizada y el euro caerá por sí sólo –lo que, paradójicamente, puede ayudar a las exportaciones alemanas-. Probablemente, entonces a Mr. Trichet se le ocurrirá que no debe seguir reduciendo los tipos para no perujudicar más al euro, pero se equivocará de nuevo, porque cuando él se encuentre disparando contra el carry-trade de los mercados de divisas, los inversores en esos mercados ya estarán valorándolas en términos de expectativas de crecimiento de cada área, o sea, lo que se cotizará en febrero será la caída de los fundamentos de la economía europea.... and so forth. 5

importaciones6). Gráfico III7

Por cierto, la reacción de Setser ante los datos de la balanza de capitales publicada por el Tesoro en octubre (Treasury International Capital: TIC) fue, primero, de una cierta incredulidad, pero en los días subsiguientes ésto se ha ido 6

“About three quarters of exports of goods “made in Germany” were shipped to European countries. 65% of all goods were delivered to the member states of the European Union. The second important sales market for German goods in 2007 was Asia with a share of about 11%, followed by America, with a share of approximately 10%. Africa and Australia / Oceania only accounted for small percentages of German exports (2% and 1%, respectively). The majority of German imports also came from Europe (71%), followed by Asia (17%) and America (9%). Goods from Africa and Australia / Oceania played just a subordinate role in imports too (2% and 0.4%, respectively).” Véase el texto y los gráficos II en: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Navigation/Statistics/Au ssenhandel/Handelspartner/Handelspartner.psml 7

En 2007: X= 965,2 mM €; M= 769,9 mM €; X-M= 195,3 mM €. Gráfico importado de: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Navigation/Statistics/Au ssenhandel/Gesamtentwicklung/Gesamtentwicklung.psml

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materializando en una brillante construcción intelectual, contrastada con la evidencia empírica disponible: desde 2006 Europa ha sustituido a EE.UU. en la colocación de las reservas chinas, que financian un desequilibrio creciente en el comercio exterior euro-chino, como ocurría en EEUU durante la fase a la que Roubini y el propio Setser denominaron “régimen Bretton Woods II” (RBWII)8, de modo que a este nuevo régimen podríamos denominarlo RBWII’. Pero entonces, ¿cómo es que Europa no ha experimentado el exceso de liquidez que experimentó América anteriormente? ¡Ah! ¡Es que, en paralelo con ese proceso, se ha producido otro por el que Europa ha sustituido parcialmente a China como financiadora del déficit americano, volviendo a la situación denominada RBWI! ¡Lo que antes era Chiamérica ahora es Chieuropa+Euroamérica! O sea, que en un plazo de tiempo de dos años hemos pasado del régimen RBWII de flujos internacionales de capitales (y de desequilibrios comerciales) a otro al que podríamos denominar Bretton Woods III (RBWIII), que es, en realidad, equivalente a la suma de los dos anteriores (aunque después de haber pasado Europa a sustituir parcialmente a EEUU en el RBWII). O sea: RBWIII = RBWI + RBWII’. Antes, estos cambios ocurrían una o dos veces cada siglo. Ahora, dos veces por quinquenio. En el grágico IV puede observarse que la apreciación del dólar durante la marcha hacia el euro entre 1986 y 2001 produjo un avance impresionante de la posición competitiva de los Costes laborales unitarios europeos (en primer lugar, de los alemanes, pero también del promedio de los seis mayores PIB de la eurozona, y de España) respecto de los norteamericanos, que alcanzó su máximo en 2001, aunque durante el trienio subsiguiente el desequilibrio se corrigió, hasta quedar reabsorbido prácticamente en 2004, en el caso de 8

Véase Nouriel Roubini y Brad Setser, “Will the Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005-2006”, Presentado en el Simposio Revived Bretton Woods System: A New Paradigm for Asia Development?, Federal Reserve Bank of San Francisco, Febrero 2005, en: http://www.frbsf.org/economics/conferences/0502/Roubini.pdf . Las ideas básicas habían sido enunciadas dos años antes por Michael P. Dooley, David Folkerts-Landau y Peter Garber en “An Essay on the Revived Bretton Woods System”, NBER Working Paper 9971, Septiembre de 2003, disponible en: http://www.nber.org/papers/w9971. 7

Alemania (que ha experimentado después fluctuaciones cíclicas mucho menos apreciables). En el caso de España el desequilibrio se invirtió, hasta alcanzar un máximo del 31% respecto a Alemania en 2007, del 26,6% respecto a EE.UU. y del 8,5% respecto a los seis mayores PIB de la Eurozona Gráfico IV

Costes laborales unitarios en las manufacturas En dólares a tipo de cambio de mercado: 1996=100

Costes laborales unitarios en las manufacturas

130

120

Alemania

EE.UU.

España

Eurozona 6

110

100

90

80

70

60 1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Fuente: BLS (Eurozona 6: Bélgica, Francia, Alemania, Italia Países Bajos y España)

En contrapartida a este mayor equilibrio con los CLU alemanes, en la etapa más reciente, a partir de 2001, los beneficios de las preferencias generalizadas derivados de la entrada de China en la OIC permitieron al gigante asiático ir acumulando un superávit en su balanza por cuenta corriente cuya dimensión no tenía precedentes históricos. Tal superávit era el resultado de la agresividad exportadora edificada sobre dos pilares: la total ausencia de restricciones a la competencia destructuva en costes salariales –implícitas en las instituciones laborales democráticas- y la falta total de respeto hacia el compromiso adoptado en Bretton Woods de no intervenir sistemáticamente en los mercados de tipos de cambio de la moneda, que los países de la OCDE habían 8

seguido aceptando (aunque sólo como código de buenas prácticas) desde la ruptura del sistema BW en 1971. El cambio en la estructura internacional de reservas implícito en el RBWII fue una respuesta adaptativa a la crisis asiática, aunque en realidad la problemática que condujo a ello –que no fue otra que la incapacidad para articular un sistema ordenado de pagos internacionales que liberase a los deudores de la dictadura de los prestamistas, cuando éstos eran los titulares de las monedas de reserva internacional- había quedado pendiente desde la crisis de la deuda de los años ochenta. No abordar el problema –tal como lo planteaba a comienzos de los años noventa Kaushik Basu9condujo a la secuencia de crisis financieras internacionales del último deceno del siglo XX, que no fueron otra cosa que la novela por entregas de la crisis final de 2008. Para no someterse a la dictadura del prestamista internacional de última instancia, China –seguida del resto de Asia- copió el esquema seguido por Europa y Japón durante la segunda posguerra, resultado, a su vez, de la experiencia traumática alemana de entreguerras, cuando el incumplimiento del Plan Dawes condujo al país a la bancarrota y lo echó en manos del nazismo10. Esa fue, en realidad, la raíz de la búsqueda compulsiva de excedente comercial y de acumulación de reservas en Europa y Japón que condujo al régimen Breton Woods I, que ahora ha sido imitado por China y los países asiáticos emergentes, tras la experiencia traumática de la crisis de la deuda de los ochenta y de las crisis financieras de los años noventa. China imitó a la Europa de la segunda posguerra para diseñar su propio esquema de crecimiento desequilibrado, basado en las exportaciones y en la acumulación de reservas. Esto es lo que 9

Véase su “The International Debt Problem, Credit Rationing and Loan Pushing: Theory and Experience”, Princeton Studies in International Finance, nº 70, octubre 1991, Princeton University, Department of Economics, International Finance Section, disponible en: http://www.princeton.edu/~ies/IES_Studies/S70.pdf 10

Y fruto también del ostracismo exportador al que los aliados trataron de condenar a la Alemania de posguerra. Véase en El País (28-XII-2008) la entrevista con el primer ejecutivo de Siemens, Gerhard Cromme, en la que declara que la práctica generalizada del soborno en la contratación fue empleada por las empresas alemanas para romper aquella prescripción. 9

acabó de producir la “pletora mundial de ahorros”,11 a la que se refería Bernanke (de la que se hace eco Mark Landler, tratando de atenuar la responsabilidad americana sobre la burbuja, lo que produce el enfado de Krugman), que es la contrapartida de la creación del mayor desequilibrio jamás visto en el sistema de intercambios internacionales. Consecuencia de este colosal desequilibrio ha sido la escasez extrema de activos financieros en los que colocar las reservas, escasez que condujo a la degradación de su calidad, hasta que lo insostenible del proceso se puso de manifiesto con el estallido del paquete más frágil de los nuevos activos creados de forma precipitada y culposa (las MBS de las hipotecas subprime). El movimiento pendular subsiguiente condujo a la “huída hacia la calidad”, que detecta Robert Lucas, y que, como suele suceder, está resultando todavía más histérica que 11

Pero eso sucedió ya en el siglo XXI. A comienzos del último decenio del XX había escasez mundial de ahorro y de demanda de activos. La experiencia japonesa de los años ochenta proporcionó una evidencia inestimable para el mundo financiero. El envejecimiento de la población japonesa –prematuro en términos internacionales-, había elevado de forma anómala la tasa de ahorro de ese país a escala macroeconómica durante los años ochenta, lo que contribuyó a explicar la elevación exponencial de la demanda de activos, que condujo a la burbuja japonesa (véase el epígrafe “Demografía y ahorro: el ‘excepcionalismo’ Japonés”, en Sobre estabilidad de precios, deflación y trampas de liquidez en el G, 200), disponible en: http://biblioteca.meh.es/DocsPublicaciones/LITERATURAGRIS/SOBRE%20ESTABILIDA D%20DE%20PRECIOS%20EN%20EL%20G-3%202004.pdf Pero para cuando los “chicos díscolos” del MIT analizaban el impacto del envejecimiento sobre la burbuja japonesa y la deflación subsiguiente (resultados sintetizados en K. Murata, “Precautionary Savings and Income Uncertainty: Evidence from Japanese Micro Data” Monetary And Economic Studies, Octubre 2003: http://www.imes.boj.or.jp/english/publication/mes/2003/me21-3-2.pdf), los economistas financieros (los “chicos listos”, a sueldo de Wall Street) ya se habían percatado del inmenso yacimiento de ahorro y de demanda potencial de activos que se escondía en la generación del Baby-Boom (que empieza a jubilarse ahora en Norteamérica, y, enseguida, en el resto del mundo). Sólo había que difundir a escala planetaria el mitologema sobre la quiebra de los sistemas de pensiones de la seguridad social para estimular el exceso de ahorro con que cebar el crecimiento de la demanda y la burbuja de activos (algo parecido al mitologema de George W. Bush sobre la pretensión de hacer propietario de su casa hasta al norteamericano más pobre. Tony Blair generalizó la idea en su objetivo de “Hacer de Gran Bretaña un país de tenedores de activos”). La reforma sueca y la propia práctica de la Seguridad social de EEUU son los mejores ejemplos de que todo ello fue un inmenso infundio. Véase mi Estado de Bienestar y competitividad. La Experiencia europea (2007), Fundación Carolina/Siglo XXI.: Capítulo final: “A modo de Síntesis: ¿Existe un modelo europeo de Estado de bienestar?”, disponible en: http://www.ucm.es/centros/cont/descargas/documento6148.pdf. El cambio del esquema de desequilibrios –que coincide con el comienzo de siglo- quedó sintetizado en los dos cuadros que aparecen al final de la entradilla del CD 86-9º.

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la huída hacia el riesgo y la despreocupación por la calidad durante la etapa de hinchazón de la burbuja. Muchos economistas se preguntan estos días: ¿qué nos ha pasado?12 De hecho, la magia de las curvas de demanda perversas de la economía de activos sedujo también a la parte más vulnerable de la profesión (vulnerable desde la perspectiva del conocimiento ecuánime, no desde el pecuniario; al contrario, lo uno y lo otro suele ir en relación inversa, porque la “sociedad del conocimiento” paga mal a quienes producen su mejor herramienta), que explicó lo inexplicable generando una variedad de pseudo-conocimiento denominada “nuevo paradigma” o “nueva economía”. Las falacias de este discurso aprovecharon “pro domo sua” los agujeros teóricos para acomodar los graves problemas de la deuda y las finanazas internacionales –a los que se refería Kaushik Basu-, en el conjunto del conocimiento económico. Krugman expresaba estos agujeros así: “[Es preciso] reconciliar el modelo macroeconómico en que creo [que viene a ser el de Mundell-Fleming, con algunas modificaciones] con el modelo de comercio internacional en el que creo [por mucho que todavía choque con resistencias ideológicas]: la teoría del comercio internacional, las finanzas y la economía monetaria. Construir un puente entre la teoría intertemporal sobre el ahorro y la inversión y el modelo macroeconómico, tras el paisaje desolador de las expectativas racionales. Lo que necesitamos saber es cómo evaluar la microeconomía del sistema monetario internacional. Mientras no lo sepamos, el diseño o el consejo acerca de las políticas lo tendremos que hacer apelando a la experiencia y la intuición (‘by the seat of our pants’)”13 Y en ese contexto, algunos pensaron: “pues si se trata de experiencia e intuición, tanto vale la mía como la de Krugman y de 12

Véase Drake Bennett, “Paradigm lost. Economists missed the brewing crisis. Now many are asking: How can we do better?”, The Boston Globe, 21, Diciembre, 2008

13

Véase su “What do we need to know about the Internacional Monetary System?”, Essays in International Finance, nº 190, julio, 1993, Princeton University, Department of Economics, International Finance Section, en: http://www.princeton.edu/~ies/IES_Essays/E190.pdf

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todos estos keynesianos demodés”. La edificación del RBWIII ha sido el resultado de esta larga cabalgada –que ya va para dos decenios, si no incluimos la Vodoo economics del decenio de los ochenta, ni la magia de las expectativas racionales- en los que, abrumados por la enormidad de la aparición de la economía global, muchos economistas decidieron prescindir de todo lo que habían aprendido, y los que no lo hicieron se vieron obligados a iniciar siempre sus críticas con una disculpa: Brad Delong solía decir “llámenme carroza, pero yo creo que preservar un mínimo de equilibrios macroeconómicos sigue siendo importante”; Krugman hace gala de basar sus principales aseveraciones en los manuales de “Economics 301” (el nivel intermedio de los estudios de economía en las universidades norteamericanas), pero es Samuelson quien lo sintetiza mejor que nadie (y que se aplique el cuento el BCE): “Volvamos a leer los discursos pronunciados por Alan Greenspan o por Mervyn King, gobernador del Banco de Inglaterra, entre 1987 y 2006. ¿Es posible que no fueran a clase el día en que se enseñó el concepto [de trampa de liquidez]?” Estamos en tiempos de historiadores. Los primeros textos de este CD son de algunos de los buenos: hablan sobre los ciclos de la política económica (véase la joya de Skidelsky, que, por una vez, conecta los ciclos de Schlesinger con el concepto de las generaciones14) Y tambien hay buenos textos sobre economistas outsiders, como Nouriel Roubini, quien junto a Brad Setser se anticipó al colapso, y por eso han sido ellos los mejores guías durante estos últimos meses. Como suele suceder, cuando se parte de un buen diagnóstico la observación de la realidad se enriquece de manera insospechada (no es que suene la flauta por casualidad, como piensan los mainstream economists acerca de los aciertos de Roubini, sin concederle el menor mérito). Por eso, Setser expresaba con tanta gracia lo que viene observando en el RBWIII: para canalizar todo el flujo de capitales con que financiar el desequilibrio comercial, 14

Y da el crédito merecido a Ortega y Manheim. Ya era hora. Vid. mi vindicación de ambos: http://biblioteca.meh.es/DocsPublicaciones/LITERATURAGRIS/GENERACIONES%20Y% 20CAMBIO%20SOCIAL%20CIS.pdf 12

Chieuropa adquiere títulos americanos. Pero, como los valores privados, e incluso los bonos de las agencias estatales de tipo F&F, no ofrecen seguridad (y existe la huída hacia la calidad, como dice Lucas, que responde -esta vez sí- a expectativas racionales, aunque ahora la racionalidad consista en huir de los ladrones, como Madoff), la compra se desplaza hacia los títulos del Tesoro (en un movimiento encabezado por los bancos centrales). Sin embargo, haciendo gala del provervial desparpajo, propio de la economía de la depresión (que Samuelson, siguiendo a Schumpeter, sintetiza en la imagen de “meter al capitalismo en una tienda de oxígeno”), el Tesoro y la Fed se encargan de recanalizar todo ese flujo, adquiriendo ellos mismos los títulos inseguros rechazados por el mercado internacional de reservas (hasta que el cuerpo aguante; porque, como dice Buiter, ¿puede quebrar un banco central?) No se piense que el que Europa se dirija impávida hacia el abismo, bajo el liderazgo de frau Merkel -y que esto pueda reportar alguna ventaja competitiva a EEUU- tranquiliza a Setser ni a Krugman. Tanto uno como otro se muestran mucho más preocupados por la recesión que se avalanza sobre Europa que tranquilizados por la buena noticia de la continuidad en las garantías de financiación y las mejores perspectivas para corregir el déficit de la balanza americana que proporciona el RBWIII. Al fin y al cabo ¿de qué vale mantener el equilibrio intercontinental, mientras toda la troika se hunde? Unos y otros ganarían más, o perderían menos, si se lograra detener el hundimiento entre todos –aunque la posición relativa de alguno de los tres empeorase algo, o mejorase un poco menos de lo esperado-. Por eso, ambos se alegran de que la continuidad en la crisis de los mercados de cambios frustre las expectativas de frau Merkel, ¡a ver si así abandona su actitud obstruccionista y da el visto bueno a una acción masiva de estímulo coordinada en la UE! Aunque, para que eso suceda, probablemente se necesite un nuevo liderazgo, que G. W. Bush ya no puede proporcionar (¡y anda que la UE, con la presidencia de Váklav Klaus!). Habrá que esperar a después de la toma de posesión del 20 de enero, y especialmente a la cumbre del G-22 del 20 de abril: ¡Pero todavía faltan cuatro meses! ¡Para esas fechas el Euro puede haber llegado a la luna! 13

Lo mejor y más honesto de la profesión se dedica a dar consejos a Obama. Le (nos) van a hacer falta (porque también son válidos para Europa). Mientras tanto, los economistas que anduvieron por las nubes buscan consuelo estos meses escribiendo opiniones editoriales para confesar su arrepentimiento. Pero estamos en la era del pragmatismo: No hay absolución; son responsables y están condenados a pertenecer a la mainstream economics del demonio hasta que produzcan algo útil, con sentido común (de lo común), y reparen el daño causado. Porque, armados de la absurda hipótesis de las expectativas racionales –que fue el trampolín para legitimar la omnisciencia del mercado-, ellos son quienes pusieron los cimientos para edificar un castillo de naipes financiero, tipo Ponzi (de ahí el pánico generalizado tras la aparición de Madoff, y la evidencia de que surgirán nuevos casos de la misma ralea), concebido precisamente para explotar al máximo la ineficiencia y el mal comportamiento (bad behaviour) de los mercados de activos (el cuerno de la luna en cuarto creciente, que dibujamos en el CD 86-22º). Edmund Phelps había avisado, a comienzos de los años setenta, que las expectativas sólo eran racionales en relación con la información accesible para cada participante, y Stiglitz –junto a algunos otroshabía construido y contrastado la teoría de la información imperfecta (no sólo asimétrica), que desmentía la de expectativas racionales. Además, el interés de los participantes en el mercado depende de la estructura de incentivos; existen costes de transación que invalidan el falso teorema de Coase (Olson-Dixit dixerunt), externalidades negativas, etc., etc., etc. Poco importaba que el buen conocimiento llevase un tercio de siglo (dos tercios, si nos remontamos a Pigou, por no hablar de Keynes) desmintiendo (falsando) la hipótesis de mercados perfectos (y ello, sin mencionar el mercado de trabajo, imperfecto donde los haya, aunque unos sean más imperfectos que otros, y es ahí donde aparecen las disfuncionalidades, como dice la OCDE). Las imperfeciones sólo pueden ser prevenidas, evitadas y corregidas mediante instituciones, pero la economía institucionalista va muy rezagada porque casi nadie invierte en ella (salvo en la rama de Law&Economics, pero sólo en la dirección promercado). Y el 14

poder financiero dispuso de recursos inagotables para desarrollar hasta la más mínima posibilidad la hipótesis absurda que sirvió de punto de partida a todo esto. Y así es como se impuso la ideología “científica” del mercatus gloriosus (vale decir, sin instituciones). El contrato social, explícito o implícito, que sirve de fundamento a todo mercado, según Arrow, fue olvidado o, más bien, destruido: Se fijó el objetivo de abandonar todas las cautelas y de eliminar cualquier barrera o contrapeso a la fuerza libre incontenible del mercado (vale decir: poder) financiero. Y, por supuesto, nada de edificar nuevas instituciones como expresión de existencia de un contrato social fundacional para el nuevo mercado global. El resultado de todo ello es el caos (porque las tendencias con forma de cuerno de luna son, evidentemente, no lineales ni convexas, y resultan incontrolables). Viene ahora el movimiento pendular que da inicio a un nuevo ciclo de preocupación por el interés público, como vaticinaran los dos Schlesinger (y que, como dice Skidelsky, probablemente sobreactuará). El IFO observa que el indicador de actividad alemán ya está en mínimos del último cuarto de siglo (y los exportadores, aterrados con lo que se les viene encima), mientras frau Merkel y herr Steinbrück continúan su guerra particular contra el “estúpido keynesianismo” británico y del resto de Europa. “Dios ciega a quienes quiere perder”. En un mundo occidental desarrollado en el que la condición de pais con amplio excedente exportador es una de las más escasas -lo que plantea graves dificultades para la “economía después de la burbuja”, como dice Krugman con pleno conocimiento de causa, tras haber estudiado durante más de un decenio el caso de Japón-, la ebriedad derivada del extraordinario éxito de las exportaciones alemanas debe de haber hecho pensar a su élite dirigente que el país es inmune a la economía de la depresión y que pueden hacer la guerra por su cuenta. Quizás hayan olvidado cuán desolador puede llegar a ser el paisaje de las ciudades alemanas en depresión. Eso también sucedió en Norteamérica durante los “roaring nineties”–y en Japon, durante los correspondientes eighties-. Pero ahora todo eso confluye y se generaliza en la recesión global, que no perdonará a nadie (de hecho, en octubre las exportaciones alemanas ya sólo 15

crecieron a una tasa anual del 1,3%, frente a un crecimiento de las importaciones del 5,2%). El artículo de P. S. Goodman sobre la ciudad de Columbia (South Carolina) presenta a esta ciudad como el verdadero microcosmos de la recesión americana actual. Según los comentarios del blog de Krugman, la crisis afecta particularmente a estas alturas al “cinturón manufacturero de gran sensiblidad cíclica”, asociado al “corrredor de la automoción” –que, paradójicamente, no se había visto afectado por la burbuja inmobiliaria-. Quizás esto pueda hacerles reflexionar, porque, de no reaccionar a tiempo, el efecto llegará también a las ciudades alemanas: “As the American economy sinks deeper into one of the more punishing recessions since the Depression, frustration and fear color the national conversation”.

Somos animales de costumbres. El comportamiento alemán se ve profundamente afectado por la historia de éxito del Bundesbank durante la etapa de lucha contra la inflación, practicando una política enormemente parsimoniosa, sólo sobresaltada por los mínimos repuntes de la inflación y por las violentas caídas de la actividad15 (al igual que sucede en otros casos con el éxito o el fracaso del intervencionismo16). Pero tambien se muere de éxito: la lucha contra la gran inflación no fue lo mismo que evitar la gran depresión (aunque ambas parezcan simétricas). Cuando ésta llegue y todos los indicadores de actividad muestren el hundimiento, ya será demasiado tarde para intervenir, porque Europa se encontrará atrapada en el “mal japonés”. El Bundesbank no puede convertirse en la maldición del BCE y en el lastre que lo lleve al fracaso. No es hora de dejarse guiar por el conocimiento económico cuantitativo convencional, que sólo parece capaz de prever la extrapolación lineal de la tendencia observada en el pasado reciente. El mejor conocimiento disponible (y también el de los economistas alemanes) es unánime al respecto. 15

Véase Andreas Beyer, Vitor Gaspar, Christina Gerberding y Otmar Issing, “Opting Out of the Great Inflation: German Monetary Policy After the Break Down of Bretton Woods”, NBER WP nº14596, en: http://papers.nber.org/papers/W14596

16

Véase: Francisco J. Buera, Alexander Monge-Naranjo, Giorgio E. Primiceri”, “Learning the Wealth of Nations”, NBER WP nº 14595 (EFG), en: http://papers.nber.org/papers/W14595

16

What do Unions do? (¿Para qué sirven los sindicatos?) Por cierto, en el treinta aniversario del trabajo clásico de Richard Freeman podríamos parafrasear su título y preguntarnos, ¿para qué sirve la Confederación Europea de Sindicatos (CES)? ¿Va a hacer algo para forzar a sus colegas germanos a que tomen medidas que ayuden a meter en vereda a la pareja de guerreros teutónicos? Es de esperar que a la DGB no se le ocurra seguirles la corriente, aceptando entrar en una especie de alianza antikeynesiana nefanda, acentuando las restricciones salariales para tratar de compensar con exportaciones intraeuropeas la desventaja de costes frente al exterior de la zona euro, extrapolando lo que han venido haciendo desde 2002, respecto al conjunto de la eurozona (e incluso respecto a España, desde 2005): Gráfico V

Costes laborales por hora en las manufacturas En dólares a tipo de cambio de mercado: 1996=100 170

Total costes laborales en las manufacturas

160

Alemania

EE.UU.

España

Eurozona 7

150 140 130 120 110 100 90 80 70 60

1996 1997 1998 1999 2000 2001 2002 2003 2004 Fuente: BLS (Eurozona 6: Bélgica, Francia, Alemania, Italia, Países Bajos y España)

2005

2006

2007

Todo ello sería un verdadero atentado contra la moneda única

17

(como decía Feldstein17). Pero, como a nadie va a pasársele por la cabeza abandonar el sistema18 ni romper las reglas de juego del mercado interior, de seguir así a los sindicatos de la Europa “estúpidamente keynesiana” no les quedaría otra salida que lanzar un boicot general contra las exportaciones alemanas, hasta que sus colegas germanos y sus dirigentes entren en razón (y, si no lo hacen por su propia iniciativa, quizás se vean arrrastrados a ello por los movimientos de protesta social, que estallarán inexorablemente si la depresión se apodera de la economía europea: un anticipo lo tenemos en Grecia, que es la economía más frágil de la eurozona). Pero esperemos que no haya que llegar a tales extremos. La crisis de los tipos de cambio, que no ha hecho más que comenzar, puede ayudar a que Merkel y Steinbrück entren en razón. Ellos, y Trichet. Bien es verdad, además, que la mejora competitiva fundamental de Alemania no proviene del desfondamiento de los salarios reales, sino de la productividad (gráfico VI). Y en este punto es donde entra de lleno la problemática de adaptación competitiva de las empresas, sobre las que incide de lleno el marco institucional del mercado de trabajo. No hay forma de edificar empresas innnovadoras (que compitan en diferenciación y calidad, no sólo en precios) con mercados de trabajo spot, en los que no existe incentivo para que los participantes inviertan en capital humano específico, sobre el que se apoya el capital intangible y la competitividad de las empresas de punta.19 Pero, en general, la productividad implica aprovechamiento de economías de escala y, cuando las empresas maduran y la expansión de los mercados resulta difícil, es preciso 17

Véase “¿Sobrevivirá el euro a la crisis actual?”, Expansión, 25-XI-2008, disponible en: http://www.project-syndicate.org/commentary/feldstein5/Spanish

18

El único caso conocido y bien estudiado de ruptura de una unión monetaria, no causada por guerra civil ni por imposición extranjera, es la ruptura del Impero Austro-Húngaro en 1918. El análisis de las implicaciones monetarias de esta ruptura lo realizaron P. M. Garber y Michael G. Spencer, en “The dissolution of The Austo-Hungarian Empire: Lessons for currency reform”, Essays in International Finance, nº 191, febrero 1994, Princeton University, Department of Economics, International Finance Section. 19

Véase Empresa, Competencia, Competitividad, Fundación Argentaria, 1998, disponible en: http://biblioteca.meh.es/DocsPublicaciones/LITERATURAGRIS/EMPRESA%20COMPETE NCIA%20COMPETITIVIDAD.pdf 18

ajustar el empleo de forma paulatina y flexible (y no precisamente el empleo más reciente, fuente de renovación y vigor competitivo). La autorización administrativa previa al despido colectivo (y la práctica judicial de aplicar la figura del despido improcedente, de carácter penal, a las amortizaciones individuales de empleo redundante) son un obstáculo casi insalvable al avance de la productividad en España. Corregirlo es imperioso, pero la entrada en vigor de la reforma legal no debería producirse antes de controlar la depresión. Otra cosa facilitaría las estrategias de desinversión apresurada, como la iniciada por Kraft en Menorca, anunciando la desaparición de las fábricas de El Caserío para concentrar su producción en Alemania, aprovechando economías de escala en la producción y captura de marca y mercado (estrategias legítimas, siempre que se respeten las normas, y éstas en su día implicaban asumir barreras de salida, que ahora no es el momento de levantar). En cambio, a la salida de la depresión, si esas instituciones siguen en pié, no habrá inversión, o será mínima. Gráfico VI

Productividad por hora en las manufacturas En dólares a tipo de cambio de mercado: 1996=100 180

Productividad por hora en las manufacturas

170

Alemania

EE.UU.

España

Eurozona 7

160 150 140 130 120 110 100 90

1996 1997 1998 1999 2000 2001 2002 2003 2004 Fuente: BLS (Eurozona 6: Bélgica, Francia, Alemania, Italia, Países Bajos y España)

2005

2006

2007

19

La Ratio Q y la vuelta al modelo IS-LM de Tobin La otra cuenta de la que se hacía eco Krugman en su blog del día 10 se refiere a las estimaciones realizadas por Russell Napier20 (estratega de CLSA Ltd.) sobre la ratio Q21 aplicada a los precios del índice Standard & Poors, a partir de los que se dibujaban las gráficas del CD 86-22º. La ratio Q es el cociente entre el valor de mercado de las acciones y el valor de reposición de los activos de las empresas cotizadas. Según Napier, Q se sitúa actualmente en 0,7, habiendo caído desde un máximo temporal de 2,9, alcanzado en 1999. Las especulaciones históricas a las que se libra Napier a partir de ahí vienen a confirmar la necesidad de adoptar, en caso necesario, una política monetaria de fuerte expansión cuantitativa por parte de los bancos centrales para evitar que los mercados sobreactúen, hundiendo las cotizaciones hasta un nivel que, en ausencia de intervención, podría llegar a reducir las valoraciones actuales hasta la mitad, ya que la experiencia histórica de los últimos 130 años indica que en las situaciones de depresión (como 1921, 1932 o 1949) la ratio Q puede llegar a descender hasta 0,3. De hecho, según las estimaciones de Tobin y Brainard, tras la primera crisis del petróleo, en 1974 la ratio Q había descendido por debajo de la paridad, hasta 0,96, desde un máximo de 2,64 situado en 1968 (para llegar a 0,3 en 1982, según los cálculos de Napier). En realidad, la señal de alarma se enciende cuando la ratio Q se encuentra por debajo de la unidad, ya que teóricamente en ese momento el mercado deja de funcionar como indicador eficiente del sistema de precios, puesto que tal cosa es tanto como decir que el valor conjunto de las empresas cotizadas es cero. Porque, de acuerdo con la teoría de la empresa de Ronald Coase22, el valor de 20

En: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a4A_dYqM9xkQ

21

Desarrollada por James Tobin y William C. Brainard (1976), “Asset Markets and the Cost of Capital”, Cowles Foundation Discussion Papers [CFDP 427], Publicado en Economic Progress, Private Values and Public Policy, Essays In Honor of William Fellner, R. Nelson & B. Balassa (eds.), North-Holland, 1977, pp. 235-262, reimpreso en Cowles Foundation Reprints: CFP 440, http://cowles.econ.yale.edu/P/cp/p04a/p0440.pdf

22

Véase Ronald Coase, “The nature of the Firm”, Económica, new series, vol 4, 1937, pp. 386-405, disponible (solo lectura) en: http://www.scribd.com/doc/2530438/COASETheNature-of-the-Firm 20

la empresa consiste precisamente en la diferencia entre su valor de mercado y el valor de reposición de los activos que la componen. Ofende al sentido común y a la intuición básica sobre la que se funda nuestra percepción económica admitir que en un momento dado el conjunto de las empresas de EE.UU. ha dejado de existir y que su único valor es el de sus activos despedazados. Y lo mismo ocurriría con las empresas de todas las economías modernas, ya que los mercados de valores funcionan en red, con escasas diferencias de valoración, derivadas tan sólo de los costes de transación entre ellos. En un contexto excepcional, en el que hasta la industria global de semiconductores amenaza con quiebras en cadena -como informa BusinessWeek-, la alternativa a esa hipótesis descabellada consiste en atribuir sencillamente el hecho anómalo a las imperfecciones de los mercados, que dejan de funcionar a partir del momento en que los animal spirits de los inversores son presas del pánico, convirtiendose en herramientas inútiles; o, más bien, en máquinas de destrucción de valor, cuyo funcionamiento es capaz de enviar a muchas empresas viables a la liquidación.23 Esa es la razón de que el valor de mercado de las empresas (en el sentido de Coase) pueda llegar a cero, o bajar incluso por debajo del valor de sus activos, ya que un mercado presa de pánico ni siquiera se detiene en el valor teórico de la empresa (derivado del valor actual capitalizado del flujo permanente de beneficios esperados), sino que se limita a capitalizar los beneficios esperados a corto plazo. Y, en tiempos de depresión, lo más probable es que buena parte de las empresas incurran en pérdidas, sin que ello signifique que la empresa haya dejado de existir (lo que no existe es el mercado). 23

El problema es bien conocido a escala de la empresa individual, ya que, cuando se presenta la necesidad de extinguir las obligaciones de un deudor respecto a un colectivo de acreedores, el bien público consiste, en primer lugar, en preservar la empresa en funcionamiento cuando todavía existe –en el sentido de Coase- que es cuando su valor de mercado es mayor que el valor de sus activos antes de entrar en liquidación (situación que implica la depreciación inmediata de los mismos). Sin embargo, tal diferencia no puede conocerse a priori. De ahí la necesidad de las instituciones concursales. Véanse Milton Harris y Artur Raviv, “The Role of Games in Security Design”, The Review of Financial Studies, vol. 8, 1995, nº 2, verano, pp. 327-367, y la segunda parte de mi trabajo “Opciones de Política Legislativa para la Reforma de la Legislación Concursal Española” Hacienda Pública Española, nº 114, I/1998, pp. 1728, disponible en: http://www.ucm.es/centros/cont/descargas/documento2718.pdf.

21

Por ese motivo, Nouriel Roubini señalaba a finales de octubre que, llegados a ese punto, era conveniente cerrar los mercados –y el presidente de la CEOE, por su propia iniciativa, ya había declarado el 17 de septiembre “que se haga un paréntesis en el libre mercado”. Una alternativa menos radical consiste precisamente en el tipo de intervención propuesto por John N. Muellbauer, analizada en el CD 86-22º, que se asemeja mucho a la idea de Schumpeter de proporcionar por un tiempo “respiración asistida al capitalismo”. Porque estamos en el mundo de los mercados de activos -en el modelo IS-LM de Tobin-, en la fase de deflación de deuda, de Irving Fisher. El problema, obviamente, es el de fijar el umbral de intervención. Pero estas cosas no se deciden teóricamente, sino por la vía de la práctica, como acaba de hacer Bernanke (responsabilizándose del “mercado de valores de última instancia”). Su decisión implica establecer aquel umbral algo por debajo del nivel 0,7 de Q, de acuerdo con las estimaciones de Napier. Comparando sus estimaciones con las del CD 86-22º, resultaría que el nivel Q =1 vendría a situarse algo por encima de la tendencia observada desde los años ochenta, mientras que el nivel 0,7 se situaría algo por encima de la línea situada en el 80% del nivel tendencial, lo que indica que la aproximación teórica de Tobin y la percepción empírica de Bernanke coinciden (ya habrá tiempo de realizar el fine tuning más tarde). En todo caso, como sucede con los sistemas concursales, de lo que se trata es de crear un nivel de garantía, paliando el colapso del mercado con la creación de un pseudomercado. Y es que, parafraseando a Arrow, “la existencia misma del mercado depende en última instancia de que no todos los agentes actúan impulsados por la motivación de la maximización de la utilidad individual y orientados por el mecanismo de los precios”. Aquí también se necesita un garante de última instancia. Existe casi unanimidad en afirmar que en este aspecto Bernanke ha actuado siguiendo la rama más fiable del conocimiento disponible. Probablemente el reconocimiento más rotundo haya sido el de Robert Lucas Jr., ya que no se recuerda un elogio más encendido e incondicional que el suyo dirigido hacia un banquero central –proveniente de una de las autoridades económicas más 22

respetadas en el establecimiento económico académico-, cuando afirma: “Hoy por hoy, el mejor estímulo es Ben Bernanke”. Ciertamente, uno y otro comparten la idea de que estas cosas no pueden preverse, aunque pueda actuarse frente a ellas, pero echemos pelillos a la mar. Sus manifestaciones al Boston Globe parecen querer decir –o soñar-: “Existen expectativas racionales; pero, aunque no existieran, actuemos como si existiesen, porque... siempre nos quedará Bernanke”24. Estas son sus palabras: “La política monetaria aplicada por Mr. Bernanke ha sido, en mi opinión, la acción antidepresiva más beneficiosa adoptada hasta la fecha, y continuará produciendo mucho bien en futuros meses. Es rápida y flexible. No había otro modo de poner tanto numerario en el sistema ni con tal celeridad como se pusieron los 600.000 millones de dólares [de reservas adicionales durante los últimos cuatro meses, respecto a un nivel inicial de 50.000], y, si fuera necesario, podrían retirarse tan rápidamente como se pusieron. El dinero se pone en circulación bajo la forma de préstamos [aunque técnicamente se realicen comprando en el mercado valores que no son bonos del tesoro]. Pero esas adquisiciones no implican que el gobierno se haga cargo de nuevas empresas, ni que el gobierno posea sus acciones, ni que vaya a fijar precios o establecer otro tipo de controles sobre las operaciones de las empresas individuales, ni que el gobierno vaya a desempeñar papel alguno en la asignación de capital hacia las distintas actividades. Esas me parecen virtudes importantes.” Ya está ¡Mr. Trichet ya lo tiene! No se podía pedir mayor legitimación -desde uno de los portavoces más autorizados de la mainstream economics- de que la intervención sobre el mercado está justificada en este caso, incluso desde las posiciones promercado más acérrimas (Lucas le proporciona los argumentos ortodoxos para la rueda de prensa en que anuncie las medidas de expansión cuantitativa: figuran subrayados en el texto anterior. 24

Aunque su inmerecida presuntuosidad le impida ver a “nadie implicado” capaz de haber previsto la crisis. Roubini o Setser no son, para este hombre, “gente implicada” (para serlo, en Harvard conviene rematar la firma con un Jr.). Para Financial Times, sí. Y probablemente tampoco lo sería Irving Fisher redivivo. Para salvar los muebles del edificio mainstream, a Lucas le basta con Bernanke, como gran bombero. ¡Ojalá se haga merecedor del elogio! 23

BACKGROUND PAPERS: 1. RGE Monitor - What Are The Key Questions for 2009?... 29 2. Where do we go from here?, by Robert Skidelsky... 36 3. It's My "Vital Center", by Arthur Schlesinger ... 43 4. Gazprom, Once Mighty, Is Reeling, by Andrew E. Kramer... 47 5. GMAC To Get $6 Billion Lifeline, by Neil Irwin and Binyamin Appelbaum... 50 6. Fifty Herbert Hoovers, by PAUL KRUGMAN... 52 7. Six vital lessons of the 1931 depression, by William Rees-Mogg... 55 8. Y luego está el resto del mundo, por PAUL KENNEDY... 57 9. Consejo para Barack Obama: pásese al centro, por PAUL A. SAMUELSON... 59 10. World Economy in 2009: Three priorities for recovery, by Wolfgang Münchau... 62 11. Bailout of Long-Term Capital: A Bad Precedent? , by Tyler Cowen... 64 12. Un año pésimo (y vamos a peor), El País. Negocios... 67 13. El 'ladrillo' se viene abajo, El País. Negocios... 71 14. El ocaso del alquimista, por Luis Gómez,... 73 15. "El soborno era una red tolerada u oculta por la anterior dirección", Entrevista: Gerhard Cromme... 77 16. Memorias del 'Made in Italy', por Miguel Mora... 80 17. Krugman's "hangover theory", revisited, by Steve Randy Waldman... 82 18. Faces ff the Crisis: Nouriel Roubin, by Chrystia Freeland... 85 19. Barack be Good, by PAUL KRUGMAN... 88 20. Chinese Savings Helped Inflate American Bubble, by Mark Landler... 96

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21. Bernanke Is the Best Stimulus Right Now, by ROBERT E. LUCAS JR.... 103 22. A Healthy Economy, by Jacob S. Hacker... 105 23. Do Not Forget the Strong Euro Mr Trichet, BBH... 108 24. Madoff's People, by TIMESONLINE... 109 25. Madoff Victims May Have to Return 6 Years of Profits, Principal, by Carlyn Kolker... 111 26. Plunge in Exports Reverberates Across Asia, by Glenn Kessler... 113 27. Bailing out Banker Bonuses, by Investor's Business Daily... 115 28. Life Without Bubbles, by PAUL KRUGMAN... 116 29. U.S. Investors Optimistic About Longer Term, by Dennis Jacobe... 121 30. Madoff as Metaphor, by Llewellyn H. Rockwell, Jr.... 125 31. A Reeling City Is a Snapshot of Economic Woes, by Peter S. Goodman... 128 32. More Firms Cut Labor Costs Without Layoffs , by Matt Richtel... 132 33. Paradigm lost, by Drake Bennett ... 135 34. White House Philosophy Stoked Mortgage Bonfire, by Jo Becker, Sheryl Gay Stolberg and Stephen Labaton... 140 35. El gran bocado de Campofrío, por Santiago Hernández... 150 36. In Need of Cash, More Companies Cut 401(k) Match, by Mary Williams Walsh and Tara Siegel Bernard... 152 37. Extended Benefits Are a Lifeline for Many Unemployed, by Michael Luo... 155 38. At Siemens, Bribery Was Just a Line Item, by Siri Schubert and T. Christian Miller... 158 39. The central bank flight to safety, by Brad Setser... 164 40. After 30 Years, Economic Perils on China’s Path, by Jim Yardley... 173

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41. And now a currency crisis, Eurointelligence... 176 42. Las rebajas ya están aquí , por Juan Carlos Martínez... 179 43. Deutsche Bank Breaks With Hybrid Capital Convention: A Dangerous Precedent?, RGE... 181 44. The Madoff Economy, by PAUL KRUGMAN... 183 45. Madoff Scandal Shaking Real Estate Industry , by Christine Haughney... 186 46. The Great Unraveling , by Thomas L. Friedman... 189 47. S.E.C. Issues Mea Culpa on Madoff , by Alex Berenson and Diana B. Henriques... 191 48. Fed Cuts Key Rate to a Record Low, by Edmund L. Andrews and Jackie Calmes... 193 49. Quantitative easing, Econbrowser... 196 50. On currency dynamics around the globe, RGE Monitor's Newsletter. ... 199 51. Has Global Stag-Deflation Arrived? ...and comment on the Fed ZIRP decision, by Nouriel Roubini... 203 52. FED, For immediate release... 206 53. Five Opportunities to Help Beat World Recession, Matthew Lynn... 207

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54. Joseph Stiglitz, and the Failed Ideas of Economists, by John Tamny... 209 55. Hamilton's Counterfeit Capitalism, by George F. Smith... 212 56. Chipmakers on the Edge, by Bruce Einhorn... 218 57. New Poll Shows 63% Are Already Hurt by Downturn, by Michael A. Fletcher and Jon Cohen... 220 58. Majority of Public Opposes Auto Rescue , by Jon Cohen and Jennifer Agiesta... 223 59. SEC Didn't Act on Madoff Tips, by Binyamin Appelbaum and David S. Hilzenrath... 225

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60. How the Fed Reached Out to Lehman, by Andrew Ross Sorkin... 228 61. How to Make a Madoff, by Ben Levisohn... 230 62. Madoff Losses Will Change Hedge Funds, by Matthew Goldstein... 232 63. Madoff's police escort, by David Weidner... 234 64. The conman, the dream - and the sharp suit, by Daniel Finkelstein... 236 65. S.E.C. Image Suffers in a String of Setbacks, by Stephen Labaton... 238 66. Investors With Madoff May Get Tax Relief, by Lynnley Browning... 240 67. Madoff's $50bn Ponzi Scheme Fraud: Tracking The Fallout, RGE... 242 68. Banking on Steriods, by Satyajit Das... 244 69. European Crass Warfare, by Paul Krugman... 247 70. Q Ratio Signals ‘Horrific’ Market Bottom, CLSA Says, by Patrick Rial... 256 71. Fleeing Investors Put a Strain on Funds, by Geraldine Fabrikant... 258 72. The 17th Floor, Where Wealth Went to Vanish, by Diana B. Henriques and Alex Berenson... 260 73. States’ Funds for Jobless Are Drying Up, by Jennifer Steinhauer... 263 74. Evidence that the Fed Caused the Housing Boom, by Robert P. Murphy... 266 75. Asian Tools to Fight Global Credit Crisis: Liquidity Injections, Rate Cuts, Swap Lines, RGE... 272 76. The Man Who Is Unwinding Lehman Brothers, by Jonathan D. Glater... 275 77. The World’s Biggest Ponzi Scheme?, by Steve Keen... 281

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78. Fund Fraud Hits Big Names, by Robert Frank, Peter Lattman, Dionne Searcey Aaron Lucchetti... 285 79. Fees, Even Returns and Auditor All Raised Flags, by Gregory Zuckerman... 290 80. Questions Are Raised in Trader’s Massive Fraud, by Alex Berenson and Diana B. Henriques... 292 81. For Investors, Trust Lost, and Money Too, by Diana B. Henriques and Alex Berenson... 295 82. Hedge Funds Are Victims, Raising Further Questions, by Michael J. de la Merced... 298 83. Citadel Halts Withdrawals From Two Hedge Funds After 50% Drop, by Saijel Kishan and Katherine Burton... 300 84. Madoff Told Sons of $50 Billion Fraud Before Telling FBI Agents, by David Voreacos and David Glovin... 301 85. Be Smart, but Don’t Think That You’re Special, by Ron Lieber and Tara Siegel Bernard... 304 86. La gestora de 'hedge funds' del Santander, entre las víctimas del fraude masivo, by S. P.... 307 87. Bernard L. Madoff, by Ruby Washington... 308 88. "Frequentists vs Bayesians", by Steve Hsu... 306 89. After the Crash: How Software Models Doomed the Markets, by Scientific American Magazine... 311 90. Global Liquidity & Capital Flows – Grand Illusions, by Satyajit Das... 313 91. Risky business, by Kenneth Arrow... 318 92. Breve historia del éxito que explicaremos en Washington, por Ana R. Cañil... 321 93. 'Es razonable elevar la provisión por hipotecas', por Raimundo Poveda... 329

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RGE Monitor's Newsletter RGE Monitor - What Are The Key Questions for 2009? Greetings from RGE Monitor! North America

Does the U.S. Need a Dollar Policy to Prevent Dollar Crisis in the Face of Rising Public Debt? •

The Fed and Treasury are setting the stage for a disorderly adjustment of the Dollar by ignoring the external imbalance (Duy)

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A renewed fall of the dollar could deepen the housing crisis and economic weakening. Rate cuts would exacerbate dollar weakness. It may be necessary to consider currency intervention in the strategy for responding to the crisis (Bergsten). Given the nation's huge funding needs in the years ahead, a stable to gently rising USD would help keep attracting in much needed capital from abroad (BNY)

U.S. Long-Dated Treasury Yields Hit Record Lows: Are Bailouts a Hidden Buying Opportunity? •

What can happen: Concerns about sovereign credit risk from deteriorating US fiscal and monetary position, increased Treasury issuance, and the growth boost from bailouts can raise yields. On the other hand, worries that bailouts won't prevent deflation can depress yields

•

What has happened: Long-term yields have been falling despite rising default risk signaled by widening CDS spreads. However, recent Treasury auctions reveal signs of indigestion from growing Treasuring issuance

U.S. Stocks: Where Is the Bottom? •

According to Tobin's q, S&P 500 is still too expensive relative to the cost of replacing assets. S&P may plunge another 55% to a trough of 400 by 2014 (CLSA)

•

After RTC was established in 1989, it took 1 year for the stock market to bottom, 2 years for the economy to bottom, and 3 years for the housing market to bottom. Valuations are more attractive now but credit crisis worries will prevail. S&P 500 to bottom at c. 660 (Merrill Lynch)

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Latin America Can We Find a Trend for Latin Currencies in 2009? •

The Brazilian Real remains a source of concern on the inflation front, continuing to show a weakening bias after having depreciated over 30% in the last three months. While Brazil's external indicators suggest the currency is overshooting, the persistent weakening is a present fact that at this point the authorities cannot ignore. Estimates of the historical pass-through from BRL movements to domestic consumer prices stand at around 8-10% after approximately one year. But there are good reasons to believe that this effect will be smaller this time around

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The Chilean peso (CLP) has discounted a sharp contraction in trade-linked currency flows, despite a relatively solid fiscal position. Interest rate differentials are not a CLP supporting factor in spite of the fact that the central bank has earmarked the fight against inflation as a key priority. The sharp commodity price adjustment anticipates a weakening prospect for Chile's export sector. (Lloyds TSB)

•

The Peruvian sol (PEN) has been quite stable, trading at an average rate of 3.04 per USD over the past month; during the recent wave of financial turmoil it has also experienced the lowest volatility amongst peer-group floating currencies within Latin America. The central bank will continue to heavily intervene in the foreign currency market if need be. We expect USD/PEN to close this year at 3.00 (MS)

Ten Years Later, LatAm May Default Again? •

Ecuador just announced a default on its external debt and the market is also worried about Argentina and Venezuela. There does not seem to be much light at the end of the tunnel for Argentina, but the government looks able to finance 2009. In Venezuela, the ability to pay should never be in question. The rest of the region looks financially sound to us. We would worry if governments looked to implement strong growth policies at any cost (BNP Paribas)

•

The Argentine government has the resources to avoid the default in 2009, although given the external backdrop and current developments, demand for Argentine assets is likely to be limited, and there are still downside risks due to concerns about the deteriorating economy and the resulting increased fiscal stress. S&P downgraded Argentine debt [from B- to B w/ stable outlook] in the beginning of Nov emphasizing the critical balance between lower revenues, wide financing gap and an overall sharp slowdown in the economy. The government still has a cushion with potential to capture more resources from nationalization of pension funds and the possibility of a rollover of the PGs (Merrill Lynch)

Europe Welcome to EMU@10: What Will the Next 10 Years Bring? •

A large majority of continental Europeans believe the euro could overtake the dollar in global importance in the next five years. The survey showed that Europeans would welcome a further expansion of the Eurozone beyond its 15 members, but highlighted fears among consumers that the euro has fuelled inflation - which they believe the European Central Bank has failed to control effectively (FT)

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•

EMU has been monetary success, less so an economic success in terms growth and other indicators. Increased imbalances among member states since start of EMU are a key challenge (Wolf)

Which Eastern European Economies Are Most Vulnerable To Global Turmoil? Why? •

Impact of global turmoil on Eastern Europe is becoming increasingly visible; several countries, including Hungary and Latvia, have already turned to the IMF for support

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Key vulnerabilities: widespread foreign currency lending, high current-account deficits, impact of slump in Eurozone on exports, banks' heavy dependence on foreign borrowing

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Most vulnerable: Baltic states, Bulgaria, Romania, Hungary, Serbia

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Least vulnerable: Czech Republic, Poland, Slovakia

Asia Pacific Could Japan Be Facing Deflation Yet Again? •

Japan, which underwent deflation from 1999 to 2005, could be facing a protracted period of falling prices yet again

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Declining demand at home combined with an inflow of cheaper goods from abroad triggered by recent appreciation of the yen, could drive down prices into the feared deflationary spiral

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Deflation Drivers: 1) strength of yen vis-a-vis other major currencies, 2) falling commodity prices since July 2008, 3) domestic recession, 4) loss of export growth engine due to global downturn 5) anemic domestic demand, 6) sluggish wages

Can China Be An Engine of Global or Asian Demand Growth? •

China cannot save Asia from the global recession given that most final demand for Chinese products rests in G3. But countries better able to latch on to China's domestic demand should be better able to weather the recession

•

China may remain the most resilient economy in Asia, but it may not be that much of a support for the region and commodity exporters globally as most intra-asia trade has a final destination in the OECD. In 2008, a decline in intra-Asia trade was driven largely by a reduction in Chinese demand for processing trade inputs

•

Chinese final demand accounts for only 6-7% of exports from Indonesia, Malaysia, the Philippines and Thailand. Exports to China are more significant for Japan, Korea, and Singapore, accounting for over 10% of exports (HKMA)

External Debt Burden: Is Korea Headed for Another Financial Crisis? •

Korea's ratio of external debt-to-exports, 77%, is more typical of countries with BBB ratings (such as India) rather than single-A ratings. Korean banks may have to pay higher coupons to retain access to the market in 2008. South Korea's short-term foreign loans amounted to $260.4 billion, more than the country's foreign reserves of $200.5 billion

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Korean banks' high reliance on wholesale funding is transmitting higher funding costs from global credit markets into the leveraged Korean economy. The foreign currency debt maturity profile of Korean financials show USD6.4bn maturing in Aug-Dec 2008 and

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USD13.2bn in 2009. Policy banks account for 75% of maturities (HSBC)

Middle East, Central Asia and Africa MENA FDI Performance: Can Intra-Arab Investments be Sustained? •

Foreign investment into MENA and notably FDI flows increased substantially. FDI inflows into the MENA region more than quadrupled (from 14.1 billion USD to 69.6 billion USD) over the period 2003-2007. There has also been a substantial increase of intra-regional FDI, increasing by 60 billion USD between 2002 and 2006.

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On a sub-regional level, North African countries have been the net recipients of FDI, led by Egypt, receiving almost 52% of FDI in 2007, while Saudi Arabia and UAE have been largest recipients of FDI among the GCC countries (57% and 31% respectively)

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Yet, there exists a risk of reversal of flows in the midst of the current crisis. Intra-Arab FDI has already been adversely affected as a result of the hit that the Gulf economies have taken due to the global credit crisis. Egypt's FDI fell 44% in the first quarter of FY 2008/09 to $1.65 billion compared to $2.96 billion in the same period in 2007/2008. One third of Egypt's FDI comes from the GCC.

Could the Middle East Real Estate Boom Go Bust? •

The Middle East property boom of recent years was driven by growth, ample credit, negative real interest rates, population growth, but is now facing severe headwinds as some regional economies slow, global credit contracts and some supply shortages have eased, raising the risk of a bust in the countries most reliant on external credit.

•

All markets are also expected to face price declines and slowdowns in the development of projects as speculative buying diminishes, demand eases and financing for both buyers and developers dries up. Shifting market conditions may also cause developers to focus more on end-users, particularly in the middle-income bracket that has been poorly served during the boom years - government policy actions may further support this

Global Issues State of Global Imbalances: Will The Credit Crisis Finally Reduce Imbalances? •

Enforced increase in US domestic savings, reduction in surpluses by oil exporting regions may reduce current account imbalances. However, credit crisis could make imbalances intractable or lead to violent unwinding of imbalances.

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Wolf: Countries with large external surpluses import demand from the rest of the world while suppressing it at home. In a deep recession, this is a contractionary "beggar-myneighbour" policy

Is the Commodity Super-Cycle Dead or Just Taking a Break? •

The low prices in commodities has led to production cuts and investment delays, sowing the seeds of a future supply crunch when commodity demand recovers

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Economic growth in developing countries argues for the eventual resumption of the secular bull market in commodities. However, the credit crisis may permanently restrict

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the ability to leverage, keeping the commodity supercycle's uptrend moderate compared to the pre-crisis run-up

How Will the Financial Crisis Shape Geopolitics in 2009? •

The financial crisis has the potential to accelerate several ongoing trends including restructuring of global economic institutions and rising nationalism and social unrest while freezing progress in democratization, and toughening the meeting of climate change targets

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Political uncertainty in Asia and other EMs may exacerbate financial market stress and make it more difficult to attract investment.

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The western-centered financial crisis may reinforce the perception that the U.S. and the EU are becoming relatively weaker, both in terms of hard and soft power. The plunge in oil prices will leave Russia, Iran and Venezuela short of cash and political clout

Islamic Finance: How Insulated From Conventional Finance Shocks? •

Proponents of Islamic finance suggest that its focus on asset-based not debt finance keeps it immune from global financial market turmoil. However, issuance is exposed to devaluation of the underlying assets (especially property) and to a broader liquidity shortage which has led to a reduction in both islamic and conventional debt issuance

•

The Islamic bond (sukuk) market received a double blow in 08, suffering from a global liquidity freeze and a controversy over which types of sukuk are compliant with Islamic law hit the market. Global sukuk (Islamic bond) issuance dropped 60% to $15.2 billion between January and October 2008 compared with the same period in 2007 as global liquidity dropped and a controversy over which types of bonds are compliant with Islamic law erupted. Demand from financial institutions, insurance companies, and pension funds across Islamic and non-Islamic countries may boost demand in the long-term but low oil prices and regional liquidity may suppress demand in 2009

The Future of Investment Banking: What Might It Look Like? •

When Goldman Sachs (GS) and Morgan Stanley (MS) became bank holding companies in Sep 2008, it seemed to mark a historic shift; the end of an era in investment banking. Following JPMorgan's takeover of Bear, the collapse of Lehman and Bank of America's purchase of Merrill Lynch, it was the culmination of a year that had turned the financial world upside down. What lies ahead for the industry both from a business model perspective and an appropriate regulatory structure is debatable.

•

Rather than being forced to change in order to comply with commercial banking regulations, GS and MS could end up changing the commercial banking landscape to fit their businesses. While GS and MS have been given a 2 year exemption from current commodity regulations restricting commercial banking activity in the industry, with a further three in the offing, MS has applied for the exemptions to extend beyond the 5 year window. Some believe that current restrictions will be permanently removed, opening the commodities markets to further incursion by other commercial banks (The Banker)

The Shrinking Hedge Fund Industry: From $2 Trillion To $1 Trillion By 2009? •

Between 1990 and last year the industry's assets under management grew almost 50-fold, to nearly $2 trillion. Now industry executives predict that assets could fall by 30-40%, as clients stampede for the exit. The number of funds, which climbed to over 7,000 as a

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generation of financiers headed for the gold-paved streets of Mayfair in London and Greenwich, Connecticut, could fall by half (Economist) •

The global hedge-fund industry lost $64 billion of assets in November, with an index tracking its performance declining for a sixth month as economies in Asia and Europe joined the U.S. in recession (Eurekahedge)

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Hedge fund assets worldwide shrank by 9 percent to $1.56 trillion in October, the lowest level in two years, after investors withdrew cash and stock markets declined(FinWeek)

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Investors pulled $40 billion from hedge funds in October, according to Chicago-based Hedge Fund Research Inc., while market losses cut industry values by $115 billion. Investors withdrew $22 billion from funds of funds, which pool money to invest in hedge funds. About 350 hedge funds shut down in the first half of 2008, up 16 percent from 303 a year earlier, according to data compiled by Chicago-based Hedge Fund Research Inc.

M&A: Will It Ever Be the Same ? •

Since the beginning of the credit crisis in August 2007, many activities that were part and parcel of investment banking have undergone seismic shifts and contractions. Deal volume in Mergers and Acquisitions (M&A), and the overall ability of companies to bring a deal to conclusion is one such area:

•

Global merger volume dropped by almost a third in 2008, ending five years of deal growth as a lack of available credit, plunging stock markets and a worldwide financial crisis undermined companies' ability to make acquisitions. Global merger volume totaled $2.89trillion, marking the lowest annual volume since 2005. A record number of previously agreed deals -- over 1,100 -- were canceled in 2008 (Reuters)

EUR: Just a Temporary Rally Versus the USD? •

Portfolio rebalancing, fund repatriation from CEE and Latam back to Europe, and thin markets have pushed the USD significantly lower but the USD will not see sustained weakness as a funding currency until risk appetite improves (BNP Paribas)

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Repatriation flows and pro-active policy can see USD rewarded in 2009. The question is whether the USD should be punished for a large budget deficit or rewarded for an aggressive stimulus package. With budget deficits deteriorating around the world, we suspect growth concerns will win out and the USD to strengthen (ING)

Sovereign Wealth Funds and Foreign Exchange Reserves: Slower Growth and More Conservative Asset Allocation in 2009? •

Reduction in the oil price and slowing capital inflows to emerging markets reduced inflows to sovereign wealth funds after August 2008 while equity and alternative asset class losses likely eroded past investment gains meaning sovereign wealth funds may actually manage less today than they did a year ago despite record inflows to oil funds for much of this year. Going forward, the rate of growth of sovereign investors might slow considerably (Ziemba).

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The trend of rising foreign reserve accumulation (which have grown from $2 tr at the start of this decade to near $7 tr) appears to have peaked, amid the global slowdown. Major reserve holders in Asia - Japan, Taiwan, India, Brazil, S.Korea and oil-producing countries (correction in oil prices) face headwinds; reserve accumulation is much slower than in H208.Global foreign exchange reserve accumulation has stalled and possibly

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reversed in the third and fourth quarters with only China and a few oil exporters (Saudi Arabia, Libya, Algeria) still adding reserves - these may now be spending reserves. Other countries ( Russia, India etc) are now spending their reserves by intervening in Fx markets •

Even as governments receive fewer inflows they may privilege liquid assets needed to support their financial sector and provide stimulus to other sectors, thus diverting diversification plans. However funds that privilege domestic economic development may continue to make significant purchases.

Best Wishes for a Happy Holiday Season from RGE Monitor!

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Issue 154 , January 2009

Where do we go from here? by Robert Skidelsky The markets have ruled for a third of a century, but it has all ended in tears. A return to selfish nationalism is possible. If we are to avoid this sombre outcome, we must find ways to rub the rough edges off globalisation Robert Skidelsky is the author of John Maynard Keynes 1883-1946: Economist, Philosopher, Statesman (Pan) Any great failure should force us to rethink. The present economic crisis is a great failure of the market system. As George Soros has rightly pointed out, "the salient feature of the current financial crisis is that it was not caused by some external shock like Opec… the crisis was generated by the system itself." It originated in the US, the heart of the world's financial system and the source of much of its financial innovation. That is why the crisis is global, and is indeed a crisis of globalisation. There were three kinds of failure. The first, discussed by John Kay in this issue, was institutional: banks mutated from utilities into casinos. However, they did so because they, their regulators and the policymakers sitting on top of the regulators all succumbed to something called the "efficient market hypothesis": the view that financial markets could not consistently mis-price assets and therefore needed little regulation. So the second failure was intellectual. The most astonishing admission was that of former Federal Reserve chairman Alan Greenspan in autumn 2008 that the Fed's regime of monetary management had been based on a "flaw." The "whole intellectual edifice," he said, "collapsed in the summer of last year." Behind the efficient market idea lay the intellectual failure of mainstream economics. It could neither predict nor explain the meltdown because nearly all economists believed that markets were self-correcting. As a consequence, economics itself was marginalised. But the crisis also represents a moral failure: that of a system built on debt. At the heart of the moral failure is the worship of growth for its own sake, rather than as a way to achieve the "good life." As a result, economic efficiency—the means to growth—has been given absolute priority in our thinking and policy. The only moral compass we now have is the thin and degraded notion of economic welfare. This moral lacuna explains uncritical acceptance of globalisation and financial innovation. Leverage is a duty because it

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"levers" faster growth. The theological language which would have recognised the collapse of the credit bubble as the "wages of sin," the come-uppance for prodigious profligacy, has become unusable. But the come-uppance has come, nevertheless. Historians have always been fascinated by cyclical theories of history. Societies are said to swing like pendulums between alternating phases of vigour and decay; progress and reaction; licentiousness and puritanism. Each outward movement produces a crisis of excess which leads to a reaction. The equilibrium position is hard to achieve and always unstable.

In his Cycles of American History (1986) Arthur Schlesinger Jr defined a political economy cycle as "a continuing shift in national involvement between public purpose and private interest." The swing he identified was between "liberal" (what we would call social democratic) and "conservative" epochs. The idea of the "crisis" is central. Liberal periods succumb to the corruption of power, as idealists yield to timeservers, and conservative arguments against rent-seeking excesses win the day. But the conservative era then succumbs to a corruption of money, as financiers and businessmen use the freedom of de-regulation to rip off the public. A crisis of under-regulated markets presages the return to a liberal era. This idea fits the American historical narrative tolerably well. It also makes sense globally. The era of what Americans would call "conservative" economics opened with the publication of Adam Smith's Wealth of Nations in 1776. Yet despite the early intellectual ascendancy of free trade, it took a major crisis—the potato famine of the early 1840s—to produce an actual shift in policy: the 1846 repeal of the Corn Laws that ushered in the free trade era. *** In the 1870s, the pendulum started to swing back to what the historian AV Dicey called the "age of collectivism." The major crisis that triggered this was the first great global depression, produced by a collapse in food prices. It was a severe enough shock to produce a major shift in political economy. This came in two waves. First, all industrial countries except Britain put up tariffs to protect employment in agriculture and industry. (Britain relied on mass emigration to eliminate rural unemployment.) Second, all industrial countries except the US started schemes of social insurance to protect their citizens against life's hazards. The great depression of 1929-32 produced a second wave of collectivism, now associated with the "Keynesian" use of fiscal and monetary policy to maintain full employment. Most capitalist countries nationalised key industries. Roosevelt's new deal regulated banking and the power utilities, and belatedly embarked on the road of social security. International capital movements were severely controlled everywhere. This movement was not all one way, or else the west would have ended up with

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communism, which was the fate of large parts of the globe. Even before the crisis of collectivism in the 1970s, a swing back had started, as trade, after 1945, was progressively freed and capital movements liberalised. The rule was free trade abroad and social democracy at home. The Bretton Woods system, set up with Keynes's help in 1944, was the international expression of liberal/social democratic political economy. It aimed to free foreign trade after the freeze of the 1930s, by providing an environment that reduced incentives for economic nationalism. At its heart was a system of fixed exchange rates, subject to agreed adjustment, to avoid competitive currency depreciation. The crisis of liberalism, or social democracy, unfolded with stagflation and ungovernability in the 1970s. It broadly fits Schlesinger's notion of the "corruption of power." The Keynesian/social democratic policymakers succumbed to hubris, an intellectual corruption which convinced them that they possessed the knowledge and the tools to manage and control the economy and society from the top. This was the malady against which Hayek inveighed in his classic The Road to Serfdom (1944). The attempt in the 1970s to control inflation by wage and price controls led directly to a "crisis of governability," as trade unions, particularly in Britain, refused to accept them. Large state subsidies to producer groups, both public and private, fed the typical corruptions of behaviour identified by the new right: rent-seeking, moral hazard, free-riding. Palpable evidence of government failure obliterated memories of market failure. The new generation of economists abandoned Keynes and, with the help of sophisticated mathematics, reinvented the classical economics of the self-correcting market. Battered by the crises of the 1970s, governments caved in to the "inevitability" of free market forces. The swing-back became worldwide with the collapse of communism. A conspicuous casualty of the swing-back was the Bretton Woods system that succumbed in the 1970s to the refusal of the US to curb its domestic spending. Currencies were set free to float and controls on international capital flows were progressively lifted. This heralded a wholesale change of direction towards free markets and the idea of globalisation. This was, in concept, not unattractive. The idea was that the nation state—which had been responsible for so much organised violence and wasteful spending—was on its way out, to be replaced by the global market. The prospectus was perhaps best set out by the Canadian philosopher, John Ralston Saul, in a 2004 essay in which he proclaimed the collapse of globalisation: "In the future, economics, not politics or arms, would determine the course of human events. Freed markets would quickly establish natural international balances, impervious to the old boom-and-bust cycles. The growth in international trade, as a result of lowering barriers, would unleash an economic-social tide that would raise all ships, whether of our western poor or of the developing world in general. Prosperous markets would turn dictatorships into democracies." Today we are living through a crisis of conservatism. The financial crisis has brought to a head a growing dissatisfaction with the corruption of money. Neo-conservatism has sought to justify fabulous rewards to a financial plutocracy while median incomes stagnate or even fall; in the name of efficiency it has promoted the off-shoring of millions of jobs, the undermining of national communities, and the rape of nature. Such a system needs to be fabulously successful to command allegiance. Spectacular failure is bound to discredit it. The situation we are in now thus puts into question the speed and direction of progress. Will there be a pause for thought, or will we continue much as before after a cascade of minor adjustments? The answer lies in the intellectual and moral sphere. Is economics capable of

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rethinking its core principles? What institutions, policies and rules are needed to make markets "well behaved"? Do we have the moral resources to challenge the dominance of money without reverting to the selfish nationalisms of the 1930s? *** The enquiry must start with economics. If the case for the deregulated market system is intellectually sound, it will be very hard to change. Free- marketeers claim, contrary to Soros, that the crisis is the fault of governments. US money was kept too cheap for too long after the technology bubble burst in 2000 and the attacks of 11th September 2001. The market was temporarily fooled by the government. This is a shaky defence, to say the least: if the market is so easily fooled, it cannot be very efficient. One can also argue that the problem is not with the market system, but the fact that markets are too few and inflexible. This seems to be the view of Yale economist Robert J Shiller. He likens the financial system to an early aircraft. Just because it is prone to crash doesn't mean we should stop trying to perfect it. Shiller claims that new derivative products will soon be able to insure homeowners against the risk of house prices going down. To my mind, this is an example of trying to cure a state of inebriation by having another whiskey. There are two things wrong with it. First, if financial innovation is, in fact, the route to greater market efficiency, the financial system would have been getting more stable in the last 25 years of explosive financial engineering. Instead it has become more volatile. Second, the assumption that, given enough innovation, uncertainty can be reduced to risk, is just wrong. There will never be sufficient knowledge to enable contracts to be made to cover all future contingencies. An analogous argument is that there was not enough marketisation in the global monetary system. Instead of the "clean" floating of currencies, "dirty" floating became the rule. Importantly, China and most of east Asia refused to float their currencies freely. China reverted unilaterally to a form of Bretton Woods, deliberately undervaluing the yuan against the US dollar. The resulting imbalances enabled American consumers to borrow $700bn a year from the parsimonious but super-competitive Chinese, at the cost of losing millions of manufacturing jobs to them. The Chinese saved, the Americans spent, and their debt-fuelled spending created the asset bubbles that led to the credit collapse. This source of instability needs no revision of economic theory, simply the establishment of a free market in foreign currencies. However, the assumption that a world in which currencies were allowed to float freely would be immune from the financial storms we have experienced depends on the belief that currencies will always trade at the correct prices—the global version of the efficient market hypothesis. A different claim, which goes back to Marx, is that certain structures of economy are less stable than others. Globalisation has increased instability by producing a shift in world GDP shares from wages to profits as the release of low-wage populations into the global economy has undermined the bargaining power of labour in rich countries. This has led to a crisis of under-consumption, staved off only by the expansion of debt (as Gerald Holtham points out, in Prospect's December 2008 issue). There is some truth in this. A greater equality of incomes would create more stable purchasing power. But the main source of instability lies in the financial markets themselves. And here it is clear that the battle of economic ideas still needs to be fought. Keynes is important in this because he produced the most powerful case for supposing that financial markets are not efficient in the sense required by efficient market theory. As he explained in The General Theory of Employment, Interest, and Money (1936), classical economics had ignored the two main causes of systemic financial failure: the existence of (unmeasurable) uncertainty and the role

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of money as a "store of value." The first led to periodic collapses of confidence; the second led investors to hoard cash if interest rates fell too low, making automatic recovery from collapses difficult. The function of government was to remove the depressive effect of both by giving investors continuous confidence to invest. Contrary to the belief of some recent economic theories, the future is just as unknowable as Keynes thought it was. The mathematical "quants" who set up the Long Term Capital Management hedge fund in 1994 worked to a risk model which showed that the kind of financial meltdown which, in fact, bankrupted them four years later, could occur only once every four million years. This was not a rationalisation of financial interests: it was selfdeception. What economics needs, therefore, if it is to have any purchase on real world behaviour, is a new starting point. It needs to accept that the changing nature of the world precludes people from having enough information to always make contracts at the "right" prices. Such a change is a necessary condition for a permanent change in policy. Each previous crisis has produced a leading economist with the authority to challenge the prevailing consensus. So the call for a new Keynes is not just rhetorical Opinion as to the degree of supervision, regulation and control needed to make a market economy well-behaved is to be found along a continuum. At one end are the free-marketeers who believe only the lightest touch only is needed; at the other are classical Marxists who believe it requires public ownership of the whole economy. In between are varieties of social democrats and middle wayers, the most famous of whom is Keynes. This territory is sure to be extensively explored over the next few years as the pendulum starts swinging back. For the question of making markets well behaved goes beyond the question of securing their efficiency. It involves making the market economy compatible with other valued aspects of life. The French social democratic slogan of the mid-1990s—"market economy yes, market society no"—encapsulates the idea that limits should be placed on the power of the market to shape social life according to its own logic. The battleground will be about the role of the nation-state in the globalising economy of the future, for the nation-state is the main repository and guardian of the values and traditions threatened by the disruptive power of the global market. A paradox of globalisation—which was supposed to see a withering of the nation-state—is that it has led to a revival of nationalism. A deregulated world turned out, unsurprisingly, to be one dominated by the strong. This process reached its apogee with the presidency of George W Bush and the Iraq war—which emphasised US determination to act as a free agent. Other states, too, in Europe and elsewhere, are now acting as semi-free agents. The effective choice is between a more regulated global capitalist system and its possibly violent breakup into a menagerie of warrior nationalisms. But to ensure we have an ordered system requires us to make globalisation efficient and acceptable. In the course of that debate, I expect one crucial point to emerge: the benefits of globalisation are real, but have been exaggerated. Improvements in the allocation of capital and reductions in opportunities for corruption are offset by increased volatility. Globalisation also raises huge issues of political accountability and social cohesion that are scarcely considered by economists, and only lazily by politicians. There seem to be four main reasons for this blind spot. The first is the intellectual domination of economics in this debate, with its individualistic and developmental perspective. Globalisation—the integration of markets in goods, services, capital and labour—must be good because it has raised many millions out of poverty in poorer countries faster than would

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otherwise have been possible. Any interference with this process is impious. A second idea is that it is inevitable: technology—most conspicuously the internet—abolishes national frontiers. Technology cannot be undone. So, whether we like it or not, globalisation is our fate, and our morals and social conventions must adapt to it. The third idea is that globalisation is evolutionary; any check would be regressive. Fourthly, globalisation forces us to think of the world as a unit, which is necessary if we are to solve planet-wide problems. These are powerful propositions, derived from the era of scarcity and not adjusted to the era of partial abundance, nor to the existence of natural limits to growth. Today the benefits of globalisation are much more obvious for poor than for rich countries. In the 1950s and 1960s, the northern hemisphere was for free trade, the southern protectionist. Today the position is partly reversed. Globalisation offers the best hope for poor countries to catch up with the rich. But growth has become less important for rich countries. In the early 1930s, Keynes thought that the international division of labour could be carried too far. "Let goods be homespun," was the title of an article he wrote in 1932. He wanted a "well-balanced" or "complete" national life, allowing a country to display the full range of its aptitudes, and not simply to be a link in a value-adding productive chain spanning the globe. Moreover, the economic benefits of offshoring are far from evident for richer states. Since 1997, Britain has lost 1.1m manufacturing jobs—29 per cent of its total—many of them to developing countries. The result has been a dramatic deterioration in Britain's current account balance, and a decline into deficit on the investment income balance too, meaning we pay more to foreign investors in interest and dividends than we receive from abroad. This makes it harder for Britons to pay down their huge debts to the outside world. Keynes's warning that the pursuit of export-led growth is bound to set nations at each others' throats is still relevant. But that does not mean just sticking as we are. Some rowing back of financial globalisation and cross-border financial institutions is required to rebalance market and state. This process is underway, as national regulators take a tighter grip over the financial institutions they are bailing out. Regulators are increasingly sceptical of banks that depend excessively on wholesale funding. Without this, there will be a natural tendency for banks to shrink back within their own frontiers. One of the biggest problems with the global trading order remains the enormous arbitrages in tax, labour and non-wage costs that exist. These have encouraged companies to relocate operations, and depressed the bargaining power of labour. Companies like WalMart of the US and Nokia of Finland have been huge outsourcers to Asia. The only solution short of raising barriers is for governments to co-operate in flattening out some of these differences—for China, for example, to increase wages. Ralston Saul has noted that the era of globalisation saw "multiple binding economic treaties… put in place while almost no counterbalancing binding treaties were negotiated for work conditions, taxation, the environment or legal obligations." It will be difficult to create new global systems that balance public good and self interest. But the alternative is the beggar-my-neighbour world of protectionism. Another way to curb outsourcers would be to use antitrust powers. Breaking up megalithic multinationals would at least prevent them enjoying quasi-monopoly rents, and thus reduce the incentive. Globalisation is necessarily blind to the idea of political accountability because none exists at the planetary level. Yet the crisis has challenged the idea that we should all unthinkingly follow the logic of the bond market. When the crunch came, we discovered that national taxpayers still stand behind banks, and national insolvency regimes matter. A more rules-

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based exchange rate system is not inconceivable. This might seek to put some curbs on capital movements—especially at times of economic stress. And, in this new climate, national politicians are likely to reach for ideas and influences that until recently would have seemed exotic. The idea, for example, that economic growth does not, beyond a certain point, make people happier. David Cameron, a market-friendly Conservative, has talked about the importance of general wellbeing as an alternative to the mania for economic growth. Rich countries could probably abandon the globalist project without much damage to their material standards and with possible gain to their quality of life. Rejecting the inevitability of market-based globalisation would not necessarily be harmful—especially if it were accompanied by a reassertion of democracy at a national level. This is not a pipe dream. New Zealand, which was the first country to attempt to become a post-national nation state in the 1980s with a radical programme of privatisation and deregulation, changed tack in 1999. The electorate endorsed an interventionist government devoted to raising taxes, reimposing economic regulations and establishing a stable private sector. It happened because reform failed to deliver the goods. Other countries may follow suit if the political costs of maintaining a global economy are seen as too high. Rich countries surely have a duty to help poor countries, but not at the expense of an awful way of life. "Well-behaved" markets should not only be more stable, they should be more morally acceptable. It is indefensible for a top American CEO to earn 367 times more than the average worker (against 40 times in the 1970s). Part of the swing-back in political economy will be to use the tax system to redress the balance between capital and impotent labour. The crisis has rightly led to a revival of interest in Keynes. But he was a moralist as well as an economist. He believed that material wellbeing is a necessary condition of the good life, but that beyond a certain standard of comfort, its pursuit can produce corruption, both for the individual and for society.

He reunited economics with ethics by taking us back to the primary question: what is wealth for? The good life was one to be lived in harmony with nature and our fellows. Yet "we destroy the beauty of the countryside because the unappropriated splendours of nature have no economic value. We are capable of shutting off the sun and the stars because they do not pay a dividend." Not everything should be sacrificed for efficiency. And Keynes was a liberal nationalist. In terms of our pendulum analogy, he was someone who instinctively sought an equipoise: not in the timeless equilibrium of classical economics, but in a balance in political economy between freedom and control, national and international wellbeing, efficiency and morality. He was an Aristotelian, who believed that vices are virtues carried to excess. This is a good philosophy for today.

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Slate It's My 'Vital Center' The historian who coined what has become President Clinton's favorite new buzz phrase gives him an earful. By Arthur Schlesinger Jr. Posted Friday, Jan. 10, 1997, at 3:30 AM ET

It's My "Vital Center" The historian who coined what has become President Clinton's favorite new buzz phrase gives him an earful. By Arthur Schlesinger Jr. (1,533 words; posted Friday, Jan. 10; to be composted Friday, Jan. 17) As a nonmember of the Internet, I enter this conversation late; but my spies inform me that SLATE's "Committee of Correspondence" recently discussed a couple of concepts with which I have been associated--the "vital center," a phrase latterly adopted by President Clinton, and the theory of cycles in American politics. "We proclaim," the president said on the night of his re-election, "that the vital American center is alive and well." In a press conference two days later: "Our people voted for the ideas of the vital American center." And, in his December 1996 speech before the Democratic Leadership Council: "We have clearly created a new center ... the vital center that has brought so much progress to our nation in the last four years. ... Let us commit together to mobilizing that vital center." When I named the book I wrote in 1949 The Vital Center, the "center" I referred to was liberal democracy, as against its mortal international enemies--fascism to the right, communism to the left. I used the phrase in a global context. President Clinton, as suggested by his reference to "the vital American center," is using the phrase in a domestic context. What does he mean by it? His DLC fans probably hope that he means the "middle of the road," which they would locate somewhere closer to Ronald Reagan than to Franklin D. Roosevelt. In my view, as I have said elsewhere, that middle of the road is definitely not the vital center. It is the dead center. President Clinton's view? He is evidently saying that the United States is facing vital problems that the American people must attack together without reference to shibboleths of the past. He has tried out variations on the phrase before. "This is a time of such profound change," he said in April 1995, "that we need a dynamic center that is not in the middle of what is left and right

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but is way beyond it. ... I want us [Democrats and Republicans] to surprise everybody in America by rolling up our sleeves and working together." What is the "profound change" that generates the "new challenges"? In his Dec. 13, 1996 press conference, Clinton recalled the time a century ago when "we moved from the farm to the factory" and "became primarily an urban manufacturing country." Today, he suggested, we are undergoing a parallel mutation caused by the shock of a new "basis of economic activity ... knowledge and information and technology." Our contemporary shift from a factory-based to a computer-based economy is even more traumatic than our great-grandparents' shift from farm to factory. After all, the Industrial Revolution extended over several generations and allowed time for human and societal adjustment. The Cybernetic Revolution is far more immediate and drastic in its impact. Every few months, new "generations" spring out of the microchip arsenal. Moreover, where the Industrial Revolution in the end created more jobs than it destroyed, the Cybernetic Revolution threatens to destroy more jobs than it will create. It also threatens to erect new and less permeable class divisions. Those who flunk the computer will become the new Blade Runner proletariat. The cybernetic challenge--so Clinton, I take it, believes--renders the familiar divisions between left and right obsolete. The new technologies, he says, "make it possible for people to be more empowered at lower levels of government and lower levels of business, indeed, individually and in their own families." The era of big government is therefore over. The era of local solutions has arrived. Is this a realistic expectation? No doubt the new technologies, with their interactive potential, create new political possibilities. Brian Beedham in the Dec. 21, 1996, Economist even argues that representative democracy is finished and the age of direct, "full" democracy--government through referendum and plebiscite--has dawned. If that is so, the republic will become California, and heaven help us. The wisdom of the Federalist Papers--the need for deliberative democracy--is not yet outmoded. And when Clinton keeps on announcing the "end of big government," one wonders whether this is not one more of his placatory phrases. For he plainly remains a believer in activist government--even if the scope of his activism is, for the moment, very limited. Concern for his place in history should nerve him to less modest initiatives. He told the DLC that "our first task is to finish the job of balancing the budget." Our first task? Another placatory phrase, one must hope. Andrew Jackson was the only president to extinguish the national debt, but if that were all Jackson had accomplished, he would not be considered among the great presidents. Nor will cutting entitlements win Clinton a nomination for Mt. Rushmore. The rest of his agenda--education and literacy, bringing the underclass into the mainstream, pressing the fight against crime and drugs, strengthening families, campaign-finance reform-makes more sense. But much of that will involve him in political combat--an art for which he has shown considerable skill but, alas, only intermittent taste. Still, if you want to change things, you can count on the hostility of those who benefit from the way things are. No great president was a middle-of-the-roader. "Judge me," said FDR, "by the enemies I have made." The prognosis for activist government brings up the question of political cycles. Let me recall the cyclical hypothesis, which I inherited from a more distinguished historian, my father. This hypothesis finds a pattern of alternation in American politics between "negative" and "affirmative" government--that is, between times in which voters see

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private action as the best way of meeting national problems and times in which voters call for a larger measure of public action. Thus the Reagan 1980s represented a high point in the faith in the omnicompetence of the private marketplace. But it was also a replay of the pro-business Eisenhower 1950s, 30 years earlier, and the Eisenhower era was itself a replay of the Harding-CoolidgeHoover 1920s. Similarly, at 30-year intervals come periods of public activism: Theodore Roosevelt and the Progressive era in 1901; Franklin D. Roosevelt and the New Deal in 1933; John F. Kennedy and the New Frontier in 1961. If the 30-year rhythm held, the 1992 election was scheduled to see a swing away from Reaganism and toward affirmative government--and that is what appeared to happen with the election of Bill Clinton. There is no mystery, by the way, about this periodicity. Thirty years is roughly the span of a generation. People tend to be influenced by the ideals dominant at the time they arrive at political consciousness. Young people who grew up in the Progressive era--like FDR, Eleanor Roosevelt, Harry Truman--when they came to power, carried forward the Progressive ideals they had imbibed in their youth. Young people who grew up under FDR--like John Kennedy, Lyndon Johnson, Hubert Humphrey, Robert Kennedy--when they came to power, tackled the New Deal's unfinished business. As the Kennedys and Johnson were in effect Roosevelt's children, so Bill Clinton and Albert Gore Jr., who arrived at their political consciousness in the 1960s, are Kennedy's children. I do not suggest that the cycles determine the course of history. The mainspring of the cycle is the generation. José Ortega y Gasset and Karl Mannheim long ago pointed out the power of generational change. After a time, each phase of the cycle runs out of ideas and out of steam, and the voters turn to the alternative. This is what Herbert Stein calls "the boredom-fatigue factor." "The public," says Stein, "becomes bored with a government that doesn't do anything and yearns for more action. But then they become tired out by a government that is always getting into fights and nagging them to think about or try something new." These are cycles of opportunity, not of necessity. As the national mood swings back and forth, new leaders arrive and confront new possibilities. What the leaders do with these possibilities depends upon their own ideas, capacities, skills, and visions, and upon the conjuncture of objective circumstance. What happened to the activist cycle that seemed about to begin in 1992? My guess is that it was derailed by the Cybernetic Revolution. Even as the country prospers in the present, it is filled with foreboding about the future. This accounts for the otherwise inexplicable coexistence in America today of relative contentment with pervasive and deep-running anxiety. Political leaders have failed to allay these anxieties. Voters were mad at George Bush in 1992 and defeated him. They were mad at Bill Clinton in 1994, humiliated him, and elevated Newt Gingrich. By 1996, Gingrich had become the most unpopular politician in the country. Because "big government" has seemed impotent before the structural transformation, it has become a favorite scapegoat. But if anyone really thinks that turning national and international problems over to state governments and the private market will end our troubles, they are due for further disillusionment. The very character of our problems--from race relations and the reform of education to the extension of health care and the provision of jobs for people thrown off welfare--calls for public initiatives.

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The cycle, though derailed, is not necessarily dead--and the vital center from which to navigate the mysterious future does not lie in the middle of the road. Links If President Clinton cares to probe the original meaning of the phrase "vital center," he can read an excerpt from Schlesinger's 1949 book. To see Clinton's own twist on the term, read his speech to the Democratic Leadership Council. Is the DLC closer to Reagan than to FDR? Check out the DLC home page to find out. The Industrial Revolution may have gone easier on people than the Cybernetic one. Here's a wrap-up of the I.R. and a definition of the C.R. The journal cy.Rev probes the Cybernetic Revolution. Read up on your fate. So the age of direct democracy is upon us? For an example of government by referendum, see California's recent election ballot, loaded down with scores of initiatives. And read Federalist 10 for a taste of what James Madison thought of such notions. Arthur Schlesinger Jr. is a historian , writer, and former special assistant to President Kennedy. A new edition of his book, The Vital Center, will be published by Transaction at Rutgers University later this year.

DAVIS: Obama's time: Cycles of history Lanny Davis Monday, October 6, 2008 http://www.washingtontimes.com/news/2008/oct/06/obamas-time-the-cycles-of-americanhistory/ ………………………………………………………………………………………… In a 1949 essay, famous historian Arthur Schlesinger Sr. - father of the even more famous historian Arthur Schlesinger Jr. - identified 11 such swings in American history (as of 1949). These were what his son described in his 1986 book, "The Cycles of American History," as "periods of concern for the rights of the few and periods of concern for the wrongs of the many”. The senior Mr. Schlesinger pointed out from George Washington's presidency in 1788 through Harry Truman's in 1947 that the objective in six of the periods was to increase democracy and in five to contain it. The average duration of the liberal-conservative cycle, at least up to 1949, was about 16 years. For example, in the first four decades of the 20th century, the senior Mr. Schlesinger said, there were three such cycles: the Progressive Era, 1901 to 1919; the Republican conservative restoration, 1919 to 1931; and the New Deal Era of strong, progressive government under Franklin D. Roosevelt and Truman, 1931 to 1949 (which lasted through 1952, when the next cycle of center-right conservatism under President Dwight Eisenhower set in) The pattern continued in the last half of the 20th century. But as communications and technology accelerated the flow of information - especially in the 1990s, with the revolutionary impact of the Internet and 24/7 cable TV news - the pace of change accelerated and the cycles shortened

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World Business December 30, 2008

Gazprom, Once Mighty, Is Reeling By ANDREW E. KRAMER MOSCOW — A year ago, Gazprom, the Russian natural gas monopoly, aspired to be the largest corporation in the world. Buoyed by high oil prices and political backing from the Kremlin, it had already achieved third place judging by market capitalization, behind Exxon Mobil and General Electric. Today, Gazprom is deep in debt and negotiating a government bailout. Its market cap, the total value of all the company’s shares, has fallen 76 percent since the beginning of the year. Instead of becoming the world’s largest company, it has tumbled to 35th place. And while bailouts are increasingly common, none of Gazprom’s big private sector competitors in the West is looking for one. That Russia’s largest state-run energy company needs a bailout so soon after oil hit record highs last summer is a telling postscript to a turbulent period. Once the emblem of the pride and the menace of a resurgent Russia, Gazprom has become a symbol of this oil state’s rapid economic decline. During the boom times, Gazprom and the other Russian state energy company, Rosneft, became vehicles for carrying out creeping renationalization. As oil prices rose, so did their stocks. But rather than investing sufficiently in drilling and exploration, Russia’s president at the time, Vladimir V. Putin, used them to pursue his agenda of regaining public control over the oil fields, and much of private industry beyond. As a result, by the time the downturn came, they entered the credit crisis deeply in debt and with a backlog of capital investment needs. (Under Mr. Putin, now the prime minister, Gazprom and Rosneft are so tightly controlled by the Kremlin that the companies are not run by mere government appointees, but directly by government ministers who sit on their boards.) “They were as inebriated with their success as much as some of their investors were,” James R. Fenkner, the chief strategist at Red Star, a Russian-dedicated hedge fund, said of Gazprom’s ambition to become the world’s largest company. “It’s not like they’re going to produce a better mousetrap,” he said. “Their mousetrap is whatever the price of oil is. You can’t improve that.” Investors are now fleeing Gazprom stock, once such a favorite that it alone accounted for 2 percent of the Morgan Stanley index of global emerging market companies. Gazprom is far from becoming the world’s largest company; its share prices have fallen more quickly than those of private sector competitors. The company’s debt, amassed while consolidating national control over the industry, is one reason. After five years of record prices for natural gas, Gazprom is $49.5 billion in debt. By comparison, the entire combined public and private sector debt coming due for India, China and Brazil in 2009 totals $56 billion, according to an estimate by Commerzbank.

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Mr. Putin used Gazprom to acquire private property. Among its big-ticket acquisitions, in 2005 it bought the Sibneft oil company from Roman A. Abramovich, the tycoon and owner of the Chelsea soccer club in London, for $13 billion. In 2006 it bought half of Shell’s Sakhalin II oil and gas development for $7 billion. And in 2007, it spent more billions to acquire parts of Yukos, the private oil company bankrupted in a politically tinged fraud and tax evasion case. Rosneft is deeply in debt, too. It owes $18.1 billion after spending billions acquiring assets from Yukos. And in addition to negotiating for a government bailout, Rosneft is negotiating a $15 billion loan from the China National Petroleum Corporation, secured by future exports to China. Under Mr. Putin, more than a third of the Russian oil industry was effectively renationalized in such deals. But unlike Hugo Chávez of Venezuela or Evo Morales of Bolivia, who sent troops to seize a natural gas field in that country, the Kremlin used more sophisticated tactics. Regulatory pressure was brought to bear on private owners to encourage them to sell to state companies or private companies loyal to the Kremlin. The assets were typically bought at prices below market rates, yet the state companies still paid out billions of dollars, much of it borrowed from Western banks that called in the credit lines in the financial crisis. Rosneft, which was also held up as a model of resurgent Russian pride and defiance of the West as it was cobbled together from Yukos assets once partly owned by foreign investors, was compelled to meet a margin call on Western bank debt in October. Critics predicted Russia’s policy of nationalization would foster inefficiency, or at the very least disruption as huge companies were bought and sold, divided up and repackaged as state property. At stake were assets worth vast sums: Russia is the world’s largest natural gas producer and became the world’s largest oil producer after Saudi Arabia reduced output this summer to support prices. A deputy chief executive of Gazprom, Aleksandr I. Medvedev, predicted the company would achieve a market capitalization of $1 trillion by 2014. Instead, its share price has fallen 76 percent since the beginning of the year and its market cap is now about $85 billion. By comparison, Exxon’s share price Monday of $78.02 is down 18 percent since January. The company’s market capitalization is $393 billion. And the Standard & Poor’s 500-stock index stocks is down more than 40 percent for the year Mr. Medvedev, the Gazprom executive, defended Gazprom’s performance and attributed the steep drop in its share price relative to other energy companies to the company’s listing on the Russian stock exchange, which is volatile and lacks investors who put their money into companies for the long term. Mr. Medvedev said the share price “does not reflect the company’s value” and blamed the financial crisis that began on Wall Street for the company’s woes. It is true that Gazprom is far from broke. The company made a profit of 360 billon rubles, or $14 billion, from revenue of 1,774 billion rubles, or $70 billion, in 2007, the most recent audited results released by the company. Valery A. Nesterov, an oil and gas analyst at Troika Dialog bank in Moscow, said Gazprom’s ratio of debt to revenue — before interest payments, taxes and amortization —

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was 1 to 5 in 2007, high by oil industry standards but not so excessive as to jeopardize the company’s investment grade debt rating. The company, meanwhile, says it will go ahead with capital spending to develop new fields in the Arctic, and continues to pour money into subsidiaries in often losing sectors like agriculture and media. It is also assuming, through its banking arm, a new role in the financial crisis of bailing out struggling Russian banks and brokerages. Investors say an unwillingness to cut costs in a downturn is a common problem for nationalized industries, and another reason they have fled the stock. When oil sold for less than $50 a barrel in 2004, Gazprom’s capital outlay that year was $6.6 billion; for 2009, the company has budgeted more than $32 billion. Gazprom executives say they are reviewing spending but will not cut major developments, including two undersea pipelines intended to reduce the company’s reliance on Ukraine as a transit country for about 80 percent of exports to Europe. Gazprom and Ukraine are again locked in a dispute over pricing that Gazprom officials say could prompt them to cut supplies to Ukraine by Thursday. “All our major projects in our core business — upstream, midstream and downstream — will continue with very simple efforts to meet demand both in Russia and in our export markets,” Mr. Medvedev said. But revenue is projected to fall steeply next year. Gazprom received an average of $420 per 1,000 cubic meters for gas sold in Western Europe this year; that is projected to fall to $260 to $300 in 2009. “For them, like everybody else, sober realism has intruded,” Jonathan P. Stern, the author of “The Future of Russian Gas and Gazprom” and a natural gas expert at Oxford Energy, said in a telephone interview. A significant portion of the country’s corporate bailout fund — about $9 billion out of a total of $50 billion — was set aside for the oil and gas companies. Gazprom alone is seeking $5.5 billion. For a time, Gazprom, a company that evolved from the former Soviet ministry of gas, had been embraced by investors as the model for energy investing at a time of resource nationalism, when governments in oil-rich regions were shutting out the Western majors. In theory, minority shareholders in government-run companies would not face the risk their assets would be nationalized. But with 436,000 employees, extensive subsidiaries in everything from farming to hotels, higher-than-average salaries and company-sponsored housing and resorts on the Black Sea, critics say Gazprom perpetuated the Soviet paternalistic economy well into the capitalist era. “I can describe the Russian economy as water in a sieve,” Yulia L. Latynina, a commentator on Echo of Moscow radio, said of the chronic waste in Russian industry. “Everybody was thinking Russia had succeeded, and they were wondering, how do you keep water in a sieve?” Ms. Latynina said. “When the input of water is greater than the output, the sieve is full. Everybody was thinking it was a miracle. The sieve is full! But when there is a drop in the water supply, the sieve is again empty very quickly.”

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GMAC To Get $6 Billion Lifeline Financing for Dealers, Customers Was at Risk By Neil Irwin and Binyamin Appelbaum Washington Post Staff Writers Tuesday, December 30, 2008; D01 The government will invest $6 billion to prop up GMAC, the auto financing giant, the Treasury Department said last night, expanding its bailout of the troubled U.S. auto industry. The Treasury said it would use $5 billion from the $700 billion financial rescue fund it oversees to buy preferred stock from the company. It said it would also lend $1 billion to General Motors, which owns 49 percent of GMAC, to allow it to invest further in the firm. GMAC provides financing for most GM dealers and many customers, making its continued operations critical for the automaker. But the financing company has struggled in recent months to borrow the money it needs to keep making loans. Last week, the Federal Reserve approved the firm's application to become a bank holding company, giving it access to new sources of funding, including a direct investment by the Treasury. In return, GMAC will be subject to additional regulation, and it must cut some of its extensive ties to GM. At a time when the government has allowed major financial firms to fail, and pushed others to sell themselves -- in each case denying the companies financial assistance -- the rescue of GMAC highlights how far it is willing to go to support the auto industry. Earlier this month, the government announced $17 billion in loans to GM and Chrysler. The new loans push the government's planned investments under the financial rescue beyond the $350 billion that Congress has authorized; in order to make all the investments that Treasury Secretary Henry M. Paulson Jr. has agreed to, Congress would need to approve a second $350 billion infusion into the so-called Troubled Asset Relief Program. A Treasury official said last night that the government has not committed all of the money in the $250 billion pot set aside to make investments in financial institutions, so the Treasury has leeway to direct some of that cash to GMAC. "It's not fair to say we've overcommitted," said the official, adding that many of the expected bank investments are still being reviewed by bank regulators. GMAC spokeswoman Toni Simonetti said the investment was "very significant" for the company, but added that much work remains to turn the auto financier into a full-fledged bank. "We're not resting on our laurels here," she said. Simonetti said that the company would pursue additional funding from private investors through a Federal Deposit Insurance Corp. program that guarantees short-term bank debt and that GMAC would start pursuing consumer deposits more aggressively. The company will also add to its capital through the completion of a program to restructure its existing debt. GMAC initially said it needed 75 percent of its bondholders to participate in the

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program simply to become a bank, but after bondholders balked, the company convinced the Fed to accept its application without securing their support. Simonetti said that the company had now completed negotiations with bondholders and that a final announcement on how many had agreed to participate would come soon. In exchange for the $5 billion investment, the government is to receive preferred shares that pay an 8 percent dividend, a more generous payout to taxpayers than the 5 percent dividend on the government's investments in banks. GMAC will be required to meet executive compensation restrictions that include cutting its bonus pool for senior executives by 40 percent from 2007 levels. GMAC also will get an investment of $1.25 billion from General Motors and Cerberus, the private equity firm. Cerberus, which owns 51 percent of the company, will invest $250 million. General Motors will invest $1 billion that it is borrowing from Treasury. The deal is lopsided -- such investments are generally proportional to existing ownership stakes -- and it could have the effect of restoring GM to majority ownership of GMAC. The distinction would be short-lived, however, because the Federal Reserve has required both companies to divest most of their ownership stakes as a condition of allowing GMAC to become a bank holding company.

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Opinion December 29, 2008

OP-ED COLUMNIST

Fifty Herbert Hoovers By PAUL KRUGMAN

No modern American president would repeat the fiscal mistake of 1932, in which the federal government tried to balance its budget in the face of a severe recession. The Obama administration will put deficit concerns on hold while it fights the economic crisis. But even as Washington tries to rescue the economy, the nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession, often at the expense both of their most vulnerable constituents and of the nation’s economic future. These state-level cutbacks range from small acts of cruelty to giant acts of panic — from cuts in South Carolina’s juvenile justice program, which will force young offenders out of group homes and into prison, to the decision by a committee that manages California state spending to halt all construction outlays for six months. Now, state governors aren’t stupid (not all of them, anyway). They’re cutting back because they have to — because they’re caught in a fiscal trap. But let’s step back for a moment and contemplate just how crazy it is, from a national point of view, to be cutting public services and public investment right now. Think about it: is America — not state governments, but the nation as a whole — less able to afford help to troubled teens, medical care for families, or repairs to decaying roads and bridges than it was one or two years ago? Of course not. Our capacity hasn’t been diminished; our workers haven’t lost their skills; our technological know-how is intact. Why can’t we keep doing good things? It’s true that the economy is currently shrinking. But that’s the result of a slump in private spending. It makes no sense to add to the problem by cutting public spending, too. In fact, the true cost of government programs, especially public investment, is much lower now than in more prosperous times. When the economy is booming, public investment

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competes with the private sector for scarce resources — for skilled construction workers, for capital. But right now many of the workers employed on infrastructure projects would otherwise be unemployed, and the money borrowed to pay for these projects would otherwise sit idle. And shredding the social safety net at a moment when many more Americans need help isn’t just cruel. It adds to the sense of insecurity that is one important factor driving the economy down. So why are we doing this to ourselves? The answer, of course, is that state and local government revenues are plunging along with the economy — and unlike the federal government, lower-level governments can’t borrow their way through the crisis. Partly that’s because these governments, unlike the feds, are subject to balanced-budget rules. But even if they weren’t, running temporary deficits would be difficult. Investors, driven by fear, are refusing to buy anything except federal debt, and those states that can borrow at all are being forced to pay punitive interest rates. Are governors responsible for their own predicament? To some extent. Arnold Schwarzenegger, in particular, deserves some jeers. He became governor in the first place because voters were outraged over his predecessor’s budget problems, but he did nothing to secure the state’s fiscal future — and he now faces a projected budget deficit bigger than the one that did in Gray Davis. But even the best-run states are in deep trouble. Anyway, we shouldn’t punish our fellow citizens and our economy to spite a few local politicians. What can be done? Ted Strickland, the governor of Ohio, is pushing for federal aid to the states on three fronts: help for the neediest, in the form of funding for food stamps and Medicaid; federal funding of state- and local-level infrastructure projects; and federal aid to education. That sounds right — and if the numbers Mr. Strickland proposes are huge, so is the crisis. And once the crisis is behind us, we should rethink the way we pay for key public services. As a nation, we don’t believe that our fellow citizens should go without essential health care. Why, then, does a large share of funding for Medicaid come from state governments, which are forced to cut the program precisely when it’s needed most? An educated population is a national resource. Why, then, is basic education mainly paid for by local governments, which are forced to neglect the next generation every time the economy hits a rough patch? And why should investments in infrastructure, which will serve the nation for decades, be at the mercy of short-run fluctuations in local budgets? That’s for later. The priority right now is to fight off the attack of the 50 Herbert Hoovers, and make sure that the fiscal problems of the states don’t make the economic crisis even worse.

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December 29, 2008, 8:27 pm

Optimal fiscal policy in a liquidity trap (ultra-wonkish) One thing that’s been bothering me about the discussion over fiscal stimulus is the virtual absence of fully worked-out models, with all their t’s dotted and eyes crossed, or something. Not that a rigorous model is always better than a rough-and-ready but more realistic approach, but I like to have both on hand. So I’ve tried a very rough sketch of a full, intertemporal maximization yada yada analysis of the fiscal policy issue. It was written in a hurry, so it’s surely incomprehensible to readers who don’t know the New Keynesian Economics literature, and probably incomprehensible even to those who do. But here’s what the model says: when monetary policy is up against the zero bound, the optimal fiscal policy is to expand government purchases enough to maintain full employment. Unreadable little paper here: . You have been warned.

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From The Times December 29, 2008

Six vital lessons of the 1931 depression AS WE ENTER A SECOND YEAR OF SLUMP, HISTORY HAS SOME KEY POINTERS TO THE BEST WAY FORWARD William Rees-Mogg Those of us who were alive at the time, or who have seen the film, have vivid memories of the sinking of HMS Hood in 1941, and of the pursuit and subsequent sinking of the German battleship Bismarck. Ten years earlier the Hood had been involved in another episode of naval history, which had a significant influence on British economic history. On September 19, 1931, Captain J.F.C. Patterson, the acting Senior Officer, Atlantic Fleet, sent a signal to the Admiralty: “For two days, the ships at Invergordon of the Atlantic Fleet were in a state of open mutiny... large numbers of men were massed on the forecastles of Hood, Rodney and Dorsetshire. Men on the forecastle of Hood had refused to allow any work to be done to commence on unmooring, and it became evident that neither Hood nor Rodney could go to sea.” Patterson had some sympathy with the underlying grievance. He informed the Admiralty: “The use of force was in my opinion quite out of the question,” and that “with regard to the causes of the outbreak, there is no doubt that first and foremost was the disproportionate reduction (in pay) of the lower ratings who entered before 1925”. On the same day that Patterson sent his report of the Invergordon mutiny, a small conference was held at 10 Downing Street; the Prime Minister, Ramsay MacDonald, reported that he had had a discussion with Stanley Baldwin, the leader of the Conservative Party, and Sir Herbert Samuel, the leader of the Coalition Liberals. The result had been an agreement that it was essential to get legislation that would release the Bank of England from the obligation to pay out gold. E.R. Peacock, a director of the Bank of England, commented: “A sudden blizzard has struck the world. People have got anxious about their bank, that is to say, Great Britain, and they are gravely anxious about themselves.” The Downing Street meeting agreed to take Britain out of the gold standard. The sailors at Invergordon were loyal and patriotic - many were to die for their country in the Second World War. But they were not prepared to have their pay docked - unfairly as they thought - to defend the convertibility into gold. In this, they were good Keynesians. In September 1931 the gold pound lost the confidence of British sailors, Cambridge economists and French bankers. That combination was irresistible. September 19, 1931, was approximately the second anniversary of the start of the Great Depression in 1929. The mutiny and the decision to leave the gold standard proved to be the recovery point for Great Britain. From that point on, recovery became possible. Two lessons were taught by Invergordon and the withdrawal from the gold commitment: governments should not try to balance the budget by cutting the pay of essential public servants; and they should not defend at all costs an overvalued fixed exchange rate. Britain does not now have a fixed exchange rate, although some people still want to join the euro. If we were in the euro, we would probably be arguing about when to leave. 55

The year 2009 can be paired with 1931. Both are the second year after the start of a big recession: 1931 was, beyond question, a year of depression. In the US the Federal Reserve Board kept statistics of the profits of 500 companies. In 1929 the index had been 998; in 1930 it had fallen to 760; in 1931 it was 370, and went as low as 267 in the final quarter. Between 1929 and 1931 US employment fell by a third. If we based a forecast for 2009 on 1931 we would produce ghastly figures. The American recovery really began only in March 1933, after the inauguration of President Roosevelt. Britain had a lighter and shorter recession. However, we can follow, and perhaps guard against, the acceleration of “the vicious spiral” of depression in 1931 itself. The turning of the screw actually began in June 1930, with the disastrous Hawley-Smoot tariff. Intended to protect US industry from excessive imports, it aroused international resentment and retaliation against US exports. If British experience offers the first two lessons, this would be the third: do not raise tariffs in a recession. In May 1931, the Credit Anstalt, the leading bank in Austria, became insolvent and had to close. As the American economist, Irving Fisher, observed: “It was a great bank, and its collapse embarrassed both Germany and England.” Lesson four: do not allow systemic banks to fail. This was not applied to Lehmann Brothers, which may be regarded as the Credit Anstalt of the Wall Street panic of 2008. In June 1931 after runs on other Austrian banks, its Government belatedly guaranteed the liabilities of the Credit Anstalt. In July 1931, the Bank of England rescued the German Reichsbank, which had been embarrassed by the failure of the Credit Anstalt. The French withdrew gold from Germany and the Bank of England for having taken the risk of supporting Germany. Lesson five: do not depend on central bankers in a panic. On September 21 Britain left the gold standard, followed by 23 other nations. The US and France maintained gold convertibility. In October 1931 President Hoover proposed the creation of the Home Mortgage Corporation, the ancestor of Fannie Mae and Freddie Mac, the mortgage banks that did not become insolvent until 77 years later. In December Hoover announced his relief programme. Fisher commented: “To meet the rapidly developing emergency, each step was too small and by the time it was enacted into law, it was too late.” Lesson six: in a depression, too much and too early is safer than too little and too late.

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TRIBUNA: PAUL KENNEDY

Y luego está el resto del mundo PAUL KENNEDY 28/12/2008 Está cada vez más claro, al menos para este observador, que el equipo de Barack Obama, por muy listo, experimentado y maravilloso que sea, no puede satisfacer todas las esperanzas que han depositado en él todos esos estadounidenses alegres pero ansiosos y todas esas multitudes de otros países igualmente ansiosas pero ilusionadas. Este próximo presidente de Estados Unidos, audaz y optimista en sus discursos y precavido, reflexivo y prudente después de ellos, tiene el temple necesario para ser un gran líder. Pero, al mismo tiempo, se enfrenta a una extraordinaria lista de problemas y retos en este momento en que Estados Unidos y el mundo van entrar en el año 2009. Barack Obama debe saber que tiene que establecer sus prioridades: no puede ser todo para todos, no puede cumplir todas las esperanzas, no puede ocuparse de todos los males de la Tierra. Si no se centra, estará perdido. Hay dos áreas que exigen una atención inmediata y sostenida del Gobierno de Obama. Debe dedicar gran parte de sus energías al rescate y la recuperación de la economía estadounidense y sus redes financieras y comerciales en todo el mundo; sin esa recuperación, estaremos en una situación muy difícil. Pero Washington no puede concentrarse sólo en los asuntos económicos, porque debe prestar asimismo mucha atención a la política mundial, es decir, a las relaciones con una China susceptible y en ascenso, una Rusia susceptible y cada vez más débil (lo crean o no), el polvorín del sur de Asia, el horrible campo de minas que constituyen los países árabes. El nuevo presidente estadounidense tiene que encaminarse hacia el futuro con Adam Smith y John Maynard Keynes en una mano y Carl von Clausewitz y sir Halford Mackinder en la otra. Ahora bien, si el plan nacional de recuperación socioeconómica, la economía mundial y la geopolítica de las grandes potencias ocupan el centro del primer mandato de Obama, ¿qué cuestiones tendrán que quedarse relegadas a segundo plano, empujadas a la periferia? ¿A qué asuntos puede no dedicar mucha atención o muchos recursos una nueva Administración llena de buenas intenciones, tremendamente optimista y enormemente popular, sin dejar de hablar de lo importantes que son? La lista es larga y el espacio corto, así que vamos a limitarnos a cuatro áreas que, por importantes que sean sus protagonistas, no tienen muchas probabilidades de ocupar los primeros lugares en la agenda de Obama. Personalmente, creo que todas ellas son importantes, pero no me parece que vayan a ser objeto de demasiada atención. ¡Cuánto me gustaría equivocarme! La primera es Latinoamérica.Siempre me ha asombrado la escasa atención que presta Estados Unidos al resto del hemisferio occidental, sobre todo a nuestro vecino del sur, México, pero también a países tan fundamentales como Brasil y Argentina. Las visitas que he hecho en los últimos años a estos tres países indican que en todo el subcontinente existe un deseo muy extendido de tener una relación respetuosa y equilibrada con su primo yanqui. Pero ¿le dedicará mucha atención el Washington de Obama, aparte de una o dos visitas presidenciales simbólicas? Lo dudo. Solemos dar a Latinoamérica por descontada, y sería extraordinario que Obama fuera capaz de romper con esa forma de pensar. En segundo lugar, África. Parece ridículo, ya lo sé. Toda la retórica de la campaña del nuevo presidente hace pensar que el destino del continente en el que se encuentran sus raíces familiares es algo que le toca muy de cerca. Es muy posible que sea así. Pero el verdadero enigma es qué puede hacer exactamente y de forma sistemática la nueva Administración para ayudar a África. La ayuda más eficaz e inmediata sería organizar un alza brusca de los precios de las materias primas mundiales -café, cacahuetes, caucho, petróleo, madera, fosfatos- que invirtiera la caída de sus exportaciones, les proporcionara divisas fuertes y asegurase puestos de trabajo. Pero la actual depresión mundial hace que

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eso sea poco probable, y, además, Estados Unidos prefiere que los precios de las materias primas en el mundo sean bajos, porque importa muchas de ellas. También sería fantástico que el Gobierno de Obama pudiera llevar milagrosamente la paz y la seguridad a unas regiones desgarradas por la guerra que, en puro tamaño, son seguramente el doble de Europa. Ninguna otra potencia exterior podría hacerlo. Un compromiso de enviar 250.000 soldados estadounidenses durante 10 años, con todo el apoyo logístico necesario, podría lograrlo. ¿Qué probabilidades hay de eso? Ninguna. De aquí a dos o tres años, ¿a qué altura del tótem de la nueva Administración estará África central? No estoy siendo cínico, estoy siendo meramente realista. Si se produce en el futuro una crisis importante relacionada con Ucrania o Taiwán, ¿cuándo hablará el subsecretario para África con el presidente, si es que alguna vez lo hace? Lo tercero es la reforma de Naciones Unidas y las instituciones de Bretton Woods. Buena suerte con eso. Todo el mundo sabe que las estructuras internacionales creadas en 1944 y 1945, tanto las económicas y financieras como las políticas y de seguridad, se han quedado anticuadas en este nuevo siglo; en realidad, seguramente se quedaron anticuadas hacia 1980. Un sistema mundial de seguridad en el que sólo cinco de los 192 países pertenecientes a él tienen derecho de veto y privilegios como miembros permanentes (por ejemplo, del Consejo de Seguridad de la ONU), y en el que tres de esos cinco se encuentran en un declive relativo desde hace tiempo -Reino Unido, Francia y, digámoslo con claridad, la Rusia aldeana y del Potemkin de Putin- es un verdadero absurdo en estos tiempos. Como los Cinco Permanentes no van a renunciar a sus poderes, lo mínimo que pueden hacer es permitir que India y Brasil se unan a su excelsa mesa. Pero eso no puede ser una de las prioridades del nuevo Gobierno de Washington. Tampoco puede serlo un cambio significativo en los equilibrios de poder del Banco Mundial y el Fondo Monetario Internacional, hábilmente situados en el propio centro de esa ciudad; a Estados Unidos le gusta el statu quo actual de Bretton Woods. Por supuesto, Obama empujará al Banco Mundial a ayudar a los 60 países más pobres del mundo y presionará al FMI para que sea benévolo con Islandia. Pero no es una de las cuestiones principales. En cuanto a otras reformas relacionadas con la ONU -lograr una mejor cooperación en las labores de paz, perfeccionar las técnicas de desarrollo-, todo es estupendo, pero que no se molesten en venir a buscarnos a nosotros. En cuarto lugar, Europa, la UE y las relaciones transatlánticas en general. Esta conclusión quizá suscite reacciones en Berlín, Roma, Londres y París (¿qué es lo que no suscita reacciones en París?), pero me da la impresión de que la tendencia de toda Europa a derretirse con Obama -¿se acuerdan de los 200.000 entusiastas en el Tor de Brandenburgo?- no tendrá una identificación recíproca de Europa como la estrella y la guía de la política exterior y la estrategia de Estados Unidos. Europa está bastante bien como está. No es un problema, como China, Rusia, Oriente Próximo, Irán. Cada vez sirve menos de ayuda en el terreno militar y estratégico. Desde luego, es importante a la hora de pensar en la coordinación económica, pero eso se hace más desde Nueva York que desde el Distrito de Columbia. Para decirlo claramente, el extraordinario aprecio que sienten en Europa por Obama no tendrá seguramente un equivalente a la inversa, aunque oiremos muchos discursos muy bonitos sobre la larga y sólida relación en los años que se avecinan. Pero el nuevo presidente tiene otros asuntos más importantes de los que ocuparse. Los expertos, por tanto, tienen razón: rescatar la economía estadounidense y preservar el orden geopolítico tienen que ser las dos grandes prioridades del nuevo Gobierno de Obama. El resto, incluso áreas tan importantes como África, Latinoamérica, Europa y la ONU, están un poco por detrás. Aquellos maravillosos y cínicos diplomáticos franceses de otros tiempos lo habrían sabido ver. Al fin y al cabo, ¿cuál era la expresión que utilizaban?: "Gouverner, c'est choisir". "Gobernar es escoger". Siempre lo ha sido.

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TRIBUNA: LABORATORIO DE IDEAS PAUL A. SAMUELSON

Consejo para Barack Obama: pásese al centro PAUL A. SAMUELSON 28/12/2008

Es una vieja historia eso de que se produzca una burbuja inmobiliaria ascendente seguida del estallido de esa burbuja. Es posible que ese proceso cíclico empezase poco después de que los humanos dejasen las cuevas. Sin embargo, lo que ha causado la caótica convulsión en Wall Street y en todo el mundo, esta vez ha sido un factor completamente nuevo: que esta crisis en la construcción de viviendas y en el préstamo hipotecario se deriva de las nuevas invenciones monstruosas de los ingenieros de las matemáticas financieras. Prácticamente ningún experto de Wall Street entendía las cosas tan raras que ocurrían cada semana. Bancos de inversión como Goldman Sachs y Morgan Stanley, así como enormes bancos normales como Bank of America, descubrían de repente que su deuda crecía muy por encima de sus activos disponibles. Curiosamente, la actividad en la economía real, en la que la gente busca trabajo y espera ganar suficiente dinero como para ahorrar para los tiempos de vacas flacas y la posible jubilación, no cayó tanto ni tan deprisa en 2007 y 2008. Pero a estas alturas, tan seguro como que el sol se

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pone por la noche, las economías reales de todo el mundo están sufriendo, y mucho. Sus males son directamente atribuibles a los chanchullos de Wall Street. De acuerdo con los pronósticos del Fondo Monetario Internacional y del Banco Mundial, lo peor está por venir; y puede durar más que todo lo visto entre 1929 y 1939, los años de la gran depresión. Como macroeconomista, intento fijarme en los mercados financieros y en cómo reaccionan los bancos centrales -la Reserva Federal estadounidense y el Banco Central Europeo, así como el centenario Banco de Inglaterra- para intentar capear los vientos adversos de los mercados especulativos. Eso ocupa mi mente matemática. Pero lo más importante, lo que ocupa mi corazón como economista académico, es lo que probablemente les ocurrirá a las familias en los primeros años de la presidencia de Obama. ¿Cómo va a reparar el presidente el daño causado por ocho años de chapuzas de George Bush? Tengo que reconocer que los rescates financieros del Gobierno eran necesarios para evitar el hundimiento total de la economía. El presidente Franklin Roosevelt lo descubrió en la semana posterior a su aceptación del cargo, en 1933. Pero como líder del new deal que salvó el sistema capitalista, Roosevelt descubrió que los banqueros, después de ser salvados, se negaban tajantemente a aventurarse a conceder préstamos a empresas arriesgadas y a las familias. Entonces, ¿cómo consiguió el new deal eliminar la mayor parte del desempleo en 1939? Los economistas que hoy tienen menos de 60 años han olvidado la respuesta a esa pregunta, si es que alguna vez conocieron la respuesta verdadera. Hasta el jefe de la Reserva Federal, Ben Bernanke, alumno aventajado de Harvard y del MIT, estaba indebidamente influido por el tosco monetarismo de Milton Friedman cuando escribió su tesis doctoral sobre la gran depresión en 1979. De hecho, ni la Reserva Federal ni el Banco de Inglaterra realizaron la difícil labor que elevó el nivel de empleo y reactivó el crecimiento saludable del producto interior bruto en 1939. ¿Por qué no? Desde muy pronto y durante buena parte de la década de 1930, los tipos de interés de los bancos centrales habían caído casi a cero. De hecho, en el momento de escribir estas líneas, The Wall Street Journal publica la noticia de que los bonos del Tesoro estadounidense a 90 días, seguros y de gran calidad, se venden en el mercado de subastas a un tipo de interés cero (¡!). Eso significa que Obama empieza con una trampa de liquidez muy parecida a la que mantiene a Japón en una recesión desde 1991. Durante una trampa de liquidez, lo inteligente es acumular dinero y no gastarlo ni en mano de obra ni en bienes de consumo. Volvamos a leer los discursos pronunciados por Alan Greenspan o por Mervyn King, gobernador del Banco de Inglaterra, entre 1987 y 2006. ¿Es posible que no fueran a clase el día en que se enseñó ese concepto? Para centrarme en mi argumento principal, las pruebas actuales y la historia económica dan a entender claramente que durante la presidencia de Obama harán falta fuertes dosis de gasto fiscal deficitario para sacar a Europa, América y Asia de la recesión posterior a la catástrofe. Sólo después de eso empezarán las herramientas normales de la Reserva Federal a recuperar su fuerza. El nuevo presidente se verá inundado de consejos contradictorios. Esto es lo que yo le sugiero: que tire por el camino de en medio y se pase al centro. Y no es porque no pueda decidirse. En la izquierda están las nociones fracasadas de Marx, Lenin, Stalin, Castro y Mao. Todos ellos eran como los incompetentes polis del cine mudo en lo que a organizar una gran economía se refiere. Y en la derecha están las opiniones libertarias extremistas de la caterva posterior a Reagan. Sí, sólo los sistemas de mercado pueden conservar la riqueza y el progreso 60

de este milenio. Sin embargo, los mercados descontrolados causarán su propia defunción, como hemos podido ver. Los centristas están condenados a hacer concesiones. Cuando todo va viento en popa, puede ser una locura el tratar de mantener a flote a las tambaleantes empresas automovilísticas de Detroit (el economista de Harvard Joseph Schumpeter lo llamaba "capitalismo en una tienda de oxígeno"). Cuando las tasas de desempleo se disparan hasta el 10% o más, tal vez esté justificado tomar otra decisión. Tirar billetes verdes recién acuñados desde helicópteros puede ser un modo de generar crecimiento. Ese dinero nuevo se gastará en lugar de ser atesorado o ahorrado. Sin embargo, gastar ese dinero nuevo en carreteras que conduzcan a alguna parte será mejor que emplearlo en carreteras que no vayan a ninguna. En Japón fueron los grupos de presión del sector de la construcción los que decidieron adónde debía dirigirse el gasto público. En Estados Unidos podemos hacerlo mejor, siempre que la vieja pandilla de Bush ya no sea más que un recuerdo desagradable. Moraleja: manténgase en el centro a la hora de tomar decisiones para ayudar a los pobres y a las clases medias. Las mujeres y los hispanos y otros que llegan tarde a la fiesta merecen justicia en el tribunal centrista. Quienes presumen de dar consejo pronto resultan aburridos. Aun así, ofrezco una última advertencia importante. Un centrista tiene que ser, por fuerza, un centrista limitado. Un centrista sólo puede reducir en un grado limitado las desigualdades inevitables en un sistema de mercado. Eso dista mucho de abolir la mayor parte de la desigualdad. Perseguir ese objetivo inalcanzable y quijotesco sería un modo seguro de hundir el mundo moderno en una fase de estancamiento como las anteriores.

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COLUMNISTS

World Economy in 2009: Three priorities for recovery By Wolfgang Münchau Published: December 28 2008 18:01 | Last updated: December 28 2008 18:01 It is easy and difficult at the same time to predict the economy in 2009. It is easy to predict it will be an awful year for the US, Europe and large parts of Asia. The industrialised world will be in a deep synchronised recession. Global gross domestic product will probably contract also for the first time since the 1930s. There is not a great deal we can do to prevent this. The difficult part of the forecast is to predict whether policymakers will succeed in preventing the recession turning into a depression and lay the foundations for a sustainable recovery in 2010. What I can predict with near certainty is that policy will matter a great deal next year. We know that the current driving force behind this downturn is “deleveraging”. Overindebted households and undercapitalised banks are adjusting their balance sheets, building up savings in the first case and restricting lending in the latter. There is no chance of a sustained economic recovery until that process is almost complete. We are still some way from that point. For example, on my calculations it will take a total peak-to-trough decline in real US house prices of some 40-50 per cent to get back towards long-term price trends and for price-rent ratios to return to more sustainable levels. We are about half-way through this process. The good news is that most of the nominal adjustment will have taken place by the end of 2009 or early 2010. I am a lot less optimistic about the financial sector. While it is also reducing its leverage, it will not achieve a sustainable position quickly without a lot more government capital. But this would require deep restructuring and would take time. On the basis of this admittedly brief sketch, I arrive at three policy priorities for 2009. The first is for central banks to avoid deflation. If ever there has been a need for a central bank to target price stability, it is now. I mean this in the European sense of the term, meaning a small but distinctly positive rate of inflation, say 2 or 3 per cent annually. I assume that central banks will succeed in this endeavour, given the full power of policies deployed. I worry, though, that the US will try to raise inflation afterwards, which would reduce the real level of US debt but create massive distortions in exchange rates and financial flows and produce another global financial and economic crisis. The second priority is to shrink the financial sector. A disorderly collapse would be catastrophic, but it is neither desirable, nor possible, to maintain the financial sector at its current excessive size. Take the market for credit default swaps, an unregulated $50,000$60,000bn casino that serves no economic purpose except to enrich its participants at massive risk to global financial stability. I would be in favour, as a matter of principle, of regulating any financial activity on the basis of its economic purpose. Since a CDS constitutes insurance from an economic point of view, we should treat it as such and subject it to insurance regulation (which would kill it of course).

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In particular, we should try to avoid the temptation to regulate too much in detail. This is a game regulators will lose. The financial sector is good at deploying existing instruments, and creating new ones, to circumvent any inflexible rule set. We should instead focus on breaking up too-large-to-fail banks and reducing the size of the financial sector in relation to a country’s GDP. In particular, we should not try to guarantee the obligations of a banking sector several times the size of our economies. Third, and perhaps most important, we need to co-ordinate the policy response at global level, since this is a global crisis with many global spillovers. What I would like to hear from US President-elect Barack Obama’s economic team is not a narrow-minded discussion about whether the stimulus will be $700bn or $850bn, or which programmes it will be spent on. What I want to know is how they intend to co-opt the Europeans and the Chinese into a joint strategy. What national governments should not do is blow even more money on infrastructure investments and on education. Whatever problem this is supposed to solve, it is a different problem from the one we need to solve right now. Nor do I see any real policy co-ordination, in which governments commit to policies they would otherwise not have considered. At present, in Europe at least, the co-ordination process works the other way round. Each government decides unilaterally what it wants to do. And then, at European Union level, they dress it up as policy co-ordination. It is not difficult to construct a plausible scenario of an economic catastrophe. Pick some of the following and you could end up with a depression that beats every modern record: a rise in global protectionism; competitive currency devaluations; a sterling crisis; social unrest in China, leading to political instability; a well-timed terrorist attack; continued refusal by eurozone leaders to co-ordinate; a payment default by a large sovereign in the eurozone; an acute emerging market crisis; continued lack of synchronisation of monetary policies, or a collapse of the CDS market. Obviously, the insolvency of a large global bank or the annihilation of the hedge fund industry would not go unnoticed either. Alternatively, we can try to keep the lid on the 2009 recession and lay the foundations for a sustainable but unspectacular recovery. This would be the best outcome. But for that we would have to recognise that the global economy is more than the sum of its parts. It implies that policymakers will have to smarten up, work together and start thinking outside the box. The trouble is this is not what they usually do.

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Economy December 28, 2008 ECONOMIC VIEW

Bailout of Long-Term Capital: A Bad Precedent? By TYLER COWEN

THE financial crisis is a result of many bad decisions, but one of them hasn’t received enough attention: the 1998 bailout of the Long-Term Capital Management hedge fund. If regulators had been less concerned with protecting the fund’s creditors, our current problems might not be quite so bad. Long-Term Capital was advised by finance quants, or quantitative analysts, who made a number of unsound, esoteric bets, including investments in interest rate derivatives. When Russia’s inability to pay its debts roiled global markets, the fund, saddled with highleverage and off-balance-sheet obligations, was near collapse. Because Long-Term Capital owed large sums to banks and other financial institutions, the Federal Reserve Bank of New York organized a consortium of companies to buy it out and cover the debts. Alan Greenspan, then the Fed chairman, eased monetary policy to restart capital markets, which were starting to freeze up. Long-Term Capital’s shareholders were wiped out, but none of the creditors took losses. At the time, it may have seemed that regulators did the right thing. The bailout did not require upfront money from the government, and the world avoided an even bigger financial crisis. Today, however, that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed. Of course, there were many reasons for the reckless lending and failures of risk management that led to the most recent systemic credit shocks. And we have now entered 64

the realm of trillion-dollar bailouts, vast contagion across financial institutions, rapid deleveraging of banks and an economic crisis that some people are starting to compare to the Great Depression. The Long-Term Capital episode looks small when viewed against all of that. But it was important precisely because the fund was not a major firm. At the time of its near demise, it was not even a major money center bank, but a hedge fund with about 200 employees. Such funds hadn’t previously been brought under regulatory protection this way. After the episode, financial markets knew that even relatively obscure institutions — through government intervention — might be able to pay back bad loans. The major creditors of the fund included Bear Stearns, Merrill Lynch and Lehman Brothers, all of which went on to lend and invest recklessly and, to one degree or another, pay the consequences. But 1998 should have been the time to send a credible warning that bad loans to overleveraged institutions would mean losses, and that neither the Fed nor the Treasury would make these losses good. What would have happened without a Fed-organized bailout of Long-Term Capital? It remains an open question. An entirely private consortium led by Warren E. Buffett might have bought the fund, but capital markets might still have frozen because of the realization that bailouts were not guaranteed. And Fed inaction might have had graver economic consequences, especially if a Buffett deal had fallen through. In that case, a rapid financial deleveraging would have followed, and the economy would have probably plunged into recession. That sounds bad, but it might have been better to have experienced a milder version of a downturn in 1998 than the more severe version of 10 years later. In 1998, there was no collapsed housing bubble, the government’s budget was in surplus rather than deficit, bank leverage was much lower, and derivatives markets were smaller and less far-reaching. A financial crisis related to Long-Term Capital, however painful, probably would have been easier to handle than the perfect storm of recent months. The ad hoc aspect of the bailout created a precedent for what has come to be called “regulation by deal” — now the government’s modus operandi. Rather than publicizing definite standards and expectations for bailouts in advance, the Fed and the Treasury confront each particular crisis anew. Decisions are made as to whether a merger is possible, whether a consortium can be organized, what kind of loan guarantees can be offered and what kind of concessions will be extracted in return. So far, every deal — or lack thereof, in the case of Lehman Brothers — has been different. While there are some advantages to leaving discretion in regulators’ hands, this hasn’t worked out very well. It has become increasingly apparent that the market doesn’t know what to expect and that many financial institutions are sitting on the sidelines, waiting to see what regulators will do next. Regulatory uncertainty is stifling the ability of financial markets to engineer at least a partial recovery. John Maynard Keynes famously proclaimed that “in the long run we are all dead.” From the vantage point of 1998, today is indeed the “long run.” We’re not quite dead, but we are seriously ailing. As we look ahead, we may be tempted again to put off the hard choices. But perhaps the next “long run,” too, is no more than 10 years away. If we take the Keynesian maxim too seriously, and focus only on the short run, our prospects will be grim indeed. Tyler Cowen is a professor of economics at George Mason University.

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REPORTAJE: PRIMER PLANO

Un año pésimo (y vamos a peor) El mundo se prepara para una profunda recesión económica en 2009 NEGOCIOS 28/12/2008 El 2008 económico -un año atroz- tiene algo de la escena del asesinato en la ducha de Psicosis. Esa banda sonora de chirriantes violines acompaña desde hace meses una secuencia vertiginosa de pésimas noticias financieras, el final de una era que algunos han definido con un expresivo "capitalismo de casino". Los destinatarios de esas informaciones, del más humilde trabajador a la aristocracia financiera de Londres y Nueva York, han visto peligrar sus ahorros o esfumarse sus inversiones en medio de un pánico sin precedentes y con esa música de fondo. Wall Street ya nunca será lo mismo. Y el frío se ha colado desde el subsuelo de las finanzas al conjunto de la economía. Con medio mundo asomándose ya a la recesión -el medio mundo rico, para más señas-, lo peor está por venir. En 2009 remitirán las turbulencias en la banca, pero a cambio llegará la resaca de la peor crisis financiera desde los años treinta, con una recesión profunda en pleno corazón del sistema, desde EE UU hasta Europa y Japón. Palabras mayores: al hilo de la peligrosa subida del desempleo, los más agoreros empiezan a hablar incluso de depresión, una situación inimaginable hace sólo unos meses y que obliga a pensar en los culpables de todo esto. La lista de villanos es inacabable. Los gobiernos han fracasado miserablemente al permitir años de excesos y no acaban de contener la sangría a pesar de los esfuerzos, de la vuelta al intervencionismo del Estado en la economía a base de dinero fresco. Los consumidores no dudaron en unirse a la fiesta de consumo que alimentó varias burbujas. Los bancos centrales, con Alan Greenspan a la cabeza, incentivaron el sobreendeudamiento con grandes y duraderas bajadas de tipos, e iniciaron una peligrosa carrera hacia la desregulación en la que han campado a sus anchas los especuladores. Los mercados se instalaron en la exuberancia irracional. Casi nadie -en ese magma de economistas, supervisores, analistas, periodistas, oráculos y un doloroso etcétera- lo vio venir, por lo que no había diques para contener ese tsunami. Pero los banqueros se llevan la palma: "Primero cruzaron varios límites que no debían haber sobrepasado y cebaron todas las burbujas; ahora ahogan a la economía productiva al cerrar el grifo del crédito", asegura desde Washington Carmen S. Reinhart, economista de la Universidad de Maryland y una de las grandes expertas internacionales en crisis financieras. "Demasiado riesgo ayer, demasiada prudencia hoy. En ambos casos, los bancos son culpables", sentenció el presidente francés, Nicolas Sarkozy, en el peor momento de la crisis. Y lo peor sucedió el pasado 15 de septiembre. Para entonces ya era imponente la cascada de entidades que no superaron el virus tóxico de las subprime (las hipotecas concedidas a clientes con un mal historial de crédito y que al dejar de pagar sus casas por el pinchazo de la burbuja inmobiliaria en Estados Unidos activaron el detonador de la crisis), aunque en marzo la Administración de Bush salió al rescate de Bear Stearns y pareció que con ese golpe de mano las turbulencias habían tocado fondo.

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Nada más lejos de la realidad. Tras intervenir varios gigantes financieros más, ese fatídico 15 de septiembre Estados Unidos decidió dejar caer Lehman Brothers, uno de los grandes bancos de inversión del mundo, para dar una lección: algo así como que quien la hace la paga. Pero inmediatamente después salvó de la quema a la primera aseguradora del mundo, AIG, una de esas entidades que los Gobiernos consideran demasiado grandes para caer. "Esa improvisación fue desastrosa: en un mercado saturado de incertidumbre, el Gobierno de Bush añadió más presión e hizo de un problema serio algo que en algún momento rozó el colapso total", explica Reinhart. "Porque con esos bandazos nadie sabía qué podía pasar, a quién se salvaría en caso de quiebra y a quién no. La bancarrota de Lehman Brothers provocó una abrupta contracción del crédito en todo el mundo. Un alud de desconfianza. Y en los mercados, la desconfianza suele derivar en pánico. Eso fue lo que sucedió: lo de Lehman quedará como uno de los grandes errores de gestión económica de todos los tiempos. Convirtió un grave episodio de turbulencias financieras en una recesión profunda. Y veremos si en algo más". En esa tesitura llegaron los grandes remedios: la intensificación de la crisis y el pánico desencadenado en algunos momentos sobrepasaron la capacidad de los bancos centrales para suavizar las restricciones de crédito y abastecer de liquidez al sistema, y obligaron a los Gobiernos a actuar. Estados Unidos anunció un plan de rescate multimillonario para comprar activos tóxicos, la mayor intervención pública en la economía en un país que hizo dogma del libre mercado, de la desregulación, del laissez faire económico y financiero. Europa ha acabado aprobando algo parecido tras la intervención del Reino Unido, que dio con la tecla al inyectar el dinero público directamente en el capital de los bancos. Al final, ése es el denominador común de los salvavidas aprobados a ambos lados del Atlántico, que han conseguido detener el reguero de cadáveres en la banca, pero siguen generando dudas: los planes de rescate -en el fondo, un intento de salvar al capitalismo de los capitalistas- no han impedido que la metástasis atraviese las finanzas y se instale en la economía y en la industria. El desempleo ha iniciado una escalada peligrosa. Eso supone menos consumo. Y claro, más problemas. En economía, las desgracias nunca vienen solas. Una mala noticia llama a la siguiente. Y lo de 2008 es algo parecido a un círculo vicioso. Con la Bolsa en liquidación, la continua caída de precios de los activos financieros acabó provocando un desaguisado en la banca y una intensa contracción del crédito, que ha acabado contagiando a la economía real. La recesión ha llegado para quedarse, y eso a su vez complica la crisis financiera. Para los expertos consultados, ese panorama hace imprescindible la intervención pública con objeto de evitar una deflación (una caída de precios en la economía real) que puede derivar en una intensa depresión de la actividad. La deflación es una enfermedad peligrosísima: los precios empiezan a caer y, aun así, los consumidores no compran, no gastan, no entran en las tiendas y obligan a las empresas a producir menos, a despedir a más gente. Tiene una cura difícil. Ahora mismo es sólo una posibilidad: el comercio mundial ya ha frenado en seco, aunque la temida depresión parece aún poco probable. Pero no imposible. La prueba es que la Reserva Federal ha agotado prácticamente todos sus cartuchos con el recorte de los tipos de interés hasta un histórico 0%. Pregúntele cualquier cosa a un buen economista y obtendrá al menos dos respuestas. El chiste dice que si se trata de Keynes -que vuelve siempre a estar de moda cuando vienen curvas-, las respuestas serán tres. En esa línea, desde la Universidad de Lovaina, el profesor Paul de Grauwe analiza 2009 desde dos escenarios posibles. "El optimista consiste en que los paquetes de estímulo de los Gobiernos empezarán a funcionar en breve y permitirán salir de la recesión a final de año, lo que a su vez ayudará a la recuperación de la banca. Pero un escenario más 67

negativo supondría que los planes de rescate tienen poco que hacer. De ser así, la economía mundial entraría en una espiral deflacionista, los países reaccionarían con medidas proteccionistas y los bancos recibirían una segunda tunda de golpes. Espero que esto no ocurra, pero ni mucho menos puede descartarse". Definitivamente, 2009 no pinta bien. En especial, para un sector bancario que no deja de encajar golpes directos a la mandíbula con episodios que rozan lo estrafalario, como la reciente estafa descubierta en EE UU. Una pirámide financiera, un timo en el que han picado grandes bancos y que socava más y más la ya muy minada confianza en los banqueros. La reputación de la banca -que el lenguaje imposible de las finanzas maquilla con un ampuloso "riesgo reputacional"- está en horas bajas. Los grandes países parecen decididos a reformar el sistema, para conjurar el riesgo de una Gran Depresión como la de los años treinta, a juzgar por la última reunión del G-20. Aunque puede que la pesadilla vaya remitiendo, al menos en las finanzas. El economista francés Charles Wyplosz afirma desde Suiza que la peor fase de la crisis financiera "ya ha pasado". Pero atención, eso no significa que el sector bancario vaya a estar instantáneamente sano. "La recuperación va a ser lenta, con numerosos accidentes en el camino. Los bancos van a sufrir, e incluso puede que quiebren más entidades". Y cierra: "Los planes de rescate son cruciales. Siguen sin salir todos los activos tóxicos, por lo que sería necesaria una segunda oleada de intervención. Además, la economía va a peor y eso añadirá más pérdidas, difíciles de digerir tras un año plagado de dificultades. La cura definitiva aún está lejos". Lo asombroso de la escena de Psicosis es que se ve la sangre, pero nunca cómo se clava el cuchillo en el cuerpo de la pobre Janet Leigh. Hitchcock lo esconde en un montaje que es un alarde de malabarismo. Los bancos han hecho algo parecido con su contabilidad. No han podido ocultar la sangría de pérdidas: a estas alturas van más de 700.000 millones de euros y más de 200.000 despidos en la industria financiera mundial. Pero nadie conoce la profundidad de la herida, hasta dónde va a llegar la cuantía definitiva. Y nadie lo sabe porque los bancos se encargaron de sacar la porquería de sus balances, conscientes del alto riesgo de las hipotecas basura. Empaquetaban esos préstamos junto a otros de distinta solvencia en vehículos financieros de nombres impronunciables -credit default swaps (CDS), conduits y otras lindezas por el estilo- y los vendían a otras entidades financieras en el mercado secundario pagando al comprador unos intereses por el riesgo. Así cuantas veces fuera necesario. Joaquín Estefanía firmaba hace unos días un artículo en este periódico en el que no dudaba en calificar esta operativa como "estafa piramidal", al estilo de la protagonizada por Bernard Madoff. En poco tiempo, el sistema ha cambiado de arriba abajo. El gobernador del Banco de España, Miguel Ángel Fernández Ordóñez, lo describe así en un discurso reciente: "Si en un principio las dificultades parecieron circunscribirse a apenas unos pocos fondos de inversión y pequeñas hipotecarias estadounidenses, el conjunto de entidades afectadas fue aumentando en un proceso en el que se han sucedido, sin solución de continuidad, nacionalizaciones, quiebras, intervenciones de bancos, creación de nuevos esquemas de garantías para inversores e importantes limitaciones en las prácticas de mercado, como las que han afectado a las ventas en descubierto de acciones". La catástrofe financiera no ha respetado siquiera a los supuestos intocables: los reyezuelos de los últimos años, los bancos de inversión, ya no existen como tales; o bien han desaparecido o se han tenido que transformar en bancos comerciales. Brillantes, arrogantes y temerarios a partes iguales, inventaron una forma de hacer negocios basada en el endeudamiento que les hizo ganar dinero a espuertas y a su vez cavó su propia tumba. 68

Es interesante ver cómo los expertos de esas entidades resumen la hecatombe de los últimos meses. El antiguo equipo de estrategia de Lehman Brothers, engullido ahora por el de Barclays, disecciona en un informe de diciembre los hechos de los últimos meses con la precisión del bisturí de un médico forense: "Estamos pagando los excesos de los últimos 10 años, en los que la acumulación de riqueza se construyó con una sola premisa: deuda. Nadie es inmune a la actual espiral de desapalancamiento, que durará años". Eso sí, hay cosas que no cambian. "Con los mercados dislocados, tras los cambios en el terreno de juego y el reajuste en el precio de los activos, las oportunidades están ahí", apunta el estudio sobre las oportunidades de 2009. Los organismos internacionales -con la reputación por los suelos tras los continuos errores de bulto en la prevención y la detección de los problemas- hablan de una crisis "sin precedentes". Reinhart y Kenneth Rogoff titulan uno de sus trabajos más recientes, que analiza nada menos que 800 años de crisis financieras, con un irónico Esta vez es diferente. "Algo parecido a esto ya ha pasado. Y volverá a suceder. Las crisis financieras se producen tras liberalizaciones o innovaciones financieras que desencadenan periodos de euforia y alimentan burbujas de todo tipo. Y eso es lo que ha sucedido otra vez: que algunos creyeron que habíamos descubierto la penicilina y se embarcaron en excesos de todo tipo hasta que el globo pinchó", explica telefónicamente la autora de este trabajo. "Eso sí, se trata de un agujero que suele verse una vez en un siglo", concede. Sí hay algunos elementos novedosos: "La crisis se desencadena en el centro financiero y el contagio es huracanado. Y a partir de ahí se produce una reacción de política monetaria muy rápida y agresiva, que se estudiará durante mucho tiempo. Y cuyos resultados están en el alero". Con todo, el papel activo de los bancos centrales no ha impedido una sobrerreacción: en los mercados financieros se ha pasado de una situación generalizada de infravaloración del riesgo a otra caracterizada por la extrema cautela. Las condiciones financieras se han endurecido notablemente. Y eso complica la recuperación. "Seríamos muy afortunados si la economía tocara fondo en 2009", afirma el profesor de Harvard Martin Feldstein. Al pinchazo inmobiliario se le suman la restricción sobre el crédito, el castigo de las Bolsas y el repunte del desempleo. El ciclo inmobiliario dura una media de unos seis años: la burbuja en EE UU pinchó en enero de 2006, por lo que la recuperación en el mercado norteamericano debería llegar en 2010, coinciden las fuentes consultadas. "Pero ésa no es una fecha uniforme para todo el mundo. En EE UU, la corrección del mercado inmobiliario ya es del 30%, pero en España esa cifra es muy inferior. A medida que vaya cayendo la vivienda, se verá más la debilidad del sector bancario español. Además, la exposición de la economía española a América Latina es elevada, y eso tampoco pinta bien", aventura Reinhart. Los políticos, los banqueros y hasta los rockeros repiten últimamente el mantra más manido del último año: que toda crisis es también una oportunidad. No faltan aspectos positivos del terremoto financiero: el petróleo y las materias primas se han relajado tras unos meses al límite, y con ellos, la inflación; las economías en desarrollo han demostrado cierta resistencia, pese a que empiezan a flaquear; los bancos centrales han dejado de lado el discurso ultraortodoxo de la contención de precios y parecen más centrados en el crecimiento, y el papel de los Gobiernos supone un contrapeso al predominio neoliberal de los años ochenta y noventa y apunta a una vuelta a la regulación, e incluso a un mayor activismo de los organismos internacionales para ayudar a las economías en dificultades. "Pero en 2009 veremos las peores cifras de crecimiento en muchos años. Si 2008 ha sido el annus horríbilis de las finanzas, 2009 será el annus horríbilis de la economía", asegura Marco Annunziata, economista jefe de Unicrédito.

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En fin, 2008 será recordado como un año desastroso en lo económico, pero sobre todo en lo financiero. Los últimos episodios dan idea del manojo de nervios en el que está atrapada una economía que no cesa de dar desagradables sorpresas, espasmos inesperados. El anuncio de que un estafador fue capaz de engañar a las élites de las finanzas durante más de 15 años. El recorte de tipos al 0%, que supone una cura y a la vez da cuenta de la gravedad del enfermo. La intuición de que en el fondo todo podía haber ido incluso peor. Las crisis suelen estar asociadas con la irrupción de nuevos nombres: además del marasmo financiero, 2008 será recordado por la victoria de Barack Obama en EE UU. En el sector financiero internacional también se han producido numerosos relevos. De la cúpula de los gigantes financieros internacionales han desaparecido de un plumazo los ejecutivos de los últimos años, algunos de los temerarios jugadores de ruleta que llevaron a los bancos al desastre. Han llegado otros que se enfrentan a un desafío descomunal, plagado de perspectivas sombrías. Y que no cobrarán tanto, eso seguro, al menos hasta que demuestren que saben cómo salir de ésta. La revolución es un simple cambio de personal: eso dejó escrito Josep Pla hace ochenta años. De momento, habrá que esperar que de esa revolución en el elenco bancario no emerja algo parecido a la figura de Norman Bates, el asesino de Psicosis.

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V REPORTAJE: EMPRESAS & SECTORES

El 'ladrillo' se viene abajo Las inmobiliarias pasan del dinamismo a los concursos de acreedores en un año NEGOCIOS 28/12/2008 Si algo han aprendido las inmobiliarias este año es que el tamaño, al final, no importa. De esta crisis no se ha librado apenas nadie. Ni los gigantes del sector ni empresas históricas que habían sobrevivido incluso a guerras. El sector del ladrillo, que se creía preparado para afrontar un "aterrizaje suave" de los precios, ha sucumbido a una de sus crisis más graves de su historia. Las compraventas de pisos se han desplomado más de un 30% -y en algunas comunidades supera el 50%-, la financiación se ha frenado en seco, la caída en la construcción de pisos llega al 60%, las refinanciaciones se han vuelto imposibles y, como consecuencia, se cuentan por decenas las empresas que han acudido al juzgado para solicitar el concurso de acreedores. El sector venía ya de un 2007 que dio bastantes avisos del agotamiento que sufría el mercado inmobiliario español. Las transacciones de suelo estaban paradas, apenas se cerraban ventas de segundas residencias y el inversor en viviendas estaba en retirada. Para colmo, Llanera presentó el concurso de acreedores (antigua suspensión de pagos) y Enrique Bañuelos, en Astroc, y Luis Portillo, en Colonial, tuvieron que abandonar dos de las operaciones más sonadas de ese año. La crisis de las hipotecas subprime fue el detonante. "Íbamos a un descenso de los precios y la producción, pero la crisis financiera internacional afectó a la concesión de créditos, que tal vez se hubieran mantenido, aunque a la baja", sostiene el profesor de Derecho Mercantil Ignacio Sanz, de Esade. Eso también creían los promotores, pero el mercado se paró en seco. Sus activos se fueron depreciando rápidamente. Y los pilló a contrapié: apenas doce meses atrás acababan de comprar todo cuanto hallaban para crecer con deudas multimillonarias. Colonial, Metrovacesa, Martinsa-Fadesa, Habitat o Reyal Urbis empezaron a refinanciar sus deudas. No siempre con un buen resultado. Tras una cadena de concursos de inmobiliarias medianas, Martinsa-Fadesa protagonizó la mayor suspensión de pagos de España el pasado mes de julio con un pasivo de alrededor de 7.000 millones de euros. Con el proceso concursal, además, se van abriendo poco a poco algunas ventanas hacia lo que fueron las prácticas que hincharon la burbuja: tasaciones que en apenas meses rebajaban el valor de los activos de 10.800 millones a 7.400 millones o apuntes contables que consistían en revalorizaciones de hasta el 19.000%. El segundo mayor concurso lo protagonizó en noviembre Habitat, con una deuda de cerca de 2.300 millones. La compañía que preside Bruno Figueras ya venía de un proceso de refinanciación con un sindicato bancario de 39 entidades financieras, por lo que el concurso supuso un golpe para quienes pensaban que la banca no dejaría caer a las grandes compañías. De hecho, a punto estuvo Metrovacesa de temer lo peor. La familia Sanahuja debía refinanciar un préstamo de 4.005 millones de euros por la compra de la sociedad y, además, la inmobiliaria estaba enredada en el pago de un inmueble de Londres por el que abonó 1.597

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millones de euros en abril de 2007 y que había anunciado a bombo y platillo como la "mayor operación de la historia en Gran Bretaña". Al final, la banca acreedora se hizo con la mayoría del capital de la compañía. Las seis entidades acreedoras (Santander, BBVA, Banesto, Popular, La Caixa y Caja Madrid) han accedido a canjear los 4.000 millones de euros que les adeuda por el 54% del capital de la empresa, con la posibilidad de elevar su participación al 65,4% del capital. Pero todavía hay algún cabo suelto. La familia Sanahuja no quiere darse por vencida y está negociando con la banca la recompra de acciones de Metrovacesa en un periodo de cuatro años. También Colonial ha quedado en manos de las entidades financieras. La inmobiliaria catalana, que cambió deuda por capital con 15 bancos y cajas acreedores, se enfrenta con otro obstáculo: la venta de un paquete del 15% de FCC, el 33% de su filial francesa SFL y la totalidad de Riofisa. Una operación difícil en el actual contexto económico que, de no efectuarse, llevaría a la compañía al concurso de acreedores, según reconoce la inmobiliaria. "Este año hemos visto mucho de lo que esperábamos. No parece que en el primer semestre del año que viene tengamos que ver demasiados concursos grandes, pero sí varios de empresas con deudas de alrededor de 100 millones", asegura el consejero delegado de Jones Lang LaSalle, Andrés Escarpenter. Para mantenerse, todo dependerá de si los mercados recuperan su estado líquido. Para reflotar, de que el mercado absorba el stock de más de 675.000 pisos que siguen sin venderse. La banca gana Todavía quedan muchas incógnitas que despejar sobre el futuro del sector inmobiliario. Pero si algo tienen claro analistas, inversores y promotores es que las grandes empresas del futuro están en manos de la banca. Las entidades financieras, además de pasar a controlar Colonial y Metrovacesa, han ido acumulando patrimonio a lo largo de este año. Lo han hecho por ejecuciones de préstamos y para cancelar deuda a través de la compra de activos para evitar que se dispare la morosidad con la figura de la dación en pago. "Las nuevas grandes inmobiliarias de este país van a ser las de los bancos. ¿Al mismo nivel que ahora? Hay que ver qué harán en 2009, en principio el ritmo de compra de activos será más lento", asegura el consejero delegado de Jones Lang LaSalle, Andrés Escarpenter. La mayoría de las entidades financieras, precisamente, vendieron sus filiales inmobiliarias cuando el ciclo estaba más alto. Es decir, cuando los precios tocaron techo. Lo hizo La Caixa con Colonial, Banesto con Urbis, Banc Sabadell con Landscape o Caixa Catalunya con Riofisa. Ahora las vuelven a rearmar. Esta semana Banc Sabadell ha anunciado la creación de Solvia Gestión Inmobiliaria, la nueva sociedad que gestionará los activos que vaya adquiriendo el grupo (hasta septiembre se gastó alrededor de 500 millones de euros). La sociedad, con un equipo directivo similar al de Landscape, tiene un 70% de suelo urbanizable, un 10% de promociones en curso, un 10% de inmuebles en alquiler y un 10% de bloques de viviendas finalizados. Pero prácticamente todas las entidades admiten estar adquiriendo activos. Banco Santander desembolsó 2.700 millones en nueve meses, y BBVA, 340 millones. Pero también será crucial el papel de la banca en los concursos de acreedores, de los que podría salir, todavía, con más activos inmobiliarios de los que posee ahora. -

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REPORTAJE: FRACASO DEL AÑO

El ocaso del alquimista Eran empresarios anónimos. Tenían buenos contactos políticos y disfrutaban de jugosas ganancias. La ambición de poder económico les perdió. Salieron de compras por el mundo. Hoy son la cara de la bancarrota del sector inmobiliario español LUIS GÓMEZ 28/12/2008 Enrique Bañuelos (Sagunto, 1966) apareció en el mercado como un nuevo alquimista. Alguna razón tenía de su parte: conocía la fórmula para convertir un solar de terreno baldío en una mina de oro. En ningún sitio como en España la suma de dinero barato, legislación sin restricciones y bonanza económica podían originar que el valor de una hectárea de tierra improductiva alcanzara el nivel de una piedra preciosa. Eso sucedió a primeros de siglo y, como consecuencia de ello, nació una generación de emprendedores anónimos que, llegado el momento, salió a la superficie dispuesta a comerse el mundo. Bañuelos fue uno de ellos. Joven. Amable en el trato. Extrovertido. Y un depredador cuando pisaba la alfombra roja del mundo de las finanzas: "A mí me dejan desnudo en Central Park y en 24 horas estoy paseándome por la Quinta Avenida en una limusina". Bañuelos es hoy una de las bajas identificadas del pinchazo de la burbuja inmobiliaria, un derrumbe sin precedentes que ha protagonizado las suspensiones de pagos más cuantiosas de la historia de España. Astroc, su empresa, la madre de un proyecto de inmobiliaria internacional que ofreció por medio mundo, ha desaparecido del mercado de valores. Su cotización llegó a multiplicarse por 1.000 en apenas un año. Como él, otros empresarios han experimentado el mismo ciclo: ascensión a las alturas y caída en picado. Abandonaron su anonimato y se abrazaron a la tentación del poder económico. Cada uno a su estilo, no midieron su ambición. La caída del imperio del ladrillo amenaza un sector que representaba el 2,5% del PIB español. La biografía de Bañuelos comenzó a rodar a demasiadas revoluciones a partir del año 2006. De ser un desconocido pasó a formar parte del selecto club de los 100 hombres más ricos del planeta, según la revista Forbes. Con razón afirmaba Bañuelos que para él "un año dura tres meses". "No me encariño con las cosas", afirmaba. Compraba empresas y vendía nuevos proyectos en cualquier parte del mundo. Necesitaba más espacio. Dejó Valencia, se trasladó a Madrid, luego a Nueva York, en pleno Manhattan, donde quería hacer realidad uno de sus proyectos -las Spanish Towers-, unos rascacielos donde podrían instalar sus sedes sociales en Estados Unidos las principales empresas españolas. Adquirió un jet privado, el mismo Falcon 900 que usaban los grandes patronos de la economía española. Pero no quería ser un igual, quería diferenciarse, así que adquirió un modelo con una característica de la que carecían los otros: el jet de Bañuelos disponía de detector antimisiles. O así lo afirmaba. Bañuelos no era el único caso de súbita irrupción en el mercado inmobiliario. Estaba Luis Portillo (Sevilla, 1962). Si Bañuelos había hecho dinero en el entorno de la Comunidad Valenciana sacando partido de la figura del agente urbanizador (una novedad en la ley urbanística que permitía convertir en urbanizable un suelo rústico con la simple presentación de un proyecto inmobiliario), Portillo era el exponente de la explosión urbanística andaluza.

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De origen más humilde, hijo de albañil, Portillo hizo dinero con las reformas de inmuebles y, más tarde, con la expansión de la localidad de Dos Hermanas, en el cinturón de Sevilla. Ambos hicieron mucho dinero bajo el amparo de sus contactos políticos y la complicidad de las cajas de ahorros locales. Pero hubo un momento en el que tanto Valencia como Andalucía se les quedaron pequeñas. Y dieron un salto más: dejaron el anonimato y se fueron de compras por el mundo. Portillo había empezado antes que Bañuelos, entre otras cosas porque su patrimonio era mucho más sólido. Tras un primer asalto a la constructora Metrovacesa, después de adquirir participaciones en el Santander y el BBVA, compró la inmobiliaria Inmocaral, donde compartió accionariado con algunos de los grandes apellidos del establishment nacional, léase Alicia Koplowitz, Amancio Ortega o Joaquín Rivero. Luis Portillo es un hombre sin formación, con serias dificultades para expresarse correctamente en público, pero a quien se le reconocía una extraordinaria inteligencia natural para moverse en el mundo del urbanismo. Después de la compra de Inmocaral y una posterior OPA a Colonial, una constructora tres veces más grande que la suya, Portillo había traspasado ya la barrera de su entorno natural. De la licencia de obras al mundo de las finanzas hay un abismo. Ya no era un personaje anónimo, ya no se movía sigilosamente entre políticos y banqueros locales, ahora estaba expuesto a la luz: sus empresas cotizaban en Bolsa y, como Bañuelos, sus proyectos traspasaban fronteras. Portillo comenzó a ser un hombre de excesos. Entre su patrimonio figura una propiedad que llama la atención, un colegio. Todas las fuentes consultadas para este reportaje ofrecen la misma versión de aquella adquisición. Las diferencias entre la dirección del colegio y Portillo, relacionadas con los estudios de una de sus hijas, acabó con una acción terminante: Portillo compró el colegio y despidió al director. Pudo haber sucedido algo parecido tiempo después cuando, tras un incidente en un hotel, Portillo quiso saldar el problema con idéntica actitud y amenazó en público: "Esto lo arreglo en un momento: compro el hotel, despido al director y me quedo tan tranquilo". Ahora Colonial, la joya de su patrimonio, lleva tres meses sin vender un piso y lucha para evitar la suspensión de pagos. Y Portillo ha perdido la presidencia de la empresa. "Gestionar como gestionaron estos personajes no tiene ningún misterio", explica un catedrático, consultor en el sector, que no autoriza a dar su nombre. "En una época de dinero barato y en un sector sin tarifas reguladas donde podían obtenerse márgenes extraordinarios, estos empresarios se fueron de compras sin darse cuenta de que caminaban con muletas. Y si pierdes la muleta, te caes. Eso es lo que pasó". Fernando Martín era un perfecto desconocido incluso cuando entró a formar parte de la directiva del Real Madrid junto a Florentino Pérez, en julio de 2004. Su papel como vocal fue irrelevante en una junta donde figuraban otros pesos pesados (Abelló, Fernández Tapias, Luis del Rivero en aquellos momentos), pero no así su patrimonio, consolidado sobre todo a la sombra de la expansión urbanística de Madrid. De nuevo, las mismas claves: amistad con ediles y amparo de los bancos. De ser un empresario anónimo, aunque muy rico, pasó a ser una celebridad momentánea con su ascenso a la presidencia del Real Madrid. Apenas duró unos meses en el cargo, pero viajar por el mundo representando al Madrid y moverse con guardaespaldas y en primera línea de palco cambiaron algunas formas en la conducta de Fernando Martín, según sus allegados. "Ya no aceptaba cualquier invitación, comenzó a poner condiciones", explican. Martín dio también un paso adelante y quiso convertir su empresa, Martinsa -una sociedad de estructura familiar donde su mujer trabajaba como responsable de marketing- en algo más. También salió de compras. Adquirió Fadesa y entró en bolsa. Total, costaba 4.000 millones de euros.

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Lo que desconocía Fernando Martín era que José María Castellano, brazo derecho de Amancio Ortega en la irresistible expansión de Inditex, le había hecho una recomendación especial a Manuel Jove, dueño de Fadesa: "Vende". Jove estaba muy afectado por la muerte de su hija, en quien había puesto toda su confianza como heredera del negocio, y sufría serios problemas de estructura en una inmobiliaria que tenía proyectos en marcha tanto en España como en Europa del Este y el norte de África. El consejo de Castellano, que conocía las interioridades de Fadesa, fue muy útil: cuando todos compraban, Jove vendió. Algunos de los protagonistas de la burbuja inmobiliaria coincidieron en la búsqueda del mismo signo de identidad: tener asiento como consejeros en alguno de los dos grandes bancos españoles. Fracasaron en el intento. Actualmente, todos ellos están en suspensión de pagos o al borde de ella, mientras Jove ha podido instalarse como un accionista importante del BBVA. Es curioso cómo colaboradores de Bañuelos, Portillo o Fernando Martín coinciden en calificarles como "personas normales", amables en el trato y correctas con sus empleados, como queriendo separar su perfil humano de su personalidad como empresario. Otros testigos afirman que en el mundo de sus negocios inmobiliarios se conducían como tiburones. Pero aún había otro escalón: qué personalidad desarrollaron cuando vivieron en la cresta de la ola. De todos los protagonistas del desplome del sector inmobiliario, sólo Luis del Rivero (Murcia, 1950) tiene un perfil menos ondulante: autoritario, prepotente, irascible y ambicioso. Nadie discute estas características del personaje. Por ello, quizá, Luis del Rivero, una vez instalado en Sacyr-Vallehermoso, quiso jugar la apuesta más alta. Sus amistades no se limitaban a los Gobiernos locales. Picaba en el Gobierno central. Picaba más alto. No se fijó en inmobiliarias ni en constructoras. Buscó el asalto a un banco (BBVA) y, cuando fracasó, optó por el sector energético entrando, entre otras empresas, en el capital de Repsol. Ahora, Luis del Rivero necesita vender su participación en Repsol para intentar salvar su imperio, en cuya sede central hay una visible diferencia entre las plantas donde se mueve Rivero (que dispone de restaurante y comedor privado) y el resto de las dependencias, conocidas en la casa como la "oficina de Cuéntame" por su deterioro. De entre todos estos personajes, el más explosivo fue Enrique Bañuelos. Nadie puede predecir dónde habría querido llegar. Si alguien puede representar los extremos de la burbuja es este hombre criado en Sagunto que cayó al vacío tan rápido como pareció subir al cielo. Porque, a diferencia de sus compañeros de bancarrota, Enrique Bañuelos se trabajó una biografía como medio para obtener un fin. Tenía dotes para hablar en público. Dotado de una energía contagiosa, transmitía y convencía. "Era un fuera de serie", dice todavía un antiguo colaborador suyo. "En una reunión de tres horas, él era capaz de hablar durante dos horas y 59 minutos y dejar el último minuto para su interlocutor", coinciden de forma gráfica varios testigos que han estado presentes en sus reuniones de trabajo. "Decía y ejecutaba", explica otro colaborador. Proyectar una imagen de éxito fue un empeño premeditado. Si para darse a conocer en Nueva York fue capaz de organizar una paella para 25.000 comensales en Central Park es porque no había límites a su necesidad de ser conocido y reconocido. Pagó lo que fuera necesario para estar presente en algunos actos sociales de Nueva York, encontró sitio para formar parte de una delegación que acompañó a la visita del Príncipe de Asturias a la Casa Blanca. No dudó en gastarse un millón de euros para ser uno más de los selectos empresarios españoles que invertían en la Fundación Procenic, cuyos fondos se destinaban a la investigación cardiovascular dirigida por el cardiólogo Valentín Fuster. Y, tras fundar la Fundación Astroc, dedicada al mundo de la cultura, compró un palacete en Madrid como sede. El palacete, sin embargo, tenía un defecto: estaba situado en el número 1 de la calle de López de Hoyos. No era una calle con pedigrí, pero nada se le resistía a Bañuelos en aquellos tiempos, ni siquiera el

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callejero de Madrid. Así que, dado que la finca tocaba en un extremo con el paseo de la Castellana, entre dos edificios, los números 56 y el 58 de dicha calle, se las ingenió para que el Ayuntamiento le reconociera al inmueble una segunda dirección: paseo de la Castellana, 56 bis. Ese detalle permitía a Bañuelos tener una propiedad en una de las calles más conocidas del mundo de los negocios. Allí, en la última planta, hizo que le construyeran cuatro apartamentos de lujo, con jacuzzi incluido y seguridad las 24 horas, reservados para sus invitados. "Así hago yo los negocios", explicaba. Su proyecto cayó como un castillo de naipes a partir de abril de 2007. La cotización se desplomó a pesar de sus esfuerzos por sostener el valor a fuerza de comprar en el mercado. En unos días empleó todas sus energías, y mucho dinero, para mantener a flote su imperio, pero alguien le traicionó. Alguien de los suyos, de quienes compartían viaje con él en el accionariado de Astroc. Alguien vendió dos millones de acciones y tumbó irremediablemente a Bañuelos. ¿Una traición? A cierta altitud, en el mundo de los negocios no se conjuga el verbo traicionar. No se sabe a ciencia cierta quién acabó con su carrera. Ninguno de estos personajes ha aceptado una entrevista. Ahora huyen del primer plano de la actualidad. Y han vuelto a cierta normalidad. Bañuelos fue visto hace unas semanas paseando con su mujer por una céntrica calle de Valencia. A Luis Portillo se le ve ahora, con alguna frecuencia, en el AVE Madrid-Sevilla. –

Viviendas en construcción en Seseña- ULY MARTÍN

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ENTREVISTA: GERHARD CROMME CONSEJERO DELEGADO DEL GRUPO SIEMENS

"El soborno era una red tolerada u oculta por la anterior dirección" JÖRG SCHMITT, GEORG MASCOLO Y THOMAS TUMA 28/12/2008 La empresa alemana Siemens ha sido condenada en Estados Unidos a una multa de 800 millones de dólares (cerca de 570 millones de euros) por corrupción. Y además ha de transferir otros 395 millones de dólares (unos 285 millones de euros) al Estado de Baviera. El consejero delegado de Siemens, Gerhard Cromme, de 65 años, habla sobre la investigación a la que ha sido sometido este grupo y las responsabilidades de la anterior dirección. Pregunta. A lo largo del proceso se habló de multas de hasta 5.000 millones de euros... Respuesta. ... Y más. En teoría podrían haberse alcanzado estas sumas, pero todo el proceso habría durado más tiempo y habría sido más caro. P. ¿Por qué Siemens ha salido tan bien parada al final? R. La colaboración entre las autoridades alemanas y estadounidenses ha sido excelente. Gracias a las estrechas relaciones que existen entre la SEC (el organismo regulador de la Bolsa estadounidense), el Ministerio de Justicia de Washington y la Fiscalía alemana, Siemens no ha recibido dos condenas distintas por los mismos delitos. El caso ha resultado también ejemplar para la SEC, a fin de demostrar que quien coopera recibe su recompensa. Todo eso ha ayudado. P. También le impulsaba a usted el miedo de que Siemens pudiera quedarse sin contratos públicos en Estados Unidos... R. Lo que habría sido horrible. Eso también teníamos que impedirlo a toda costa, sí. P. ¿En algún momento le pidió ayuda a la canciller? R. Estábamos siempre en contacto con el Gobierno federal y con el de Baviera, así como con los embajadores. Y también dijimos desde un principio que no íbamos a poder superarlo solos. Todos, incluidos los Estados Unidos, nos han elogiado por no haber intentado orquestar presiones políticas. P. Los competidores de Siemens, como la estadounidense General Electric, habrían respaldado sanciones duras. R. Sobre eso se puede especular mucho. Pero aunque haya sido el caso, nunca nos ha dado la impresión de que alguien se haya dejado influir por eso. P. Estamos hablando de la mayor sanción monetaria que la justicia estadounidense ha impuesto en un caso así. ¿Se merece Siemens esta condena? R.

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Ésa es, al fin y al cabo, una cuestión de valoración moral. Preferiría que siguiéramos sobre una base racional. P. ¿Cuánto le va a costar todo el asunto a la empresa? R. En total hemos pagado 1.200 millones de euros de sanción, a lo que hay que añadirle otros costes, como los cerca de 200 millones que irán al despacho de abogados Debevoise & Plimpton y los 350 millones para la auditora Deloitte & Touche. P. Usted viajó unas cuantas veces a Washington para suavizar el ambiente. ¿Fue una penitencia? R. Hay citas más agradables porque, aunque sea extremadamente justo, también es durísimo. Por ello a todo el mundo le doy un buen consejo: eviten estas instituciones en la medida de lo posible. No se puede tratar con ellas con una actitud alemana, sino que hay que presentarse con rectitud y modestia. Si los estadounidenses hubieran aprovechado todos los instrumentos de tortura que pone a su disposición el sistema jurídico estadounidense, Siemens habría podido caer en una peligrosa crisis. P. En total han incurrido en unos costes de cerca de 2.000 millones de euros, sin contar con el pago complementario de impuestos. Esta cantidad podríamos restarla a todos los encargos que Siemens ha obtenido durante décadas gracias a la corrupción y todo este embrollo incluso podría haber sido rentable, si cabe. R. No estoy de acuerdo, porque los daños a la imagen de la empresa son difíciles de calcular, pero son enormes. Desde que la Fiscalía de Baviera empezó con sus redadas, en noviembre de 2006, ya no hay sobornos en la multinacional. Los pedidos han aumentado y, por lógica, tendrían que haberse hundido si los sobornos hubieran sido tan necesarios para la supervivencia. P. Entonces, ¿tenía algún sentido toda la corrupción? R. Ahí es precisamente donde tengo mis dudas. Más bien creo que, tanto externa como internamente, se había desarrollado una especie de industria común del soborno que al final debía hacer que todos tuvieran la impresión de que los sobornos eran necesarios. No se puede excluir que los que participaban en este sistema se aprovecharan para sacarse un dinero extra. P. ¿Cuándo vio usted claro que detrás del creciente número de supuestos sobornos debía esconderse todo un sistema? R. Antes de la sesión de abril de 2007 del Consejo de Administración. A partir de ahí dejé de entender cómo nos podíamos haber empantanado de esa forma, que se hacía cada vez más y más grande, sin que el presidente lo supiera o lo tolerara. P. Usted viene de la empresa ThyssenKrupp, con negocios relacionados con fragatas y tanques de rastreo, que estuvo en el punto de mira de los investigadores. R. ¡Un momento! El proceso de investigación no condujo a ninguna sanción contra ThyssenKrupp ni contra sus colaboradores. El negocio que ha mencionado tiene su origen en

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1991, esto es, muchos años antes de que Thyssen y Krupp se fusionaran, en 1999. Sería injusto relacionarme a mí con esos casos. P. ¿Se siente engañado por los anteriores responsables de la junta directiva, Heinrich von Pierer y Klaus Kleinfeld? R. La verdad es que me habría gustado que hubieran sido más francos... P. Algo que quizás no podía ser, precisamente porque Siemens había aceptado anteriormente la corrupción como base. R. Hoy sabemos que esta base surgió poco después de la Segunda Guerra Mundial, en una época en la que a las multinacionales de Alemania, un país vencido, ni siquiera se les permitía todavía entrar en los países buenos. Así que tuvieron que empezar en países bastante difíciles y hubieron de adaptarse a prácticas locales. P. En las investigaciones apenas aparecen casos de corrupción en Alemania y otros países europeos. ¡Cómo si no se hubiera sobornado a nadie en ellos! R. En Europa empezaron antes con controles más estrictos. Y en Alemania las investigaciones no han encontrado nada nuevo... P. Los fiscales estadounidenses descubrieron 4.283 pagos ilegales y 332 proyectos dudosos protocolizados: desde el tren de cercanías en Venezuela y centrales eléctricas en Israel, hasta encargos de tecnología médica en Vietnam. ¿Hay algún sector en el que no hubiera sobornos? R. El soborno se practicaba en muchos ámbitos, sobre todo en el de las comunicaciones. Era una red, un universo paralelo, ocultado, tolerado o incluso promovido por la anterior Junta Directiva. P. Un compañero suyo del Consejo de Administración, el presidente de Deutsche Bank, Josef Ackermann, estalló y dijo que ya no sabía qué le sentaba peor de la anterior cúpula de Siemens: que no supieran nada o que no hubieran hecho nada. R. Ése era el principal problema. Me habría gustado que los miembros anteriores de la junta directiva nos hubieran informado a tiempo. Así los afectados nos habríamos ahorrado muchas molestias en los últimos dos años. P. ¿Quiere de verdad que sus antecesores les devuelvan los 2.000 millones perdidos? R. Sería absurdo. Lo que intentamos conseguir es más bien una contribución simbólica. P. ¿El acto de conciliación estadounidense con Siemens va a suponer un hito también para otros países, otras empresas? R. Creo que sí. Hasta 1999, la corrupción en Alemania estaba considerada, a lo sumo, como indecente moralmente. Luego se aprobaron nuevas leyes que tipificaron como delito el pago de sobornos. Pero muchas personas siguieron sin entenderlo. El caso de Siemens ha hecho que lo comprendieran de golpe. P. Hay expertos que calculan que todos los sectores de negocios podrían entrar en números rojos el año que viene. R. No. Pero un desplome tan repentino y tan extendido como el de ahora no lo había visto nunca. En 2009 se van a oír sollozos y rechinar de dientes en todo el mundo.

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Memorias del 'Made in Italy' Una exposición recorre un siglo de arte y diseño de la mano de 50 marcas míticas MIGUEL MORA - Roma - 27/12/2008 La historia de las grandes marcas italianas entra por los ojos; se renueva sin cesar, se reinventa con un gesto. Vean si no el feliz y brusco nacimiento de la empresa de sombreros Borsalino: un hombre pegó a otro un estacazo en la cabeza, y el hueco quedó tan bien que marcó tendencia. Todo empezó a mediados del XIX. Los príncipes andaban moribundos o en fuga; los Papas habían colmado su capacidad de acaparar la desmesura, los nobles se entregaban al moderno mal del despilfarro y el mecenazgo en Italia ya no era lo que había sido. Entonces llegó, manu militari, la unificación (1861), y con ella la burocracia y el fascismo, Cinecittà y los 50 distritos industriales, los barrios burgueses y la publicidad, el cinquecento y el poderoso influjo del amigo americano. Los empresarios no perdieron el tiempo. Mientras unos exportaban la mafia, otros, más pacíficos pero no menos ambiciosos, tiraron de tradición y furbizia (agudeza), y aplicaron su genética para la invención y la creatividad a la venta (sin palabras o con muchas palabras) y el envoltorio fino. Sociedades como Perugina, Lavazza, Peroni, Barilla, Alfa Romeo y tantas otras comenzaron a elevarse sobre el resto recurriendo a los artistas para pensar, elaborar y vender sus productos. Se convirtieron en los nuevos mecenas: encargaron carteles y dibujos, objetos y prototipos, logos y anuncios. Crearon envases nunca vistos, macarrones de formas novedosas, diseñaron bicicletas con motor, zapatos y vestidos que parecían, y a veces eran, obras de arte. Una vez renovada la receta romana (lujo + inteligencia = buena vida), nació la marca de país más rentable jamás creada. Se llamaba Made in Italy. Éste es, a grandes rasgos, el fascinante relato cultural, social y económico que narra la exposición Logos de Italia, recién abierta en el museo nacional Castel Sant'Angelo de Roma y que puede visitarse hasta el 25 de enero. Subtitulada Historias del arte 'di eccellere' (de brillar, y también de ser excelentes), la muestra arranca con las dos empresas pioneras -ambas se daban a la bebida, la licorera calabresa Amarelli (1731) y la cervecera Peroni, fundada en 1846-; pasa por la industria alimentaria de principios del siglo XX (chocolate Perugina, ollas Lagostina, pastas Barilla...), se detiene a mitad de siglo en los muebles de Zanotta o las lámparas de Guzzini, abraza la dolce vita de los modistos, las terrazas Martini y las divas calzadas con joyas, y acaba en las futuristas construcciones del pujante presente exportador. La muestra se divide en tres secciones: la memoria, la identidad y el futuro. Historias de marcas, Historias de nombres y Lugares de amor. El corazón es Historias de marcas, que a su vez se divide en cuatro espacios: comunicación, arte, diseño e innovación. En la primera se aprecia la riqueza de soportes y recursos empleados para seducir al cliente. Entre los éxitos, el agua efervescente natural Ferrarelle ("¿lisa, con gas o Ferrarelle?") el boom de la vespa en los años cincuenta y sesenta y las fotografías de Oliviero Toscani para Benetton.

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El paseo por las mazmorras y salones del antiguo castillo papal desborda talento y pasión emprendedora, solidez y finezza. El lema parece ser "esto consiste en vender, pero sin que se note (estúpidos)".

Carteles de la empresa Ducati, de Pastas Buitoni y de Lana Gatto

Quizá de ahí, la gran variedad de formatos: de los dibujos de Emma Bonazzi (en arte Tigiù) y los carteles post románticos de Depero y Séneca, a los cartones animados de Armando Testa para los cafés Lavazza y Paulista, y, cuando toca, los documentales con cineastas y actores famosos. Tres ejemplos: Bertolucci y su filme para la petrolera Eni (La vía del petróleo, 1967); Antonioni con la espléndida Mónica Vitti vendiendo glamour, y la ironía sin prejuicios de Mina, madre soltera, cantando para Barilla, durante el Concilio Vaticano II: "Cocina para tu hombre". La parte dedicada al arte permite entender otro secreto a voces del buen patrón italiano: el talento cuesta dinero, pero se paga. Y es igual si viene dentro o de fuera: Palladino, Guttuso, Dalí (que colaboró con Alessi haciendo una escultura titulada Objeto inútil), e incluso Andy Warhol, autor de los carteles de la campaña de Martini en EE UU. En la sala Historias de nombres se cuenta la participación de personajes y familias que marcaron el camino del mecenazgo industrial. Se trataba de ser distintos y parecerlo. De ser, si no mejores, más refinados. Populares y simpáticos, eso nunca estorba. Pero jamás vulgares. Son más de 50 empresas, presentes con 250 piezas y objetos que han recorrido el mundo. Ahí están los revolucionarios biberones y chupetes de Chicco, el logo y la madera de Alfa Romeo, el caballito rampante de Ferrari, las botellas retornables de Peroni, los zapatos-escultura de Prada, los sillones y sofás de Giovanetti donde tanto descansó Fellini, los cubos de basura alto diseño de Kartell o la futurista arquitectura de Fuksas para albergar sedes de automóviles o bodegas. La lección del fiel vendedor acaba en los lugares de las empresas con arte: los territorios que han alimentado la creatividad y que serán la excelencia del futuro. Elegancia, estética y buena vida siguen siendo sinónimos de Italia. Viendo esta exposición, sólo queda asumirlo: unos lloran la crisis, los italianos la cabalgan con estilo y un punto de nostalgia.Son 250 piezas que han recorrido el mundo, desde biberones a zapatos.

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INTERFLUIDITY Krugman's "hangover theory", revisited. Steve Randy Waldman — Saturday December 27, 2008 I'm trying to write something hard, and failing. I'll keep trying. But this is easy, and I cannot resist. Paul Krugman is once again attacking "hangover theorists", the idea that booms of a certain kind inevitably beget recessions. I do not buy the traditional Austrian story of hangovers — that misallocations and depletions of capital (including human capital) necessarily take time to undo. But I think that now and in his original piece, Krugman is far too quick in his dismissal of the idea that there must be something about some booms that makes subsequent recessions pretty hard to avoid. Krugmans writes that "[a] recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time." It is rather surprising, isn't it, that "whatever reason" almost always happens subsequent to years of unusual prosperity? Choose your poison — if you don't like the Austrians, go with Hyman Minsky — but if we don't acknowledge the relationship between some kinds of booms and the bad times that follow, we'll have a hard time preventing those bad times. Krugman is absolutely correct to inveigh against the "morality play" that sometimes seeps into the Austrian rhetoric surrounding recessions. Personally, I think morality play deserves a much larger place in economics than it currently has, but a fable in which masses of innocents suffer to absolve the sins of the reckless wealthy is hardly moral. The "hangover theory" is best described as an immorality play, which we are watching unfold before our eyes this every moment as financial assets are relentlessly supported while the value of a pair of hands is let to plummet. However, recessions and depressions do follow booms, and there are reasons for that. Austrians have their vices, but a vice of Keynesians is to underestimate the role of information. Krugman points out that the hangover theory doesn’t explain why there isn’t mass unemployment when bubbles are growing as well as shrinking — why didn’t we need high unemployment elsewhere to get those people into the nail-pounding-in-Nevada business? The obvious answer is that when there is a boom, entrepreneurs know into what sector resources must be reallocated, and pull already employed workers from existing jobs into the new big thing. During a bust, from a God's eye view, the same process must occur: resources must be shifted out of some sectors and into others. But entrepreneurs are only human. They do not know to where resources might be productively employed, only that they cannot be productively employed where they are. This is the asymmetry, I think, that explains mass unemployment 82

during busts. Krugman also points out that the hangover theory... doesn’t explain why recessions reduce unemployment across the board, not just in industries that were bloated by a bubble. I think that this gets to the point about why it is that only certain kinds of booms lead to great and terrible busts. Industries rise and fall all the time, in good times as well as bad. In the 1980s, there was a great boom in the recording industry owing to the advent of compact discs. The boom eventually went bust, but mass unemployment did not ensue. Hangovers result not from booms in and of themselves, but from booms which result in unhealthy concentration of the aggregate investment portfolio. US capital, viewed as a whole, was overly concentrated in housing and construction this decade. China's capital has been overly concentrated in exports and construction. Traditional portfolio theory views the menu of investments as fixed, and suggests that investors diversify among them. But in the aggregate, there is only one portfolio extant at any point in time. The art of "macro portfolio theory" is to control the evolution of that portfolio so that it remains reasonably efficient. The easy answers don't work: Micro portfolio choices don't necessarily compose into a dynamically sane macro portfolio. We have reason to be skeptical of very heavy-handed industrial policy. So we have work to do. I'll end with an intuition: I think that there's a trade-off between microlevel diversification and macro-efficiency. Barry Bosworth warned that "diversification devalues knowledge". One reason that micro portfolio choices fail to compose is because it is often sensible for investors to "buy the market". Every individual has a unique information set, and ideally we would want all that decentralized knowledge "priced into the market" independently of the judgments of others. However, each individual knows that her own information is profoundly uncertain and incomplete, and that the market represents an aggregation of the judgments of millions of others. So, as passive-investment types have been telling us for more than a decade, it may be optimal for individuals to ignore their own information and defer to the judgement of the market-ex-me. (This is a kind of "information cascade".) But, each person who defers to the market increases the concentration of investment decision making, and decreases the breath of information that is priced into the market. If the aggregate portfolio is disproportionately by the decisions of a relatively small group of people, there is no reason to suspect its quality would be better than that decided upon by a bureaucracy of planners. There is reason to suspect, in fact, that it would be worse, because at least the planners know they should at least pretend to serve a broad public interest, while private decisionmakers might quite legitimately think they're just trying to get a piece of next year's bonus pool. In sum, I think there is a tension between micro diversification and macro diversification. If we want to maintain a well-diversified aggregate portfolio, it may be necessary to restrict the degree to which the portfolio of firms and individuals can be diversified. This implies forcing individuals to bear more risk than they

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would otherwise choose, in order to reduce systemic risk. We might be better off by letting individuals shed risk via some form of social insurance while forcing investment choices to be sharp, than by encouraging people to blur the information they present in their portfolio choices in order to diversify and hedge.

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COMMENT

FACES OF THE CRISIS: NOURIEL ROUBINI By Chrystia Freeland Published: December 26 2008 20:16 | Last updated: December 26 2008 20:16

In the buzzy, scruffy warren of offices in New York from which Nouriel Roubini runs his economics aggregration and commentary website, one of the young cyber-serfs has taped a New York Post story about the boss to the chalky wall. “NYU Playboy Warns: Econ Party’s Over”, the sub-heading declares, next to a photograph of a smiling, open-shirted Mr Roubini, sandwiched between two attractive young women. Not so long ago, the phrase “playboy economist” would have been a joky oxymoron, likely to feature in satirical lists alongside “selfless hedge fund manager” and (at least before the US surge in Iraq) “military intelligence”. But, in a sign that practitioners of the dismal science are among the few beneficiaries of the global economic meltdown, this crisis has transformed the 50-year-old New York University professor from a respected academic economist into a minor celebrity.

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Mr Roubini, who offered one of the first and most nuanced predictions of the financial and economic crash, is ambivalent about the personal scrutiny his fame has attracted. After Nick Denton, founder of the Gawker website, first pointed to the contrast between the economist’s “Dr Doom” public persona and his party-going private life, Mr Roubini sent Mr Denton a Facebook message in which he declared: “I work very, very hard and I also enjoy life . . . To paraphrase Seinfeld: anything wrong with that?” But sitting at his modest desk in the corner of an open-plan office, Mr Roubini tells me the “playboy” tag was “a gross mischaracterisation”. He said he was sometimes recognised on the street, but mostly by “geeks and wonks”. “There are not paparazzi yet,” Mr Roubini, wearing jeans, a black jacket and a deep tan that belies the miserable New York weather, says with a self-deprecating chuckle. “No one has said, ‘You have a brilliant mind’, and asked me out.” He is keener still to debunk the view that he is a “perma-bear” whose prescient forecasts are simply a matter, as one critic has said, of even a stopped clock telling the right time twice a day. Well before his 15 minutes, Mr Roubini had amassed an armoury of intellectual credentials, earning his PhD from Harvard, working in the economics department at Yale and spending two years as a policymaker in Washington, including serving as senior adviser to Tim Geithner, then an undersecretary at the Treasury, and now President-elect Barack Obama’s choice as Treasury chief. Moreover, Mr Roubini says it was economic analysis, rather than a gloomy cast of mind – he describes himself as a cheerful pragmatist – that inspired his bleak predictions. “This crisis was not a Black Swan event,” he argues, citing Nassim Nicholas Taleb’s book on the importance of the extreme and the unknowable. “It was more of a generalised asset and credit bubble throughout the economy . . . But whenever you are in the middle of a bubble people find ways to justify the asset prices.” Mr Roubini’s fans – particularly in the business world, where he is now in high demand – agree. “He’s been the most right of all the economists around,” fund manager and philanthropist George Soros says. Lawrence Summers, the incoming head of Mr Obama’s National Economic Council, who was Mr Roubini’s ultimate boss at the Treasury and who has been an adviser to his website, said this autumn: “Nouriel’s great virtue is that he was right. A lot of stuff that he laid out that people thought was nuts has happened, so I give him credit.” Mohamed El-Erian, chief executive of asset-manager Pimco, describes Mr Roubini as “brilliant” and a favourite intellectual combatant because “he is not shy to engage in discussions”. Mr El-Erian says Mr Roubini first started to develop a following in the investing community at the beginning of this decade when his website, RGE Monitor, became more widely known: “He started to look at these negative feedback loops in the economy earlier and more than anyone else I know.” Pimco rated him highly enough that in 2004 the California-based company invited him to a special meeting of its investment committee. One of his strengths, according to Mr El-Erian, is his willingness “to think outside the box”. That iconoclasm may stem in part from Mr Roubini’s peripatetic biography. Born in Istanbul to Iranian-Jewish parents, as a preschooler he moved with his family to Tehran and Tel Aviv, before they settled in Milan when he was five. He grew up speaking Farsi at home with his parents, Italian at school, Hebrew on frequent visits to his relatives in Israel, where his parents still maintain a home, and English as his education progressed. He is now a US citizen and a resident of New York’s trendy Tribeca area. He has never married.

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He describes his upbringing as that of “a true international economist”. As a self-described “global nomad”, he simultaneously feels at ease almost everywhere but never fully assimilated anywhere. That perspective, and his youthful experience of societies in transition, helped him to see a continuity between the emerging market crises he analysed in Bailouts or Bail-ins, the 2004 book he wrote with economist Brad Setser, and looming problems in the US. “It was almost like a natural continuation of my interest in emerging markets,” he says. “I saw that the US had very large twin deficits, a housing boom, I saw the private sector excesses . . . There were things in the US that could delay the crisis but not prevent it.” It is a parallel that may seem obvious today. But back in the days of Francis Fukuyama’s The End of History theory, US exceptionalism and free-market triumphalism, Mr Roubini’s was definitely a minority view. Although his former bosses from the Clinton Treasury are going back to Washington next month, he says the role of outside oracle suits him best. Like his carpet-importing father, Mr Roubini is an avid entrepreneur, as enthusiastic about the prospects for his website – he boasts about his 40 employees and offices in Hong Kong and New York – as he is about economics. As for the future, he warns that 2009 will probably be the worst year: “I expect a global recession and a very severe one.” But he promises not to be an eternal pessimist: “In the medium term, the integration of India and China is a boon for the global economy and I think the US can fix its market, too. Maybe one day Dr Doom can become Dr Boom.” This is the first in a series

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Opinion December 26, 2008 OP-ED COLUMNIST

Barack Be Good

Fred R. Conrad/The New York Times

By PAUL KRUGMAN Times have changed. In 1996, President Bill Clinton, under siege from the right, declared that “the era of big government is over.” But President-elect Barack Obama, riding a wave of revulsion over what conservatism has wrought, has said that he wants to “make government cool again.” Before Mr. Obama can make government cool, however, he has to make it good. Indeed, he has to be a goo-goo. Goo-goo, in case you’re wondering, is a century-old term for “good government” types, reformers opposed to corruption and patronage. Franklin Roosevelt was a goo-goo extraordinaire. He simultaneously made government much bigger and much cleaner. Mr. Obama needs to do the same thing. Needless to say, the Bush administration offers a spectacular example of non-goo-gooism. But the Bushies didn’t have to worry about governing well and honestly. Even when they failed on the job (as they so often did), they could claim that very failure as vindication of their anti-government ideology, a demonstration that the public sector can’t do anything right. The Obama administration, on the other hand, will find itself in a position very much like that facing the New Deal in the 1930s. Like the New Deal, the incoming administration must greatly expand the role of government to rescue an ailing economy. But also like the New Deal, the Obama team faces political opponents who will seize on any signs of corruption or abuse — or invent them, if necessary — in an attempt to discredit the administration’s program. F.D.R. managed to navigate these treacherous political waters safely, greatly improving government’s reputation even as he vastly expanded it. As a study recently published by the National Bureau of Economic Research puts it, “Before 1932, the administration of 88

public relief was widely regarded as politically corrupt,” and the New Deal’s huge relief programs “offered an opportunity for corruption unique in the nation’s history.” Yet “by 1940, charges of corruption and political manipulation had diminished considerably.” How did F.D.R. manage to make big government so clean? A large part of the answer is that oversight was built into New Deal programs from the beginning. The Works Progress Administration, in particular, had a powerful, independent “division of progress investigation” devoted to investigating complaints of fraud. This division was so diligent that in 1940, when a Congressional subcommittee investigated the W.P.A., it couldn’t find a single serious irregularity that the division had missed. F.D.R. also made sure that Congress didn’t stuff stimulus legislation with pork: there were no earmarks in the legislation that provided funding for the W.P.A. and other emergency measures. Last but not least, F.D.R. built an emotional bond with working Americans, which helped carry his administration through the inevitable setbacks and failures that beset its attempts to fix the economy. So what are the lessons for the Obama team? First, the administration of the economic recovery plan has to be squeaky clean. Purely economic considerations might suggest cutting a few corners in the interest of getting stimulus moving quickly, but the politics of the situation dictates great care in how money is spent. And enforcement is crucial: inspectors general have to be strong and independent, and whistle-blowers have to be rewarded, not punished as they were in the Bush years. Second, the plan has to be really, truly pork-free. Vice President-elect Joseph Biden recently promised that the plan “will not become a Christmas tree”; the new administration needs to deliver on that promise. Finally, the Obama administration and Democrats in general need to do everything they can to build an F.D.R.-like bond with the public. Never mind Mr. Obama’s current high standing in the polls based on public hopes that he’ll succeed. He needs a solid base of support that will remain even when things aren’t going well. And I have to say that Democrats are off to a bad start on that front. The attempted coronation of Caroline Kennedy as senator plays right into 40 years of conservative propaganda denouncing “liberal elites.” And surely I wasn’t the only person who winced at reports about the luxurious beach house the Obamas have rented, not because there’s anything wrong with the first family-elect having a nice vacation, but because symbolism matters, and these weren’t the images we should be seeing when millions of Americans are terrified about their finances. O.K., these are early days. But that’s precisely the point. Fixing the economy is going to take time, and the Obama team needs to be thinking now, when hopes are high, about how to accumulate and preserve enough political capital to see the job through. December 27, 2008, 3:31 pm THE YIELD CURVE (WONKISH) I’m a little late getting to this, but via Mark Thoma I see that economists at the Cleveland Fed are taking some comfort from the positive slope of the yield curve. Long-term interest rates are higher than short-term rates, which is usually a sign that the economy will expand.

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Not this time, I’m afraid. It’s all about the zero lower bound. The reason for the historical relationship between the slope of the yield curve and the economy’s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped. But here’s the thing: the Fed can’t cut rates from here, because they’re already zero. It can, however, raise rates. So the long-term rate has to be above the short-term rate, because under current conditions it’s like an option price: short rates might move up, but they can’t go down. Indeed, if we look at Japan we find that the yield curve was positively sloped all the way through the lost decade. In 1999-2000, with the zero interest rate policy in effect, long rates averaged about 1.75 percent, not too far below current rates in the United States. So sad to say, the yield curve doesn’t offer any comfort. It’s only telling us what we already know: that conventional monetary policy has literally hit bottom.

December 27, 2008, 10:08 am Hangover theorists Somehow I missed this: via Steve Levitt, John Cochrane explaining that recessions are good for you: “We should have a recession,” Cochrane said in November, speaking to students and investors in a conference room that looks out on Lake Michigan. “People who spend their lives pounding nails in Nevada need something else to do.” So the hangover theory, which I wrote about a decade ago, is still out there. The basic idea is that a recession, even a depression, is somehow a necessary thing, part of the process of “adapting the structure of production.” We have to get those people who were pounding nails in Nevada into other places and occupation, which is why unemployment has to be high in the housing bubble states for a while. The trouble with this theory, as I pointed out way back when, is twofold: 1. It doesn’t explain why there isn’t mass unemployment when bubbles are growing as well as shrinking — why didn’t we need high unemployment elsewhere to get those people into the nail-pounding-in-Nevada business?

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2. It doesn’t explain why recessions reduce unemployment across the board, not just in industries that were bloated by a bubble. One striking fact, which I’ve already written about, is that the current slump is affecting some non-housing-bubble states as or more severely as the epicenters of the bubble. Here’s a convenient table from the BLS, ranking states by the rise in unemployment over the past year. Unemployment is up everywhere. And while the centers of the bubble, Florida and California, are high in the rankings, so are Georgia, Alabama, and the Carolinas. So the liquidationists are still with us. According to Brad DeLong, Milton Friedman would recall that at the Chicago where he went to graduate school such dangerous nonsense was not taught But now, apparently, it is. Update: Not to mention the idea that employment is dropping because workers don’t feel like working. December 26, 2008, 4:30 pm

Cultural ignorance Sometimes I despair. As I was driving over to my parents’, I heard a radio ad for some kind of housing development offering “your choice of exterior finish — brick, stone, or stucco.” Clearly, whoever wrote the copy for that ad has no knowledge of the classics (which seem especially relevant right now): Groucho : You can have any kind of a home you want. You can even get stucco. Oh, how you can get stucco. December 26, 2008, 10:07 am

Hoocoodanode, part a zillion Informative Times piece on the global savings glut, the housing bubble, and the sum of all fears. But I don’t think the piece accurately conveys the state of the debate circa, say, the summer of 2005. The piece says this: In hindsight, many economists say, the United States should have recognized that borrowing from abroad for consumption and deficit spending at home was not a formula for economic success. Actually, a number of economists said this, not in hindsight, but as it was happening: people like Dean Baker, Calculated Risk, and yes, yours truly (I was reading Dean and CR). “These days,” I wrote in August 2005, “Americans make a living selling each other houses, paid for with money borrowed from the Chinese. Somehow, that doesn’t seem like a sustainable lifestyle.”

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So it wasn’t that people failed to notice the problem. Instead, what happened was active — and often angry — denial. Conservatives, who didn’t want anything to interfere with their visions of a wonderful Bush Boom, denounced the likes of CR as bubbleheads. And Alan Greenspan, still viewed as a demigod — and probably unwilling to admit that anything was going wrong during his last years in office — declared that “a national severe price distortion seems most unlikely.” The answer, in short, to the question of why key players didn’t see the problem coming is that they didn’t want to know. December 26, 2008, 9:38 am

Mortgage rates are still too high Mortgage rates have dropped a lot in recent weeks, which is a good thing. But there’s still a huge spread between mortgage rates and rates on federal debt. Here’s the spread between conventional 30-year mortgages and 10-year Treasuries (10year because most mortgages get paid off early, when houses are sold, and the average duration is about 10 years.) This spread was historically stable at about 150 basis points, but has been nearly double that lately.

The spread isn’t dead. Why is the spread so high? Presumably because investors are still seeking the safety of government bonds. But what’s bizarre is that these days the government is the dominant mortgage lender, in the form of Fannie and Freddie, which have been nationalized for all practical purposes. The persistence of the spread offers one opportunity for quick economic stimulus: declare that Fannie and Freddie are backed by full faith and credit, and if that doesn’t work, have the Treasury borrow on their behalf. This can bring mortgage rates down by more than 100 basis points. By itself, that’s not nearly enough to turn the economy around, but it could really help the economic recovery package. December 25, 2008, 2:18 pm

The second Great Depression has arrived … …. in Ukraine. From Edward Hugh: This …

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… looks as bad as this (INPRO: USA Industrial production Index 1928-1933)

GDP in United States Jan 1929 to Jan 1941 December 24, 2008, 11:55 am

Wages and employment, again Just a quick question for those who think that FDR prolonged the Great Depression by preventing a fall in nominal wages: what would be the benefits, right now, if the United States were to implement a Latvian program and cut everyone’s wages by, say, 15 percent? Seriously, how would it help? The real monetary base would grow — but the Fed is already expanding the monetary base enormously, with little effect because shortterm interest rates are essentially zero. (Yes, there would be a real balance effect, but it would be trivial.) Meanwhile, a general fall in prices would raise the burden of debt on everyone, almost surely having a contractionary effect on the economy. So here’s the thing: if lower wages wouldn’t help now, why would they have helped in, say, 1935? Yet if you take away the wage argument, the whole FDRmade-the-Depression-worse thing falls apart.

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December 24, 2008, 11:37 am

Keynes’s difficult idea Great piece by Martin Wolf today. I particularly liked this: Keynes’s genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge. That’s the point of my favorite Keynes quote, where he declared of the Great Depression, “we have magneto trouble.” What’s been striking me lately is how many people who talk and write about macroeconomics just don’t get Keynes’s essential point — the fact that economies can suffer from insufficient aggregate demand because people want to acquire liquid assets rather than real goods. Not to single out any one commentator, but this morning I read this: Government spending doesn’t increase aggregate demand. All it does is transfer spending power from one party to another by borrowing from or taxing the public. That’s exactly the infamous “Treasury view” from the 1920s, against which Keynes had to struggle. And it’s still out there. Anyway, good for Martin; we’re going to need every possible voice to counter the niggling nabobs of negativism. December 23, 2008, 5:33 pm

Latvia is the new Argentina (slightly wonkish) I’ve been saying this for a couple of weeks, but Edward Hugh has the goods. Hugh puts his finger, in particular, on one gaping hole in the logic of the opponents of devaluation. We can’t devalue, they say, because the Latvian private sector has a lot of debts in euros, and a devaluation would make it very hard for borrowers to service those debts. As Hugh points out, the proposed alternative — sharp wage cuts, and basically a major domestic deflation — will also make it hard to service those debts. In fact, I’d be a bit more specific than Hugh: other things equal, a nominal devaluation and a real depreciation achieved through deflation should have exactly the same effect on debt service (unless some of the debt is in lats rather than euros, in which case devaluation would do less damage.) This looks like events repeating themselves, the first time as tragedy, the second time as another tragedy. December 23, 2008, 5:16 pm

Bubble blindness Ezra Klein and Dean Baker are wondering why so few economists saw the crisis coming. I think it’s a two part question. 94

I think it’s understandable, though not entirely forgivable, that economists didn’t see the risks of a broad financial breakdown. We’re accustomed to thinking of banks as big marble buildings with “member of the FDIC” signs in the window; besides, those are the institutions on whom the standard data series report. (Indeed, some economists still fixate on those data, which is why there are still economists denying that there’s a credit crunch.) So neither the size nor the vulnerability of the “shadow” or parallel banking system were widely understood. The big mystery is the failure to see the housing bubble. The data screamed “bubble”, even in real time. And there was no excuse for believing that such things don’t happen in efficient markets, not with the dead body of the dot-com bubble still warm. So why did so few people point out the obvious? One answer may be that macroeconomists, in particular, didn’t want to go up against bubble denier Alan Greenspan, which might get them blackballed from Jackson Hole and all that. But overall, the failure to see the most obvious bubble of my lifetime remains a puzzle. December 23, 2008, 4:52 pm

Economics of English food I see that Stephen Dubner is wondering why restaurant food is lousy in London. I actually wrote about that once; my theory, basically, was that England industrialized in an era when primitive transportation technology wasn’t up to delivering fresh food to the new urban masses, and the lack of taste stuck. But I have to say that this theory can’t explain why good food is available in the food halls but not in the restaurants. And it doesn’t explain something else that has been conspicuous in my last few trips to London: the plague of pretty bad Italian restaurants that has overrun the city. Where are the kebab houses of yore? Anyway, it’s more fun to think about than the collapsing world economy.

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Asia Pacific December 26, 2008 THE RECKONING

Chinese Savings Helped Inflate American Bubble By MARK LANDLER “Usually it’s the rich country lending to the poor. This time, it’s the poor country lending to the rich.” — Niall Ferguson WASHINGTON — In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending. The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption. This colossal credit cycle could not last forever, he said. But in a global economy, the transfer of Chinese money to America was a market phenomenon that would take years, even a decade, to work itself out. For now, he said, “we probably have little choice except to be patient.” Today, the dependence of the United States on Chinese money looks less benign. And the economist who proposed the theory, Ben S. Bernanke, is dealing with the consequences, having been promoted to chairman of the Fed in 2006, as these cross-border money flows were reaching stratospheric levels. In the past decade, China has invested upward of $1 trillion, mostly earnings from manufacturing exports, into American government bonds and government-backed mortgage debt. That has lowered interest rates and helped fuel a historic consumption binge and housing bubble in the United States. China, some economists say, lulled American consumers, and their leaders, into complacency about their spendthrift ways. “This was a blinking red light,” said Kenneth S. Rogoff, a professor of economics at Harvard and a former chief economist at the International Monetary Fund. “We should have reacted to it.” In hindsight, many economists say, the United States should have recognized that borrowing from abroad for consumption and deficit spending at home was not a formula for economic success. Even as that weakness is becoming more widely recognized, however, the United States is likely to be more addicted than ever to foreign creditors to finance record government spending to revive the broken economy. 96

To be sure, there were few ready remedies. Some critics argue that the United States could have pushed Beijing harder to abandon its policy of keeping the value of its currency weak — a policy that made its exports less expensive and helped turn it into the world’s leading manufacturing power. If China had allowed its currency to float according to market demand in the past decade, its export growth probably would have moderated. And it would not have acquired the same vast hoard of dollars to invest abroad. Others say the Federal Reserve and the Treasury Department should have seen the Chinese lending for what it was: a giant stimulus to the American economy, not unlike interest rate cuts by the Fed. These critics say the Fed under Alan Greenspan contributed to the creation of the housing bubble by leaving interest rates too low for too long, even as Chinese investment further stoked an easy-money economy. The Fed should have cut interest rates less in the middle of this decade, they say, and started raising them sooner, to help reduce speculation in real estate. Today, with the wreckage around him, Mr. Bernanke said he regretted that more was not done to regulate financial institutions and mortgage providers, which might have prevented the flood of investment, including that from China, from being so badly used. But the Fed’s role in regulation is limited to banks. And stricter regulation by itself would not have been enough, he insisted. “Achieving a better balance of international capital flows early on could have significantly reduced the risks to the financial system,” Mr. Bernanke said in an interview in his office overlooking the Washington Mall. “However,” he continued, “this could only have been done through international cooperation, not by the United States alone. The problem was recognized, but sufficient international cooperation was not forthcoming.” The inaction was because of a range of factors, political and economic. By the yardsticks that appeared to matter most — prosperity and growth — the relationship between China and the United States also seemed to be paying off for both countries. Neither had a strong incentive to break an addiction: China to strong export growth and financial stability; the United States to cheap imports and low-cost foreign loans. In Washington, China was treated as a threat by some people, but mostly because it lured away manufacturing jobs. Others argued that China’s heavy lending to this country was risky because Chinese leaders could decide to withdraw money at a moment’s notice, creating a panicky run on the dollar. Mr. Bernanke viewed such international investment flows through a different lens. He argued that Chinese invested savings abroad because consumers in China did not have enough confidence to spend. Changing that situation would take years, and did not amount to a pressing problem for the Americans. “The global savings glut story did us a collective disservice,” said Edwin M. Truman, a former Fed and Treasury official. “It created the idea that the world was doing it to us and we couldn’t do anything about it.” But Mr. Bernanke’s theory fit the prevailing hands-off, pro-market ideology of recent years. Mr. Greenspan and the Bush administration treated the record American trade deficit and heavy foreign borrowing as an abstract threat, not an urgent problem. Mr. Bernanke, after he took charge of the Fed, warned that the imbalances between the countries were growing more serious. By then, however, it was too late to do much about

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them. And the White House still regarded imbalances as an arcane subject best left to economists. By itself, money from China is not a bad thing. As American officials like to note, it speaks to the attractiveness of the United States as a destination for foreign investment. In the 19th century, the United States built its railroads with capital borrowed from the British. In the past decade, China arguably enabled an American boom. Low-cost Chinese goods helped keep a lid on inflation, while the flood of Chinese investment helped the government finance mortgages and a public debt of close to $11 trillion. But Americans did not use the lower-cost money afforded by Chinese investment to build a 21st-century equivalent of the railroads. Instead, the government engaged in a costly war in Iraq, and consumers used loose credit to buy sport utility vehicles and larger homes. Banks and investors, eagerly seeking higher interest rates in this easy-money environment, created risky new securities like collateralized debt obligations. “Nobody wanted to get off this drug,” said Senator Lindsey Graham, the South Carolina Republican who pushed legislation to punish China by imposing stiff tariffs. “Their drug was an endless line of customers for made-in-China products. Our drug was the Chinese products and cash.” Mr. Graham said he understood the addiction: he was speaking by phone from a Wal-Mart store in Anderson, S.C., where he was Christmas shopping in aisles lined with items from China. A New Economic Dance The United States has been here before. In the 1980s, it ran heavy trade deficits with Japan, which recycled some of its trading profits into American government bonds. At that time, the deficits were viewed as a grave threat to America’s economic might. Action took the form of a 1985 agreement known as the Plaza Accord. The world’s major economies intervened in currency markets to drive down the value of the dollar and drive up the Japanese yen. The arrangement did slow the growth of the trade deficit for a time. But economists blamed the sharp revaluation of the Japanese yen for halting Japan’s rapid growth. The lesson of the Plaza Accord was not lost on China, which at that time was just emerging as an export power. China tied itself even more tightly to the United States than did Japan. In 1995, it devalued its currency and set a firm exchange rate of roughly 8.3 to the dollar, a level that remained fixed for a decade. During the Asian financial crisis of 1997-98, China clung firmly to its currency policy, earning praise from the Clinton administration for helping check the spiral of devaluation sweeping Asia. Its low wages attracted hundreds of billions of dollars in foreign investment. By the early part of this decade, the United States was importing huge amounts of Chinesemade goods — toys, shoes, flat-screen televisions and auto parts — while selling much less to China in return. “For consumers, this was a net benefit because of the availability of cheaper goods,” said Laurence H. Meyer, a former Fed governor. “There’s no question that China put downward pressure on inflation rates.”

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But in classical economics, that trade gap could not have persisted for long without bankrupting the American economy. Except that China recycled its trade profits right back into the United States. It did so to protect its own interests. China kept its banks under tight state control and its currency on a short leash to ensure financial stability. It required companies and individuals to save in the state-run banking system most foreign currency — primarily dollars — that they earned from foreign trade and investment. As foreign trade surged, this hoard of dollars became enormous. In 2000, the reserves were less than $200 billion; today they are about $2 trillion. Chinese leaders chose to park the bulk of that in safe securities backed by the American government, including Treasury bonds and the debt of Fannie Mae and Freddie Mac, which had implicit government backing. This not only allowed the United States to continue to finance its trade deficit, but, by creating greater demand for United States securities, it also helped push interest rates below where they would otherwise have been. For years, China’s government was eager to buy American debt at yields many in the private sector felt were too low. This financial and trade embrace between the United States and China grew so tight that Niall Ferguson, a financial historian, has dubbed the two countries Chimerica. ‘Tiptoeing’ Around a Partner Being attached at the hip was not entirely comfortable for either side, though for widely differing reasons. In the United States, more people worried about cheap Chinese goods than cheap Chinese loans. By 2003, China’s trade surplus with the United States was ballooning, and lawmakers in Congress were restive. Senator Graham and Senator Charles E. Schumer, Democrat of New York, introduced a bill threatening to impose a 27 percent duty on Chinese goods. “We had a moment where we caught everyone’s attention: the White House and China,” Mr. Graham recalled. At the People’s Bank of China, the central bank, a consensus was also emerging in late 2004: China should break its tight link to the dollar, which would make its exports more expensive. Yu Yongding, a leading economic adviser, pressed the case. The American trade and budget deficits were not sustainable, he warned. China was wrong to keep its currency artificially depressed and depend too much on selling cheap goods. Proponents of revaluation in China argued that the country’s currency policies denied the fruits of prosperity to Chinese consumers. Beijing was investing their savings in lowyielding American government securities. And with a weak currency, they said, Chinese could not afford many imported goods. The central bank’s English-speaking governor, Zhou Xiaochuan, was among those who favored a sizable revaluation. But when Beijing acted to amend its currency policy in 2005, under heavy pressure from Congress and the White House, it moved cautiously. The renminbi was allowed to climb only 2 percent. The Communist Party opted for only incremental adjustments to its economic model after a decade of fast growth. Little changed: China’s exports kept soaring and investment poured into steel mills and garment factories.

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But American officials eased the pressure. They decided to put more emphasis on urging Chinese consumers to spend more of their savings, which they hoped would eventually bring the two economies into better balance. On a tour of China, John W. Snow, the Treasury secretary at the time, even urged the Chinese to start using credit cards. China kicked off its own campaign to encourage domestic consumption, which it hoped would provide a new source. But Chinese save with the same zeal that, until recently, Americans spent. Shorn of the social safety net of the old Communist state, they squirrel away money to pay for hospital visits, housing or retirement. This accounts for the savings glut identified by Mr. Bernanke. Privately, Chinese officials confided to visiting Americans that the effort was not achieving much. “It is sometimes hard to change successful models,” said Robert B. Zoellick, who negotiated with the Chinese as a deputy secretary of state. “It is prototypically American to say, ‘This worked well, but now you’ve got to change it.’ ” In Washington, some critics say too little was done. A former Treasury official, Timothy D. Adams, tried to get the I.M.F. to act as a watchdog for currency manipulation by China, which would have subjected Beijing to more global pressure. Yet when Mr. Snow was succeeded as Treasury secretary by Henry M. Paulson Jr. in 2006, the I.M.F. was sidelined, according to several officials, and Mr. Paulson took command of China policy. He was not shy about his credentials. As an investment banker with Goldman Sachs, Mr. Paulson made 70 trips to China. In his office hangs a watercolor depicting the hometown of Zhu Rongji, a forceful former prime minister. “I pushed very hard on currency because I believed it was important for China to get to a market-determined currency,” Mr. Paulson said in an interview. But he conceded he did not get what he wanted. In late 2006, Mr. Paulson invited Mr. Bernanke to accompany him to Beijing. Mr. Bernanke used the occasion to deliver a blunt speech to the Chinese Academy of Social Sciences, in which he advised the Chinese to reorient their economy and revalue their currency. At the last minute, however, Mr. Bernanke deleted a reference to the exchange rate being an “effective subsidy” for Chinese exports, out of fear that it could be used as a pretext for a trade lawsuit against China. Critics detected a pattern. They noted that in its twice-yearly reports to Congress about trading partners, the Treasury Department had never branded China a currency manipulator. “We’re tiptoeing around, desperately trying not to irritate or offend the Chinese,” said Thea M. Lee, public policy director of the A.F.L.-C.I.O. “But to get concrete results, you have to be confrontational.” An Embrace That Won’t Let Go For China, too, this crisis has been a time of reckoning. Americans are buying fewer Chinese DVD players and microwave ovens. Trade is collapsing, and thousands of workers are losing their jobs. Chinese leaders are terrified of social unrest.

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Having allowed the renminbi to rise a little after 2005, the Chinese government is now under intense pressure domestically to reverse course and depreciate it. China’s fortunes remain tethered to those of the United States. And the reverse is equally true. In a glassed-in room in a nondescript office building in Washington, the Treasury conducts nearly daily auctions of billions of dollars’ worth of government bonds. An old Army helmet sits on a shelf: as a lark, Treasury officials have been known to strap it on while they monitor incoming bids. For the past five years, China has been one of the most prolific bidders. It holds $652 billion in Treasury debt, up from $459 billion a year ago. Add in its Fannie Mae bonds and other holdings, and analysts figure China owns $1 of every $10 of America’s public debt. The Treasury is conducting more auctions than ever to finance its $700 billion bailout of the banks. Still more will be needed to pay for the incoming Obama administration’s stimulus package. The United States, economists say, will depend on the Chinese to keep buying that debt, perpetuating the American habit. Even so, Mr. Paulson said he viewed the debate over global imbalances as hopelessly academic. He expressed doubt that Mr. Bernanke or anyone else could have solved the problem as it was germinating. “One lesson that I have clearly learned,” said Mr. Paulson, sitting beneath his Chinese watercolor. “You don’t get dramatic change, or reform, or action unless there is a crisis.” David Barboza contributed reporting from Shanghai, and Keith Bradsher from Hong Kong.

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DECEMBER 23, 2008

Bernanke Is the Best Stimulus Right Now A zero interest rate isn't the last weapon in the Fed arsenal. By ROBERT E. LUCAS JR. The Federal Reserve's lowering of interest rates last Tuesday was welcome, but it was also received with skepticism. Once the federal-funds rate is reduced to zero, or near zero, doesn't this mean that monetary policy has gone as far as it can go? This widely held view was appealed to in the 1930s to rationalize the Fed's passive role as the U.S. economy slid into deep depression. It was used again by the Bank of Japan to rationalize its unwillingness to counteract the deflation and recession of the 1990s. In both cases, constructive monetary policies were in fact available but remained unused. Fed Chairman Ben Bernanke's statement last Tuesday made it clear that he does not share this view and intends to continue to take actions to stimulate spending. There should be no mystery about what he has in mind. Over the past four months the Fed has put more than $600 billion of new reserves into the private sector, using them to discount -- lend against -- a wide variety of securities held by a variety of financial institutions. (The addition is to be weighed against September 2007's total outstanding level of reserves of about $50 billion.) This action has been the boldest exercise of the Fed's lender-of-last-resort function in the history of the Federal Reserve System. Mr. Bernanke said that he is prepared to continue or expand this discounting activity as long as the situation dictates. Why do I describe this as an action to stimulate spending? Financial markets are in the grip of a "flight to quality" that is very much analogous to the "flight to currency" that crippled the economy in the 1930s. Everyone wants to get into government-issued and government-insured assets, for reasons of both liquidity and safety. Individuals have tried to do this by selling other securities, but without an increase in the supply of "quality" securities these attempts do nothing but drive down the prices of other assets. The only other action people can take as individuals is to build up their stock of cash and government-issued claims to cash by reducing spending. This reduction is a main factor in inducing or worsening the recession. Adding directly to reserves -- the ultimate liquid, safe asset -- adds to supply of "quality" and relieves the perceived need to reduce spending. When the Fed wants to stimulate spending in normal times, it uses reserves to buy Treasury bills in the federal-funds market, reducing the funds' rate. But as the rate nears zero, Treasury bills become equivalent to cash, and such open-market operations have no more effect than trading a $20 bill for two $10s. There is no effect on the total supply of "quality" assets.

A dead end? Not at all. The Fed can satisfy the demand for quality by using reserves -- or "printing money" -- to buy securities other than Treasury bills. This is the way the $600 billion got out into the private sector.

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This expansion of Fed lending has not violated the constraint that "the" interest rate cannot be less than zero, nor will it do so in the future. There are thousands of different interest rates out there and the yield differences among them have grown dramatically in recent months. The yield on short-term governments is now about the same as the yield on cash: zero. But the spreads between governments and privately-issued bonds are large at all maturities. The flight to quality means exactly that many are eager to trade private paper for non-interest bearing (or low-interest bearing) reserves and with the Fed's help they are doing so every day. Could the $600 billion in new reserves be called a bailout? In a sense, yes: The Fed is lending on terms that private banks are not willing to offer. They are not searching for underpriced "bargains" on behalf of the public, nor is it their mission to do so. Their mission is to provide liquidity to the system by acting as lender-of-last-resort. We don't care about the quality of the assets the Fed acquires in doing this. We care about the quantity of its liabilities. There are many ways to stimulate spending, and many of these methods are now under serious consideration. How could it be otherwise? But monetary policy as Mr.

Bernanke implements it has been the most helpful counter-recession action taken to date, in my opinion, and it will continue to have many advantages in future months. It is fast and flexible. There is no other way that so much cash could have been put into the system as fast as this $600 billion was, and if necessary it can be taken out just as quickly. The cash comes in the form of loans. It entails no new government enterprises, no government equity positions in private enterprises, no price fixing or other controls on the operation of individual businesses, and no government role in the allocation of capital across different activities. These seem to me important virtues. Mr. Lucas, a professor of economics at the University of Chicago, received the Nobel Prize in Economic Sciences in 1995.

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A Healthy Economy Medicine is the best stimulus. Jacob S. Hacker , The New Republic Published: Wednesday, December 31, 2008 As we move deeper into the recession, most economists are urging President-elect Obama to spend big money right away in order to stimulate and prop up the economy. The sticking point for a lot of people, however, is the long-term budget picture, especially given that Obama is planning to keep most of his predecessor's tax cuts. How are we going to drop huge sums of money on job creation and fiscal stimulus right now without continuing to suffer through yawning budget deficits years down the road? In fact, we have a magic bullet for short-term spending and long-term saving--health care reform. During the campaign, skeptics complained that a health care overhaul would involve a lot of upfront costs and that the saving would only come later. But that's exactly what we need right now. Health care involves major spending in the near future, but, more than other initiatives, it will put a brake on federal outlays in the far future. All this argues for temporarily throwing fiscal caution to the wind when it comes to health care reform. The idea of spiking the deficit now may seem frightening, but it's a lot better than the alternative--and it could actually make it easier to bring universal health care to America. When talk turns to economic stimulus, health care usually gets short shrift. Perhaps that's because we are so used to thinking of health care as something we should spend less on; or perhaps it's because we assume that health care spending goes straight into doctors' pockets and hospitals' budgets. Yet, when done right, the biggest effect of broadening and upgrading coverage is to immediately help struggling families. The typical items on the stimulus menu--infrastructure spending, general aid to the states, benefits for the jobless, investments in new forms of energy-have a lot going for them. But they shouldn't blind us to the fact that government health spending is also an extraordinarily effective way to boost the economy. After all, health care isn't a luxury good, like a flat-screen television--something you can put off when money is tight. People do economize on health care when times are tough, but only so much and with serious risks, both physical and financial. The better way to think about health care is like an upfront deduction from family income. If you make that deduction smaller, families have more to spend on other things, improving their own situation and the economy in general. Today, however, the health care deduction is big and getting bigger. Despite widespread complaints about "overinsurance," the amount people pay for health care out of their own pocket has risen substantially as a share of personal income over the last generation, and especially in the last decade. The Commonwealth Fund recently completed two massive surveys showing that the proportion of adults younger than 65 with health insurance who spent more than 10 percent of their income on health care out of pocket (5 percent for low-income adults) skyrocketed from 13.8 million in 2003 to 21.8 million in 2007, as health plans hiked deductibles and co-payments, denied claims more aggressively, jacked up costs for out-of-network care, and so on. What's more, almost all of the increase occurred among families with higher incomes--meaning that high

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health care costs have become a standard deduction for the middle class. The problem is, of course, far worse for those who lack health insurance. Indeed, if you add the ranks of the uninsured to those without adequate coverage, you have more than 40 percent of the working-age population in an immediate economic bind because of medical costs. About half these people--slightly more of the uninsured than the underinsured, but not much more--report severe problems paying their medical bills. These are the families accounting for the 40 percent to 50 percent of people in bankruptcy or foreclosure who say health care is the number one reason for their plight. So fixing health care isn't just a recipe for better access to medical care. It's an immediate economic lifeline for working families, giving them back part of their income to use on other things. It's also a rescue package for state and local governments burdened by Medicaid and SCHIP, for doctors and hospitals who treat the uninsured and inadequately insured, for community institutions that help people in distress--in short, for all the rapidly fraying threads of our health care safety net. Put simply, most of the money we spend upgrading coverage and spreading it to the uninsured is going to go directly into the pockets of people who need help now. Spending money in the short term is also the best way to make health care reform salable. To grasp this surprising point, it helps to understand how different today's situation is from the one that Bill Clinton faced in 1993. Then, the economy was already coming out of recession, meaning that deficit reduction was the order of the day. So the Clinton reformers made big promises about how they would save big money immediately--and backed them up with a massively regulatory plan designed to get people quickly into tightly managed HMOs. The result was political disaster. As Theda Skocpol of Harvard has argued, the Clinton plan was almost tailor-made to scare Americans into thinking health care would be rationed, while providing ammunition for anti-government conservatives. Moreover, in order to rein in federal spending, the plan didn't include enough handouts to appease interest groups and was far too complex and overambitious, aiming to pull almost everyone out of employer-based insurance overnight. Reformers shouldn't make the same mistake this time around. Freed from the strictures of shortterm budget balance, they can instead do what all other countries did when creating their national health programs: buy off the opposition. Britain's health minister was once asked how he had gotten doctors on board for the National Health Service. His reply: "I stuffed their mouths with gold." Money may not change everything, but it does make it easier to win friends, or at least divide and placate them. It also makes it easier to attract public support. Americans tend to fear that reform will impair the quality and raise the costs of the care they already have. Moreover, most don't believe our nation spends too much on health care; they believe they spend too much. The way to get reform is to give Americans what they want--better coverage at lower cost, made possible in the short term by a major infusion of new federal dollars. For this to work, reform has to be simple and unthreatening. People should be able to keep employment-based coverage if their employers provide it (with new government help to lower the cost). If they don't have workplace coverage, they should be automatically enrolled in a national framework that gives them a choice between a good public insurance plan and competing private plans. The faster everyone is in the system, the faster money flows into people's pockets, and the sooner reformers start reaping the political rewards.

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And the faster all that happens, the better situated we are to start the difficult but essential task of controlling long-term health spending. Without runaway health spending, as Henry Aaron of the Brookings Institution has shown, the future fiscal picture of the federal government looks surprisingly rosy, even if taxes stay right where they are as a share of the economy. With runaway health spending, it looks catastrophic. Plus, as bad as the federal picture looks, it's prettier than what businesses and workers are facing. According to Sarah Axeen and Elizabeth Carpenter of the New America Foundation, if employer-sponsored insurance premiums and family income rise at the same rate they have for the past decade, an average family health plan will cost more than 45 percent of a typical family's income by 2016. Lowering costs might not happen fast, but it is possible in the long term. There are some relatively easy and quick ways to bring down costs, like streamlining administration and reducing the rate of payment increase for specialty services and prescription drugs. But a good deal of the savings have to come from using resources more efficiently--and here, again, spending now will help us spend less later. The federal government invests a pittance in health-information technology and comparative-effectiveness research, and we know the private sector won't make these investments on an appropriate scale. These are public goods that require public investment. A Manhattan Project to collect health-outcomes data, develop new practice guidelines and quality measurements, and really test the effectiveness of new medical technology won't come cheap. But it will make health care cheaper--and, more important, better at improving health--in the long run. The beauty of all this spending is that it will mean higher wages and employment, a more flexible labor market in which people feel free to change jobs or strike out on their own without risking their health and finances, and, yes, less pressure on public and private budgets down the road. We'll be running up hefty federal bills for a while. But we'll be doing so confident we're going to improve the economic standing of millions of Americans and our long-term budget situation in the bargain. Jacob S. Hacker is co-director of the Center for Health, Economic, and Family Security at U.C. Berkeley, and a fellow at the New America Foundation. He recently edited Health at Risk: America's Ailing Health System--and How to Heal It.

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23 December 2008

Do Not Forget the Strong Euro Mr Trichet P o s t e d o n F r i d a y , 1 9 D e c 2 0 0 8 , 1 1 : 1 2 G M T Euro strength has made the headlines over the past few weeks, with the European currency staging an impressive recovery across the G10 currency world. We are of the view that the recent moves were more due to technical than fundamental forces, with the Fed’s unprecedented move to quantitative easing providing further ammunition to euro bulls in a highly illiquid market early this week. The net result has been substantial: the euro has appreciated by 17% versus the US dollar, by 15% against the British pound and by 12% versus the yen since the beginning of the month. On a trade weighted index basis (which is more relevant for monetary policy matters), the euro has appreciated by about 10% since November. This is a roughly equivalent to a 130bp tightening in monetary conditions in the euro area, partly offsetting the 175bp monetary easing delivered by the ECB since early October. The ECB President Trichet has clearly hinted a few days ago that there is reluctance to cut interest rates again in January, noting that ‘…there is a limit to the decrease in rates’ and highlighting the need to pursue policies that would encouraging lending activity. On that matter, yesterday’s 100bp reduction in the ECB’s deposit rate and the subsequent widening in the spread with the lending rate to 200bp should contribute to filtering liquidity onto the real economy. One thing is sure though: the sharp euro rise of the past few weeks could not have come at a worse time for the euro economy which will endure a loss of competitiveness in an already highly depressed export market. The 130bp tightening in monetary conditions in the recent euro rally context makes the case for further imminent interest rate cuts all the more compelling and while we believe that the ECB will be consistent with its recent policy message and leave rates on hold in January, the case for another cut in interest rates is getting stronger by the day. If not January, it will be February.

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December 23, 2008

Madoff's People THE ARCHITECT OF HISTORY'S BIGGEST FRAUD DEPENDED ON SO MANY OTHERS TO PERPETUATE HIS CRIMES THAT HIS DOWNFALL MUST BE SEEN AS AN INDICTMENT OF HIS ERA For anyone still struggling to grasp the sheer scale of Bernard Madoff's fraud, the records of the Fairfield Greenwich Group are instructive. The boutique finance firm has lost $60 million of its own directors' funds by channelling them to Mr Madoff's Ponzi scheme. But it has earned nearly ten times as much in fees for doing the same thing with clients' money. Fairfield Greenwich kept the fees, but lost the clients' investments - all $7.3 billion of them. It has taken two weeks for investigators to begin to establish how Mr Madoff's “one big lie” operated, what it cost, and whom it stung in a direct and ruinous way. But it is already clear that the scandal's broader effect will be to tarnish a global financial services industry reeling from the effects of its own greed and hubris with evidence of staggering gullibility and neglect as well. Estimates of the size of the black hole that the Madoff affair has left in world markets range from $30 billion to $50 billion. Bill Gates's entire net worth could not undo the damage. Its victims are emerging in ever expanding circles centred on three floors of luxuriously appointed offices in midtown Manhattan. They include New York spinsters robbed of their life savings, Jewish charities from California to Tel Aviv rendered worthless overnight, high street banks on at least three continents and hedge fund managers who have cultivated superhuman reputations only to be exposed as childishly inept or worse. There is a difference between outright criminality and the bad practice that must be blamed for much of the financial crisis. But there is also a difference between Mr Madoff's fraud and earlier seismic financial scandals. Barings Bank collapsed because of an inadequately supervised rogue trader. SocGen, the French giant, lost nearly €5 billion to the secretive dealings of Jérôme Kerviel. Mr Madoff was not secretive, or rogue. His alleged deception grew and deepened over decades and depended on the explicit trust of thousands. He may have operated in a world of lies, but his actions will have consequences in the real world. As one observer notes, they have turned a bad year for hedge funds into a catastrophe. They may also sour a generation on the idea of trusting their personal wealth to others. To this extent the Madoff scandal is emblematic of the great crash of 2008 and will need a regulatory response as well as retribution in the courts. As Barack Obama has noted, nothing has brought home quite so powerfully the need for “adult supervision” of financial services.

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But first Mr Obama and his incoming administration must focus on the case in hand. Who knew what, and when? US officials are said to believe that Mr Madoff, who confessed his fraud to his apparently unknowing sons this month, cannot have acted alone. No wonder. His compliance officer was his brother. His chief attorney was his niece. His niece's husband used to have responsibility for compliance inspections at the Securities and Exchange Commission (SEC). Not everyone fell for the Madoff mystique. The SEC now admits that it has been receiving formal complaints about Mr Madoff's methods since 1999, including a 2005 report entitled The World's Largest Hedge Fund is a Fraud. The report was shelved in 2006; no action taken. The SEC, under its new management, must find out why. It must establish why feeder funds, from Connecticut to London and Paris, were so relaxed about investing vast sums without even a semblance of due diligence. And it must ask Mr Madoff's sons awkward questions about how they could have known so little for so long. Before writing new rules for a new financial era, the old ones must be enforced on any who broke them.

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Madoff Victims May Have to Return 6 Years of Profits, Principal By Carlyn Kolker, Tiffany Kary and Saijel Kishan

Dec. 23 (Bloomberg) -- Like some of Bernard Madoff’s clients, a Florida restaurant owner was lucky enough to withdraw part of his investment before the money manager allegedly confessed to a $50 billion Ponzi scheme. Now he’s worried he might be asked to give it back. The 53-year-old investor, who asked not to be identified to protect his stake, took out about $600,000 this year from his $1.5 million account, using some of it to pay down a mortgage. He and other Madoff clients who withdrew funds as long as six years ago may be sued on behalf of other victims to return profits and even principal, securities and bankruptcy lawyers say. “Right now there are Madoff winners and Madoff losers,” said Lynn LoPucki, who teaches bankruptcy law at Harvard University. “Before this is over there will be nothing but Madoff losers.” Clients of Madoff had about $36 billion with his firm, according to a Bloomberg tally that may include some double counting. Before his arrest on Dec. 11, Madoff, 70, confessed to employees that his “giant Ponzi scheme” may have cost as much as $50 billion, according to an FBI complaint. His misconduct may have stretched back to at least the 1970s, two people familiar with the government’s inquiry of Madoff said last week. The Florida investor, who first gave his money to Madoff five years ago, said he had no hint of fraud and would go to jail rather than give up the amount he took out. Irving Picard, the trustee appointed to liquidate Madoff’s brokerage, Bernard L. Madoff Investment Securities LLC, holds the fate of the restaurant owner and other investors in his hands. Enough Funds Left? Picard, who didn’t return a call seeking comment on plans to sue victims to recover funds, said in a court filing yesterday that “there has not been any showing or determination that there are sufficient funds” to satisfy victim claims. A so-called clawback of paid-out funds in the Madoff liquidation could result in lawsuits against investors such as charities, hedge funds and individuals who redeemed profits and took out principal. Nonprofit institutions such as the Carl and Ruth Shapiro Family 111

Foundation, a foundation controlled by Democratic U.S. Senator Frank Lautenberg of New Jersey, and Yeshiva University relied on funding from Madoff investments. Lawyers and representatives of the Shapiro and Lautenberg foundations didn’t return calls seeking comment. In a statement, Rick Matthews, a Yeshiva University spokesman, said, “Our lawyers and accountants are in the process of an investigation.” ‘Further Risk’ “Charities are looking at their legal options as regarding their right to recoup money,” said Mark Charendoff, president of the New York-based Jewish Funders Network, whose 1,000 members fund Jewish causes and are assessing losses from Madoff investments. “I don’t know that they’ve been focused on or are aware that they may in fact be at further risk of loss.” Bankruptcy laws authorize a trustee like Picard to recover money that was distributed as part of a fraud and share it among the victims, LoPucki said. “The purpose of these laws is to balance the losses among the various investors, but how that balance is supposed to be struck is not clear,” LoPucki said. Under New York state law, which can be invoked for Madoff recoveries, a trustee can seek redemptions going back six years, said Tracy Klestadt, a New York bankruptcy lawyer. In a similar case, U.S. Bankruptcy Judge Adlai Hardin in White Plains, New York, ordered investors of defunct hedge-fund manager Bayou Group LLC in October to disgorge profits they’d taken out. Investors were required to pay back any gains they’d redeemed involving “fictitious profits.” Before the fraud was discovered, Bayou paid out more than $135 million, according to court papers. ‘Good Faith’ Rule Hardin also ruled some investors would have to hand back their principal. Only investors who acted in “good faith” -- a legal standard that makes investors prove they didn’t have knowledge or suspicion of fraud -- could protect their initial stake, Hardin ruled. He said investors could show they had good faith if they didn’t see any “red flags” when they withdrew the funds. That decision could be a guide for Picard, Klestadt said. The Bayou decision set a high bar for investors who hope to protect their principal, said Carole Neville, a lawyer representing Bayou investors. “What the Bayou case holds at the moment, is, if you had any reason to feel uncomfortable about your investment and took your money out, you don’t have good faith,” Neville said. “On the surface it seems a standard that’s almost impossible for people to meet,” said Robert Crane, president of New York’s JEHT Foundation, a group dedicated to criminal justice matters that relied on donors who invested with Madoff and said it’s closing in January. Seeking money from investors who say they were defrauded can result in protracted litigation. In the Bayou case, which is being appealed, $20 million of the $33 million recovered from redeeming investors went to pay legal fees, Neville said.

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Plunge in Exports Reverberates Across Asia Japan Reports Record Drop as Regional Trade Slows; Toyota Warns of First Loss in 70 Years By Glenn Kessler Washington Post Staff Writer Tuesday, December 23, 2008; A01 Japan reported yesterday that its exports plunged a record 27 percent in November, signaling a dramatic deterioration in the world's second-largest economy and the collapse of the exportled boom that had lifted many Asian nations. Indeed, even mighty Toyota said yesterday that it would post its first operating loss in seven decades, providing a vivid example of how some of the world's most profitable companies have been quickly humbled by the global recession. Japan's stunning decline in exports is being echoed across Asia, where country after country is reporting data that have exceeded even the grimmest forecasts. Thailand said yesterday that its exports in November fell by nearly 19 percent, the most in 17 years. Similarly, Taiwan's exports fell 23 percent in November, and a government report on future export orders set to be released today is expected to show another steep drop. "Everyone is tanking together. A fall of 27 percent is really striking and portends substantially greater weakness," said Easwar Presad, a senior professor of trade policy at Cornell University. "The bottom line is that many of these countries that relied on export-led growth will have to rely on domestic demand to get out of this thing." China had reported that its November exports took their biggest dive in seven years -- a drop that has reverberated across Asia because China has become the largest export market for many of its neighbors. Japanese shipments to China fell 25 percent, the steepest decline in 13 years, the Japanese Finance Ministry said. As much as 50 percent of China's trade is related to processing -- buying semiconductors and other parts from Japan, South Korea and other neighbors and then assembling them at low cost into finished products for companies such as Sony, Panasonic and Samsung. China, in effect, is the final assembly station for vast global production networks, which are now sputtering to a halt. Japan has already officially entered a recession, propelled by its close ties to the U.S. economy, and the government has cut interest rates and boosted domestic spending in an effort to mitigate the recession's impact. But Toyota's woes are the latest sign of what the World Bank predicts will be the first decline in global trade since 1982. Last year, Toyota's operating profit was more than $25 billion, which can be largely attributed to the success of fuel-efficient models like the hybrid Prius. Until recently Toyota had projected an operating profit of nearly $7 billion for the fiscal year ending in March. But yesterday, Toyota President Katsuaki Watanabe announced that the company expects to post a $1.7 billion loss because of what he called a once-a-century event of collapsing consumer demand and the rapidly rising value of the Japanese yen. "The tough times are hitting us far faster, wider and deeper than expected," he said at a gloomy news conference at the company's Nagoya headquarters. "This is an unprecedented crisis requiring urgent action."

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In the United States, Toyota postponed opening a new factory planned for Prius production and slowed output of its Tundra pickup truck at a factory in Texas. Toyota has made similar announcements at factories in Europe, Africa and China. Because the November figures reflect pre-Christmas sales, even larger declines may loom in the coming months. Even so, many countries already are reporting sharp declines in exports. Saudi Arabia, for instance, projected that its non-oil exports of metal products, electrical goods and industrial equipment could fall as much as 30 percent in the coming year, after rising 21 percent the year before. In India, where auto parts exports had been estimated to grow 20 percent this fiscal year, the auto parts association is now projecting the first decline in such exports in more than two decades. Indian parts makers had been buoyed by demand from U.S. automakers eager to cut costs, boosting exports to $3.6 billion in the most recent fiscal year, but now Detroit is sharply curtailing production. In Switzerland, the luxury watch industry also took a hit, with exports falling 19 percent in November, the all-important pre-Christmas month for the industry. The decline hit both premium models selling for thousands of dollars and the most basic plastic Swatch watches, the industry association said. Japan's export woes have been exacerbated by a startling rise in the value of the yen to 13year highs of about 90 yen to a dollar. The yen has appreciated about 24 percent against the dollar this year as the United States plunged into a recession, but the surging currency has made Japanese goods significantly more expensive, weakening demand and reducing profits for global manufacturers such as Toyota. The yen slumped yesterday against the dollar and euro after the grim export report was released. Staff writer Sholnn Freeman contributed to this report.

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December 23, 2008 -05:28:52 AM CST

BAILING OUT BANKER BONUSES By Investor's Business Daily Bailouts: Amid coast-to-coast cutbacks and layoffs by the thousands, bankers at the center of the financial crisis pay themselves $1.6 billion in taxpayer-funded bonuses. This is a major symptom of what's wrong. In any real crisis, everyone sacrifices to weather the storm. But the panicky $700 billion bailout that Congress approved for 116 banks in the fall shows an entirely different sense of urgency. On Sunday, the Associated Press found that $1.6 billion of bailout cash was converted to gravy for 600 bankers. They got bonuses, club dues, financial planners, corporate jet travel, daily limousines and home security systems, courtesy of the taxpayers. This is a bad sign of what's ahead if failure continues to be rewarded and government keeps propping up uncompetitive companies and industries in crisis. It's obvious these banker bonuses had no correlation to productivity or performance. In the real world, enterprises provide such benefits only when executives produce results • that is, profits. On Monday, for example, executives of Caterpillar gave up compensation to ensure that their firm would survive. The banks • especially investment banks • seem to play by different rules. AP asked 21 bank spokesmen how their companies were spending their taxpayer money and got only evasive answers. Goldman Sachs told AP it needed to retain and motivate its talent to ensure its "continued success," not mentioning where this talent is threatening to migrate in a global and industry downturn. To take bailout money, even a mere $1.6 billion, and blow it on bonuses is a violation of the public trust. We reluctantly backed the bailout because banks' main product, money, is a critical medium of exchange. But to use it for perks makes voters distrustful and cynical, and far more reluctant to save cash for a real crisis. It also makes other bailout mendicants far less willing to make necessary sacrifices. The United Auto Workers cite the bank bailout as reason to not give back bloated benefits that render the Big Three uncompetitive. Their argument has just been fortified by the bank bonuses. But with unemployment rising fast, there's a real crisis and real sacrifice is necessary, especially from those who require the federal bailouts. Bank bonuses should wait until these banks are profitable; so should raises in inflated salaries. Maybe Goldman's $600,000 earners can make do on the $400,000 salary of a U.S. president or the $200,000 salary of a senator to show some sort of leadership. At a time like this, they should be marshaling all their resources to invest in viable growth. 115

Opinion December 22, 2008 OP-ED COLUMNIST

Life Without Bubbles By PAUL KRUGMAN Whatever the new administration does, we’re in for months, perhaps even a year, of economic hell. After that, things should get better, as President Obama’s stimulus plan — O.K., I’m told that the politically correct term is now “economic recovery plan” — begins to gain traction. Late next year the economy should begin to stabilize, and I’m fairly optimistic about 2010. But what comes after that? Right now everyone is talking about, say, two years of economic stimulus — which makes sense as a planning horizon. Too much of the economic commentary I’ve been reading seems to assume, however, that that’s really all we’ll need — that once a burst of deficit spending turns the economy around we can quickly go back to business as usual. In fact, however, things can’t just go back to the way they were before the current crisis. And I hope the Obama people understand that. The prosperity of a few years ago, such as it was — profits were terrific, wages not so much — depended on a huge bubble in housing, which replaced an earlier huge bubble in stocks. And since the housing bubble isn’t coming back, the spending that sustained the economy in the pre-crisis years isn’t coming back either. To be more specific: the severe housing slump we’re experiencing now will end eventually, but the immense Bush-era housing boom won’t be repeated. Consumers will eventually regain some of their confidence, but they won’t spend the way they did in 2005-2007, when many people were using their houses as ATMs, and the savings rate dropped nearly to zero. So what will support the economy if cautious consumers and humbled homebuilders aren’t up to the job? A few months ago a headline in the satirical newspaper The Onion, on point as always, offered one possible answer: “Recession-Plagued Nation Demands New Bubble to Invest In.” Something new could come along to fuel private demand, perhaps by generating a boom in business investment. But this boom would have to be enormous, raising business investment to a historically unprecedented percentage of G.D.P., to fill the hole left by the consumer and housing pullback. While that could happen, it doesn’t seem like something to count on. A more plausible route to sustained recovery would be a drastic reduction in the U.S. trade deficit, which soared at the same time the housing bubble was inflating. By selling more to other countries and spending more of our own income on U.S.-produced goods, we could get to full employment without a boom in either consumption or investment spending.

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But it will probably be a long time before the trade deficit comes down enough to make up for the bursting of the housing bubble. For one thing, export growth, after several good years, has stalled, partly because nervous international investors, rushing into assets they still consider safe, have driven the dollar up against other currencies — making U.S. production much less cost-competitive. Furthermore, even if the dollar falls again, where will the capacity for a surge in exports and import-competing production come from? Despite rising trade in services, most world trade is still in goods, especially manufactured goods — and the U.S. manufacturing sector, after years of neglect in favor of real estate and the financial industry, has a lot of catching up to do. Anyway, the rest of the world may not be ready to handle a drastically smaller U.S. trade deficit. As my colleague Tom Friedman recently pointed out, much of China’s economy in particular is built around exporting to America, and will have a hard time switching to other occupations. In short, getting to the point where our economy can thrive without fiscal support may be a difficult, drawn-out process. And as I said, I hope the Obama team understands that. Right now, with the economy in free fall and everyone terrified of Great Depression 2.0, opponents of a strong federal response are having a hard time finding support. John Boehner, the House Republican leader, has been reduced to using his Web site to seek “credentialed American economists” willing to add their names to a list of “stimulus spending skeptics.” But once the economy has perked up a bit, there will be a lot of pressure on the new administration to pull back, to throw away the economy’s crutches. And if the administration gives in to that pressure too soon, the result could be a repeat of the mistake F.D.R. made in 1937 — the year he slashed spending, raised taxes and helped plunge the United States into a serious recession. The point is that it may take a lot longer than many people think before the U.S. economy is ready to live without bubbles. And until then, the economy is going to need a lot of government help.

Blog: The Conscience of a Liberal December 22, 2008, 8:49 pm

BAD ANTI-STIMULUS ARGUMENTS A number of conservative economists have been arguing against a stimulus plan centered on government spending. Fair enough. But one argument I keep reading bugs me: it’s the claim that spending-based stimulus is bad because economic theory tells us that a marginal dollar of private spending is better than a marginal dollar of government spending. That’s just wrong; it’s a misreading of basic, Econ 101 level, economics. Yes, the standard theory of consumer choice says that a consumer gains more utility if he or she gets to freely allocate a dollar of spending than if someone else makes the choices: I’d rather buy myself a $10 meal than have you feed me $10 worth of food that you select. But that’s not what we’re talking about when we talk about stimulus spending: we’re not talking about the government buying consumption goods for the public at large. Instead, we’re

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talking about spending more on public goods: goods that the private market won’t supply, or at any rate won’t supply in sufficient quantities. things like roads, communication networks, sewage systems, and so on. And every Econ 101 textbook explains that the provision of public goods is a necessary function of government. When we’re asking whether it’s better to have the government stimulate the economy or to try to stimulate private spending, we’re asking among other things whether a marginal dollar spent on public goods is worth more or less than a marginal dollar spent on private consumption. And there’s nothing, even in Econ 101, that clearly favors private spending on private goods over public spending on public goods. In other words, the attempt to claim the authority of economics for the idea that stimulus in the form of tax cuts is better, at a microeconomic level, than stimulus in the form of infrastructure spending is a case of bait and switch. Don’t fall for it. December 22, 2008, 8:32 pm

CRAZY CONSPIRACY THEORISTS So Rush Limbaugh, Bill O’Reilly, and Karl Rove all claim that the financial crisis was a liberal conspiracy, generated either by evil mastermind Chuck Schumer or by wily journalists. Why does such stuff flourish? Probably because there is no punishment for it — as long as you’re on the right, and I mean right, side. Let Michael Moore point out, entirely correctly, the close ties between the Saudis and the Bush family, and he’s blasted as a crazy conspiracy theorist. On the other hand, let Donald Luskin suggest, in 2004, that George Soros is planning to engineer a financial crisis to defeat Bush, and he gets to publish front-page articles in the Washington Post Outlook section declaring that there isn’t a recession. December 22, 2008, 9:28 am

SOUTHERN DISCOMFORT Heartrending story in the Times about the woes of South Carolina. In fact, unemployment rates in the Southeast have risen more than in the United States as a whole; there’s a sort of Slump Belt extending from the industrial Midwest down to the Carolinas. Why is this happening? The Slump Belt does sort of look like the “auto corridor”; maybe what we’re seeing is the geographical location of cyclically sensitive manufacturing industries. Anyway, it’s striking that the worst of the crisis is hitting states that largely didn’t experience a housing bubble. December 21, 2008, 7:36 pm

The Bushies and the bubble Fascinating piece (“White House Philosophy Stoked Mortgage Bonfire”). But: 1. I’m with Calculated Risk: the story of the young analyst who had a “nagging feeling” based on price-rent ratios in March 2007 — March 2007! — is mind-boggling. CR was flagging the clear signs of a bubble based on exactly these numbers in March 2005. 2. I’m also with Barry Ritholtz that Bush’s emphasis on homeownership was not the problem. Bush favored homeownership; I’m sure he also favored marital fidelity; his

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influence on homeownership and his influence on adultery were probably comparable. It’s Bush’s opposition to financial regulation that did the evil deed.

Jason Thomas had a nagging feeling. The New Century Financial Corporation, a huge subprime lender whose mortgages were bundled into securities sold around the world, was headed for bankruptcy in March 2007. Mr. Thomas, an economic analyst for President Bush, was responsible for determining whether it was a hint of things to come. At 29, Mr. Thomas had followed a fast-track career path that took him from a Buffalo meatpacking plant, where he worked as a statistician, to the White House. He was seen as a hiz kid, “a brilliant guy,” his former boss, Mr. Hubbard, says. As Mr. Thomas began digging into New Century’s failure that spring, he became fixated on a particular statistic, the rent-to-own ratio. Typically, as home prices increase, rental costs rise proportionally. But Mr. Thomas sent charts to top White House and Treasury officials showing that the monthly cost of owning far outpaced the cost to rent. To Mr. Thomas, it was a sign that housing prices were wildly inflated and bound to plunge, a condition that could set off a foreclosure crisis as conventional and subprime borrowers with little equity found they owed more than their houses were worth. It was not the Bush team’s first warning. The previous year, Mr. Lindsay, the former chief economics adviser, returned to the White House to tell his old colleagues that housing prices were headed for a crash. But housing values are hard to evaluate, and Mr. Lindsay had a reputation as a market pessimist, said Mr. Hubbard, adding, “I thought, ‘He’s always a bear.’ ” In retrospect, Mr. Hubbard said, Mr. Lindsay was “absolutely right,” and Mr. Thomas’s charts “should have been a signal.”

http://www.calculatedriskblog.com/2008/12/ny-times-ideologues-aided-mortgage.html

NYT: Blaming Bush for the Wrong Things That Bush had as a goal increased home ownership is, quite bluntly, irrelevant. It is a worthy goal, and certainly one that could be achieved without forcing the collapse of the financial system. Indeed, as the chart at right shows (source: NYT), home ownership has increased every year since 1994. Funny, from that year and for each of the next 10 years, there was no collapse. You have to ask yourself why. No, the 1997 Tax Break, did not, as the NYT implied yesterday, Help Cause Housing Bubble. Home ownership was rising years before that went into effect. What Bush did differently than prior Presidents was that he genuinely believed that regulations proscribing bad corporate behavior were unnecessary. It was that ruinous belief system, one he shared with other key players, that led to the crisis. ................................................................. Increasing home ownership in America is a legitimate political goal. Waiving down-payments requirements, dropping lending standards, allowing predatory lenders to flourish — that is what is the underlying cause of boom bust and collapse.

http://www.ritholtz.com/blog/2008/12/nyt-blaming-bush-for-the-wrong-things/

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What Does Regulation Regulate? By Barry Ritholtz - December 22nd, 2008, 6:15AM Here’s one of the simple truisms that gets lost in the political (i.e., bumper sticker) discussions. Don’t regulate the free markets! Don’t interfere with innovation! Don’t stifle incentives! What bullshit. One of the best ways to win a debate is to control the language used. This was one of the elements George Orwell was discussing in 1984, and why the language in the novel was degraded to phrases like “double plus good.” All nuance was dismissed. He who controls the language controls the political economy is what Orwell was saying. In modern times, its done not with boot-jacks and guns, but with catchphrases and clever marketing. Its not as heavy handed, its just more insidious. When we discuss “Regulations,” we are talking about regulating human behavior. And that behavior can range from following misplaced incentives to falsifying accounting data to overtly legal but destructive actions — like putting people into loans they knew (or reasonably should have known) were likely to default. What a terrible sham the no “regulation cry” has been. It is really a vote for no rules against illegal and/or criminal behavior . . . Tom Toles via Washington Post:

http://www.ritholtz.com/blog/

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December 22, 2008

U.S. Investors Optimistic About Longer Term SLIGHTLY OPTIMISTIC ABOUT PERSONAL PORTFOLIOS; HIGHLY PESSIMISTIC ABOUT ECONOMY by Dennis Jacobe, Chief Economist PRINCETON, NJ -- Not surprisingly, American investors -- defined as those having $10,000 or more of investable assets -- remain highly pessimistic about the overall investment with the Gallup Index of Investor Optimism falling to -49 in a new Dec. 16-18 poll. This down slightly from the already highly pessimistic rating of -47 in November.

Investors Highly Pessimistic About the Economic Outlook A year ago in December 2007, investors were slightly pessimistic about the economic outlook for the next 12 months with the Economic Dimension of the Index at -7 -- a negative number reflects investors as a group turning pessimistic about the future direction of the economy. This turned out to be a prescient view, as we now know that the U.S. economy has been in recession since December of last year. Earlier this year, investors turned even more pessimistic about the economic outlook as the Economic Dimension of the Index plunged to -40 in February, surpassing its previous low of -30 in March 2003 set at the outset of the Iraq war. By November, investor pessimism concerning the outlook for the economy over the next 12 months deepened with this dimension of the Index falling even further to -60 before its most recent decline to -64 this month.

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Investors Slightly Optimistic About Their Own Portfolios In sharp contrast to their expectations concerning the future direction of the economy, investors have been reasonably optimistic about their own investment portfolios. Last December, the Personal Dimension of the Index stood at +57. In February of this year, even as they became considerably more pessimistic about the economic outlook, investors remained fairly optimistic about their own portfolios as the Personal Dimension of the Index was at +62. Not surprisingly given the plunging equity markets and the global financial crisis, investor expectations concerning their own investment portfolios have fallen sharply. Nonetheless, in December of this year, investors remained slightly optimistic about their personal portfolios, with the Personal Dimension at +15 -- one of the lowest levels of personal financial optimism since inception of the Index in October 1996. Still, this positive number is somewhat amazing considering how much the investment climate has deteriorated since the equity markets peaked in October 2007.

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Investors Optimistic About Longer Term One key source of investor optimism about their personal portfolios has to do with their view of the longer term. By a margin of 57% to 28%, investors say they are optimistic as opposed to pessimistic about their ability to achieve their investment goals over the next five years. On the other hand, investors have more mixed views of the near term. In terms of their income, they are more optimistic (53%) than pessimistic (27%) about being able to maintain or increase their earnings over the next 12 months. However, in terms of being able to reach their investment targets over the next 12 months, they are more pessimistic (47%) than optimistic (33%).

Commentary Gallup's Index of Investor Optimism is designed to reflect American investors' views of the investment climate. Econometric analysis has shown that Gallup's Index a somewhat better predictor of the future direction of the U.S. economy than traditional consumer confidence measures. The Index of Investor Optimism peaked in January 2000 at 178 -- prior to the bursting of the dot-com bubble. Before this year, the low for the Index was 5 in March 2003 reflecting investor concerns at the outset of the Iraq war.

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Investor pessimism this year -- particularly, its depth in November and December -suggests pervasive pessimism among upper-income Americans heading into 2009. This is consistent with Gallup's other consumer confidence measures and its Christmas spending estimates. Of course, none of this is good news for the nation's retailers this holiday season or early next year -- particularly those serving the upscale market. Still, there is a positive aspect of this new Index of Investor Optimism poll. Even with all the financial chaos of 2008 -- the unprecedented market volatility, the collapse of numerous major financial institutions, and topped off by the crash of the biggest Ponzi scheme in history -- American investors remain optimistic as a whole about their personal investments, particularly in the longer term. This is a huge vote of confidence in the U.S. financial system, the free markets, and the U.S. economy on the part of the average American investor. It is a remarkable way to end one of the most financially tumultuous years in U.S. history and something positive for the new Obama administration to build on in 2009. Survey Methods Gallup Poll Daily interviewing includes no fewer than 1,000 U.S. adults nationwide each day during 2008. The Index of Investor Optimism results are based on questions asked of 1,000 or more investors over a three-day period each month (Dec. 16-18, Nov. 24-26, June 3-6, April 25-28, March 28-31, and Feb. 28-March 2). For results based on this sample, the maximum margin of sampling error is ±3 percentage point. Results for May are based on the Gallup Panel study and are based on telephone interviews with 576 national adults, aged 18 and older, conducted May 19-21, 2008. Gallup Panel members are recruited through random selection methods. The panel is weighted so that it is demographically representative of the U.S. adult population. For results based on this sample, one can say with 95% confidence that the maximum margin of sampling error is ±5 percentage points. For investor results prior to 2008, telephone interviews were conducted with at least 800 investors, aged 18 and older, with at least $10,000 of investable assets. For the total sample of investors in these surveys, one can say with 95% confidence that the margin of sampling error is ±4 percentage points. In addition to sampling error, question wording and practical difficulties in conducting surveys can introduce error or bias into the findings of public opinion polls. http://www.gallup.com/poll/113521/US-Investors-Optimistic-About-LongerTerm.aspx?version=print

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Madoff as Metaphor Daily Article by Llewellyn H. Rockwell, Jr. | Posted on 12/22/2008 12:00:00 AM

The mystery of Bernard Madoff will be storied a hundred years from now. As history's biggest financial criminal, he took a cheap ripoff that you can use at home—the Ponzi scheme—and turned it into a global empire worth some $50 billion. One ingredient was financial intelligence. Madoff had buckets of it. Early in his career, he was the real deal, an actual innovator. He combined this with an amazing lack of conscience, for his scam was rooted most fundamentally in lying and stealing. The difference between him and all who came before was his grand scale, the grandest scale imaginable. There is a saying in the world of Austrian economics about the business cycle. The puzzle is not to explain business failures. Those are part of the normal course of life, and the sign of a healthy economy. The puzzle is to explain the "cluster of errors" that appears at the beginning of a recession. How could so many have been so wrong about so much at the same time? The business cycle is a system-wide failure, not merely the mistaken judgment of a few. So it is with Modoff's scheme. The mystery isn't how one person was able to fool a few. The scheme in which yesterday's "investors" are paid off with the money of today's victims is known in all places and probably all times—and it always goes belly up to the originator's complete disgrace. It is a classic example of how moral laws are self-enforcing in the world of economics. The critical difference this time is that Madoff ran his scheme during an economic boom, a time when people's normal sense of incredulity is put on the shelf. This is part of the grave cultural distortion introduced by funny money. Money is the most widely demanded good in society, and the Fed is making new quantities of it not as a reflection of new real wealth, but purely as an administrative decree. There is a sense in which funny money literally drives everyone crazy, leading to what is sometimes called the "madness of crowds." Guido Hulsmann explains it all in his remarkably timely and revealing new book: The Ethics of Money Production. With artificial stimulation from the credit machine, multitudes are willing to believe in something that cannot possibly be true. In Madoff's case, it was that he could, even in falling markets, earn 15-20% a year without risk. Why not? Most everyone believed in some version of the myth. We believed that house prices would go up and up despite the reality that houses are physical things that deteriorate from the 125

instant they are finished, just like cars or computers or anything else. Why did we believe this about houses? Again, you have to look to the fraudulent money system to see why. And we believed that we could all become millionaires by putting our money in the stocks of companies that weren't actually earning money or paying dividends, companies whose wealth was entirely based on infusions of cash from the stock market which in turn were based on the belief that others would buy the stocks and so on. In other words, we believed that something out of nothing was possible, and anyone who didn't believe it was a chump. It’s exactly what people believed during the other great inflations of history. What's more, we believed that buying these stocks constituted not consumption, but savings for the future. In fact, people routinely attacked official savings data on grounds that they did not include what people were “saving” in terms of their stock market accounts. In a similar way, people were measuring our national wealth not in terms of accumulated capital, but rather through consumption data, as if granite kitchen counters in bigger houses were a measure of wealth instead of the opposite: the depletion of wealth. The left is big on attacking the salaries of investment bankers, and they were indeed outlandish. But these too represented not a unique problem, but more evidence of inflationary finance. In a bubble economy, the money chases what is most fashionable, and financial services qualified. So the salaries were market. What was wildly distorted was the market itself. Now let's talk about government finance during these years. The market tried to correct itself from 1999-2001, but the government wouldn't tolerate it. Instead, it used every sign of downturn as an excuse to keep the illusion going, creating billions and billions in new dollars. The Fed drove interest rates lower and lower despite the non-existence of savings available to back them up. (Low interest rates in a sound money system are a reflection of accumulated capital and deferred consumption. When you see the Fed pushing them down during a boom, it is creating a dangerous mirage.) Did anyone stop and wonder where the government was getting all this money to pump up the system? Yes, the Austrian economists warned us. The pages of Mises.org and LewRockwell.com were filled with alarms. But it was something people wanted to ignore. We are talking about human nature: the desire to believe in things that do not exist. The government was happy to fuel this sense because it gave the Fed, its connected industries, and the state more power and more money in the short term. Madoff's scheme played into the belief that wealth was not something to work for, but something to scheme for. It could be generated by playing your cards right, hooking into the right networks, and finding the right "investments." The people with whom he dealt had, it turns out, some internal sense that there was something a little bit shady about the whole operation. But they dispensed with this sense when the fat checks arrived, and concluded that whatever was making this perpetual motion machine operate, it did work. But listen: the government right now is using the same tactic to convince you that it is saving you from the recession. The whole scheme partakes of the same sense of denying reality that characterized Madoff's scheme. And I'm not just talking about Social Security, which is almost an exact replica of the Ponzi version, except that at least Charles Ponzi didn't force people to give him money. I'm speaking of something broader. The entire financial system that is propped up by the Treasury and the Fed is based on the same idea: that something out of nothing is possible.

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So they will jail Madoff. Wall Street would flog him if it could. He is disgraced for all of history. But meanwhile, the likes of Bush, Bernanke, Paulson, Obama, and all the rest are still riding high, even though their scheme is far larger and more egregious. Most of us like to believe that we wouldn't have been tricked by Madoff. But are you being tricked by the elites who claim that they can conjure up a trillion dollars to stabilize our economy by clicking a few buttons on a computer screen? Most people are. Certainly the press seems to have bought it. Many people were outwitted by Madoff. Many more people are today being outwitted by the government and its central bank. And it will all end in disgrace and disaster, only on a far, far grander scale.

Llewellyn H. Rockwell, Jr. is president of the Ludwig von Mises Institute in Auburn, Alabama, editor of LewRockwell.com, and author of Speaking of Liberty.

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Economy December 22, 2008

A Reeling City Is a Snapshot of Economic Woes By PETER S. GOODMAN COLUMBIA, S.C. — Even before the job fair opens, the line snakes into the parking lot of the state fairground, a muted parade of lives derailed by layoffs. “It kills me, it eats me up inside,” said Raymond Vaughn, who has been out of work for seven months, since he lost his job as a window installer. His fiancée now pays the bills. “I go into this fantasy world where I’m like, I’m in the wrong life and I’m actually a millionaire. It really bothers me I can’t do the things I’d like for her. Sometimes you get where you feel less than a man.” As the American economy sinks deeper into one of the more punishing recessions since the Depression, frustration and fear color the national conversation. This city in the center of South Carolina is an ideal listening post. According to a range of indicators assembled by Moody’s Economy.com — from job growth to change in household worth — this metropolitan area came closer than any other to being a microcosm of the nation over the last decade. This is now an unfortunate distinction. Some 533,000 jobs disappeared from the economy in November, the worst month since 1974. In South Carolina, a government panel is predicting that the state’s unemployment rate could reach 14 percent by the middle of next year. No speculative real estate bubble can explain what is happening in this metropolitan area of roughly 700,000 people. Neither the brick Georgian homes in the city’s core nor the ranchstyle houses on the suburban fringes rose or fell much in value. The financial wizards of Wall Street seem far from the palmetto-dotted campus of the University of South Carolina and the domed state capitol downtown. Yet as the toll continues to mount from an era of financial recklessness — as banks cut credit from households and businesses, reinforcing austerity — the damage has spread here, choking economic activity at places ranging from shopping malls to factories. “This was not of our doing,” said Doug Woodward, an economist at the University of South Carolina. “We just got swept up in the crisis of confidence.” The Carolinas may conjure thoughts of textile mills and tobacco fields, but Columbia has a diverse economy. The state is a major employer. So is the university, along with hospitals and banks. The Fort Jackson Army base employs 9,200 people. United Parcel Service has a regional hub here. Michelin operates a tire factory next door in Lexington County. The Computer Science Corporation develops software north of the city.

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Early in the year, layoffs were concentrated among factory and warehouse workers. “Now, they run the gamut,” said Jessica Horsely, a case manager at the local employment office. “You see a heightened sense of desperation. People are just grasping for anything.” President-elect Barack Obama has pledged to spend as much as $775 billion on his economic plan, including infrastructure projects like bridges, roads and classrooms, to put people back to work. Columbia’s mayor, Bob Coble, is consumed with capturing some of those dollars for his city. He has assembled a list of ready-to-go projects totaling $140 million that he said could generate construction jobs and propel further economic development. Mr. Coble, a Democrat who has been mayor for 18 years, has in mind the redevelopment of North Main Street, a bedraggled corridor of hard-luck retailers that lacks sidewalks in many spots, with exposed power lines dipping down to cracked pavement. That project is already under way, putting down sidewalks and burying power lines in a $19 million first phase. An additional $54 million could complete it. Similar projects have restored shine to Columbia’s downtown, which was in a similar state of decay a decade ago, and nurtured the Vista neighborhood, a collection of brick warehouses transformed into trendy eateries. The mayor has also been focused on expanding the so-called Innovista project, a campus developed by the university centered on research in areas like hydrogen-powered fuel cells and biotechnology. The aim is to cluster research labs, private companies and condominiums. “This will be a once in a generation opportunity to transform a city with projects that have been on the books,” the mayor said over breakfast at a newly opened downtown Sheraton hotel set in an old bank whose original vault has become a cozy martini bar. “These are not bridges to nowhere.” Yet questions confront the notion of putting people to work through federal largess. South Carolina’s governor, Mark Sanford, a Republican, has been an ardent opponent of federal aid for states, branding it pork barrel spending. If the money is delivered to state agencies like the Department of Transportation, which has its own list of priorities, Columbia might be disappointed. Despite the attractiveness of Main Street, new sidewalks have drawn few retailers. North Main Street runs through a largely poor area, making it even less likely that improvements will attract business. Meanwhile, the recession intensifies. At the state fairgrounds, Lori Harris, 47, waited for the job fair to open. A year has passed since she graduated from college with an associate degree in medical assisting, yet she has been unable to find a decent job. Ms. Harris previously ran her own house-painting company, but opted for a more stable career in a growing field. She saw an ad for the degree program on television: “Come become a medical assistant!” Now, such talk seems farcical. She is paying $95 a month toward $23,000 in student loan debt. She is living with her boyfriend, who is supporting her, not always cheerfully. She has no health insurance and cannot see a specialist for a torn rotator cuff and recently applied for food stamps. “I tried to better myself,” she said, “and I’m getting nowhere.”

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She was offered one job, as a medical technician dispensing pills to patients. The pay was $7.50 an hour. “Forget it,” she said. “I was like, ‘Is it worth going to college? Did I waste my time?’” She wondered if her age explains the rejections. Or her Boston accent. Or the smell of her cigarette smoking. “It’s getting really discouraging,” she said. As the doors opened, people filed in quietly, entering a dark warehouselike space with concrete floors. “You want a job that makes you smile,” proclaimed a placard at a booth for Wendy’s, the fast food chain. Another sign advertised the benefits for counter workers, among them: “free uniforms.” A Border Patrol officer stood in his olive green uniform, his laptop running video footage of Latinos running frantically through garbage strewn patches of desert, chased by helicopters and jeeps. Raymond Vaughn stopped and inquired about a job. “You will have to relocate to the southwest border,” said the recruiter, Michael Day. The entry level pay was $36,000 a year. But the Border Patrol was looking for people no older than 40. Mr. Vaughn was 43. At the window install job, Mr. Vaughn made $11.50 an hour. Since his layoff, he has been living on an unemployment check of $221 a week, and on the wages his fiancée brings home from her job as a hospital receptionist. He has applied for more jobs than he can recall. “They always say they’ll call me,” he said. “They never do.” A former high school track star, Mr. Vaughn carried himself with pride. Yet as the months passed and his car deteriorated without any cash for repairs, as his loose-handled cooking pots went unreplaced, he was sinking. Among African-Americans, the national unemployment rate is above 11 percent, with Mr. Vaughn now part of that number. “Inside of me, I always felt like I was going to be greater than I am now,” he said. The job fair brought more disappointment. Only one job seemed possible, a technician position at an air-conditioning company. The starting salaries were less than $10 an hour. “Even if I work for this, I’m taking a cut in pay,” he said. “But something’s better than nothing.” At a booth for Amcol, a collection service that specializes in overdue medical bills, a recruiter made an aggressive pitch. “The more you do in collections,” he said, “the more you make.” Mary Bamou waited in line, holding copies of her résumé. She has been out of work for three months, ever since she was briefly hospitalized, ending her minimum wage job as a food service worker at the university. Now, she is getting by on an unemployment check of less than $100 a week. Ms. Bamou, 50, has experience in medical billing, a skill she figured may translate to medical collections. “Calling people up in these times is not going to be an easy task,” she said. “It’s a job. Worst thing they can do to me after cussing me out is to hang up.” Frank Kelly, 52, surveyed the booths and wondered how much further this slide would go.

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In the 1990s, he wrote computer manuals for I.B.M. in upstate New York, earning $65,000 a year. After he lost that job, he spent a dozen years supervising a lab that tested raw materials at a brake pad factory in nearby Orangeburg, S.C., where he made more than $55,000 a year. In October, amid the rapid deterioration of the Detroit automakers, Mr. Kelly was laid off. At the job fair, he was standing in line in a suit and tie, waiting to apply for a position at a pet food processor. He and his wife have been living off her income as an accountant for a food distributor. One of her duties is to check the creditworthiness of customers, which gives her an uncomfortable view. “She gets to see everybody going downhill,” Mr. Kelly said.

Brett Flashnick for The New York Times Lori Harris is disappointed with her job prospects after having earned an associate degree in medical assisting a year ago. She now pays $95 a month toward $23,000 in student loan debt.

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Business December 22, 2008

More Firms Cut Labor Costs Without Layoffs By MATT RICHTEL Even as layoffs are reaching historic levels, some employers have found an alternative to slashing their work force. They’re nipping and tucking it instead. A growing number of employers, hoping to avoid or limit layoffs, are introducing four-day workweeks, unpaid vacations and voluntary or enforced furloughs, along with wage freezes, pension cuts and flexible work schedules. These employers are still cutting labor costs, but hanging onto the labor. And in some cases, workers are even buying in. Witness the unusual suggestion made in early December by the chairman of the faculty senate at Brandeis University, who proposed that the school’s 300 professors and instructors give up 1 percent of their pay. “What we are doing is a symbolic gesture that has real consequences — it can save a few jobs,” said William Flesch, the senate chairman and an English professor. He says more than 30 percent have volunteered for the pay cut, which could save at least $100,000 and prevent layoffs for at least several employees. “It’s not painless, but it is relatively painless and it could help some people,” he said. Some of these cooperative cost-cutting tactics are not entirely unique to this downturn. But the reasons behind the steps — and the rationale for the sharp growth in their popularity in just the last month — reflect the peculiarities of this recession, its sudden deepening and the changing dynamics of the global economy. Companies taking nips and tucks to their work force say this economy plunged so quickly in October that they do not want to prune too much should it just as suddenly roar back. They also say they have been so careful about hiring and spending in recent years — particularly in the last 12 months when nearly everyone sensed the country was in a recession — that highly productive workers, not slackers, remain on the payroll. At some companies, employees are supporting the indirect wage cuts — at least for now. The downturn hit so hard, with its toll felt so widely through hits on pensions and 401(k) retirement plans and with the future so murky, that employers and even some employees say it is better to accept minor cuts than risk more draconian steps. The rolls of companies nipping at labor costs with measures less drastic than wholesale layoffs include Dell (extended unpaid holiday), Cisco (four-day year-end shutdown), Motorola (salary cuts), Nevada casinos (four-day workweek), Honda (voluntary unpaid vacation time) and The Seattle Times (plans to save $1 million with a week of unpaid furlough for 500 workers). There are also many midsize and small companies trying such tactics.

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To be sure, these efforts are far less widespread than layoffs, and outright pay cuts still appear to be rare. Over all, the average hourly pay of rank-and-file workers — who make up about four-fifths of the work force — rose 3.7 percent from November 2007 to last month, according to the latest Labor Department data. Watson Wyatt, a consulting firm that tracks compensation trends, published survey data last week that found that 23 percent of companies planned layoffs in the next year, down from 26 percent that said they planned to do so in October. Companies say they are considering other cost cuts, like mandatory holiday shutdowns, salary freezes or cuts, four-day workweeks and reductions of contributions to retirement and health care plans. Companies seem particularly determined to find alternatives to layoffs in this recession, said Jennifer Chatman, a professor at the Haas School of Business at the University of California, Berkeley. “Organizations are trying to cut costs in the name of avoiding layoffs,” she said. “It’s not just that organizations are saying ‘we’re cutting costs,’ they’re saying: ‘we’re doing this to keep from losing people.’ ” She said the tactic builds long-term loyalty among workers who are not laid off and spares the company having to compete again to hire and train anew. That was part of the thinking at Global Tungsten & Powders, a metal plant in Towanda, Pa., whose business has dropped 25 percent from a year ago. The company has already cut overtime and travel, as well as purchases of office supplies and equipment. It is now allowing and indeed encouraging its 1,000 workers to take unpaid furloughs to stave off more drastic cuts. “We have a very skilled and competent work force and the last thing we want to do is lose them when we’re assuming this economy is going to come back,” said Craig Reider, the company’s director of human resources. Workers, he said, are buying in to the concept. “In this holiday season, many employees want to support our efforts here to minimize costs,” he said. In San Francisco, a Web design firm called Hot Studio laid off a handful of workers when the dot-com bubble burst in 2000. But the company’s owner, Maria Guidice, said the tactic was painful, and she did not want to repeat it. This time, her first step is to take away bonuses — for the first time in the company’s 12-year history — and instead give people paid time off over the holidays. “In 2000, it was like ‘cut the heads,’ ” she said of the ethos of the era. This time, she says, it feels different. “Our No. 1 priority is to keep people employed and to do that we’re going to bank the money and keep it for when we need it,” she said, adding, “I know some people are super bummed, but they understand we’re trying to keep the work force intact.” Several employees at Hot Studio said they did not mind the policy, particularly as they have heard of layoffs elsewhere in the economy. “People feel they’d much rather have a job in six months than get a bonus right now,” said Jon Littell, a Web designer. The magnanimous feeling will probably pass, said Truman Bewley, an economics professor at Yale University who has studied what happens to wages during a recession. If the sacrifices look as though they are going to continue for many months, he said, some workers will grow frustrated, want their full compensation back and may well prefer a layoff that creates a new permanence. “These are feel-good, temporary measures,” he said.

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But John Challenger, chief executive of Challenger, Gray & Christmas, a company that tracks layoffs, said employers were being driven now not by compassion but by hard calculations based on data they have never had before. More than ever, he said, companies have used technology to track employee performance and productivity, and in many cases they know that the workers they would cut are productive ones. “People are measured and ‘metricked’ to a much greater degree,” he said. “So companies know that when they’re cutting an already taut organization, they’re leaving big gaps in the work force.” At the Pretech Corporation, a concrete manufacturer in Kansas City, Kan., that has not had a layoff in 15 years, part of the rationale is pride. To keep the perfect track record, the company has cut overtime, traded a $5,000 holiday party for an employee-only barbecue lunch, and trimmed its pipe-making operation to four days from five, which allows it to save substantially on heating and electrical costs. Business is down sharply in some of the company’s divisions, but Pretech is also transforming to take on more work making concrete for infrastructure jobs, like the kind the government might support through stimulus efforts, the company’s co-owner, Bob Bundschuh, said. He said employees seemed to embrace the changes, knowing that a small sacrifice in overtime pay could preserve their job and the health insurance benefits that go with it. “We’re optimistic about the future,” he said, adding that he thought things could turn around in six months. If so, “We want our guys to stay around because they’re good guys and they work hard.” David Leonhardt contributed reporting.

readers' comments December 22, 2008 5:51 am Peter Drucker was famous for saying to companies to resort to layoffs as a last resort to downturns. Human capital is not readily developed and firms must be ready to respond when the economy turns around which it inevitably will. Discarding skills and knowledge is a short sighted strategy for business. — alberto, Calgary, AB

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Paradigm lost

ECONOMISTS MISSED THE BREWING CRISIS. NOW MANY ARE ASKING: HOW CAN WE DO BETTER? By Drake Bennett | December 21, 2008

THE DEEPENING ECONOMIC downturn has been hard on a lot of people, but it has been hard in a particular way for economists. For most of us, pain and apprehension have been mixed with a sense of grim amazement at the complexity of what has unfolded: the dense, invisible lattice connecting house prices to insurance companies to job losses to car sales, the inscrutability of the financial instruments that helped to spread the poison, the sense that the ratings agencies and regulatory bodies were overmatched by events, the wild gyrations of the stock market in the past few months. It's hard enough to understand what's happening, and it seems absurd to think we could have seen it coming beforehand. The vast majority of us, after all, are not experts. But academic economists are. And with very few exceptions, they did not predict the crisis, either. Some warned of a housing bubble, but almost none foresaw the resulting cataclysm. An entire field of experts dedicated to studying the behavior of markets failed to anticipate what may prove to be the biggest economic collapse of our lifetime. And, now that we're in the middle of it, many frankly admit that they're not sure how to prevent things from getting worse. As a result, there's a sense among some economists that, as they try to figure out how to fix the economy, they are also trying to fix their own profession. The discussion has played out in blog posts and opinion pieces, in congressional testimony and at conferences and in working papers. A field that has increasingly been defined, at least in the public eye, by quirky studies explaining the economics of our everyday lives - most famously in the best-selling book "Freakonomics" has turned decisively, in the last couple months, to more traditional economic turf. And at economics powerhouses like Harvard, MIT, and the University of Chicago, faculty lunch discussions that once might have centered on theoretical questions and the finer points of Bayesian analysis are now given over to dissecting bailout plans. Long-held ideas - about the stability of the business cycle, the resilience of markets, and the power of monetary policy - are being challenged. "Everyone that I know in economics, and particularly in the worlds of academic finance and academic macroeconomics, is going back to the drawing

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board," says David Laibson, a Harvard economist. "There are very, very, very few economists who can be proud." A few are suggesting, as well, that there are deeper problems in the discipline. Economists are asking aloud whether the field has grown too specialized, too abstract - and too divorced, in some sense, from the way real-world economies actually function. They argue that many of the models used to explain and predict the dynamics of financial markets or national economies have been scrubbed clean, in the interest of theoretical elegance, of the inevitable erraticism of human behavior. As a result, the analytical tools of the trade offer little help in a crisis, and have little to say about the sort of collapses that led to this one. "You can't just say, 'I have a model for tremors that works great, I just can't explain earthquakes,' " says Kenneth Rogoff, a Harvard economist who has studied financial crises. Historically, periods of severe economic distress have shaken up economics, and helped drive its evolution. And in the midst of the current crash, there is an urgent search for approaches and models that might better illuminate how to speed the recovery and forecast future meltdowns, and that might help us better understand the unruly flow of money. The question of how well economists can model crises takes on an even greater importance because of the central role economic experts will play in Barack Obama's administration - not only at the Federal Reserve, the Council of Economic Advisors, and the Treasury, but in the Economic Recovery Advisory Board, a newly formed body created by the president-elect and headed by former Federal Reserve chairman Paul Volcker. Obama has a reputation as someone who places a great deal of stock in expertise and the power of data. For better or worse, the evolving understanding of economic breakdowns will have ample opportunity to test itself against the real thing. Along with everything else they have done, the financial meltdown and attendant economic slump have spurred unprecedented political attention and participation on the part of economists. "In my lifetime as an economist I've never seen economists so engaged by what's going on," says Richard Thaler of the University of Chicago. "At the University of Chicago people always talk economics at lunch, but for the last three months they've all been talking about the crisis and the bailout, and writing op-eds." This is something of a change. The topics economists study often have little to do with the average person's economic life - as in most any academic field, practical relevance can have little to do with what questions are deemed most interesting and rewarding. This divergence was exacerbated, many economists say, during the span of almost uninterrupted economic growth that began in the late 1980s, a period when many of the more practical questions in economic policy-making came to be seen as having been settled. For years, leading economic figures like Larry

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Summers and Alan Greenspan argued that the United States had more or less brought the business cycle to heel. Partly as a result, many bright young economists turned to questions that were quirkier, or more purely mathematical. To the wider public, the most visible ramification of this was the boom in papers and books about the economics of everyday life - the best-known practitioner was Steven Levitt of the University of Chicago, but economists like Ray Fisman of Columbia, Edward Miguel of UC Berkeley, and Justin Wolfers of the University of Pennsylvania also worked at least partly in this vein. In often ingenious studies, they used economics as a forensic tool to examine family dynamics, speed-dating, parking scofflaws, basketball games, or the life choices of street criminals. For those who stayed on more traditional economic turf, however, the trend was toward narrower questions, and more abstract ones. Financial economists set out to figure out why it is that stocks earn more than bonds, or to devise better ways of calculating "beta," the correlation between the price of a single asset and the price of the market it was part of. Others took on the surprisingly difficult question of defining what, exactly, money is. Wolfers, being an economist, describes these intellectually challenging but less policy-relevant questions as a sort of scholarly "luxury good." "During good times we all consume more luxuries," he says, "but during a bad economy, it feels to macroeconomists that what we should be doing is stuff to help today." Some economists have suggested that this focus may account for why so many failed to see the warning signs of the financial crisis, and to predict the size and scope of its fallout. Others see a broader problem in that the sort of behavior we've seen in everyone from home buyers to investment bankers in recent months is hard to fit into economists' analytical tools. The models that macroeconomists - those who study national and regional economies in their entirety - rely on do a poor job of describing the messiness of an actual market in flux. Many, for example, only have one variable for an interest rate, even though in times of economic turmoil the gap between various rates often widens so far that it's difficult to say what "the" interest rate actually is. As a result, economists end up oversimplifying such situations when they model them - or simply avoid studying them at all. "We have a very restrictive set of language and tools, and we tend to work on the problems that are easily addressed with those tools," says Jeremy Stein, a financial economist at Harvard. "Sometimes that means we focus on silly questions and ignore greater ones." Today there is a move to hone and rethink the models that describe the huge interlocking wheels of the economy, and to find a way to include the human tendencies that can bring them grinding to a halt. Some economists are looking to the methods and findings of psychology, others are applying themselves to 137

the tricky task of modeling bubbles, a relatively neglected topic. Whatever the approach, the study of financial crises is likely to be a predominant question for the newest generation of economists. "I guarantee that over the next couple of years you are going to see lots of papers on banking crises and financial blowups," says Andrew Lo, a financial economist at MIT's Sloan School of Management. In addition, others predict, there's likely to be a sharp migration among young economists into these fields. "Banking has been an incredibly important field that has not been hot for some time," says Edward Glaeser, a Harvard University economist. "What's happened is that banking is sexy again." Already, the crisis is reshaping long-running debates. It has chastened believers in the self-correcting abilities of the free market - Alan Greenspan said as much before Congress in October - and emboldened those who see the need for more active government intervention. In a sense, it's a debate that has been seesawing back and forth from crisis to crisis over the past century. Classical economics was devastated by the Great Depression, and in the years afterward gave way to the ideas of the British economist John Maynard Keynes: that individually rational economic decisions could add up to collectively disastrous consequences, that the "stickiness" of prices and wages could lead to long-term unemployment and stagnation, and that the government, as a result, has to step in to kick-start the economy. The stagflation of the 1970s, while mild compared with the Depression, swung the pendulum back. It was Milton Friedman, a sharp critic of Keynesianism and a fervent advocate of unfettered free markets, who solved the seeming paradox of simultaneous inflation and high unemployment by realizing the deadening power of people's expectation of future inflation, and it was Friedman's proposed solution sharply restricting the money supply - that eventually, albeit painfully, solved the problem. Today's crisis has brought Keynes back to the center of the discussion, but some economists also see it driving the field into new territory. Up until very recently, the study of market bubbles was marginalized - there was no widely accepted definition of what a bubble was, and some economists, believers in the complete rationality of markets, argued that bubbles didn't even exist. Today, however, there is a growing sense that understanding bubbles is vital to understanding markets - among those making the case is Federal Reserve chairman Ben Bernanke, who, as head of the Princeton economics department, made a point of hiring young economists interested in the topic. Over the same time period, the field of so-called behavioral economics has risen to prominence, led by, among others, Thaler, Laibson, and Robert Shiller, a Yale economist who warned of both the housing bubble and, in 2000, the dot-com bubble. By borrowing the insights and methods of psychology, 138

behavioral economics focuses on all the ways in which humans fail to act as the rational, self-interested beings that economic models call for - we aren't good at thinking about the future, we're susceptible to peer pressure, we overestimate our abilities and underrate the odds of bad things happening. It's a set of traits that describes perfectly the behavior of many of the people who, in a cascade of selfdefeating decisions, helped create the subprime crisis. "People used to think that these behavioral effects were small anomalies that turned up in experiments but washed out in the real world," says Tyler Cowen, an economist at George Mason University not himself affiliated with behavioral economics. "But there's a sense in which they get multiplied in the real world." For now, behavioral economics remains a critique without a real alternative. That may be starting to change: Lo has developed what he calls the "adaptive markets hypothesis," a model that he argues reflects both the rationality of the investor in good times and the blind panic of the bad. Nonetheless, for some economists, the lessons of the crisis are likely to be smaller, though no less humbling. These scholars argue that they're facing not a new challenge but a familiar nemesis. "What we're experiencing now is a good old-fashioned financial panic," says Jeffrey Kling, an economist at the Brookings Institution. "This is perhaps the biggest scale, but on some level it's not that different." Robert Lucas, an economist and Nobel laureate at the University of Chicago and a champion of the rationality of markets, doesn't see much fundamental change coming out of the crisis, either. What it has reminded us of, he argues, is simply the impossibility of seeing these events in advance. "I don't know anybody involved who thought he could predict these turning points. Do macroeconomists know as much as we thought we did?" he asks. "Of course not." By this logic, the problem isn't how economists see the world so much as it is what we expect of economics. Laurence Ball, an economist at Johns Hopkins, makes a similar point. "Nobody ever sees anything coming," he says. "Nobody saw stagflation coming, nobody saw the Great Depression coming, nobody saw Pearl Harbor or 9/11 coming. Really big, bad things tend to be surprises." Drake Bennett is the staff writer for Ideas. E-mail [email protected]. http://www.boston.com/bostonglobe/ideas/articles/2008/12/21/paradigm_lost /

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Business December 21, 2008

The Reckoning

White House Philosophy Stoked Mortgage Bonfire By JO BECKER, SHERYL GAY STOLBERG and STEPHEN LABATON

Rich Addicks/Atlanta Journal-Constitution THE BLUEPRINTS In June 2002, President Bush spoke in Atlanta to unveil a plan to increase minority homeownership.

“We can put light where there’s darkness, and hope where there’s despondency in this country. And part of it is working together as a nation to encourage folks to own their own home.” — President Bush, Oct. 15, 2002 WASHINGTON — The global financial system was teetering on the edge of collapse when President Bush and his economics team huddled in the Roosevelt Room of the White House for a briefing that, in the words of one participant, “scared the hell out of everybody.” It was Sept. 18. Lehman Brothers had just gone belly-up, overwhelmed by toxic mortgages. Bank of America had swallowed Merrill Lynch in a hastily arranged sale. Two days earlier, Mr. Bush had agreed to pump $85 billion into the failing insurance giant American International Group.

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The president listened as Ben S. Bernanke, chairman of the Federal Reserve, laid out the latest terrifying news: The credit markets, gripped by panic, had frozen overnight, and banks were refusing to lend money. Then his Treasury secretary, Henry M. Paulson Jr., told him that to stave off disaster, he would have to sign off on the biggest government bailout in history. Mr. Bush, according to several people in the room, paused for a single, stunned moment to take it all in. “How,” he wondered aloud, “did we get here?” Eight years after arriving in Washington vowing to spread the dream of homeownership, Mr. Bush is leaving office, as he himself said recently, “faced with the prospect of a global meltdown” with roots in the housing sector he so ardently championed. There are plenty of culprits, like lenders who peddled easy credit, consumers who took on mortgages they could not afford and Wall Street chieftains who loaded up on mortgagebacked securities without regard to the risk. But the story of how we got here is partly one of Mr. Bush’s own making, according to a review of his tenure that included interviews with dozens of current and former administration officials. From his earliest days in office, Mr. Bush paired his belief that Americans do best when they own their own home with his conviction that markets do best when let alone. He pushed hard to expand homeownership, especially among minorities, an initiative that dovetailed with his ambition to expand the Republican tent — and with the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards. Mr. Bush did foresee the danger posed by Fannie Mae and Freddie Mac, the governmentsponsored mortgage finance giants. The president spent years pushing a recalcitrant Congress to toughen regulation of the companies, but was unwilling to compromise when his former Treasury secretary wanted to cut a deal. And the regulator Mr. Bush chose to oversee them — an old prep school buddy — pronounced the companies sound even as they headed toward insolvency. As early as 2006, top advisers to Mr. Bush dismissed warnings from people inside and outside the White House that housing prices were inflated and that a foreclosure crisis was looming. And when the economy deteriorated, Mr. Bush and his team misdiagnosed the reasons and scope of the downturn; as recently as February, for example, Mr. Bush was still calling it a “rough patch.” The result was a series of piecemeal policy prescriptions that lagged behind the escalating crisis. “There is no question we did not recognize the severity of the problems,” said Al Hubbard, Mr. Bush’s former chief economics adviser, who left the White House in December 2007. “Had we, we would have attacked them.” Looking back, Keith B. Hennessey, Mr. Bush’s current chief economics adviser, says he and his colleagues did the best they could “with the information we had at the time.” But Mr. Hennessey did say he regretted that the administration did not pay more heed to the dangers of easy lending practices. And both Mr. Paulson and his predecessor, John W. Snow, say the housing push went too far.

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“The Bush administration took a lot of pride that homeownership had reached historic highs,” Mr. Snow said in an interview. “But what we forgot in the process was that it has to be done in the context of people being able to afford their house. We now realize there was a high cost.” For much of the Bush presidency, the White House was preoccupied by terrorism and war; on the economic front, its pressing concerns were cutting taxes and privatizing Social Security. The housing market was a bright spot: ever-rising home values kept the economy humming, as owners drew down on their equity to buy consumer goods and pack their children off to college. Lawrence B. Lindsay, Mr. Bush’s first chief economics adviser, said there was little impetus to raise alarms about the proliferation of easy credit that was helping Mr. Bush meet housing goals. “No one wanted to stop that bubble,” Mr. Lindsay said. “It would have conflicted with the president’s own policies.” Today, millions of Americans are facing foreclosure, homeownership rates are virtually no higher than when Mr. Bush took office, Fannie and Freddie are in a government conservatorship, and the bailout cost to taxpayers could run in the trillions. As the economy has shed jobs — 533,000 last month alone — and his party has been punished by irate voters, the weakened president has granted his Treasury secretary extraordinary leeway in managing the crisis. Never once, Mr. Paulson said in a recent interview, has Mr. Bush overruled him. “I’ve got a boss,” he explained, who “understands that when you’re dealing with something as unprecedented and fast-moving as this we need to have a different operating style.” Mr. Paulson and other senior advisers to Mr. Bush say the administration has responded well to the turmoil, demonstrating flexibility under difficult circumstances. “There is not any playbook,” Mr. Paulson said. The president declined to be interviewed for this article. But in recent weeks Mr. Bush has shared his views of how the nation came to the brink of economic disaster. He cites corporate greed and market excesses fueled by a flood of foreign cash — “Wall Street got drunk,” he has said — and the policies of past administrations. He blames Congress for failing to reform Fannie and Freddie. Last week, Fox News asked Mr. Bush if he was worried about being the Herbert Hoover of the 21st century. “No,” Mr. Bush replied. “I will be known as somebody who saw a problem and put the chips on the table to prevent the economy from collapsing.” But in private moments, aides say, the president is looking inward. During a recent ride aboard Marine One, the presidential helicopter, Mr. Bush sounded a reflective note. “We absolutely wanted to increase homeownership,” Tony Fratto, his deputy press secretary, recalled him saying. “But we never wanted lenders to make bad decisions.” A Policy Gone Awry Darrin West could not believe it. The president of the United States was standing in his living room. It was June 17, 2002, a day Mr. West recalls as “the highlight of my life.” Mr. Bush, in Atlanta to unveil a plan to increase the number of minority homeowners by 5.5 million, was

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touring Park Place South, a development of starter homes in a neighborhood once marked by blight and crime. Mr. West had patrolled there as a police officer, and now he was the proud owner of a $130,000 town house, bought with an adjustable-rate mortgage and a $20,000 government loan as his down payment — just the sort of creative public-private financing Mr. Bush was promoting. “Part of economic security,” Mr. Bush declared that day, “is owning your own home.” A lot has changed since then. Mr. West, beset by personal problems, left Atlanta. Unable to sell his home for what he owed, he said, he gave it back to the bank last year. Like other communities across America, Park Place South has been hit with a foreclosure crisis affecting at least 10 percent of its 232 homes, according to Masharn Wilson, a developer who led Mr. Bush’s tour. “I just don’t think what he envisioned was actually carried out,” she said. Park Place South is, in microcosm, the story of a well-intentioned policy gone awry. Advocating homeownership is hardly novel; the Clinton administration did it, too. For Mr. Bush, it was part of his vision of an “ownership society,” in which Americans would rely less on the government for health care, retirement and shelter. It was also good politics, a way to court black and Hispanic voters. But for much of Mr. Bush’s tenure, government statistics show, incomes for most families remained relatively stagnant while housing prices skyrocketed. That put homeownership increasingly out of reach for first-time buyers like Mr. West. So Mr. Bush had to, in his words, “use the mighty muscle of the federal government” to meet his goal. He proposed affordable housing tax incentives. He insisted that Fannie Mae and Freddie Mac meet ambitious new goals for low-income lending. Concerned that down payments were a barrier, Mr. Bush persuaded Congress to spend up to $200 million a year to help first-time buyers with down payments and closing costs. And he pushed to allow first-time buyers to qualify for federally insured mortgages with no money down. Republican Congressional leaders and some housing advocates balked, arguing that homeowners with no stake in their investments would be more prone to walk away, as Mr. West did. Many economic experts, including some in the White House, now share that view. The president also leaned on mortgage brokers and lenders to devise their own innovations. “Corporate America,” he said, “has a responsibility to work to make America a compassionate place.” And corporate America, eyeing a lucrative market, delivered in ways Mr. Bush might not have expected, with a proliferation of too-good-to-be-true teaser rates and interest-only loans that were sold to investors in a loosely regulated environment. “This administration made decisions that allowed the free market to operate as a barroom brawl instead of a prize fight,” said L. William Seidman, who advised Republican presidents and led the savings and loan bailout in the 1990s. “To make the market work well, you have to have a lot of rules.” But Mr. Bush populated the financial system’s alphabet soup of oversight agencies with people who, like him, wanted fewer rules, not more. Like Minds on Laissez-Faire

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The president’s first chairman of the Securities and Exchange Commission promised a “kinder, gentler” agency. The second was pushed out amid industry complaints that he was too aggressive. Under its current leader, the agency failed to police the catastrophic decisions that toppled the investment bank Bear Stearns and contributed to the current crisis, according to a recent inspector general’s report. As for Mr. Bush’s banking regulators, they once brandished a chain saw over a 9,000-page pile of regulations as they promised to ease burdens on the industry. When states tried to use consumer protection laws to crack down on predatory lending, the comptroller of the currency blocked the effort, asserting that states had no authority over national banks. The administration won that fight at the Supreme Court. But Roy Cooper, North Carolina’s attorney general, said, “They took 50 sheriffs off the beat at a time when lending was becoming the Wild West.” The president did push rules aimed at forcing lenders to more clearly explain loan terms. But the White House shelved them in 2004, after industry-friendly members of Congress threatened to block confirmation of his new housing secretary. In the 2004 election cycle, mortgage bankers and brokers poured nearly $847,000 into Mr. Bush’s re-election campaign, more than triple their contributions in 2000, according to the nonpartisan Center for Responsive Politics. The administration did not finalize the new rules until last month. Among the Republican Party’s top 10 donors in 2004 was Roland Arnall. He founded Ameriquest, then the nation’s largest lender in the subprime market, which focuses on less creditworthy borrowers. In July 2005, the company agreed to set aside $325 million to settle allegations in 30 states that it had preyed on borrowers with hidden fees and ballooning payments. It was an early signal that deceptive lending practices, which would later set off a wave of foreclosures, were widespread. Andrew H. Card Jr., Mr. Bush’s former chief of staff, said White House aides discussed Ameriquest’s troubles, though not what they might portend for the economy. Mr. Bush had just nominated Mr. Arnall as his ambassador to the Netherlands, and the White House was primarily concerned with making sure he would be confirmed. “Maybe I was asleep at the switch,” Mr. Card said in an interview. Brian Montgomery, the Federal Housing Administration commissioner, understood the significance. His agency insures home loans, traditionally for the same low-income minority borrowers Mr. Bush wanted to help. When he arrived in June 2005, he was shocked to find those customers had been lured away by the “fool’s gold” of subprime loans. The Ameriquest settlement, he said, reinforced his concern that the industry was exploiting borrowers. In December 2005, Mr. Montgomery drafted a memo and brought it to the White House. “I don’t think this is what the president had in mind here,” he recalled telling Ryan Streeter, then the president’s chief housing policy analyst. It was an opportunity to address the risky subprime lending practices head on. But that was never seriously discussed. More senior aides, like Karl Rove, Mr. Bush’s chief political strategist, were wary of overly regulating an industry that, Mr. Rove said in an interview, provided “a valuable service to people who could not otherwise get credit.” While he had some concerns about the industry’s practices, he said, “it did provide an opportunity for people, a lot of whom are still in their houses today.”

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The White House pursued a narrower plan offered by Mr. Montgomery that would have allowed the F.H.A. to loosen standards so it could lure back subprime borrowers by insuring similar, but safer, loans. It passed the House but died in the Senate, where Republican senators feared that the agency would merely be mimicking the private sector’s risky practices — a view Mr. Rove said he shared. Looking back at the episode, Mr. Montgomery broke down in tears. While he acknowledged that the bill did not get to the root of the problem, he said he would “go to my grave believing” that at least some homeowners might have been spared foreclosure. Today, administration officials say it is fair to ask whether Mr. Bush’s ownership push backfired. Mr. Paulson said the administration, like others before it, “over-incented housing.” Mr. Hennessey put it this way: “I would not say too much emphasis on expanding homeownership. I would say not enough early focus on easy lending practices.” ‘We Told You So’ Armando Falcon Jr. was preparing to take on a couple of giants. A soft-spoken Texan, Mr. Falcon ran the Office of Federal Housing Enterprise Oversight, a tiny government agency that oversaw Fannie Mae and Freddie Mac, two pillars of the American housing industry. In February 2003, he was finishing a blockbuster report that warned the pillars could crumble. Created by Congress, Fannie and Freddie — called G.S.E.’s, for government-sponsored entities — bought trillions of dollars’ worth of mortgages to hold or sell to investors as guaranteed securities. The companies were also Washington powerhouses, stuffing lawmakers’ campaign coffers and hiring bare-knuckled lobbyists. Mr. Falcon’s report outlined a worst-case situation in which Fannie and Freddie could default on debt, setting off “contagious illiquidity in the market” — in other words, a financial meltdown. He also raised red flags about the companies’ soaring use of derivatives, the complex financial instruments that economic experts now blame for spreading the housing collapse. Today, the White House cites that report — and its subsequent effort to better regulate Fannie and Freddie — as evidence that it foresaw the crisis and tried to avert it. Bush officials recently wrote up a talking points memo headlined “G.S.E.’s — We Told You So.” But the back story is more complicated. To begin with, on the day Mr. Falcon issued his report, the White House tried to fire him. At the time, Fannie and Freddie were allies in the president’s quest to drive up homeownership rates; Franklin D. Raines, then Fannie’s chief executive, has fond memories of visiting Mr. Bush in the Oval Office and flying aboard Air Force One to a housing event. “They loved us,” he said. So when Mr. Falcon refused to deep-six his report, Mr. Raines took his complaints to top Treasury officials and the White House. “I’m going to do what I need to do to defend my company and my position,” Mr. Raines told Mr. Falcon. Days later, as Mr. Falcon was in New York preparing to deliver a speech about his findings, his cellphone rang. It was the White House personnel office, he said, telling him he was about to be unemployed. His warnings were buried in the next day’s news coverage, trumped by the White House announcement that Mr. Bush would replace Mr. Falcon, a Democrat appointed by Bill

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Clinton, with Mark C. Brickell, a leader in the derivatives industry that Mr. Falcon’s report had flagged. It was not until 2003, when Freddie became embroiled in an accounting scandal, that the White House took on the companies in earnest. Mr. Bush decided to quit the long-standing practice of rewarding supporters with high-paying appointments to the companies’ boards — “political plums,” in Mr. Rove’s words. He also withdrew Mr. Brickell’s nomination and threw his support behind Mr. Falcon, beginning an intense effort to give his little regulatory agency more power. Mr. Falcon lacked explicit authority to limit the size of the companies’ mammoth investment portfolios, or tell them how much capital they needed to guard against losses. White House officials wanted that to change. They also wanted the power to put the companies into receivership, hoping that would end what Mr. Card, the former chief of staff, called “the myth of government backing,” which gave the companies a competitive edge because investors assumed the government would not let them fail. By the spring of 2005 a deal with Congress seemed within reach, Mr. Snow, the former Treasury secretary, said in an interview. Michael G. Oxley, an Ohio Republican and then-chairman of the House Financial Services Committee, had produced what Mr. Snow viewed as “a pretty darned good bill,” a watereddown version of what the president sought. But at the urging of Mr. Card and the White House economics team, the president decided to hold out for a tougher bill in the Senate. Mr. Card said he feared that Mr. Snow was “more interested in the deal than the result.” When the bill passed the House, the president issued a statement opposing it, effectively killing any chance of compromise. Mr. Oxley was furious. “The problem with those guys at the White House, they had all the answers and they didn’t think they had to listen to anyone, including the Treasury secretary,” Mr. Oxley said in a recent interview. “They were driving the ideological train. He was in the caboose, and they were in the engine room.” Mr. Card and Mr. Hennessey said they had no regrets. They are convinced, Mr. Hennessey said, that the Oxley bill would have produced “the worst of all possible outcomes,” the illusion of reform without the substance. Still, some former White House and Treasury officials continue to debate whether Mr. Bush’s all-or-nothing approach scuttled a measure that, while imperfect, might have given an aggressive regulator enough power to keep the companies from failing. Mr. Snow, for one, calls Mr. Oxley “a hero,” adding, “He saw the need to move. It didn’t get done. And it’s too bad, because I think if it had, I think we could well have avoided a big contributor to the current crisis.” Unheeded Warnings Jason Thomas had a nagging feeling. The New Century Financial Corporation, a huge subprime lender whose mortgages were bundled into securities sold around the world, was headed for bankruptcy in March 2007. Mr. Thomas, an economic analyst for President Bush, was responsible for determining whether it was a hint of things to come. At 29, Mr. Thomas had followed a fast-track career path that took him from a Buffalo meatpacking plant, where he worked as a statistician, to the White House. He was seen as a whiz kid, “a brilliant guy,” his former boss, Mr. Hubbard, says. 146

As Mr. Thomas began digging into New Century’s failure that spring, he became fixated on a particular statistic, the rent-to-own ratio. Typically, as home prices increase, rental costs rise proportionally. But Mr. Thomas sent charts to top White House and Treasury officials showing that the monthly cost of owning far outpaced the cost to rent. To Mr. Thomas, it was a sign that housing prices were wildly inflated and bound to plunge, a condition that could set off a foreclosure crisis as conventional and subprime borrowers with little equity found they owed more than their houses were worth. It was not the Bush team’s first warning. The previous year, Mr. Lindsay, the former chief economics adviser, returned to the White House to tell his old colleagues that housing prices were headed for a crash. But housing values are hard to evaluate, and Mr. Lindsay had a reputation as a market pessimist, said Mr. Hubbard, adding, “I thought, ‘He’s always a bear.’ ” In retrospect, Mr. Hubbard said, Mr. Lindsay was “absolutely right,” and Mr. Thomas’s charts “should have been a signal.” Instead, the prevailing view at the White House was that the problems in the housing market were limited to subprime borrowers unable to make their payments as their adjustable mortgages reset to higher rates. That belief was shared by Mr. Bush’s new Treasury secretary, Mr. Paulson. Mr. Paulson, a former chairman of the Wall Street firm Goldman Sachs, had been given unusual power; he had accepted the job only after the president guaranteed him that Treasury, not the White House, would have the dominant role in shaping economic policy. That shift merely continued an imbalance of power that stifled robust policy debate, several former Bush aides say. Throughout the spring of 2007, Mr. Paulson declared that “the housing market is at or near the bottom,” with the problem “largely contained.” That position underscored nearly every action the Bush administration took in the ensuing months as it offered one limited response after another. By that August, the problems had spread beyond New Century. Credit was tightening, amid questions about how heavily banks were invested in securities linked to mortgages. Still, Mr. Bush predicted that the turmoil would resolve itself with a “soft landing.” The plan Mr. Bush announced on Aug. 31 reflected that belief. Called “F.H.A. Secure,” it aimed to help about 80,000 homeowners refinance their loans. Mr. Montgomery, the housing commissioner, said that he knew the modest program was not enough — the White House later expanded the agency’s rescue role — and that he would be “flying the plane and fixing it at the same time.” That fall, Representative Rahm Emanuel, a leading Democrat, former investment banker and now the incoming chief of staff to President-elect Barack Obama, warned the White House it was not doing enough. He said he told Joshua B. Bolten, Mr. Bush’s chief of staff, and Mr. Paulson in a series of phone calls that the credit crisis would get “deep and serious” and that the only answer was big, internationally coordinated government intervention. “You got to strangle this thing and suffocate it,” he recalled saying. Instead, Mr. Bush developed Hope Now, a voluntary public-private partnership to help struggling homeowners refinance loans. And he worked with Congress to pass a stimulus package that sent taxpayers $150 billion in tax rebates. In a speech to the Economic Club of New York in March 2008, he cautioned against Washington’s temptation “to say that anything short of a massive government intervention in

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the housing market amounts to inaction,” adding that government action could make it harder for the markets to recover. Dominoes Start to Fall Within days, Bear Sterns collapsed, prompting the Federal Reserve to engineer a hasty sale. Some economic experts, including Timothy F. Geithner, the president of the New York Federal Reserve Bank (and Mr. Obama’s choice for Treasury secretary) feared that Fannie Mae and Freddie Mac could be the next to fall. Mr. Bush was still leaning on Congress to revamp the tiny agency that oversaw the two companies, and had acceded to Mr. Paulson’s request for the negotiating room that he had denied Mr. Snow. Still, there was no deal. Over the previous two years, the White House had effectively set the agency adrift. Mr. Falcon left in 2005 and was replaced by a temporary director, who was in turn replaced by James B. Lockhart, a friend of Mr. Bush from their days at Andover, and a former deputy commissioner of the Social Security Administration who had once run a software company. On Mr. Lockhart’s watch, both Freddie and Fannie had plunged into the riskiest part of the market, gobbling up more than $400 billion in subprime and other alternative mortgages. With the companies on precarious footing, Mr. Geithner had been advocating that the administration seize them or take other steps to reassure the market that the government would back their debt, according to two people with direct knowledge of his views. In an Oval Office meeting on March 17, however, Mr. Paulson barely mentioned the idea, according to several people present. He wanted to use the troubled companies to unlock the frozen credit market by allowing Fannie and Freddie to buy more mortgage-backed securities from overburdened banks. To that end, Mr. Lockhart’s office planned to lift restraints on the companies’ huge portfolios — a decision derided by former White House and Treasury officials who had worked so hard to limit them. But Mr. Paulson told Mr. Bush the companies would shore themselves up later by raising more capital. “Can they?” Mr. Bush asked. “We’re hoping so,” the Treasury secretary replied. That turned out to be incorrect, and did not surprise Mr. Thomas, the Bush economic adviser. Throughout that spring and summer, he warned the White House and Treasury that, in the stark words of one e-mail message, “Freddie Mac is in trouble.” And Mr. Lockhart, he charged, was allowing the company to cover up its insolvency with dubious accounting maneuvers. But Mr. Lockhart continued to offer reassurances. In a July appearance on CNBC, he declared that the companies were well managed and “worsts were not coming to worst.” An infuriated Mr. Thomas sent a fresh round of e-mail messages accusing Mr. Lockhart of “pimping for the stock prices of the undercapitalized firms he regulates.” Mr. Lockhart defended himself, insisting in an interview that he was aware of the companies’ vulnerabilities, but did not want to rattle markets. “A regulator,” he said, “does not air dirty laundry in public.” Soon afterward, the companies’ stocks lost half their value in a single day, prompting Congress to quickly give Mr. Paulson the power to spend $200 billion to prop them up and to

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finally pass Mr. Bush’s long-sought reform bill, but it was too late. In September, the government seized control of Freddie Mac and Fannie Mae. In an interview, Mr. Paulson said the administration had no justification to take over the companies any sooner. But Mr. Falcon disagreed: “They absolutely could have if they had thought there was a real danger.” By Sept. 18, when Mr. Bush and his team had their fateful meeting in the Roosevelt Room after the failure of Lehman Brothers and the emergency rescue of A.I.G., Mr. Paulson was warning of an economic calamity greater than the Great Depression. Suddenly, historic government intervention seemed the only option. When Mr. Paulson spelled out what would become a $700 billion plan to rescue the nation’s banking system, the president did not hesitate. “Is that enough?” Mr. Bush asked. “It’s a lot,” the Treasury secretary recalled replying. “It will make a difference.” And in any event, he told Mr. Bush, “I don’t think we can get more.” As the meeting wrapped up, a handful of aides retreated to the White House Situation Room to call Vice President Dick Cheney in Florida, where he was attending a fund-raiser. Mr. Cheney had long played a leading role in economic policy, though housing was not a primary interest, and like Mr. Bush he had a deep aversion to government intervention in the market. Nonetheless, he backed the bailout, convinced that too many Americans would suffer if Washington did nothing. Mr. Bush typically darts out of such meetings quickly. But this time, he lingered, patting people on the back and trying to soothe his downcast staff. “During times of adversity, he bucks everybody up,” Mr. Paulson said. It was not the end of the failures or government interventions; the administration has since stepped in to rescue Citigroup and, just last week, the Detroit automakers. With 31 days left in office, Mr. Bush says he will leave it to historians to analyze “what went right and what went wrong,” as he put it in a speech last week to the American Enterprise Institute. Mr. Bush said he was too focused on the present to do much looking back. “It turns out,” he said, “this isn’t one of the presidencies where you ride off into the sunset, you know, kind of waving goodbye.” Kitty Bennett contributed reporting.

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REPORTAJE: EMPRESAS & SECTORES

El gran bocado de Campofrío Nace la primera cárnica europea bajo la batuta de Pedro Ballvé SANTIAGO HERNÁNDEZ 21/12/2008 Campofrío Food Group inició el pasado martes su actividad como líder europeo de preparados cárnicos tras la fusión de Campofrío y Groupe Smithfield. Pedro Ballvé, impulsor de Campofrío, empresa familiar burgalesa que creara su padre, ha logrado sacar adelante una nueva fusión, esta vez con dimensión europea. "Campofrío Food Group es el producto de la visión compartida de dos empresas que son muy complementarias en términos de presencia geográfica, conocimiento, marcas y productos", afirma un Pedro Ballvé pletórico que será el presidente ejecutivo y que, junto con su hermano Fernando, controla el 12% de la nueva empresa. Ballvé considera que es el momento adecuado para buscar una nueva dimensión y "el hecho de que Smithfield estuviera en el capital de Campofrío ha sido un elemento activador de la operación". Campofrío ya pilotó en el año 2000 una fusión de cuatro empresas nacionales: Campofrío, Navidul, Oscar Mayer y Revilla. Era una fusión que contaba con grandes solapamientos, justo lo contrario de la fusión que, en opinión de Ballvé, es una unión "en la que todo es sumar por las grandes complementariedades". La empresa que acaba de nacer es líder de mercado en España, Francia, Portugal y Holanda, y cuenta con una destacada presencia en Rumania, Alemania, Reino Unido, Italia y Bélgica. "Nosotros creemos que esta empresa puede alcanzar sinergias desde ahora mismo y nos hemos propuesto alcanzar los 40 millones de euros en el año 2012", dice Ballvé. Según el actual presidente, el grupo cárnico va a trabajar de forma descentralizada y los distintos países tendrán un alto grado de autonomía, aunque vamos a contar con unos servicios centrales corporativos que buscarán continuamente la eficiencia. Cuando se le pregunta a Pedro Ballvé si estamos ante una fusión defensiva para ganar tamaño y cubrirse ante los esperados movimientos de fusión en el sector en Europa, salta como un resorte. "Para nada. Todo lo contrario, es una fusión de oportunidad que permite dotarse del músculo, la productividad necesaria y la fuerza de ventas para cuando cambie el ciclo económico". En Campofrío Food Group es plenamente consciente de que el mercado no crecerá a corto plazo por la crisis económica y de consumo, y que el reto a corto plazo es ajustar los costes para salir con mayor velocidad cuando el mercado cambie de tendencia, hecho que sucederá, en cálculos de Ballvé, hacia la mitad del año 2010. La nueva empresa tendrá su sede social en España y cotizará en el mercado español. Por debajo del presidente ejecutivo estará un consejero delegado, Robert Sharpe, que será consejero de Campofrío, y conoce el mercado porque ocupaba este puesto en Smithfield. Yiannis Petrides, que era consejero independiente de Campofrío desde 2005, ocupará la vicepresidencia de la nueva sociedad, que presentará ya a final de 2008 su primer ejercicio económico como empresa fusionada. "Siempre he sido defensor del talento en las empresas y creo que las dos compañías que ahora se fusionan cuentan en este sentido con unos equipos que son capaces de analizar y adelantarse a las tendencias de consumo, un elemento estratégico para las empresas de nuestro

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ramo", recalca Ballvé, para quien también cuentan con una gran relación con la distribución, acrecentada por su liderazgo en el sector cárnico. El máximo responsable de Campofrío Food Group reconoce que la economía española y la europea se hallan en crisis y rozan la recesión, pero esta realidad es pasajera. "Yo ya he vivido otras crisis de consumo, aunque no tan global como ésta, y hay que pensar que la recesión es un momento del ciclo económico y como tal hay que entenderlo", matiza Ballvé. El mercado objetivo de la nueva compañía lo componen los 27 países de la Unión Europea, y de hecho, el propio Ballvé afirma que la retirada del mercado ruso se produjo cuando ya se sabía que se fusionaría con Smithfield, aunque el mercado no comparte esta idea. "Afortunadamente, no tenemos que vender pisos. La alimentación es un sector que tiene un comportamiento menos malo en momentos como los actuales, aunque, evidentemente, el miedo a la crisis retrae el consumo de las familias. Además, es cierto que esta crisis se está cebando en algunos colectivos como los emigrantes, que son potenciales clientes, pero creo que, si aguantamos los 18 meses que puede durar la actual anemia del consumo e invertimos en eficiencia, podremos salir muy reforzados", resume Ballvé. La primera reunión del consejo de Campofrío Food Group del pasado día 17 de diciembre nombró el primer nivel de gestión y en las próximas semanas se irán nombrando los cuadros medios. Posteriormente se diseñará un plan estratégico que siente las bases para el crecimiento de la primera empresa cárnica europea y una de las cinco primeras del mundo. Las 11.000 personas que componen el equipo humano son para Ballvé el principal activo de una empresa que sumó en 2007 unas ventas de 2.100 millones. -

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401(k)'s and Similar Plans December 21, 2008

In Need of Cash, More Companies Cut 401(k) Match By MARY WILLIAMS WALSH and TARA SIEGEL BERNARD Companies eager to conserve cash are trimming their contributions to their workers’ 401(k) retirement plans, putting a new strain on America’s tattered safety net at the very moment when many workers are watching their accounts plummet along with the stock market.

When the FedEx Corporation slimmed down its pension plan last year, it softened the blow by offering workers enriched 401(k) contributions to make up for the pension benefits some would lose. But last week, with Americans sending fewer parcels and FedEx’s revenue growth at a standstill, the company said it would suspend all of its contributions for at least a year. “We will have to work more years and retire with less money,” said Lee Higham, a 44-yearold senior aircraft mechanic at FedEx, who has worked there for 20 years. “That’s what we are up against now.” FedEx is not the only one. Eastman Kodak, Motorola, General Motors and Resorts International are among the companies that have cut matching contributions to their plans since September, when the credit markets froze and companies began looking urgently for 152

cash. More companies are expected to suspend their matching contributions in 2009, according to Watson Wyatt, a benefits consulting firm. For workers, the loss of a matching contribution heightens the pain of a retirement account balance shriveling away because of the plunging stocks markets. “We are taking a beating,” said another FedEx mechanic, Rafael Garcia. “In a year, I lost $60,000 of my 401(k). You can’t make that up.” To many retirement policy specialists, the lost contributions are one more sign of America’s failure as a society to face up to the graying of the population and the profound economic forces it will unleash. Traditional pensions are disappearing, and Washington has yet to ensure that Social Security will remain solvent as baby boomers retire and more workers are needed to support each retiree. The company cutbacks may mean that some employees put less money into their retirement accounts. Even if they do not, the cuts, while temporary, will have a permanent effect by costing many workers years of future compounding on the missed contributions. No one knows how long credit will remain scarce for companies, or whether companies will start making their matching contributions again when credit loosens and business improves. “We have had a 30-year experiment with requiring workers to be more responsible for saving and investing for their retirement,” said Teresa Ghilarducci, a professor of economics at the New School. “It has been a grand experiment, and it has failed.” In the typical 401(k) plan, the employer’s matching contribution is more than just money for retirement. It also motivates employees to set aside more of their own money for old age. The more that workers save in a 401(k) plan, generally, the more “free money” they can get from their employers under the matching provisions. Retirement policy specialists said they did not expect employees to react immediately to the loss of this incentive by stopping their own contributions. Study after study has shown that employees procrastinate when it comes to retirement-plan chores, and in this case the inertia may work, unwittingly, in their favor. Americans, however, are facing extreme household financial pressure. President-elect Obama has said that he would support allowing withdrawals from retirement plans without penalties, which would provide short-term relief but would further undercut American’s long-term savings. Benefits specialists said that if matching contributions continued to dwindle, fewer newly hired workers could be expected to join 401(k) plans. And employees might eventually slow or stop their contributions if the recession drags on and their own cash runs short. “The problem is, we are heading into this serious recession, and we don’t know how long it will go on for,” said Alicia Munnell, director of the Center for Retirement Research at Boston College. “The bottom line is, people will have less money in their 401(k) plans, not just because the financial crisis has decimated their assets, but also because they will not have the employer match for some time.” Currently, most companies that offer 401(k) plans do provide some sort of matching contributions, according to David Wray, president of the Profit Sharing/401(k) Council of America, an association of employers that provide such plans. The most typical arrangement is for employers to match 50 cents of every dollar their employees set aside in their retirement accounts, up to 6 percent of pay. Sometimes the match 153

is more, sometimes less, and some employers vary it depending on profitability. Over all, the employer’s cost usually works out to about 3 percent of payroll. The latest 401(k) cutbacks underscore workers’ vulnerability in an age when companies have been replacing defined-benefit pension plans with the newer 401(k) design. Modern 401(k) plans give workers the power to opt in and out and require them to invest their own money, bearing market risk on their own. That may be appealing when the markets are rising, but it can be terrifying when they fall, as they have recently. An employer’s contributions to a traditional pension plan cannot be switched on and off at will. Federal rules set a firm contribution schedule, with deadlines and penalties for companies that fall behind. Employers also get significant tax and accounting benefits from operating a traditional pension plan, so they tend to think long and hard before freezing such a plan to save money when the economy cools. In a 401(k) plan, by contrast, the employer has much greater freedom to stop making matching contributions when times are tough. The contributions are normally measured as a percentage of payroll, and the savings from any cuts are realized immediately. That greatly simplifies planning and making changes. “Every percent you cut is a percent of payroll,” Ms. Munnell said. “It comes down to the choice of laying people off, or cutting back on some fringe benefits.” Many of the latest 401(k) cutbacks are turning up in industries with obvious financial problems, like the auto industry, health care and newspaper publishing. Industries that depend on free-spending consumers, like resorts and casinos, are also seeing cuts. Often when one company in an industry cuts its benefits others will follow, to keep their labor costs competitive. General Motors and Ford Motor have both suspended their matching contributions to their salaried employees’ 401(k) accounts, although their pension plans for unionized workers are unchanged. Motorola, struggling to stay competitive, stopped contributions to its 401(k) plan this month and froze its pension plan as well. Other recent cuts have occurred at Resorts International Holdings, Vail Resorts and Station Casinos. In addition to stopping their 401(k) matching contributions, companies have been freezing salaries this fall, shifting more of the cost of health care to their workers, and laying people off. “These are really hard times and people are losing their jobs, and in some ways, a suspension of a 401(k) match, while bad, is probably one of the lesser evils out there,” Ms. Munnell said. In announcing the suspension of the contributions last week, FedEx made clear that its workers in the sorting centers would not be the only ones feeling the pinch. Pay to senior executives is to be cut by 7.5 percent to 10 percent, and the chief executive, Frederick W. Smith, said he would take a 20 percent pay cut. The cutbacks are projected to save $200 million in the remainder of the 2009 fiscal year and $600 million in the 2010 fiscal year.

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U.S. December 21, 2008

Extended Benefits Are a Lifeline for Many Unemployed By MICHAEL LUO HUDSON, Fla. — Rick E. Rockwell plopped his large frame down in front of his laptop on Thursday morning, next to a foot-wide sheaf of unpaid bills still in their envelopes, lined up like an accordion on his desk. He logged into his bank account to see if his unemployment check had been deposited yet. His balance, however, remained stuck at $57.17. “That’s amazing to me,” Mr. Rockwell said. “It still hasn’t posted yet.” So Mr. Rockwell began another day as a man of the middle class who is now living on an economic precipice. Mr. Rockwell, 56, who estimates he has sent out more than 400 job applications over the last year and gone to just four interviews, is one of the more than 5.4 million people across the country receiving unemployment benefits. And Mr. Rockwell is part of arguably the hardestluck group of all — those who have been out of work for so long that they are depending on a second emergency extension of unemployment insurance that Congress passed and President Bush signed last month. In the 21 states and the District of Columbia currently with three-month average unemployment rates above 6 percent that means 20 more weeks of what has become an economic lifeline for many in the midst of one of the deepest recessions in the past century. Florida’s rate for November was 7.3 percent. (The other states get seven additional weeks.) For Mr. Rockwell, who lost his job in January as a sales manager at a computer store that he and his brother owned, the weekly checks of $275 — the maximum allowed him under Florida law and a little less than half his former take-home pay — have become like a crucial piece in the game Jenga, in which players construct a tower of blocks by removing one at a time from the bottom and moving it to the top. Mr. Rockwell is playing a balancing act so he can keep the edifice of his former life from crumbling, paying off certain bills and letting others lapse, so he can stay just ahead of his creditors. Mr. Rockwell has been without benefits for more than a month after he exhausted the first federal extension, which lasted 13 weeks, on top of the 26 weeks he had received from the State of Florida, back in October. After supporters were unable to get the legislation through Congress before the election, Mr. Bush signed the second extension in late November. Florida, like other states, has been rushing to get checks to so-called gap people like Mr. Rockwell whose benefits had expired. Advocates estimate there are about 800,000 of them nationwide. “States are really overwhelmed in terms of responding to claims,” said Andrew Stettner of the National Employment Law Project. “They were pushed beyond the brink in terms of doing the second extension.”

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Florida added 50 staff members to its unemployment insurance division in recent weeks, bringing its total to around 870. It also recently added 345 lines to its phone system for a total of just over 1,000, and has extended its call-in hours. There are, of course, people who are much worse off than Mr. Rockwell; but there are also many who have had much more of a financial cushion to get through this crisis. Last year, he was making $31,200 a year as sales manager of a small computer store that he had started 15 years ago with his brother, Rodney. But the rise of big-box stores like Best Buy, along with the recession, combined to drive their store, Comp-U-Save, into the ground. “All of a sudden, the floor came out from underneath it,” said Rodney Rockwell, who closed his old store in October and re-opened under a new name. The brothers agreed that Rick would leave in January because the store, by that point, was depending mostly on its repair business, which was Rodney’s specialty. They also figured that because Rick was younger and had some background managing restaurants, he would be able to find a job relatively easily. He had a little over $5,000 in his bank account, mostly what was left over from a $40,000 second mortgage he took out on his home four years ago for home repairs that never materialized. But Mr. Rockwell has been succumbing to a slow economic death, which accelerated significantly in the last month as his unemployment benefits lapsed. His mortgage lender has begun foreclosure proceedings on his modest two-bedroom home, which he bought in 1998 and still owes $117,000 on. He has begun packing to move into his 84-year-old mother’s two-bedroom condominium nearby. He is in danger of losing his red 2005 Mitsubishi Eclipse Spyder convertible, a prized possession that he keeps gleaming in his garage, because he is behind in his payments. He has listed for sale both that car and a 1996 Toyota RAV4, which he owns outright and keeps in the driveway, but he is hoping to keep the Spyder. The only reason he can still drive it at all is because his mother, who is mostly living just on Social Security, paid his car insurance for this month. He is two months behind on his electric bill. A partial payment by a local church that he went to recently for help helped him stave off losing his power. His water bill is in arrears as well. Mr. Rockwell was settling into his love seat two weeks ago to watch the teenage drama “One Tree Hill” — an afternoon pleasure he developed while sitting around out of work — when he found his cable had been cut off. Last Wednesday, after returning home from dinner with a reporter, Mr. Rockwell found a note on his door from his neighbor that someone had been looking for him. It turned out to be a collection agency for one of his credit cards. Mr. Rockwell has racked up about $15,000 in bills on various cards, reaching his limit on all but one. In a final indignity, Mr. Rockwell wakes up most mornings flat on his back on the ground because the air mattress he now sleeps on, after his waterbed sprang a leak earlier this year, has a hole in it.

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Mr. Rockwell now spends most of his days hunched in front of his laptop. He spends several hours going through new job postings in the morning and then devotes himself to several Internet marketing schemes promising riches that he has stumbled upon. Keeping in mind the criticism of those who say expanded unemployment benefits keep people from working, Mr. Rockwell conceded he might appear to be too picky in the jobs he would accept. He has mostly ruled out commuting to Tampa, a much larger city an hour away, because of the distance. He has also tried to confine himself to looking for management-level restaurant jobs. “I’m not going to clean grills, take out the garbage,” Mr. Rockwell said. “I’ve done that before, but I feel I’m beyond that.” His home is overflowing with sports memorabilia — autographed posters, baseballs and cards of every sort that he has collected. He has sold off some but is reluctant to part with others at fire-sale prices. On Thursday, Mr. Rockwell spent several hours plowing through job listings and wound up applying — or re-applying, actually — to just two, one for a restaurant manager at an Arby’s in nearby New Port Richey and one for a shift supervisor job at a Wendy’s in Tampa. He logged into his bank account again the next day and found to his surprise that his unemployment check had finally been deposited. It is a small reprieve for now.

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World Business December 21, 2008

At Siemens, Bribery Was Just a Line Item By SIRI SCHUBERT and T. CHRISTIAN MILLER MUNICH REINHARD SIEKACZEK was half asleep in bed when his doorbell rang here early one morning two years ago. Still in his pajamas, he peeked out his bedroom window, hurried downstairs and flung open the front door. Standing before him in the cool, crisp dark were six German police officers and a prosecutor. They held a warrant for his arrest. At that moment, Mr. Siekaczek, a stout, graying former accountant for Siemens A.G., the German engineering giant, knew that his secret life had ended. “I know what this is about,” Mr. Siekaczek told the officers crowded around his door. “I have been expecting you.” To understand how Siemens, one of the world’s biggest companies, last week ended up paying $1.6 billion in the largest fine for bribery in modern corporate history, it’s worth delving into Mr. Siekaczek’s unusual journey. A former midlevel executive at Siemens, he was one of several people who arranged a torrent of payments that eventually streamed to well-placed officials around the globe, from Vietnam to Venezuela and from Italy to Israel, according to interviews with Mr. Siekaczek and court records in Germany and the United States. What is striking about Mr. Siekaczek’s and prosecutors’ accounts of those dealings, which flowed through a web of secret bank accounts and shadowy consultants, is how entrenched corruption had become at a sprawling, sophisticated corporation that externally embraced the nostrums of a transparent global marketplace built on legitimate transactions. Mr. Siekaczek (pronounced SEE-kah-chek) says that from 2002 to 2006 he oversaw an annual bribery budget of about $40 million to $50 million at Siemens. Company managers and sales staff used the slush fund to cozy up to corrupt government officials worldwide. The payments, he says, were vital to maintaining the competitiveness of Siemens overseas, particularly in his subsidiary, which sold telecommunications equipment. “It was about keeping the business unit alive and not jeopardizing thousands of jobs overnight,” he said in an interview. Siemens is hardly the only corporate giant caught in prosecutors’ cross hairs. Three decades after Congress passed a law barring American companies from paying bribes to secure foreign business, law enforcement authorities around the world are bearing down on major enterprises like Daimler and Johnson & Johnson, with scores of cases now under investigation. Both companies declined comment, citing continuing investigations. Albert J. Stanley, a legendary figure in the oil patch and the former chief executive of the KBR subsidiary of Halliburton, recently pleaded guilty to charges of paying bribes and skimming millions for himself. More charges are coming in that case, officials say.

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But the Siemens case is notable for its breadth, the sums of money involved, and the raw organizational zeal with which the company deployed bribes to secure contracts. It is also a model of something that was once extremely rare: cross-border cooperation among law enforcement officials. German prosecutors initially opened the Siemens case in 2005. American authorities became involved in 2006 because the company’s shares are traded on the New York Stock Exchange. In its settlement last week with the Justice Department and the Securities and Exchange Commission, Siemens pleaded guilty to violating accounting provisions of the Foreign Corrupt Practices Act, which outlaws bribery abroad. Although court documents are salted throughout with the word “bribes,” the Justice Department allowed Siemens to plead to accounting violations because it cooperated with the investigation and because pleading to bribery violations would have barred Siemens from bidding on government contracts in the United States. Siemens doesn’t dispute the government’s account of its actions. Matthew W. Friedrich, the acting chief of the Justice Department’s criminal division, called corruption at Siemens “systematic and widespread.” Linda C. Thomsen, the S.E.C.’s enforcement director, said it was “egregious and brazen.” Joseph Persichini Jr., the director of the F.B.I.’s Washington field office, which led the investigation, called it “massive, willful and carefully orchestrated.” MR. SIEKACZEK’S telecommunications unit was awash in easy money. It paid $5 million in bribes to win a mobile phone contract in Bangladesh, to the son of the prime minister at the time and other senior officials, according to court documents. Mr. Siekaczek’s group also made $12.7 million in payments to senior officials in Nigeria for government contracts. In Argentina, a different Siemens subsidiary paid at least $40 million in bribes to win a $1 billion contract to produce national identity cards. In Israel, the company provided $20 million to senior government officials to build power plants. In Venezuela, it was $16 million for urban rail lines. In China, $14 million for medical equipment. And in Iraq, $1.7 million to Saddam Hussein and his cronies. The bribes left behind angry competitors who were shut out of contracts and local residents in poor countries who, because of rigged deals, paid too much for necessities like roads, power plants and hospitals, prosecutors said. Because government contracting is an opaque process and losers don’t typically file formal protests, it’s difficult to know the identity of competitors who lost out to Siemens. Companies in the United States have long complained, however, that they face an uneven playing field competing overseas. Ben W. Heineman Jr., a former general counsel at General Electric and a member of the American chapter of Transparency International, a nonprofit group that tracks corruption, says the enforcement of some antibribery conventions still remains scattershot. “Until you have energetic enforcement by the developed-world nations, you won’t get strong antibribery programs or high-integrity corporate culture,” he said. Afghanistan, Haiti, Iraq, Myanmar and Somalia are the five countries where corporate bribery is most common, according to Transparency International. The S.E.C. complaint said Siemens paid its heftiest bribes in China, Russia, Argentina, Israel and Venezuela.

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“Crimes of official corruption threaten the integrity of the global marketplace and undermine the rule of law in the host countries,” said Lori Weinstein, the Justice Department prosecutor who oversaw the Siemens case. All told, Siemens will pay more than $2.6 billion to clear its name: $1.6 billion in fines and fees in Germany and the United States and more than $1 billion for internal investigations and reforms. Siemens’s general counsel, Peter Y. Solmssen, in an interview outside a marble-lined courtroom in Washington, said the company acknowledged that bribes were at the heart of the case. “This is the end of a difficult chapter in the company’s history,” he said. “We’re glad to get it behind us.” Mr. Siekaczek, who cooperated with German authorities after his arrest in 2006, has already been sentenced in Germany to two years’ probation and a $150,000 fine. During a lengthy interview in Munich, a few blocks from the Siemens world headquarters, he provided an insider’s account of corruption at the company. The interview was his first with Englishlanguage news outlets. “I would never have thought I’d go to jail for my company,” Mr. Siekaczek said. “Sure, we joked about it, but we thought if our actions ever came to light, we’d all go together and there would be enough people to play a game of cards.” Mr. Siekaczek isn’t a stereotype of a white-collar villain. There are no Ferraris in his driveway, or villas in Monaco. He dresses in jeans, loafers and leather jackets. With white hair and gold-rimmed glasses, he passes for a kindly grandfather — albeit one who can discuss the advantages of offshore bank accounts as easily as last night’s soccer match. SIEMENS began bribing long before Mr. Siekaczek applied his accounting skills to the task of organizing the payments. World War II left the company shattered, its factories bombed and its trademark patents confiscated, according to American prosecutors. The company turned to markets in less developed countries to compete, and bribery became a reliable and ubiquitous sales technique. “Bribery was Siemens’s business model,” said Uwe Dolata, the spokesman for the association of federal criminal investigators in Germany. “Siemens had institutionalized corruption.” Before 1999, bribes were deductible as business expenses under the German tax code, and paying off a foreign official was not a criminal offense. In such an environment, Siemens officials subscribed to a straightforward rule in pursuing business abroad, according to one former executive. They played by local rules. Inside Siemens, bribes were referred to as “NA” — a German abbreviation for the phrase “nützliche Aufwendungen” which means “useful money.” Siemens bribed wherever executives felt the money was needed, paying off officials not only in countries known for government corruption, like Nigeria, but also in countries with reputations for transparency, like Norway, according to court records. In February 1999, Germany joined the international convention banning foreign bribery, a pact signed by most of the world’s industrial nations. By 2000, authorities in Austria and Switzerland were suspicious of millions of dollars of Siemens payments flowing to offshore bank accounts, according to court records.

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Rather than comply with the law, Siemens managers created a “paper program,” a toothless internal system that did little to punish wrongdoers, according to court documents. Mr. Siekaczek’s business unit was one of the most egregious offenders. Court documents show that the telecommunications unit paid more than $800 million of the $1.4 billion in illegal payments that Siemens made from 2001 to 2007. Managers in the telecommunications group decided to deal with the possibility of a crackdown by making its bribery procedures more difficult to detect. So, on one winter evening in late 2002, five executives from the telecommunications group met for dinner at a traditional Bavarian restaurant in a Munich suburb. Surrounded by dark wood panels and posters celebrating German engineering, the group discussed how to better disguise its payments, while making sure that employees didn’t pocket the money, Mr. Siekaczek said. To handle the business side of bribery, the executives turned to Mr. Siekaczek, a man renowned within the company for his personal honesty, his deep company loyalty — and his experiences in the shadowy world of illegal bribery. “It had nothing to do with being law-abiding, because we all knew what we did was unlawful.” Mr. Siekaczek said. “What mattered here was that the person put in charge was stable and wouldn’t go astray.” Although Mr. Siekaczek was reluctant to take the job offered that night, he justified it as economic necessity. If Siemens didn’t pay bribes, it would lose contracts and its employees might lose their jobs. “We thought we had to do it,” Mr. Siekaczek said. “Otherwise, we’d ruin the company.” Indeed, he considers his personal probity a point of honor. He describes himself as “the man in the middle,” “the banker” or, with tongue in cheek, “the master of disaster.” But, he said, he never set up a bribe. Nor did he directly hand over money to a corrupt official. German prosecutors say they have no evidence that he personally enriched himself, though German documents show that Mr. Siekaczek oversaw the transfer of some $65 million through hard-to-trace offshore bank accounts. “I was not the man responsible for bribery,” he said. “I organized the cash.” Mr. Siekaczek set things in motion by moving money out of accounts in Austria to Liechtenstein and Switzerland, where bank secrecy laws provided greater cover and anonymity. He said he also reached out to a trustee in Switzerland who set up front companies to conceal money trails from Siemens to offshore bank accounts in Dubai and the British Virgin Islands. Each year, Mr. Siekaczek said, managers in his unit set aside a budget of about $40 million to $50 million for the payment of bribes. For Greece alone, Siemens budgeted $10 million to $15 million a year. Bribes were as high as 40 percent of the contract cost in especially corrupt countries. Typically, amounts ranged from 5 percent to 6 percent of a contract’s value. The most common method of bribery involved hiring an outside consultant to help “win” a contract. This was typically a local resident with ties to ruling leaders. Siemens paid a fee to the consultant, who in turn delivered the cash to the ultimate recipient. Siemens has acknowledged having more than 2,700 business consultant agreements, socalled B.C.A.’s, worldwide. Those consultants were at the heart of the bribery scheme, sending millions to government officials. 161

MR. SIEKACZEK was painfully aware that he was acting illegally. To protect evidence that he didn’t act alone, he and a colleague began copying documents stored in a basement at Siemens’s headquarters in Munich that detailed the payments. He eventually stashed about three dozen folders in a secret hiding spot. In 2004, Siemens executives told him that he had to sign a document stating he had followed the company’s compliance rules. Reluctantly, he signed, but he quit soon after. He continued to work for Siemens as a consultant before finally resigning in 2006. As legal pressure mounted, he heard rumors that Siemens was setting him up for a fall. “On the inside, I was deeply disappointed. But I told myself that people were going to be surprised when their plan failed,” Mr. Siekaczek recalled. “It wasn’t going to be possible to make me the only one guilty because dozens of people in the business unit were involved. Nobody was going to believe that one person did this on his own.” The Siemens scheme began to collapse when investigators in several countries began examining suspicious transactions. Prosecutors in Italy, Liechtenstein and Switzerland sent requests for help to counterparts in Germany, providing lists of suspect Siemens employees. German officials then decided to act in one simultaneous raid. The police knocked on Mr. Siekaczek’s door on the morning of Nov. 15, 2006. Some 200 other officers were also sweeping across Germany, into Siemens’s headquarters in Munich and the homes of several executives. In addition to Mr. Siekaczek’s detailed payment records, investigators secured five terabytes of data from Siemens’s offices — a mother lode of information equivalent to five million books. Mr. Siekaczek turned out to be one of the biggest prizes. After calling his lawyer, he immediately announced that he would cooperate. Officials in the United States began investigating the case shortly after the raids became public. Knowing that it faced steep fines unless it cooperated, Siemens hired an American law firm, Debevoise & Plimpton, to conduct an internal investigation and to work with federal investigators. As German and American investigators worked together to develop leads, Debevoise and its partners dedicated more than 300 lawyers, forensic analysts and staff members to untangle thousands of payments across the globe, according to the court records. American investigators and the Debevoise lawyers conducted more than 1,700 interviews in 34 countries. They collected more than 100 million documents, creating special facilities in China and Germany to house records from that single investigation. Debevoise and an outside auditor racked up 1.5 million billable hours, according to court documents. Siemens has said that the internal inquiry and related restructurings have cost it more than $1 billion. Siemens officials “made it crystal clear that they wanted us to get to the bottom of this and follow it wherever the evidence led,” said Bruce E. Yannett, a Debevoise partner. AT the same time, Siemens worked hard to purge the company of some senior managers and to reform company policies. Several senior managers have been arrested. Klaus Kleinfeld, the company’s C.E.O., resigned in April 2007. He has denied wrongdoing and is now head of Alcoa, the aluminum giant. Alcoa said that the company fully supports Mr. Kleinfeld and declined to comment further. Last year, Siemens said in S.E.C. filings that it had discovered evidence that former officials had misappropriated funds and abused their authority. In August, Siemens said it seeks to recover monetary damages from 11 former board members for activities related to the bribery scheme. Negotiations on that matter are continuing.

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Earlier this year, Siemens’s current chief executive, Peter Löscher, vowed to make Siemens “state of the art” in anticorruption measures. “Operational excellence and ethical behavior are not a contradiction of terms,” the company said in a statement. “We must get the best business — and the clean business.” Siemens still faces legal uncertainties. The Justice Department and German officials said that investigations were continuing and that current and former company officials might face prosecution. Legal experts say Siemens is the latest in a string of high-profile cases that are changing attitudes about corruption. Still, they said, much work remains. “I am not saying the fight against bribing foreign public officials is a fight full of roses and victories,” said Nicola Bonucci, the director of legal affairs for the Organization for Economic Cooperation and Development, which is based in Paris and monitors the global economy. “But I am convinced that it is something more and more people are taking seriously.” For his part, Mr. Siekaczek is uncertain about the impact of the Siemens case. After all, he said, bribery and corruption are still widespread. “People will only say about Siemens that they were unlucky and that they broke the 11th Commandment,” he said. “The 11th Commandment is: ‘Don’t get caught.’ ” This article is a joint report by ProPublica, a nonprofit investigative journalism organization, PBS’s "Frontline" and The New York Times. A related documentary will be broadcast on “Frontline” on April 7.

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THE CENTRAL BANK FLIGHT TO SAFETY Posted on Sunday, December 21st, 2008 By bsetser Floyd Norris of the New York Times highlights a theme that I have touched on many times: foreign demand for US assets with any hint of credit risk has disappeared. Foreign demand for US corporate bonds — a category that includes “private-label” asset-backed securities like repackaged subprime mortgages — fell sharply in 2007 and hasn’t recovered. * And more recently foreign demand for US “Agency” bonds — the debt issued or guaranteed by Freddie Mac, Fannie Mae, Ginnie Mae and the like — has fallen sharply. Norris highlights this shift effectively. But he didn’t quite go as far as he could have. I would add three additional points: 1) Foreign central banks — not private investors — have led the shift out of Agencies toward Treasuries. We know this because of the data in the Fed’s custodial accounts, which show a clear shift at the end of July. From the end of 2004 to the mid 2008, central banks were only slowly adding to their holdings of Treasuries while their holdings of Agencies the the New York Fed ballooned from something like $250b at end of 2004 to close to $1 trillion at the end of June 2008. And since mid 2008, central banks have been selling Agencies and buying Treasuries in big way. The following chart plots central banks’ custodial holdings at the Fed against my best guess of central banks true holdings of Treasuries and Agencies. That guess comes from a model that I have been working on with Arpana Pandey of the Council that reattributes purchases through London to the official sector in real time, and thus avoids the jumps associated with the survey revisions.** Think of it was anticipating the outcome of the next couple of surveys of foreign portfolio investment (The survey data consistently revises central bank holdings of Treasuries and Agencies up and the UK’s holdings down). 2) The shift from Agencies to Treasuries continued in November and December. There isn’t any “TIC” for those months, but the New York Fed’s data shows a $43 billion fall in central bank holdings of Agencies in November and another $38 billion fall in the first three weeks of December. Since the end of September, central bank holdings of Treasuries are up by over $210b and central bank holdings of Agencies are down by close to $130 billion — as the following chart illustrates. 3) This shift destablized the Agency market. It kept spreads on “Agency” MBS high even after the US government effectively guaranteed Agency bonds — and that kept mortgage rates up. Agency spreads only came down when the United States Fed indicated it would increase its purchases of Agency bonds — effectively substituting a Fed bid for a Chinese bid.

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The TIC data suggests that the big sellers of Agencies recently have been Russia and China. Russia I understand. Its reserves are falling, and its main goal is to stabilize its own market. China less so. Its reserves are apparently still rising. And while the Agencies have some risk, they have less risk than they did before the US government stepped in to backstop them. My best guess is that China’s leadership was surprised to learn that they held something like half a trillion of Agencies in the summer, and they told SAFE to reduce its holdings (and generally cut the risk in SAFE’s portfolio).

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Fair enough. No country is obligated to take even a tiny bit of risk with its reserves. But actions have consequences. China’s swing away from Agencies means that it will soon have a close to $1 trillion Treasury portfolio — which is a risk of another sort.*** It also raises the question of whether China has been quite as stabilizing a presence in the market as the US Treasury claims. China certainly didn’t have to sell Agencies to raise cash. Indeed, the Fed has done a lot more to stabilize global markets in the second half of this year than the world’s reserve managers. Since the end of June, the Fed has lent close to $600 billion to foreign central banks that were short on dollars.**** The Fed effectively sold off its Treasury portfolio and took on risk in a downturn. Big reserve managers did rather the opposite: the data suggests that they were reaching for yield when times were hood (pushing down spreads) and then reversed course (pushing up spreads) when the going got tough. *Much of that demand wasn’t really coming from foreign investors so much as from offshore vehicles that borrowed dollars short and lent long. ** My formula for adjusting official holdings requires positive purchases through London. In 2000 and 2001 the US was paying down the stock of Treasuries, so there weren’t net flows through London. as a result, the adjusted data series starts in M7 2002. Having annual survey data also helps. *** Stay tuned for more on the details of China’s current portfolio — I am putting the final touches on a set of revised estimates. **** Other reserve assets — the line item that corresponds with fx swaps — have increased from a bit over $100b at the end of June to $682 billion in the last week of data. That is a rather substantial flow.

CHIEUROPA? Posted on Friday, December 19th, 2008 By bsetser The thesis that China and America should be viewed as a single economy – or at least as a single currency area – is due for a comeback. After flirting with change, the RMB is once again pegged tightly to the dollar. 6.85 is the new 8.27. I would not be surprised if China’s external surplus and the United States deficit prove to be roughly equal in size in 2009. The obvious argument is that while the US runs a big deficit, Chimerica doesn’t. East Chimerica’s surplus offsets West Chimerica’s deficit. No worries. At least so long as China’s government is willing to finance the US. The fact that the Chimerican currency union required unprecedented growth in China’s reserves was always my main objection to the Chimerica thesis. A currency union in theory shouldn’t require that kind of government intervention to keep in balance. But Chimerica never was really financially integrated. Back when the RMB was (correctly) considered a one way bet, China erected capital controls to keep American (and other) capital from speculating on its currency. And for most of this decade, the net outflow from China to America came not from a desire on the part of Chinese savers to hold dollars but rather from a desire of China’s government to hold the Chinese currency down against the dollar. That policy required that China buy dollars in the foreign exchange market, and in the process finance the US deficit.

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However, another objection may be more important. The argument that Chinese and America formed a perfect union – with US spending generating demand to offset Chinese savings, and Chinese savings financing the borrowing associated with US spending – hasn’t quite worked for the past couple of years. It leaves out Europe. And Europe, not the US, was the big spender in the world economy in 2006, 2007 and the first part of 2008. My colleague at the Council’s Center for Geoeconomic Studies, Paul Swartz, has produced a clever graph (available on the CGS website) showing that the growth in Asian exports hinges on the growth in US and European imports. Makes sense. Paul also plotted Asian export growth against American import growth and European import growth separately — and the chart of European import growth against Asian export growth highlights just how large Europe’s contribution to Asian export growth has been recently. This shouldn’t be a surprise. The depreciation of the Japanese yen and Chinese yuan against most European currencies over the past several years (and yes, I know that things changed in the past few months) was the big currency move of the past several years – at least as economically significant as the depreciation of the dollar against the euro. That depreciation produced the expect result: a surge in European imports from Asia, and a big increase in Europe’s deficit with Asia in general and China in particular. That is a clear change from earlier this decade. Back in 2003 and 2004 and even 2005, it really was the US consumer that was driving the expansion of global demand. The coupling of China’s export machine to European demand explains why China’s exports and surplus were both able to increase over the past couple of years even thugh the US non-oil deficit peaked in late 2005/ early 2006. It doesn’t take that much leg work (the data tables at the end of the IMF’s World Economic Outlook are always a good place to start … ) to figure out that a swing in Europe’s current account balance made this possible.

Let’s say that the US runs a $500 billion current account deficit next year, and the United States’ bilateral deficit with China is around $250 billion. Let’s also assume that China runs a $500 billion current account surplus next year (that makes the math easy – and it isn’t out of line with China’s November trade surplus). That implies that China is running a big surplus with the world not just the US. And Chimerica only works, in some sense, if China lends the

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(large) surplus it earns with the non-Chimerican world (and Europe in particular) to the US, allowing the US to run a deficit with the non-Chimerican world.

To make everything (too) neat, let’s assume China runs a $250 billion surplus with Europe and its trade with the rest of Asia and the oil exporters is balanced. And let’s assume that Europe runs a $150 billion surplus with the US and a $100 billion surplus with the oil exporters (offsetting its deficit with China) – and that the US has a $150 billion deficit with Europe and a $100 billion deficit with the oil exporters. That simplifies a lot. It leaves out private inflows and outflows for one, which can drive China’s reserve growth above or below its current account surplus. It also leaves out Chinese purchases of European assets and European purchases of US assets. It ignores intra-European flows – and reduces Asia to China. But it captures something important as well. China’s surplus can expand even in the absence of a rise in the United States deficit if Europe’s deficit rises, for one. And in my little thought experiment, the global flow of funds only balances if China lends its surplus with Europe to the US. Or, to put it a bit differently, if Chieuropa lends to the US …

THAT WAS FAST …. Posted on Thursday, December 18th, 2008 By bsetser Only a few days ago, so it seems, it took about $1.25 to buy a euro. Now it takes closer to $1.45 (it was more earlier today, but the dollar subsequently rallied). And — as Macro Man notes — the dollar’s move pales relative to the recent slide in the pound. Not so long ago a pound bought 1.5 euros. Now it buys a euro and change. The Anglo-Saxon currencies haven’t had a good two week run.

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Both the US and the UK had housing and finance centric economies. Both have significant external deficits. And both are inclined to use monetary and fiscal policy aggressively to combat a downturn. But with global trade collapsing, the euro’s rise can not be all that comfortable for members of the eurozone. It isn’t clear that any one wants a stronger currency right now. Currencies though are relative prices — and can go up or down amid a global contraction. In theory, everyone could ease monetary policy equally without changing the relative value of any currencies. In practice things rarely work out as neatly. Dr. Krugman, I would assume, hopes that the euro’s rise puts more pressure on Germany to join a coordinated European fiscal stimulus — with good reason. Germany’s export machine relies on global and European demand. That demand is falling (watch Russian imports for example). And if the euro’s rally is sustained, Germany will soon face an additional headwind. So too will the less competitive members of the eurozone. They are in an even more difficult position if Germany doesn’t lead a coordinated European reflation. Four other thoughts: 1) Until fairly recently, all the European currencies tended to move in tandem against the dollar. That meant their cross-rates were stable. And it meant that the euro wasn’t as strong as it seemed. The euro was strong against the dollar and the yen, but not against the pound, the Swedish krona, the Norwegian krona and similar currencies. Right now the euro is rising against all the smaller European currencies — not just against the dollar. 2) Japan is starting too worry about yen strength, not surprising. Renewed intervention seems like a possibility if the yen continues to rise. That shouldn’t be a surprise. Japan tends to intervene heavily when the interest different between the yen and dollar goes away, reducing private market demand for dollars. 3) China has to be pleased by the euro’s rally. Dollar strength translated into RMB strength — and a rising RMB when Chinese exports were slowing (and likely now falling) made Chinese policy makers uncomfortable. There was even talk of moving to a real basket peg — which would have meant that RMB would depreciate against the dollar when the dollar was strong. But I rather doubt that China now wants to appreciate against the dollar to offset the dollar’s renewed weakness against the euro. Right now China is happy to see the dollar and thus the RMB weaken … 4) Central banks have been big buyers of the pound over the past few years. Reserves were growing, and the pound’s share was rising. Central banks liked its yield — and the fact that it an easy alternative to both the dollar and the euro. By my count, central bank inflows often were large enough to cover the UK’s current account deficit. Central banks reserves are shooting up, but if they “rebalance” their portfolios they should be big buyers of pounds now — as they need to hold more pounds to keep the pound’s share of their portfolio up as the pound’s value slides. I’ll be interested to see if they do so — or if they start to view the pound as Europe’s equivalent of an Agency bond …

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THIS IS WHAT A CRISIS LOOKS LIKE IN THE BALANCE OF PAYMENTS DATA Posted on Monday, December 15th, 2008 By bsetser At least a crisis marked by a run out of risky US assets and into safe US assets. Right now Agency bonds — think Freddie and Fannie — are considered risky assets while Treasuries are not. A run out of all US assets and the dollar would look very different. The October TIC data tells a striking story — one marked by a massive surge in demand by both private and official investors for “safe” assets. Foreign investors bought $182 billion of Treasuries — including $147.4 billion of short-term Treasury bills. There is no real mystery why bill yields dropped so low even as the supply of bills surged. And foreigners added $207 billion to dollar bank accounts. Sum that up and it works out to close to $400 billion in demand for safe dollar denominated assets. If that kind of monthly inflow is annualized it is a shockingly large number. It isn’t hard to figure out why the dollar rallied. $400 billion in a month is far more than the US needs to cover its trade deficit. It allowed foreigners to reduce their holdings of Agencies by close to $75 billion (including a $25 billion fall in short-term Agencies), their holdings of long-term corporate bonds by $13 billion and their holdings of US equities by $6 billion without causing any strain on the dollar.

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Indeed, the fall in foreign holdings of US corporate bonds and US equities (though not the outflow from the Agencies) could have been financed by the sale of $36 billion of foreign assets by US residents … Usually I argue that the TIC data understates official flows. And this month’s data may well do so. Some of the $35 billion in long-term Treasury bonds bought by UK investors were probably bought by central banks, and selling by central banks could have contributed to the $13.8b in net sales of long-term Agencies. But in broad terms I don’t doubt that private demand for “safe” US assets soared as a result of the crisis — and much of the inflow came from private investors seeking to increase their holdings of the most liquid dollar assets. In October, China was about the only central bank adding to its reserves (I suspect, it hasn’t formally released its reserves data). Most central banks were selling. That shows up in the US TIC data. South Korea, Brazil, Mexico, Russia and Ukraine were all net sellers of long-term US Treasury bonds … The big central bank flow was a reallocation away from Agencies toward Treasuries. And specifically toward short-term Treasury bills. China increased its holdings of short-term Treasury bills by a stunning $56 billion while also buying $10 billion of long-term Treasuries. That flow alone would have been enough to cover the trade deficit in the absence of any offsetting outflows. Russia cut its holdings of short-term Agencies by a little over $22 billion while increasing its holdings of short-term Treasuries by almost $12 billion. So much for talk that central banks are always a stabilizing presence the market. They clearly have destabilized the Agency market. The fall in demand for Agencies over the past three months — and most Agency demand has come from central banks until recently — has been sharper than than the fall in demand for US corporate bonds (think securitized subprime mortgages, the category “corporate bonds” in the BoP data includes asset-backed securities) after the crisis of last August.

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The fall in demand for corporate bonds (the redline) is what generated a rather scary graph after the initial crisis last August. Things haven’t gotten any better since …

The Agency market is a rather important market. Increased lending by the Agencies offset the fall in demand for “private” mortgage-backed securities after the crisis last August. More recently, the absence of a “central bank bid” has kept Agency spreads wide even after the US Treasury bailout of Freddie and Fannie. And that in turn has pushed the US to adopt other measures to bring down long-term mortgage rates. The Fed and the Treasury are literally now buying the Agencies that foreign central banks are selling. Action, reaction …

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Asia Pacific December 19, 2008

After 30 Years, Economic Perils on China’s Path By JIM YARDLEY SHENZHEN, China — The ruling Communist Party threw itself a big party on Thursday. The country’s leadership marked the 30th anniversary of the reform era that transformed China into a global economic power and, in doing so, changed the world. At a triumphant ceremony at the Great Hall of the People in Beijing, President Hu Jintao invoked Deng Xiaoping, who consolidated power in 1978 and began “reform and opening.” Mr. Hu emphasized the party’s unwavering focus on economic development. “Only development makes sense,” said Mr. Hu, quoting Deng. But beyond the oratory, Mr. Hu and other Chinese leaders are now facing a new era in which Deng’s export-led economic model, as well as his iron-fisted political control, face unprecedented challenges. Global demand for Chinese goods has slumped, unrest is on the rise in the industrial heartland, and China is scrambling for a new formula to preserve stability and ensure growth. The downturn is so swift — exports fell last month for the first time in seven years — that Beijing is being forced to abruptly shift priorities. Until recently, Mr. Hu had been trying to curb excesses like rampant pollution and income inequality that posed environmental and social challenges to long-term development. Now, those priorities seem eclipsed. Instead, leaders are restoring tax breaks for exporters and pushing down the value of China’s currency to encourage exports. At the same time, they are casting about for ways to spur domestic demand and wean China’s economy off its dependence on foreign markets swept up in the global financial crisis. Politically, Chinese reformers had hoped the symbolic weight of the anniversary and the nation’s post-Olympic glow might propel some measure of political reform to address official corruption and help defuse rising social tensions. But as Beijing worries about strikes and mass layoffs even in some of its most prosperous areas, official tolerance of political dissent has seemingly narrowed. This month, a prominent dissident was detained after writing an open letter calling for greater democracy. An editor at one of the country’s leading newspapers was reassigned after publishing articles deemed too politically provocative. “We must draw on the benefits of humankind’s political civilization,” Mr. Hu said in his Thursday speech, according to Reuters. “But we will never copy the model of the Western political system.” If any place symbolizes China’s reform era, it is Shenzhen, a city conceived from Deng’s imagination — and one now in the cross hairs of the economic downturn. Thursday’s celebration was timed to a 1978 political meeting, the Third Plenum, which anointed Deng as China’s leader and introduced “reform and opening.” Two years later, Deng pointed at a sleepy fishing village in coastal southern China, near Hong Kong, and ordained it the country’s first “special economic zone” to experiment with foreign investment and export 173

manufacturing. Today, Shenzhen is a city of more than 10 million people ringed by thousands of factories. A factory district just outside Shenzhen, Fuqiao Industrial Park, is a snapshot of the economic troubles rippling through the region. Several small factories in the park have closed in recent months. At Wang Jinda Industries, the lettering had been scraped off the entrance after the owner closed last week. Two customers had arrived for a shipment of goods only to find an empty factory. Meanwhile, some factories that remained open were struggling. Workers at a large printing factory said the owners had stopped recruiting new workers in September while many others had quit. Several workers said wages had dropped significantly as the owners were reducing the length of shifts. A few workers accused owners of deliberately trying to drive down wages to force workers to quit. “Everybody is worried,” said Lin Baozeng, 26, a cashier at a canteen inside the industrial park. Her daily lunch crowd has dwindled to about 100 migrant workers from 500. “If the economy is bad,” Ms. Lin added as her 3-year-old daughter played nearby, “how can I afford to raise my child?” As yet, gauging the scale of factory closings remains difficult in Shenzhen and surrounding Guangdong Province, the country’s main export engine. Guangdong was already making a concerted effort to move up the manufacturing value chain at a time when rising labor costs and greater government regulations were making some smaller, cheaper exporters unprofitable. But the recent export slowdown is having an unanticipated impact. More than 7,000 small- and medium-sized factories have closed in recent months. Shenzhen’s mayor said 50,000 people in the city alone had lost their jobs in the last few months. And there are mounting signs that the problems could be far broader. Over all, China’s economy will continue to expand next year, but some economists say the rate of growth could fall as low as 5 or 6 percent, far slower than the double-digit pace of the preceding several years. State media have reported that 4.85 million migrant workers have returned to the countryside early before next month’s annual Lunar New Year holiday. Some inland provinces have already announced subsidies for unemployed returnees. On Thursday, the country’s official news agency, Xinhua, reported that 6.5 million migrant workers may be jobless next year. Beijing has recently restored some export subsidies that had been repealed as part of earlier efforts to rebalance the economy toward domestic demand. Huang Yasheng, a management professor at the Massachusetts Institute of Technology, said such subsidies made short-term political sense, given the huge numbers of jobs provided by factories, but did not address China’s long-term economic challenges. “I see the export supports as a crisis measure,” Mr. Huang said. “They really have no other way to maintain employment.” Mr. Huang said the government’s focus on exports and expanding the role of state-owned corporations since the 1990s had meant too little of the country’s wealth had trickled down to ordinary people. He said household incomes had lagged well behind overall growth, meaning that hundreds of millions of ordinary people still had relatively little spending money — a major problem when the government is trying to rapidly increase domestic consumption. “It’s a huge challenge,” said Mr. Huang, author of a recent book, “Capitalism with Chinese Characteristics.” China’s immediate answer is a stimulus program focused on infrastructure like railways and ports. State-owned banks are being ordered to make credit easily available, and business taxes

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on real estate sales were waived this week. Such steps may be crucial to buttressing the Chinese economy and preventing a deeper global recession. Yet some Chinese officials are wary of the potential impact of another phase of state-led industrial development. The government stimulus program enacted in response to the 1997-98 Asian financial crisis enabled China to avoid the recessions suffered by neighboring nations. Yet it also propelled the enormous investment in heavy industry that is a major reason China is now the world’s largest emitter of greenhouse gases. In an opinion article in the online edition of People’s Daily, Pan Yue, the outspoken vice minister of the Ministry of Environment, blamed Western excess for the global crisis and warned that China risked ruin if it blindly pursued Western industrial models. “China’s reform and opening has achieved in 30 years the economic gains of more than 100 years in the West — yet more than 100 years of environmental pollution in the West have materialized in 30 years in China,” Mr. Pan wrote. “The present global economic crisis shows that if China continues down the old road of Western industrial civilization, it will only come to a dead end.” China is a far more open and dynamic place than the country Deng first unleashed three decades ago. Much of that change has come from ordinary people pushing for more space in society, just as much of China’s economic success has come from the entrepreneurial energy and hard work of its work force. Yet Communist Party leaders have been careful to hoard political power: independent unions and political opposition remain illegal. Earlier this year, Shenzhen’s leaders seemed eager to position the city as a pioneer of political reform. Shenzhen officials published a reform plan that advocated some local elections and greater leeway for local legislatures and courts to make decisions. But those plans, later tempered by provincial leaders, now seem derailed as officials are focused on maintaining social stability. Some influential Chinese say more should be done. Yu Keping, a scholar at a leading Communist Party research institute who has advised top leaders, published essays this week in leading Chinese newspapers about the need for greater democratization to combat corruption. In an interview with The New York Times, Mr. Yu called for “breakthrough reform.” But he also said that change must come incrementally, given the need for social stability, with an initial emphasis on better governing and rule of law. “We need to promote democratization in China,” Mr. Yu said. “On the other hand, we need to promote social stability. If we had an election right now, we might end up like Thailand.” In fact, the limited momentum toward modest political change could well be sidelined by economic problems, some experts say. “A real huge question is how the economic downturn is going to affect any sort of political reform,” said Joseph Fewsmith, a Boston University professor who studies Chinese politics. He said officials might deliberately slow efforts to carry out a new rural land reform law approved this fall to grant farmers the ability to transfer their land rights. “People worried about social stability are going to proceed very, very slowly,” Mr. Fewsmith said. Zhang Jing and Huang Yuanxi contributed research.

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Eurointelligence 19.12.2008

AND NOW A CURRENCY CRISIS

The euro reached an all-time high yesterday, as its trade-weighted index reached a level of 117. In a volatile session, the euro peaked against the dollar at $1.47, falling back in later trading, and at over 95 British pence, as we are fast approaching nominal unity with the pound sterling. Against the dollar, the euro is stilling traded below the earlier year peak of $1.60, but this is now getting very close again. And all this, while crude oil is still falling. It was at $36.50pb. The latest decline in the pound came after remarks by Charles Bean, deputy governor of the Bank of England, who told the Financial Times that interest rates might go all the way to zero, and that the UK may also adopt a policy of quantitative easing. Brad Setser writes that euro/dollar went from $1.25 to $1.45 in no time, with similar moves by the pound. “Both the US and the UK had housing and finance centric economies. Both have significant external deficits. And both are inclined to use monetary and fiscal policy aggressively to combat a downturn.” Setser notes that this extreme appreciation of the euro might put pressure on Germany to use fiscal policy (it puts pressure on Germany, but in our view it will probably not lead to a sufficiently large stimulus in time. The Germans are currently working on a new stimulus, mostly infrastructure spending, but little that could help the economy in the short-term.) Setser also makes an interesting technical observation. Central banks have in recent times increased the percentage of sterling in their reserves, and the fall in sterling could trigger central bank purchases as they might want to rebalance their portfolios.

Germany’s Ifo falls to the lowest level since 1982 Frankfurter Allgemeine reports that the outlook for the Germany, which has not been exactly optimistic, is even worse than expected, as the Ifo index reached a 26-year low of 82.6 – the seventh consecutive decline. Companies are as pessimistic about the current situation as about the outlook in six months time. Most of the problems came from the export industry, and in the wholesale, while the retail sector is unusually cheerful. There were several more forecasts showing GDP growth at around minus 2 per

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cent for 2009. One institute, associated with the trade union sector, forecasts an average rise in unemployment of 620,000 for 2009, a further massive rise in 2010.

ECB wides interest rate margins Frankfurter Allgemeine has the story that the ECB has reversed its policy enacted only a few weeks, when it reduced the difference between the deposit and the repo rate to only 0.5%. The move was intended to support the banking system, but it led to excessive liquidity hoarding by banks, who borrowed at the repo rate, and immediate deposited the money back with the ECB. While they made a small loss with this transaction, this appeared worthwhile, and less risky than to lend the money in the interbanking-market. By widening the interest rate gap to 1pp (the deposit rate is now 1.5%, not 2%), the ECB hopes to reduce the incentives banks to park their excess cash with the ECB. And here is a nice graph from Calculated Risk, showing the changes in the size of the Federal Reserve’s balance sheet. The blog says that Richard Fisher, governor of the Texas Fed, says this would go up to $3 trillion, around 20% of US GDP, by year-end.

A government crisis in Belgium We have had several months without a government crisis in Belgium, but that changed yesterday, Frankfurter Allgemeine reports from Brussels. The government of Yves Leterme is getting into difficulties over the proposed sale of Fortis to BNP, which was advocated heavily by Leterme himself, but the deal was subsequently blocked, albeit

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temporarily, by a Belgian court. The reason the government crisis is the news that Mr Leterme and his staff may have meddled with the court, and had tried to influence its decision-making. On Thursday afternoon, the content of a letter came out written by the highest Belgian judge who said that Mr Leterme’s government had made all efforts to stop the court making its judgement on Fortis. Belgian’s finance minister Didier Reynders is also heavily implicated in this scandal.

Details on Obama’s stimulus plan The Wall Street Journal has the details on the Obama stimulus plan. The proposed size will be between $675 and $775bn over two years. Once in Congress, it will probably growth to $850bn, but the goal is to keep it under $1 trillion. The details should be ready when Congress starts Jan 6, with legislation worked out even before Obama’s inauguration Jan. 20. The plans includes a tax cut of $50-$100bn, $100bn in aid to state governments, and funding in traditional infrastructure, schools, energy efficiency, broadband access and health-information technology.

A five-point action plan George Magnus writes in the FT that only determined government action can save us from a Japanese lost decade. He proposes a five-point plan. In Europe, banks need a further $100bn-$150bn of capital. Second, governments must continue to facilitate the enormous task of sustaining credit flows and restructuring debt. Third, massive fiscal stimulus, on the scale of what the US plans. Fourth, central banks should cut rates to zero, and adopt quantitative easing. Fifth, trust in public authorities needs to be re-established.

Do’s and don’t when pump priming Samuel Brittan writes in his FT column the governments should look at some of the lessons of history. “I would draw a simple moral. When fighting a slump concentrate on demand and output. Do not interfere with prices and wages; and above all avoid doing anything that wittingly or unwittingly strengthens business, labour or agricultural lobbies.”

Eurointelligence wishes to thank the Collegio Carlo Alberto for their support to help us maintain eurointelligence.com a free public service.

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Las rebajas ya están aquí Las grandes inmobiliarias comienzan a recortar los precios de sus viviendas nuevas, en ocasiones más de un 40% JUAN CARLOS MARTÍNEZ 19/12/2008 Las inmobiliarias no van a esperar a las rebajas de enero para reducir el precio de las viviendas. No pueden. Tienen que intentar maquillar al cierre del ejercicio los paupérrimos resultados que han acumulado durante los tres primeros trimestres. Lo que se han negado a hacer a lo largo de todo el año (bajar los precios de una manera drástica), lo quieren hacer ahora, en las dos semanas que quedan antes del 31 de diciembre. La medida resulta generalizada entre todas las empresas, cotizadas o no, y los descuentos, de todo tipo. Desde prácticamente insignificantes, de apenas dos o tres puntos porcentuales, a otros que superan ampliamente el 40%. Muy por encima de ese 30% que, según aseguraba la semana pasada el presidente de Afirma, Félix Abánades, ya había caído. "Es difícil que los precios caigan mucho más", concluía. En ese mismo foro, organizado por Asprima, la patronal madrileña de promotores inmobiliarios, el presidente de Inmobiliaria Chamartín, Carlos Cutillas, manifestaba que los precios ya habían bajado lo suficiente y advertía que "no vamos a vender por debajo de la hipoteca porque, si no, el quebranto será mayor. Me conformaría con que alguien comprara al precio de la hipoteca contraída con la entidad financiera". Palabras que la realidad del mercado se está encargando de tumbar en España y en otros países europeos, donde los precios también habían crecido de forma desmesurada, como el Reino Unido. En las mejores zonas de Londres, ni las propiedades más suntuosas, hasta ahora inmunes a la caída, se salvan de la quema. "Los precios en el centro de Londres han experimentado una caída durante ocho meses consecutivos hasta retroceder por encima del 14% en lo que va de año", asegura Liam Bailey, director de Residential Research, de la consultora Knight Frank. Esa demanda desbocada y, en buena medida, ficticia por el alto porcentaje de compras especulativas, a la que hasta hace un par de años aludían los promotores -como si con ellos no fuera la cosa- como causante de que los precios se hubieran triplicado, es la misma que ahora, en lugar de adquirirlo todo, ha optado por no comprar nada. Si subieron lo que subieron entonces, ¿por qué no bajan ahora de la misma manera?, se preguntan muchos que quieren comprar pero no pueden. Victoria, una madrileña de 37 años, cuenta su experiencia: "Dicen que han bajado los precios, y algo sí, pero no lo suficiente, porque luego vas a un banco, a otro... Y todos lo mismo. Te piden tantas garantías que resulta imposible". Todos se quejan de la actitud de los bancos, tanto promotores como compradores. Y es lógico. Son las entidades financieras las que deben respaldar la compra con la concesión del crédito. Y no lo están haciendo. Estamos ante una espiral sin salida. No se otorgan hipotecas porque, con los precios actuales, a los potenciales clientes no les llega. Anulaciones de contrato Así que no queda otra que esperar a ver hasta dónde tienen que llegar esas rebajas para que bancos y cajas de ahorros financien las operaciones. Además, los últimos datos ofrecidos por el Banco de España no aventuran que la situación vaya a variar a corto y medio plazo. Más bien todo lo contrario, toda vez que, en términos absolutos y hasta el pasado mes de octubre,

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los créditos hipotecarios de dudoso cobro concedidos a empresas y particulares rozaban ya los 51.000 millones de euros de una cartera total de 1,78 billones de euros, el 2,86%. Metrovacesa, la empresa ahora en manos de varias entidades financieras tras perder el control la familia Sanahuja, no se ha andado por las ramas. Hasta el último día del año ofrece un paquete de 99 pisos repartidos por 11 provincias con descuentos medios del 22%, llegando en algún caso hasta el 41%. La inmobiliaria reconoce, además, que se trata de viviendas procedentes de anulaciones de contrato, en la mayoría de los casos, de clientes a los que las entidades bancarias no les han otorgado el crédito para financiar la operación. En los primeros días de la oferta se han vendido 20 viviendas, según la información que ofrece en su página web. Lo que no se rebajan son las plazas de garaje y los cuartos trasteros. Córdoba es una de las provincias en la que se han aplicado mayores descuentos, del 28% al 41%, en los cinco pisos ofertados en el Edificio Azarquiel. Allí se localiza uno de los inmuebles ya vendidos y el que incorpora el mayor descuento. Un ático de dos dormitorios, que estaba en 536.520 euros, se ofrece por 316.547. Casi 220.000 euros menos. Alicante, Barcelona y Málaga aglutinan casi la mitad de estos pisos rebajados. Y es precisamente la capital de la Costa del Sol donde, de momento, los compradores se están aprovechando más de los descuentos. Allí se han vendido dos pisos y un adosado. El unifamiliar, que estaba en 376.000 euros, se ha adquirido por 315.000 euros. La quinta vivienda vendida se ubica en la localidad castellonense de San Jorge, a la que se le aplicó una rebaja de 80.000 euros. En la Comunidad de Madrid son sólo tres viviendas las incorporadas. Han quedado fuera de la oferta las ubicadas en las promociones de precio más elevado de la capital, tanto la del Parque de Berlín como la del Conde de Orgaz. En el Ensanche de Carabanchel, un piso que se vendía por 333.600 euros está ahora en 280.224, y a dos chalés en Valdemoro les ha aplicado descuentos superiores a 82.000 euros. ¿21 años de espera? Reyal Urbis y Vallehermoso son otras de las inmobiliarias cotizadas en Bolsa que también han querido sumarse a última hora a los descuentos. La presidida por Rafael Santamaría tiene en marcha desde el pasado 24 de noviembre y hasta el próximo 23 de diciembre una Bolsa de Oportunidad en la que ha incluido 96 inmuebles (viviendas y locales), un tercio de ellos localizados en la provincia de Barcelona, mientras que la promotora del Grupo SyV capitaliza la quinta subasta en Internet que organiza CB Richard Ellis, con 91 de los 129 productos ofertados. El pasado miércoles, unas horas antes del cierre de la puja, y a pesar de los descuentos de entre el 2% y el 46% aplicados, sólo se había ofertado por tres de las 91 viviendas. Pero no sólo las empresas cotizadas echan mano de los descuentos para intentar reducir el cada vez mayor volumen de productos en stock. En la Comunidad de Madrid, un buen número de inmobiliarias se ha acogido a la propuesta del Gobierno regional de poner en el mercado viviendas libres a precio concertado, con rebajas del 20%. Fórmula a la que se sumaron las principales entidades bancarias, comprometiéndose a ofrecer créditos preferentes a tipo variable y fijo; los notarios, con una reducción del 10% de sus aranceles, y los registradores, dispuestos a cobrar la mitad por las notas simples. Casi dos meses después de ponerse en marcha la medida, los logros no resultan excesivamente esperanzadores. Sólo se han vendido ocho viviendas. O mejora el ritmo de ventas o, con esta cadencia, las 1.242 viviendas hasta ahora captadas tardarían en venderse 21 años. Conclusión: la rebaja, quizá, resulta insuficiente.

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Deutsche Bank Breaks With Hybrid Capital Convention: A Dangerous Precedent? Dec 19, 2008 Dec 17 FT Alphaville: Deutsche Bank rattles the callable bond market (form of hybrid capital, see definitions below) by breaking with the convention to call these notes, at par, at the first available date (January 16 for €1bn worth of 3.875 per cent 2004/2014 subordinated bonds). That’s what banks do with such lower Tier 2 capital notes even if they are currently out of the money - redeem and re-issue on a regular basis in order to retain access to the market. On this occasion, Deutsche is allowing the bonds to turn into floating rate notes, preferring to pay a penalty rate of three month euribor +88bp because it deems re-issuing a new deal more costly--> The extra yield investors demand to buy financial company bonds climbed to a record 4.83 percentage points more than government debt, according to Merrill Lynch’s European Financial Corporate Index. That compares with a spread of 1.28 percentage points at the start of the year. o

European banks use the market for bonds with call dates rather than fixed maturities to meet regulatory reserve requirements, known as Tier 1 and 2 capital. The subordinated bonds rank after senior notes and loans for repayment.

o

Davies: More than $800bn hybrid bonds have been issued globally this decade, according to Dealogic, hitting a peak of $175bn in 2007 after raising common equity has become too expensive. Most of the issuance has come from banks. Their importance in supporting bank balance sheets during the crisis is shown in the $137bn of deals in the past year.

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Davies: When banks decide not to redeem the bonds at the earliest opportunity, the market value of the instruments falls, hurting investors. Analysts and bankers said such a scenario could see investors turn away from buying these deals in the future – further narrowing banks’ ability to raise new money.

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cont.: Analysts: "You have to ask two questions. One, can that capital be replaced at any price? Two, has the regulator told Deutsche it can only call the deal if it can replace it?”

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Davies: The move raised fears about Deutsche’s capital strength and signalled a much higher likelihood that other banks would follow the example in not repaying so-called hybrid-capital bonds. See list of all other bank capital instruments callable in the next 12 months by JPMorgan (via FTAlphaville).

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Chen et al (U-Texas): Firms facing poorer future investment opportunities are more likely to issue callable bonds. In addition, firms with higher leverage ratio and higher investment risk are more likely to issue bonds. Finally, as firms call back their bonds, nonrefunding calls are associated with poor performance and low investment activities, and refunding calls are associated with good performance and high investment activities. Firms with mediocre performance and investment activities tend to not call their bonds (see also Montier via InvestorsInsight) 181

o

Economist: Convertible bonds (fixed-income instruments that can be swapped for a company’s shares) have been battered in 2008. Traditionally, these were bought heavily by hedge funds (a specialist sector called convertible arbitrage) that hedged themselves by selling short (betting on a price fall) the shares of the company concerned. The trade has been almost impossible in recent weeks, thanks to the difficulty in getting leverage and restrictions on short-selling. Convertible bonds may look cheap but no one can take advantage of them.

o

Preferred shares - A hybrid security that are technically equities but behave more like bonds. Their share prices tend not to fluctuate as much as common shares. Payments from preferreds are taxed like dividends, which makes them a tax-effective holding in taxable portfolios. Unlike dividend stocks, preferreds usually have a fixed dividend and carry no voting rights. They have priority over common stocks in the case of bankruptcy and with regard to dividends. Only after the common share dividend has been suspended would preferred dividends be at risk. As opposed to common stockholders, preferred stockholders care more about the security of dividends than the size of dividends or capital appreciation

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Acceler8now.com: Several different ways for listed banks to raise additional equity capital: •

Private placements: offer is privately presented to a limited number of investors, usually targeted at well-heeled investors, including fund managers and institutional investors--> low marketing costs and quiet way of testing markets.

•

Public offer: An already listed company sells shares to the wide public. [First time sale of shares to the public of a previously not listed company is called Initial Public Offering IPO.]

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Rights Issue (popular in Europe and UK): close to a public offer, only with the limitation that only existing shareholders of the company can buy in order to limit ownership dilution--> Shares are usually offered at a discount to the currrent market price in order to limit the negative capital dilution effect for shareholders--> rights are now traded (sold and bought), meaning that the existing shareholders can still sell their rights to persons not previously shareholders. Rights are offered to shareholders in a certain proportion to what they already own (examples 1:2; 1:5).

•

Hybrid offers, i.e. a combination of public offer and rights issue,

•

Preferred shares and other “hybrid” securities with bond and equity like features are preferred by U.S. banks: Hybrids allow to replenish capital reserves without diluting existing shareholder base, but bond-like feature increases potential leverage which is watched closely by credit rating agencies (FT Alphaville)

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Opinion December 19, 2008 OP-ED COLUMNIST

The Madoff Economy By PAUL KRUGMAN The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend. Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole? The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s not just a matter of money: the vast riches achieved by those who managed other people’s money have had a corrupting effect on our society as a whole. Let’s start with those paychecks. Last year, the average salary of employees in “securities, commodity contracts, and investments” was more than four times the average salary in the rest of the economy. Earning a million dollars was nothing special, and even incomes of $20 million or more were fairly common. The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence. But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion. Consider the hypothetical example of a money manager who leverages up his clients’ money with lots of debt, then invests the bulked-up total in high-yielding but risky assets, such as dubious mortgage-backed securities. For a while — say, as long as a housing bubble continues to inflate — he (it’s almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he’ll keep those bonuses. O.K., maybe my example wasn’t hypothetical after all. So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. And while Mr. Madoff was apparently a self-conscious fraud, many people on Wall Street believed their own hype. Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear. We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.

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But the costs of America’s Ponzi era surely went beyond the direct waste of dollars and cents. At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics, in a nicely bipartisan way. From Bush administration officials like Christopher Cox, chairman of the Securities and Exchange Commission, who looked the other way as evidence of financial fraud mounted, to Democrats who still haven’t closed the outrageous tax loophole that benefits executives at hedge funds and private equity firms (hello, Senator Schumer), politicians have walked when money talked. Meanwhile, how much has our nation’s future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else? Most of all, the vast riches being earned — or maybe that should be “earned” — in our bloated financial industry undermined our sense of reality and degraded our judgment. Think of the way almost everyone important missed the warning signs of an impending crisis. How was that possible? How, for example, could Alan Greenspan have declared, just a few years ago, that “the financial system as a whole has become more resilient” — thanks to derivatives, no less? The answer, I believe, is that there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing. After all, that’s why so many people trusted Mr. Madoff. Now, as we survey the wreckage and try to understand how things can have gone so wrong, so fast, the answer is actually quite simple: What we’re looking at now are the consequences of a world gone Madoff.

Letters To the Editor: Paul Krugman hits the nail squarely on the head (“The Madoff Economy,” column, Dec. 19). Compensation for people handling other people’s money has sometimes not been earned in the commonly understood sense of the word. An illusory profit cannot be a legitimate basis of compensation since it is not truly a profit. An author would not be paid for writing an illusory book. A surgeon would not be paid for performing an illusory operation. Yet money managers have at times been paid for generating illusory profits. This is not merely unethical; it is divorced from economic reality. Gregory J. Shibley North Palm Beach, Fla., Dec. 19, 2008 To the Editor: The investment industry receives a formidable rebuke in Paul Krugman’s column about Wall Street. Fair enough. Similar scrutiny might be applied, however, to the professors of finance, teaching at business schools, who became celebrities among the very investment bankers whom Mr. Krugman castigates. These universities usually developed the technical basis for the complex investment instruments used by investment banks. Did these university professors speak out and attempt to correct the madness? Or did they feed the monster? Wasn’t it Warren Buffett who warned, “Beware of geeks bearing formulas”? Glenn Rennels Palo Alto, Calif., Dec. 19, 2008

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Blog: The Conscience of a Liberal December 19, 2008, 9:54 am

Madoff/Merdle I’m ashamed to admit that I’ve never read Little Dorritt, by Charles Dickens. But I guess I’ll download it to my Kindle. A reader points out that the BBC is currently doing a dramatization, and that the character of Mr. Merdle, the fraudulent financier, bears a strong resemblance to Bernard Madoff.

Letters To the Editor: 7. December 19, 2008 11:48 am Keeping in line with words that make illustrative points, let me say your column today was excellent, wonderful, and great. Still, did it possess a Dickens’s like quality? Who knows? But it was quite a story…and stories greatly condense reality when they’re good. — Lloyd Little 13. December 19, 2008 11:48 am Interesting. Perhaps Mr. Madoff is based on him! — David Coyne 16. December 19, 2008 12:37 pm Link Merdle committed suicide by slitting his wrists in the bathtub, if I remember correctly. — Russell Belding 19. December 19, 2008 1:16 pm Little Dorrit is brilliant, as is the rest of Dickens work. Readers should get the 8 hour movie version with Derek Jocoby among others, made in 1989, I think. Economics grad schools should have a mandatory course in Dickens. — Wonks Anonymous 21. December 19, 2008 1:33 pm Link There was a good movie version released in 1988, with Alec Guiness as the father William. It was eye-opening for me, showing what debtors prisons were like. — Michael

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Business December 18, 2008

Madoff Scandal Shaking Real Estate Industry By CHRISTINE HAUGHNEY Almost no segment of New York City’s real estate industry was spared in the Madoff scandal, which may be history’s largest Ponzi scheme: commercial brokers large and small, littleknown developers and prominent families like the Wilpons and Rechlers all lost money to Bernard L. Madoff, industry executives say. The outsize impact on the industry may have resulted largely because Mr. Madoff (pronounced MAY-doff) managed his funds much the way that real estate leaders have operated successfully for decades: He provided little information and demanded a lot of trust. “You have a lot of wealthy people who made a lot of money on handshakes,” said Mark S. Weiss, a commercial real estate broker at Newmark Knight Frank, where several brokers had invested heavily with Mr. Madoff. There was “something about this person, pedigree and reputation that inspired trust,” he said. Across the city, industry executives said deals had been scuttled or jeopardized because of the scandal. Residential brokers are taking calls from Madoff investors who have had to put their apartments on the market. Many developers had pledged their investments with Mr. Madoff as collateral for projects, and are now worried that their banks will call in their loans. “The level of devastation, both financial and on a human level, is astounding,” said Robert J. Ivanhoe, a lawyer who is representing 10 developers and investors who lost $5 million to $50 million each with Mr. Madoff. Indeed, at an industry fund-raiser at the Grand Hyatt hotel in Manhattan last weekend, much of the chatter over sushi and crudités was about money feared lost with Mr. Madoff, according to people who attended. And a Manhattan psychotherapist who counsels real estate leaders and bankers said most of the patients he has seen this week have close friends and relatives who lost money with Mr. Madoff. The victims include executives at the global commercial brokerage CB Richard Ellis, most prominently Stephen Siegel, a major Bronx landlord who is chairman of worldwide operations at the brokerage and whose wife, Wendy, helped organize Saturday’s fund-raising dinner. Brian S. Waterman, a principal at Newmark, also invested with Mr. Madoff. So did the Rechler family, which has been a major owner of office buildings in the region. Scott Rechler, the head of RexCorp, one of the family’s largest firms, called the family’s exposure “limited.” Jerry Reisman, a lawyer based in Garden City, N.Y., said he was representing six commercial real estate investors and developers in the area who lost a total of $150 million to Mr. Madoff. They met Mr. Madoff through contacts at country clubs in the tristate area, he said.

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“They knew him from golfing in the Hamptons. They knew him from the locker rooms,” Mr. Reisman said. “He was considered a wizard.” Mr. Reisman said his clients were especially concerned because they counted on Madoff investments to complete some of their real estate projects, pledging their investments as collateral for projects. Those developers fear that when their banks realize that their investments with Mr. Madoff have disappeared, they will demand new collateral from other sources, Mr. Reisman said. Finding those alternative lenders will be difficult given the financial crisis — and given that many other real estate investors have been hurt by the Madoff case. “Many of these developers, their resources are all with Madoff,” Mr. Reisman said. There are widespread concerns that some developers will have trouble completing projects currently under construction. Edward Blumenfeld, who runs Blumenfeld Development Group, had invested heavily with Mr. Madoff and considered him a friend. Gary Lewi, a spokesman for Mr. Blumenfeld, said he still planned to complete a shopping complex in East Harlem that is to include a Target and a Costco, as well as several other projects where construction is “in the ground.” Beyond that, though, Mr. Blumenfeld is uncertain of what his development plans hold. His friendship with Mr. Madoff is even more uncertain, Mr. Lewi said. “Any long-term plans are being reviewed as we conduct a far larger analysis of this scandal and the impact it could have on us and the development community as a whole,” Mr. Lewi said. “Mr. Blumenfeld was friend to a man who apparently didn’t exist.” The Wilpon family, the major owners of the Mets, has acknowledged investing millions with Mr. Madoff. The family controls a real estate firm, Sterling Equities, whose Web site says it owns 3,000 residential units and 600,000 square feet of office space. It is unclear whether the firm’s real estate holdings are affected by the Madoff investments. “We are shocked by recent events and, like all investors, will continue to monitor the situation,” said Richard Auletta, a spokesman for Sterling. Other real estate developers are finding that their charitable giving has been wiped out by Mr. Madoff. Leonard Litwin, one of the city’s largest apartment landlords and head of Glenwood Management, had nearly all of his charitable foundation’s investments managed by Mr. Madoff. Gary Jacob, executive vice president of Glenwood, said Mr. Litwin had never met Mr. Madoff but had invested with him on the advice of a friend. The Litwin Foundation had donated money to research for cancer and Alzheimer’s disease and charities, many of them supported by the real estate industry. “It would have no impact to us as a real estate company,” Mr. Jacob said. “But it affects the charitable giving.” Some members of the real estate industry are receiving the news with a mix of schadenfreude and sadness for their peers. Jeffrey R. Gural, chairman of Newmark Knight Frank, the brokerage firm, said Mr. Madoff had turned his family down as investors about eight years ago because they would not invest at least $20 million. For years, he said, colleagues introduced to Mr. Madoff through relatives or country club friends had sung his praises. “People used to brag how they were getting these great returns when everybody else was struggling,” he said. “They thought Bernie Madoff was a genius, and anybody who didn’t give them their money was a fool.” 187

The impact is already spreading to the residential real estate business. Brad Friedman, a lawyer representing about 100 investors primarily in New York and Florida, said several clients have already said they plan to put their apartments on the market. They depended on their Madoff investments to pay their mortgages and co-op fees. “With that source of money frozen, they’ve got no cash,” Mr. Friedman said. “They can’t pay the electric bill. They can’t pay the mortgage.” Other buyers have already backed out of deals because they had invested with Mr. Madoff and can no longer finance their purchases. Michele Kleier, a prominent Upper East Side broker, had buyers pull out of purchases on two $2 million apartments because they had lost money to Mr. Madoff. The first buyer put in an offer at 3 p.m. last Thursday, the day of Mr. Madoff’s arrest, only to withdraw it by 5:30 p.m. The second set of buyers had visited an apartment three times, requested the financial information about the co-op and had the broker notify Ms. Kleier that they would be making an offer on Monday morning. On Monday, she learned that the buyers had backed out because their money was tied up with Madoff funds. “It’s now two deals in the last four days,” Ms. Kleier said. “It’s amazing.” Kenneth Mueller, a Manhattan psychotherapist who counsels many real estate and financial executives, said those who lost money to Mr. Madoff called his indictment “the nail in the coffin for the commercial real estate industry,” which had already been hurt by the recession. Dr. Mueller said many patients were re-evaluating whether they can trust their business partners after Mr. Madoff’s betrayal. “Madoff was considered a member of the family,” he said.

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Opinion December 17, 2008 OP-ED COLUMNIST

The Great Unraveling By THOMAS L. FRIEDMAN Hong Kong The stranger, a Western businessman, slipped into the chair next to me at an Asia Society lunch here in Hong Kong and asked me a question that I can honestly say I’ve never been asked before: “So, just how corrupt is America?” His question was occasioned by the arrest of the Wall Street money manager Bernard Madoff on charges of running a Ponzi scheme that bilked investors out of billions of dollars, but it wasn’t only that. It’s the whole bloody mess coming out of Wall Street — the financial center that Hong Kong moneymen had always looked up to. How could it be, they wonder, that such brand names as Bear Stearns, Lehman Brothers and A.I.G. could turn out to have such feet of clay? Where, they wonder, was our Securities and Exchange Commission and the high standards that we had preached to them all these years? One of Hong Kong’s most-respected bankers, who asked not to be identified, told me that the U.S.-owned investment company where he works made a mint in the last decade cleaning up sick Asian banks. They did so by importing the best U.S. practices, particularly the principles of “know thy customers” and strict risk controls. But now, he asked, who is there to look to for exemplary leadership? “Previously, there was America,” he said. “American investors were supposed to know better, and now America itself is in trouble. Whom do they sell their banks to? It is hard for America to take its own medicine that it prescribed successfully for others. There is no doctor anymore. The doctor himself is sick.” I have no sympathy for Madoff. But the fact is, his alleged Ponzi scheme was only slightly more outrageous than the “legal” scheme that Wall Street was running, fueled by cheap credit, low standards and high greed. What do you call giving a worker who makes only $14,000 a year a nothing-down and nothing-to-pay-for-two-years mortgage to buy a $750,000 home, and then bundling that mortgage with 100 others into bonds — which Moody’s or Standard & Poors rate AAA — and then selling them to banks and pension funds the world over? That is what our financial industry was doing. If that isn’t a pyramid scheme, what is? Far from being built on best practices, this legal Ponzi scheme was built on the mortgage brokers, bond bundlers, rating agencies, bond sellers and homeowners all working on the I.B.G. principle: “I’ll be gone” when the payments come due or the mortgage has to be renegotiated. It is both eye-opening and depressing to look at our banking crisis from China. It is eyeopening because it is hard to avoid the conclusion that the U.S. and China are becoming two countries, one system. How so? Easy, in the wake of our massive bank bailout, one can now look at China and America and say: “Well, China has a big-state-owned banking sector, next to a private one, and America now has a big state-owned banking sector next to a private one. China has big 189

state-owned industries, alongside private ones, and once Washington bails out Detroit, America will have a big state-owned industry next to private ones.” Yes, an exaggeration to be sure, but the truth is the differences are starting to blur. For two decades, a parade of U.S. officials came to China and lectured Beijing on the necessity of privatizing its banks, said Qu Hongbin, the chief economist for China at HSBC. “So, slowly we did that, and now, all of a sudden, we see everybody else nationalizing their banks.” It’s depressing because China in many ways feels more stable than America today, with a clearer strategy for working through this crisis. And while the two countries are looking more alike, they appear to be on very different historical trajectories. China went crazy in the 1970s, with its Cultural Revolution, and only after the death of Mao and the rise of Deng Xiaoping has it managed to right itself, gradually moving to a market economy. But while capitalism has saved China, the end of communism seems to have slightly unhinged America. We lost our two biggest ideological competitors — Beijing and Moscow. Everyone needs a competitor. It keeps you disciplined. But once American capitalism no longer had to worry about communism, it seems to have gone crazy. Investment banks and hedge funds were leveraging themselves at crazy levels, paying themselves crazy salaries and, most of all, inventing financial instruments that completely disconnected the ultimate lenders from the original borrowers, and left no one accountable. “The collapse of communism pushed China to the center and [America] to the extreme,” said Ben Simpfendorfer, chief China economist at Royal Bank of Scotland. The Madoff affair is the cherry on top of a national breakdown in financial propriety, regulations and common sense. Which is why we don’t just need a financial bailout; we need an ethical bailout. We need to re-establish the core balance between our markets, ethics and regulations. I don’t want to kill the animal spirits that necessarily drive capitalism — but I don’t want to be eaten by them either.

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Business December 17, 2008

S.E.C. Issues Mea Culpa on Madoff By ALEX BERENSON and DIANA B. HENRIQUES The Securities and Exchange Commission said Tuesday night that it had missed repeated opportunities to discover what may be the largest financial fraud in history, a Ponzi scheme whose losses could run as high as $50 billion. The commission said it received credible allegations about the scheme at least nine years ago and will immediately open an internal investigation to examine why it had failed to pursue them aggressively. The S.E.C. issued the statement hours after Bernard L. Madoff, the 70-year-old Wall Street executive accused of operating the scheme, discussed the fraud with federal authorities at a meeting in New York on Tuesday, according to people briefed on the meeting. “Our initial findings have been deeply troubling,” Christopher Cox, the S.E.C. chairman, said in his statement. The commission received “credible and specific allegations regarding Mr. Madoff’s financial wrongdoing,” but did not respond aggressively, he said. “I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them,” Mr. Cox said. Moreover, Mr. Cox said, the commission will investigate “all staff contact and relationships with the Madoff family and firm, and their impact, if any, on decisions by staff regarding the firm.” Mr. Cox added that he had ordered S.E.C. staff to recuse themselves from the investigation if they had “more than insubstantial personal contacts with Mr. Madoff or his family.” One of the commission’s investigative teams that had examined the Madoff firm was headed by a lawyer named Eric Swanson, who served for 10 years as a lawyer at the commission and left in 2006 while he was an assistant director of the office of compliance inspections and examinations in Washington. In 2007, Mr. Swanson married Shana Madoff, a niece of Bernard L. Madoff and daughter of his brother, Peter Madoff, the firm’s chief compliance officer. Ms. Madoff is the firm’s compliance attorney. Eric Starkman, a spokesman for Mr. Swanson, said that Mr. Swanson’s “romantic relationship with his wife began years after the compliance team he helped supervise made an inquiry about Bernard Madoff’s securities operations.” And Randy Williams, a spokesman for Mr. Swanson’s current employer, BATS Exchange in Kansas City, said that Mr. Swanson had not participated in any inquiry of into the Madoff firm or its affiliates while he was involved in a relationship with Ms. Madoff. Besides investigating Mr. Madoff, regulators are now in the embarrassing position of examining whether they should have caught him sooner.

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Mr. Madoff kept several sets of books and false documents and lied to regulators when they questioned him in previous examinations of his firm, Bernard L. Madoff Investment Securities, Mr. Cox said. Investigators never used subpoena powers to obtain information, but rather “relied on information voluntarily produced by Mr. Madoff and his firm,” Mr. Cox said. When he was arrested last week, Mr. Madoff estimated that investors lost as much as $50 billion in the fraud, according to court filings. Mr. Madoff has said the scam was a Ponzi scheme, a type of fraud in which early investors are paid off with money from later victims, until no more money can be raised and the scheme collapses. Over the decades, Mr. Madoff steadily expanded his circle of investors, drawing in small individual investors, charities, pension funds, prominent billionaires and European banks. On Tuesday, a Vienna bank, Bank Medici, became the latest major institution to acknowledge it was a client of Mr. Madoff, saying it had $2.1 billion invested with him. Institutions and individuals have now reported losses of more than $20 billion. Stephen Harbeck, the chief executive of the Securities Investor Protection Corporation, which has taken control of Mr. Madoff’s firm through a trustee, said the firm appeared to have multiple sets of books and that he was unsure how much money, if any, Mr. Madoff’s clients would eventually recover. “The trustee and SIPC have been involved in this case for about 24 hours,” Mr. Harbeck said. “You’re talking about an ongoing fraud that lasted for decades.” Attorneys for Mr. Madoff declined to comment on Tuesday night about Mr. Madoff’s conversations with government authorities. “We have said from the beginning that we are cooperating fully with the government investigation,” said Ira Lee Sorkin, one of the lawyers. When pressed, Mr. Sorkin said he had used “we” to refer to “the company, whose sole shareholder is Bernie Madoff.” Mr. Sorkin would not confirm that Mr. Madoff himself was providing first-hand cooperation. Extensive cooperation from Mr. Madoff could substantially shorten the time it will take for regulators to track down any available assets, locate any other people who may have been involved in the fraud and determine whether investors will recover any of their losses. The first indication that Mr. Madoff might be talking to authorities came at midmorning, when a federal judge delayed a bond hearing for Mr. Madoff that had originally been set for 2 p.m. Tuesday afternoon. At the request of federal prosecutors, the hearing was rescheduled for the same time on Wednesday. No reason for the postponement was given, nor would the federal prosecutor’s office or Mr. Madoff’s lawyers comment on the delay. Mr. Madoff was arrested at his Upper East Side apartment in Manhattan last Thursday by F.B.I. agents, after his two sons — both of whom work for the company — reported that he had confessed to them that his money-management business was “basically, a giant Ponzi scheme” and “a big lie.” The criminal complaint under which he was arrested charged him with a single count of securities fraud. He surrendered his passport and was released on a $10 million bond, secured by his apartment and co-signed by his wife and his brother, Peter Madoff, who was also the general counsel at his trading firm. William K. Rashbaum and Steven Labaton contributed reporting.

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Economy December 17, 2008

Fed Cuts Key Rate to a Record Low By EDMUND L. ANDREWS and JACKIE CALMES WASHINGTON — The Federal Reserve entered a new era on Tuesday, lowering its benchmark interest rate virtually to zero and declaring that it would now fight the recession by pumping out vast amounts of money to businesses and consumers through an expanding array of new lending programs. Going further than expected, the central bank cut its target for the overnight federal funds rate to a range of zero to 0.25 percent and brought the United States to the zero-rate policies that Japan used for years in its own fight against deflation. Though important as a historic milestone, the move to an interest rate of zero from 1 percent is largely symbolic. The funds rate, which affects what banks charge for lending their reserves to each other, had already fallen to nearly zero in recent days because banks have been so reluctant to do business. Of much greater practical importance, the Fed bluntly announced that it would print as much money as necessary to revive the frozen credit markets and fight what is shaping up as the nation’s worst economic downturn since World War II. In effect, the Fed is stepping in as a substitute for banks and other lenders and acting more like a bank itself. “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth,” it said. Those tools include buying “large quantities” of mortgage-related bonds, longer-term Treasury bonds, corporate debt and even consumer loans. The move came as President-elect Barack Obama summoned his economic team to a fourhour meeting in Chicago to map out plans for an enormous economic stimulus measure that could cost anywhere from $600 billion to $1 trillion over the next two years. The two huge economic stimulus programs, one from the Fed and one from the White House and Congress, set the stage for a powerful but potentially risky partnership between Mr. Obama and the Fed’s Republican chairman, Ben S. Bernanke. “We are running out of the traditional ammunition that’s used in a recession, which is to lower interest rates,” Mr. Obama said at a news conference Tuesday. “It is critical that the other branches of government step up, and that’s why the economic recovery plan is so essential.” Financial markets were electrified by the Fed action. The Dow Jones industrial average jumped 4.2 percent, or 359.61 points, to close at 8,924.14. Investors rushed to buy long-term Treasury bonds. Yields on 10-year Treasuries, which have traditionally served as a guide for mortgage rates, plunged immediately after the announcement to 2.26 percent, their lowest level in decades, from 2.51 percent earlier in the day. Yields on investment-grade corporate bonds edged down to 7.215 percent on Tuesday, from 7.355 on Monday. Yields on riskier high-yielding corporate bonds remained in the stratosphere at 22.493 percent, almost unchanged from 22.732 on Monday.

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By contrast, the dollar dropped sharply against the euro and other major currencies for the second consecutive day — a sign that currency markets were nervous about a flood of newly printed dollars. Some analysts predict that the Treasury will have to sell $2 trillion worth of new securities over the next year to finance its existing budget deficit, a new stimulus program and to refinance about $600 billion worth of maturing government debt. For the moment, Mr. Obama and Mr. Bernanke appear to be on the same page, though that could abruptly change if the economy starts to revive. Fed officials have already assumed that Congress will pass a major spending program to stimulate the economy, and they are counting on it to contribute to economic growth next year. In more normal times, the Fed might easily start raising interest rates in reaction to a huge new spending program, out of concern about rising inflation. But data on Tuesday provided new evidence that the biggest threat to prices right now was not inflation but deflation. The federal government reported on Tuesday that the Consumer Price Index fell 1.7 percent in November, the steepest monthly drop since the government began tracking prices in 1947. The decline was largely driven by the recent plunge in energy prices, but even the so-called core inflation rate, which excludes the volatile food and energy sectors, was essentially zero. Mr. Obama’s goal is to have a package ready when the new Congress convenes on Jan. 6. His hope is that the House and Senate, with their bigger Democratic majorities, can agree quickly on a plan for Mr. Obama to sign into law soon after he is sworn into office two weeks later. The Fed, in a statement accompanying its rate decision, acknowledged that the recession was more severe than officials had thought at their last meeting in October. “Over all, the outlook for economic activity has weakened further,” the central bank said. “Labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment and industrial production have declined.” The central bank added: “The committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” With fewer than 10 days until Christmas, retailers from Saks Fifth Avenue to Wal-Mart have been slashing prices to draw in consumers, who have sharply reduced their spending over the last six months. On Tuesday, Banana Republic offered customers $50 off on any purchases that total $125. The clothing retailer DKNY offered customers $50 off any purchase totaling $250. Ian Shepherdson, an analyst at High Frequency Economics, said falling energy prices were likely to bring the year-over-year rate of inflation to below zero in January. The Fed has already announced or outlined a range of unorthodox new tools that it can use to keep stimulating the economy once the federal funds rate effectively reaches zero. On Tuesday, Fed officials said they stood ready to expand them or create new ones to relieve bottlenecks in the credit markets. All of the tools involve borrowing by the Fed, which amounts to printing money in vast new quantities, a process the Fed has already started. Since September, the Fed’s balance sheet has ballooned from about $900 billion to more than $2 trillion as it has created money and lent it out. As soon as the Fed completes its plans to buy mortgage-backed debt and consumer debt, the balance sheet will be up to about $3 trillion.

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“At some point, and without knowing the timing, the Fed is going to have to destroy all that money it is creating,” said Alan Blinder, a professor of economics at Princeton and a former vice chairman of the Federal Reserve. “Right now, the crisis is created by the huge demand by banks for hoarding cash. The Fed is providing cash, and the banks want to hoard it. When things start returning to normal, the banks will want to start lending it out. If that much money is left in the monetary base, it would be extremely inflationary.” Vikas Bajaj contributed reporting from New York.

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Econbrowser ANALYSIS OF CURRENT ECONOMIC CONDITIONS AND POLICY DECEMBER 16, 2008 Quantitative easing Today's announcement from the Federal Reserve marks the end of the road for Plan A (fighting the recession by lowering interest rates), and the beginning of ... what? The Fed's announcement begins: The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent. Although that caught the headlines, it's really the anticlimactic part. The actual fed funds rate and short-term T-bill rates had been well below the Fed's previous "target" of 1.0% for some time, making today's announcement little more than an acknowledgement that that's indeed where we are. At least we can all finally agree that further rate cuts from the Fed are completely irrelevant, if for no other reason than because it's physically impossible for there to be any more ahead.

Source: FRED.

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LEHMAN AND FEDERAL RESERVE ASSETS

Big arrow: Lehman’s bankruptcy filing. Small arrow: Bear Stearns “crisis”

data source: Financial System Review, december 2008, bank of canada, page 14 The main news value of the Fed's announcement was the opportunity for the Fed to communicate what else besides rate cuts it may have in its bag of tricks: The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term AssetBacked Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity. The frustration for the Fed is that while the T-bill rate is already essentially zero, term rates charged to any of the rest of us remain far higher. The Fed continues in its hope that by changing the composition of its assets-- making loans itself, buying MBS-- it will be a big enough factor in the demand for the less favored assets to move those spreads. This of course

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is exactly the kind of thing that the Fed has been doing for the last year, with the FOMC today promising an even bigger expansion of its holdings of unconventional assets. WSJ reports this clarification on what the Fed intends from a press conference with a "senior Federal Reserve official": Is this quantitative easing? The Fed said in its statement today that it will be using its balance sheet to support credit markets and the economy. Some analysts have called the approach quantitative easing-- effectively expanding the money supply once interest rates cannot be eased further-- as Japan did during its economic turmoil. But the senior Fed official said the central bank's approach is distinct from quantitative easing and different from what the Japanese did. The Fed's balance sheet has two sides, the official explained: assets with securities the Fed holds (including loans, credit facilities, mortgage-backed securities) and liabilities (cash and bank reserves). Japan's quantitative easing program focused on the liability side, expanding cash in the system and excess reserves by a large amount. The Fed's focus, however, is on the asset side through mortgagebacked securities, agency debt, the commercial paper program, the loan auctions and swaps with foreign central banks. That's designed to improve credit-market functioning, the official said. By expanding the balance sheet by making loans, the official explained, the focus is not on excess reserves but on the asset side. That securities-lending approach directly affects credit spreads, which is the problem today-- unlike Japan earlier, where the problem was the level of interest rates in general, the official said. Will that strategy succeed if we just do it on a sufficiently large scale? I'm not at all convinced that it would. Our standard finance models treat interest rate spreads as governed primarily by fundamentals such as default risk and only secondarily by the volume of buyers or sellers. But while the Fed may have little control over the spreads between different interest rates, it does have a significant degree of control over the inflation rate. The 1.7% drop in headline CPI during November, and the -10% annual deflation rate for the last 3 months, should not be viewed as welcome developments in an environment where our primary concern is whether individuals and institutions are going to repay their debts. The Fed should want to generate enough inflation to pull those short-term interest rates above the zero floor. But to target inflation, the Fed would take exactly the opposite strategy from that outlined by the senior Fed official above. The goal would be to get cash into circulation rather than be hoarded by banks, and have the Fed's assets be ones that could be readily liquidated if the inflation starts to come in higher than desired. Greg Mankiw wishes the Fed had added to its statement something along the following lines: The Committee recognizes that moderate inflation would be desirable under the present circumstances. In particular, the overall level of prices a decade hence should be about 30 percent higher than the price level today. And I like Greg's explanation of why that's the direction we need to go: As Jim Tobin said in an earlier era, there are worst things than inflation, and we have them.

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RGE Monitor's Newsletter Greetings from RGE Monitor! miércoles 17/12/2008 10:59 In today's newsletter we focus on currency dynamics around the globe. Does the U.S. dollar's December slide mean the USD has passed its peak? Most likely not. The turn-of-the-year profit-taking on long USD positions creates a near-term blip in the dollar's uptrend but doesn't alter the medium-term trend of appreciation versus the euro. The four horseman of the carry trade apocalypse - Deleveraging, Risk Aversion, Growth Differentials and the Dollar's Reserve Currency Status - would need to retreat before we see a sustained pullback in the EUR/USD from the slide to near-parity ($1.10-$1.30). Governments, banks and other firms are still scrambling for dollars to repay their USD-denominated debt while signs of global recession and credit crisis spur on the flight-to-safety in U.S. Treasuries. European sovereign bonds offer an alternative but inferior safe haven because of the European bond market's fragmentation and exposure to emerging Europe. More aggressive policy response in the U.S. compared to Europe, could bring the U.S. out of a recession faster than the Eurozone (though growth will most likely remain subdued for some years to come), supporting the dollar against the euro. In the longer term, however, once risk appetite revives, the greenback might lose its defenses in wake of worries surrounding U.S. public debt expansion and the potential inflationary effect of quantitative easing. The Japanese yen hit a 13-year high against the dollar in mid-December when it broke below 90 per dollar. It may hold the distinction of being the only currency apart from the Swiss Franc that could appreciate against the dollar in early 2009 due to carry trade unwinding and repatriation of Japanese funds invested overseas. The recent surge in the yen is being driven by carry trade unwinding as well as a substantial shrinkage in US-Japan rate differentials. While there is room for the JPY to strengthen in the short-term, Japan's increasingly gloomy macroeconomic outlook raises questions about its continued strengthening over the mediumto-long term. The rest of Asian and the Pacific currencies are losing ground against the dollar. Faced with slowing growth and exports as well as withdrawal of foreign capital, many Asian currencies have fallen against the dollar, with those with current account deficits like South Korea and India hardest hit. Despite central bank intervention, the currencies of India, S. Korea, Thailand, Philippines, Indonesia have depreciated recently as global risk aversion contributed to outflows from EMs. Declines of around 20% for these currencies may have contributed to some slackening by Asia's other strong currency, the Chinese yuan. After appreciating against the dollar at the beginning of 2008, and tracking it closely through spring, summer and most of the fall, the yuan is now depreciating slightly against the dollar as Chinese growth slows and the Chinese try to temper the 25% appreciation against the Euro since mid 2008. Last weekend's powwow

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between China, Japan and Korea which followed the Japanese and Chinese extension of credit lines to support the Won, may be the first step in greater exchange rate coordination within Asia and may help to support some faltering Asian currencies at least in the shortterm. Meanwhile the dollar's rally is putting the Hong Kong dollar under pressure when Hong Kong is in recession, despite the strong support for its peg from authorities. The Korean won has been victim of the selloff of emerging market assets in an environment of acute risk aversion. South Korea gives the world an example of a net creditor in a currency crisis. The won's downfall also has its roots in Korea's high ratio of short-term external debt to foreign reserves (60% at end-2007). After international capital markets essentially shut down, Korean banks and firms have sought dollars to repay their external debt or sell off assets to do so - raising demand for USD versus KRW. This deleveraging, plus the export slowdown and portfolio outflows from Korean equity and debt markets, might keep the won weakening versus the USD until late 2009. The current account will likely improve if commodity prices remain low and import demand falls, but capital outflows will outweigh the effect of the current account surplus on the won. Free floating commodity currencies like the Australian, Canadian and New Zealand dollars and the Norwegian Krone have followed their commodity exports values down - together the fall in commodity prices and currency corrections of 20-30% have eroded their terms of trade. Despite the chance that they may already have overcorrected, with further rate cuts to come, these currencies could slide further. And so might the South African rand, especially now that the Reserve Bank has joined the cutting cycle. But these currencies might not gain much from any prolonged dollar weakness unless commodities pick up much steam as all of these economies are facing sharp slowdowns at best and recessions at worst. Other fuel exporters like Russia and Nigeria were reluctant to let their currencies slide and in Russia's case spent significant portions of their ample reserves to avert it. But with Russia's current account about to shift to deficit as early as this quarter and its reserves falling by almost 30%, it is now allowing more frequent 1% devaluations. The rouble may fall another 20% at current price points through Q109, meaning that Russia's fx-denominated debt may become an even greater burden for the government especially as the devaluation expectation is contributing to retail and corporate deposit withdrawals from the banks - expect to see more declines in fx reserves. Nigeria too is allowing the Naira to shift downwards and the Kazakh Tenge may not be far behind. Meanwhile the dollar peggers among the oil exporters, especially the GCC, are no longer facing the appreciation pressure they suffered earlier this year even as the dollar's rally has increased their purchasing power. In all of these countries, inflation is slowly coming down, even if it remains stubbornly in the double digits and weakening local currencies offset falling global price declines. Most MENA currencies are pegged either to the dollar or to a basket which includes exposure to the euro - these pegs are expected to remain in place. However, the region's more flexible currencies have been allowing more depreciation. Egypt's pound plunged from a five-year high of LE 5.31 per USD in August 08 to a rate of almost LE 5.53 in December 08 and may continue depreciating in 2009 as Egyptian - and global growth - slows and Egypt's balance of payments continues to be weak. With inflationary pressures easing, the Central bank of Egypt (CBE) may do little to prevent the pound's depreciation in hopes of boosting growth via cheaper exports, increasing tourism and Suez Canal revenues and attracting more FDI. Israel's monetary easing comes as the country is witnessing a significant growth

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slowdown - another rate cut on December 29 may further weaken the shekel. With many of Israel's export partners faltering, a weaker shekel has been 'desired' by the BOI for some time. However, government support of the financial sector may cause intermittent strengthening of the shekel. Eastern European currencies are coming under pressure, in part due to spill-over from global market turmoil and in part due to domestic fundamentals. Many analysts are bearish on all CEE currencies given these economies' heavy dependence on capital inflows. Nevertheless, some economies (i.e. Czech Republic and Poland) seem better placed than others (i.e. Hungary and Romania) and this should feed through to their currencies. Similarly, despite steep devaluation on the Ukrainian Hryvnia, pressure continues given its large current account and reliance on steel exports. Devaluations in the works in the Baltics? The currency pegs in the Baltic economies, particularly Latvia's, have been coming under pressure recently. Given their large external imbalances and the global financial crisis, the question has arisen as to whether these countries will be forced to give up their currency pegs to the euro. Many analysts, however, see no appetite for a devaluation as the high degree of foreign currency borrowing in these countries mean a devaluation could undermine financial stability. Moreover, the possibility of a speculative attack is limited by the shallow financial markets in the region. The Turkish lira is among most risk-sensitive of EM currencies. The TRY shows a strong correlation to carry trade baskets given Turkey's high interest rates and is therefore sensitive to unwinding. In the near-term, expectations of an IMF deal, as well as global risk appetite and monetary policy moves, are the factors determining the currency's path. Analysts expect the lira to depreciate further in next 6 to 12 months given Turkey's large current-account deficit, increased global risk aversion, and sluggish foreign direct investment (FDI) inflows since beginning of the year. Moving to Northern Europe, economic recession, vulnerability of Swedish banks (due to their exposure to sharply slowing Baltic economies) and the rate cycle have been weighing on the SEK, which hit record lows against the euro in December. Yet, a number of analysts now see the SEK strengthening over the next 12 months from its current levels. In Latin America, the Brazilian Real (BRL) remains a source of concern on the inflation front, continuing to show a weakening bias after having depreciated over 30% in the last three months. While Brazil's external indicators suggest the currency is overshooting, the authorities cannot ignore its persistent weakening. Estimates of the historical pass-through from BRL movements to domestic consumer prices stand at around 8-10% after approximately one year. The Mexican peso (MXN) seems to be stabilizing after a volatile adjustment phase that affected energy-linked emerging-market economies. Interest rate differentials, banking sector systemic health, a swift government response to the global financial crisis, still large central bank FX reserves, and the reciprocal currency arrangement between the US and Mexican central banks have been MXN-supportive. The Chilean peso (CLP) has discounted a sharp contraction in trade-linked currency flows, despite a relatively solid fiscal position. Interest rate differentials are not a CLP supporting

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factor in spite of the fact that the central bank has earmarked the fight against inflation as a key priority. The sharp commodity price adjustment anticipates a weakening prospect for Chile's export sector. The Peruvian sol (PEN) has been quite stable, trading at an average rate of 3.04 per USD over the past month; during the recent wave of financial turmoil it has also experienced the lowest volatility amongst peer-group floating currencies within Latin America. The central bank will continue to heavily intervene in the foreign currency market if need be. The USD/PEN is expected to close this year at 3.00. In Venezuela, the government has stashed away substantial funds during the windfall oil years. With prices falling bellow USD60pb and local inflation rampant the government fiscal accounts remain vulnerable. This will lead the government to devalue the VEF currency sharply in Q1, likely by 30%. In Argentina, the central bank is letting the peso devalue in a gradual and controlled manner. The central bank is managing the slide in an effort to avoid further eroding investor confidence in the peso. This message sent to [email protected] by [email protected]. RGE Monitor - 131 Varick Street Suite 1005 - New York, NY 10013-1417

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Has Global Stag-Deflation Arrived? ...and comment on the Fed ZIRP decision Nouriel Roubini| Dec 16, 2008 The column elaborates on the idea of stag-deflation that I discussed as early as January 2008 when I first warned about the risk of a global deflation and stagdeflation. While it is now fashionable to talk about such deflationary risks – and the US CPI figures today confirm that we are entering into deflation – some of us were worrying about the coming deflation well before the mainstream – concerned with short-run and unsustainable increases in commodity prices – discovered the deflationary risks in the global economy. It was clear to those of us that saw early on the risks of a severe US and global recession that, once that recession would emerge, deflationary rather than inflationary pressures would emerge as slack in goods markets, slack in labor markets and slack in commodity markets would emerge. So now we need to worry about stag-deflation, deflation, liquidity traps and debt deflation. Welcome to the world of stag-deflation or, as Krugman would put it, to the world of “depression economics”. Here is the text of my column followed by a short comment on the just announced Fed decision to reduce the target for the Fed Funds rate to a 0% to 0.25% range: Has global stag-deflation arrived? Traditionally, central banks have been the lenders of last resort, but now they are becoming the lenders of first and only resort By Nouriel Roubini The latest macroeconomic news from the US, other advanced economies and emerging markets confirms that the global economy will face a severe recession next year. In the US, recession started last December, and will last at least until next December — the longest and deepest US recession since World War II, with the cumulative fall in GDP possibly exceeding 5 percent. The recession in other advanced economies (the euro zone, the UK, the EU, Canada, Japan, Australia and New Zealand) started in the second quarter of this year, before the financial turmoil in September and October further aggravated the global credit crunch. This contraction has become even more severe since then. There is now also the beginning of a hard landing in emerging markets as the recession in advanced economies, falling commodity prices and capital flight take their toll on growth. Indeed, the world should expect a near recession in Russia and Brazil next year, owing to low commodity prices, and a sharp slowdown in China and India that will be the equivalent of a hard landing (growth well below potential) for these countries. Other emerging markets in Asia, Africa, Latin America and Europe will not fare better, and some may experience full-fledged financial crises. More than a dozen emerging-market economies now face severe financial pressures: Belarus, Bulgaria, Estonia, Hungary, Latvia,

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Lithuania, Romania, Turkey and Ukraine in Europe; Indonesia, South Korea and Pakistan in Asia; and Argentina, Ecuador and Venezuela in Latin America. Most of these economies can avoid the worst if they implement the appropriate policy adjustments and if the international financial institutions — including the IMF — provide enough lending to cover their external financing needs. With a global recession a near certainty, deflation — rather than inflation — will become the main concern for policymakers. The fall in aggregate demand while potential aggregate supply has been rising because of overinvestment by China and other emerging markets will sharply reduce inflation. Slack labor markets with rising unemployment rates will cap wage and labor costs. Further falls in commodity prices — already down 30 percent from their summer peak — will add to these deflationary pressures. Policymakers will have to worry about a strange beast called “stag-deflation” (a combination of economic stagnation, recession and deflation); about liquidity traps (when official interest rates become so close to zero that traditional monetary policy loses effectiveness); and about debt deflation (the rise in the real value of nominal debts, increasing the risk of bankruptcy for distressed households, firms, financial institutions and governments). With traditional monetary policy becoming less effective, non-traditional policy tools aimed at generating greater liquidity and credit (via quantitative easing and direct central bank purchases of private illiquid assets) will become necessary. And while traditional fiscal policy (government spending and tax cuts) will be pursued aggressively, non-traditional fiscal policy (expenditures to bail out financial institutions, lenders and borrowers) will also become increasingly important. In the process, the role of states and governments in economic activity will be vastly expanded. Traditionally, central banks have been the lenders of last resort, but now they are becoming the lenders of first and only resort. As banks curtail lending to each other, to other financial institutions and to the corporate sector, central banks are becoming the only lenders around. Likewise, with household consumption and business investment collapsing, governments will soon become the spenders of first and only resort, stimulating demand and rescuing banks, firms and households. The long-term consequences of the resulting surge in fiscal deficits are serious. If the deficits are monetized by central banks, inflation will follow the short-term deflationary pressures; if they are financed by debt, the long-term solvency of some governments may be at stake unless medium-term fiscal discipline is restored. Nevertheless, in the short run, very aggressive monetary and fiscal policy actions — both traditional and non-traditional — must be undertaken to ensure that the inevitable stagdeflation of next year does not persist into 2010 and beyond. So far, the US response appears to be more aggressive than that of the euro zone as the European Central Bank falls behind the curve on interest rates and the EU’s fiscal stance remains weak. Given the severity of this economic and financial crisis, financial markets will not mend for a while. The downside risks to the prices of a wide variety of risky assets (equities, corporate bonds, commodities, housing and emerging-market asset classes) will remain until there are true signs — toward the end of next year — that the global economy may recover in 2010.

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Nouriel Roubini is professor of economics at the Stern School of Business, New York University, and chairman of RGE Monitor, an economic consultancy. COPYRIGHT: PROJECT SYNDICATE

Afternoon Update following the FOMC Statement: The Fed decision to cut the target for the Fed Funds rate to a 0% to 0.25% range is just underwriting what was already obvious and happening in reality: while the target Fed Funds was - until yesterday - still1% in the last few weeks - following the massive increase in liquidity by the Fed - the actual Fed Funds was already trading at a level literally close to 0%. So today the Fed formalized what was already happening for weeks now, i.e. that the Fed Funds rate was already zero and that the Fed had already moved to quantitative and qualitative easing in the form of massive increase in the monetary base and aggressive use of monetary policy - via a range of new facilities and tools - to reduce short term and long term market rates that are stubbornly high in a sign that the credit crunch is severe and worsening. I predicted early in 2008 that the Fed Funds rate "would be closer to 0% than to 1%" in the midst of a severe recession. Now 12 months into this severe recession (that officially started in December 2007) - a recession that will last at least another 12 months (if not more) - the Fed Funds rate is already down to 0% (the beginning of the zero-interest-rate-policy or ZIRP for the US) and the Fed has moved into uncharted unorthodox monetary policy as a severe stag-deflation is taking place. And as predicted in this forum over a month ago the Fed is now committed to keep the Fed Funds rate close to zero for a long time and even considering purchasing long-term Treasuries as a way to push lower long term government bond yields that are already falling sharply.

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Release Date: December 16, 2008 For immediate release The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent. Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further. Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters. The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

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Updated: New York, Dec 16 07:39 London, Dec 16 12:39 Tokyo, Dec 16 21:39

Five Opportunities to Help Beat World Recession Commentary by Matthew Lynn Dec. 16 (Bloomberg) -- There is no longer any dispute that the world is going into a recession. The only question is how long and how deep: 1970s-style or 1930s? But just because business is bad doesn’t mean it stops completely. Just as plants renew themselves in a frosty winter, so the economy often does the same during a prolonged contraction. During the 1930s, new industries such as consumer electronics and plastics were created. In the turbulent mid- 1970s, the personal-computer industry was born, as companies such as Microsoft Corp. and Apple Inc. were founded. The economy didn’t look much good then, either, with soaring oil prices, rampant inflation and tumbling stock markets. That didn’t stop a young Bill Gates or Steve Jobs from setting up new businesses. No doubt there are now plenty of young entrepreneurs with bright ideas and loads of determination ready to build the corporate giants of the 2020s and 2030s. As Tom Nicholas, an associate professor at Harvard Business School, said in the latest issue of the McKinsey Quarterly, the 1930s became a period of intense innovation and experimentation. “For companies with cash and ideas, history shows that downturns can provide enormous strategic opportunities,” he said. The question is where those market openings will be in this recession -- for managers, entrepreneurs or investors. Here are five to think about. Think Local First, local manufacturing. When we are worrying about climate change, does it make sense for goods to be transported around the world, with raw materials dug up in Australia, taken to Chinese factories, then shipped as finished products to Europe or the U.S.? Or how about food? Can’t we develop the technology to grow vegetables in the U.K. or Germany during the winter rather than flying them in from Africa? Entrepreneurs should find ways to re-engineer globalization, so we can still get a vast range of goods at low prices, and yet produce them locally. Next, credit. The banking system that has developed over the past two decades looks broken beyond repair. That doesn’t mean that people don’t want to save and borrow money. We need some way of transferring cash safely from people and countries that have too much of it, to people who have too little. There used to be a far greater diversity of financial intermediaries -- from the mutual building societies in the U.K. to credit unions, to savings-and-loan associations and cooperatives. Finance needn’t be monopolized by global banks playing the international capital markets. 207

There is space for newcomers, developing other modes of business, possibly based on the Internet. The entrepreneurs who devise them will do well. Boomers Need Care Or how about aging? The baby-boom generation is starting to reach for its walking sticks. And the elderly need young people to look after them. While much of Europe has aging populations, other countries have soaring birth rates. They need to be brought together. Maybe the young people should come to Europe. Or the old people should move to where the young people are? Either way, new ways of caring for the aged will be a huge growth industry. Technology will be crucial. In recessions, ground-breaking technologies tend to get going. Perhaps that is because they don’t usually require big upfront investments -- nobody poured a fortune into starting Microsoft -- or entrepreneurs have to focus on essential, breakthrough products when times are tough. So where will the cutting edge be? Bio-technology has promised more than it has delivered so far, but put it together with computing, and dozens of new products and industries might blossom, as they did in the electrical industry in the 1930s. Books Go Digital Finally, publishing. Printed, bound books have been around for more than 500 years and have overcome predictions of their demise for at least a few centuries. Somehow they have survived. They aren’t about to go away, but they may be about to evolve. Electronic books are set to take off in a big way. Just look at how well Amazon.com Inc.’s Kindle has done. Alternatively, books can be downloaded in bite-size chunks onto mobile phones. As the technology becomes universal, new types of story-telling will emerge to take advantage of it: more episodic, more concise, and probably more communal. And the publishers who get that right will create a whole new industry. History suggests that in the next three or four years we will see the birth of the new companies and industries that will dominate the next few decades. Recessions wipe old slates clean. They create space and resources for new entrepreneurs. So, while the economic news over the next few months is likely to be gloomy, it is worth remembering that beneath the hard frost the first buds of the next spring are germinating. Spotting them is the tricky bit. But catch them early enough, and you will make a fortune. (Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.) To contact the writer of this column: Matthew Lynn in London at [email protected]. Last Updated: December 15, 2008 19:01 EST

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December 16, 2008

JOSEPH STIGLITZ, AND THE FAILED IDEAS OF ECONOMISTS By John Tamny In his 1982 book, The Economy In Mind, the late Warren Brookes relayed a story from 1979 in which a Keynesian economist from the United States was passing through customs at JFK Airport. When the customs officer processing his entry saw his profession, he commented, “I don’t know whether I should let you back in, Professor, considering what you economists have done to this country.” The officers’ words take on special meaning amid an economic crisis largely caused by economists eager to elevate central management of the economy over a decentralized system whereby profits and price signals lead to a natural process in which the prudent are rewarded over the profligate. That’s the basic nature of markets, but despite this truth, economists such as Joseph Stiglitz continue to throw free markets in front of the proverbial train in hopes of accruing to themselves a role in fixing that which should be left alone. In a recent article for Vanity Fair, Stiglitz engaged in falsehoods and contradictions in order to blame capitalism for our present troubles. It would perhaps be better for him and other elite economists to simply look in the mirror. Indeed, while Alan Greenspan’s light trashing of free markets has surely earned him a place in economic purgatory, the blame being passed his way for the housing boom and bust is not rooted in reality. Many even on the Right blame low nominal rates of interest on Greenspan’s watch for the latter, but then history shows housing has traditionally done best when interest rates are rising. More realistically, weak currencies are the biggest drivers of nominal home-price gains, and for evidence we need only study Richard Nixon’s second presidential term and Jimmy Carter’s lone term to find that much like this decade, housing was frothy under both. Stiglitz argues that Greenspan had a role here for turning on “the money spigot” with “full force” earlier in the decade, but then money supply is vastly overrated as an indicator of a currency’s direction. For evidence, we need only compare the ‘70s and ‘80s when money creation by the Fed was the same, but achieved opposite results. If Stiglitz is looking for someone to blame here, he would do better to finger a Bush Treasury that embraced a weak dollar with great vigor. Stiglitz says Greenspan should have been more vigilant about curbing “predatory” lending to low-income households and “liar loans”, but when we consider how the Right talked up “America’s Ownership Society” in concert with politicians from the Left eager for Fannie and Freddie to expand their mandate into the subprime space, it seems folly to assume that Greenspan could have blunted this bipartisan bout with political correctness. Stiglitz decries the innovation that made these loans possible, but then loans are always risky, and they’re

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only problematic when the very regulators and politicians whose actions he espouses seek to privatize the gains from same, while socializing the losses. While he served President Clinton, Stiglitz claimed he did not support the repeal of GlassSteagall, and that repeal changed the culture of banking, thus making way for the various failures in our midst. What he ignores is that with the exception of Citigroup, the majority of financial failures involved investment banks lacking a commercial-bank affiliation. Indeed, imagine what might have happened if regulations had kept commercial banks from serving as White Knights in this whole financial mess (see J.P. Morgan & Bank of America), and more broadly, what a shame that regulations kept other cash rich companies such as Wal-Mart from buying greatly weakened financial institutions in order to enter the banking space themselves. Stiglitz regularly seeks to elevate regulation as the path to financial health, but then contradicts himself in decrying a 2004 SEC decision in which investment banks were allowed to increase their debt-to-capital ratios “from 12:1 to 30:1, or higher”. The question Stiglitz fails to ask is whether regulation was in fact the problem. Indeed, the ’04 SEC decree essentially allowed risk-oriented banks to hide behind the very regulations that Stiglitz would like more of. Did it ever occur to him that absent a muscular SEC, self-interested investors with their money on the line might have regulated the investment banks themselves; allowing firms with a history of investment success higher debt-to-capital ratios, while curbing the activities of those thought to be unworthy? On the tax front, Stiglitz claims that the 2001 and 2003 Bush tax cuts “played a pivotal role in shaping the background conditions of the current crisis.” According to him, “they did very little to stimulate the economy.” About the 2001 “reductions”, he would have a point in that stimulus and tax breaks for select industries are by definition an economic retardant. But there again lies a contradiction in that while he correctly decries the imposition of Henry Paulson’s awful TARP, his reasoning has to do with Paulson’s failure to do anything “about the source of the problem, namely all those foreclosures.” Put simply, Stiglitz didn’t like the welfare that characterized Bush's Stimulus I, but somehow welfare for irresponsible homebuyers is a good thing. Regarding the ’03 cuts, if economic growth is the certain result of productive work effort bolstered by investment, and it is, how is it that lower penalties on both would harm ours or any economy? More important, Stiglitz contradicts himself again in noting the massive amount of “foreign” oil that reached our shores in subsequent years. Indeed, imports of any kind are merely a reward for productive economic activity. If the ’03 cuts had hurt the economy, this would have revealed itself through less, not more in the way of imports. Stiglitz would also do well to remember that we’re not “independent” when it comes to all manner of goods, but far from economically enervating, this lack of self-sufficiency is a positive for Americans mostly doing that which they do best. Put simply, self-sufficiency of the economic variety is merely a kind term for poverty. Stiglitz argues that “if you can’t have faith in a company’s numbers, then you can’t have faith about a company at all.” He notes that company issuance of stock options exacerbated the latter, and that the SEC failed to rein this practice in. While this writer would disagree with his position on options, if they’re toxic as he says then the discussion is irrelevant. If stock options give management “every incentive to provide distorted information”, why would CEOs need regulators to tell them to stop issuing them if investor faith is of paramount importance? With regard to TARP, Stiglitz correctly notes that the whole concept “was an act of extraordinary arrogance” on the part of Paulson and the Bush administration. So true, but in a piece rife with contradictions, Stiglitz contradicts himself yet again. Indeed, in the same 210

paragraph in which he decries banks that “made too many bad loans” he notes that the Paulson plan was faulty for failing to ensure that those same “banks would use the money to re-start lending.” Stiglitz concludes by drilling down to the supposed “one” mistake that caused this crisis. To him it resulted from the “belief that markets are self-adjusting and that the role of government should be minimal.” What he misses in a column full of misses is that markets were never free to begin with, and they certainly were never allowed to adjust. A better conclusion would be that free markets are best for wrenching capital away from the destroyers of it so that it can be placed in the hands of those who will treat it well. Put simply, in a true free market there would never be government bailouts precisely because a system of free exchange is too important to be wrecked by the blunt hand of government. John Tamny is editor of RealClearMarkets, a senior economist with H.C. Wainwright Economics, and a senior economic advisor to Toreador Research and Trading. He can be reached at [email protected]. Page Printed from: http://www.realclearmarkets.com/articles/2008/12/joseph_stiglitz_and_the_foolis.html at December 16, 2008 - 06:50:58 AM CST

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Hamilton's Counterfeit Capitalism Daily Article by George F. Smith | Posted on 12/16/2008 12:00:00 AM

As we await Bush's replacement to straighten our wayward lives, it's crucial to understand how we got here and why policy makers are so determined to do the wrong thing. Austrian economics explains why their policies are flawed, but no one with a voice seems to care. When history confirms that hands-off is the only effective and humane approach to a bust, and to prosperity generally, while hands-on brings ruination, why do governments today consider every option but free markets? You could blame it on the heavy influence of Keynesianism, but we could ask why Keynes is so popular. He got away with blaming the market for the Depression of the 1930s. How can his followers do the same today after 70 more years of intense interventionism? To read today's mainstream commentaries, you would think the free market slipped in the back door when no one was looking. We know governments have always meddled in their economies, but the United States was supposed to be appreciably different. Did we begin with unhampered markets, witness their failure, then switch to a more "progressive" approach? At what point in our history did we begin promoting interventionism as an ideal? Review the country's founding, and it isn't immediately obvious where the state's heavy hand first made its mark. Nowhere in the Declaration, for example, do we find a footnote calling for high taxes and a central bank to support our inalienable rights. It's hard to imagine that the patriots who fought at Breed's Hill or Yorktown were inspired by visions of a massive redistribution of their wealth to special interests. But when we consider the Constitution's "general welfare" clause, we start to wonder. Was it colonial shorthand for anything goes, provided sufficient political support? Thomas Jefferson said no; Congress did not have unlimited powers to provide for the general welfare, "but were restrained to those specifically enumerated." His political rival Alexander Hamilton, on the other hand, had two answers. As the author of Federalist #84, in which he referred to constitutions "as limitations of the power of government itself," he might agree with Jefferson, at least publicly. But later, as Treasury secretary under Washington, he

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dropped the façade of government restraint. As long as any proposed legislation was "in the public good," he considered it lawful under the Constitution. As Thomas J. DiLorenzo tells us in his engaging new book, Hamilton's Curse: How Jefferson's Arch Enemy Betrayed the American Revolution — and What It Means for Americans Today, Hamilton dismissed Jefferson's strict constructionism and viewed the Constitution as a grant of powers rather than as a set of limitations. With clever manipulation of words, he believed, the Constitution could be used to approve virtually all government actions without involving the citizens at all. In a recent article, DiLorenzo says that Hamilton "fought fiercely for his program of corporate welfare, protectionist tariffs, public debt, pervasive taxation, and a central bank run by politicians and their appointees out of the nation's capital." Regarding the stipulation that policies must promote "the public good" or serve "the public interest" — phrases that Hamilton used countless times — DiLorenzo reminds us that "no government policy can be said to be in 'the public interest' unless it benefits every member of the public." And how often does that happen? The "public interest" turns out to mean favored special interests. A Revolutionary War hero and aid to General Washington, Hamilton began pushing for "a government of more power" in 1780; and in 1787, with the help of a gross distortion of Shays's Rebellion, he brought state delegates together for the Constitutional Convention, the proceedings of which were closed to the public. According to an 1823 book by John Taylor of Caroline, which relied heavily on notes taken by Convention delegate Robert Yates, Hamilton moved quickly to consolidate all power in the hands of the executive branch, proposing a permanent president and senate. Governors of the states would be appointed by the national government, and any state law that conflicted with the federal constitution would be considered void. What Hamilton wanted was a "great" national government much like the one from which Americans had recently seceded. Not surprisingly, the convention attendees rejected his proposal, establishing instead a confederation of free and independent states that delegated a few specific powers to the central government. In 1802, Hamilton privately denounced the Constitution as "a frail and worthless fabric," but by then he had already established the methodology for rendering it irrelevant, as DiLorenzo puts it, through the "lawyerly manipulation of its words." HAMILTON'S AGENDA In his 1791 Report on Manufactures, he urged Congress to authorize the payment of "pecuniary bounties" (subsidies) to the manufacturers of certain items, on the basis of the general-welfare clause. The clause was "doubtless" intended to mean more than what it expressed, Hamilton argued, so it was up to Congress to decide what it meant and how to fund it. As DiLorenzo points out, generations of nationalist judges have used Hamilton's argument to expand the government far beyond its constitutional limits. In addition, the nation, not the states, had "full power of sovereignty," Hamilton insisted. The states were "artificial beings" and thus it would make no sense to talk of their right of secession — though somehow those same artificial states had united to secede from England. Furthermore, Hamilton argued, the Constitution grants the government "implied powers," one of which was to establish a national bank to promote a "paper circulation" and thereby extend loans in excess of its reserves of gold and silver. Hamilton said the Constitution's commerce

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clause gave government the power to regulate all commerce, not just interstate commerce. A national bank, which would regulate commerce within states, was thereby authorized. As DiLorenzo explains, Hamilton and his nationalist compatriots couldn't make mercantilism work with a confederation of sovereign states. If northern states passed a high protectionist tariff, for example, imports would flood into the low-tariff southern states, then spread to the rest of the country. With a nationalist government, high tariffs could be imposed on all states, with some states effectively being taxed for the benefit of other states. A STANDING ARMY OF TAX COLLECTORS Hamilton interpreted the Constitution's "war powers" to mean "that unlimited resources should be given to the military, including conscription and a standing army in peacetime," DiLorenzo writes. "He also wanted government to nationalize all industries related to the military, which in today's world would mean virtually all industries." A standing army in times of peace was necessary to enforce government taxation. And what better way to make this point than to do a little enforcing? Thus, in 1794, Hamilton personally accompanied President Washington to western Pennsylvania with 13,000 conscripts and officers from the creditor aristocracy of the eastern seaboard to crush the so-called Whiskey Rebellion. After rounding up a score of tax rebels, some of whom were old and veterans of the Revolutionary War, Hamilton drove them through the snow in chains all the way to Philadelphia, where he ordered local judges to issue guilty verdicts and sentence them to be hanged. Washington, who had returned home before the cross-state slog, pardoned the only two who were eventually convicted, leaving Hamilton bitterly disappointed. Other areas of the American frontier — in Maryland, Virginia, North and South Carolina, Georgia, and the entire state of Kentucky — engaged in home whiskey production and fiercely opposed the new tax. Whiskey was not only a beloved consumable, it served as money, as a medium of exchange, and locals considered the tax as onerous as the king's Stamp Tax of 1765. There was no rebellion in these areas because no one was willing to collect the taxes. Hamilton had picked the four counties in western Pennsylvania as his target because local officials were corrupt enough to help him. The tax and the federal assault on the protestors put the spotlight on Hamilton's "public interest" tactic. As Rothbard noted, "in keeping with Hamilton's program, the tax bore more heavily on the smaller distilleries. As a result, many large distilleries supported the tax as a means of crippling their smaller and more numerous competitors." The smaller distilleries were taxed by the gallon, while the larger ones paid a flat fee. The hated tax also helped get Jefferson elected in 1800. The election resulted in a tie between Jefferson and Aaron Burr, and was thus thrown into the House. Selecting who he considered the lesser of two evils, Hamilton used his influence to break the tie in favor of Jefferson, a deed that helped bring about his fatal duel with Burr in 1804. But before Jefferson took office, DiLorenzo explains, Federalist President John Adams helped Hamilton's cause when he appointed hundreds of "midnight judges" to the federal judiciary in the last 19 days of his administration. Though Jefferson got rid of most of them, he overlooked the appointment of Hamilton idolater John Marshall, who served as chief justice from 1801–1835. "In Marbury v. Madison [1803] John Marshall essentially asserted that he, as chief justice, had power over all congressional legislation," DiLorenzo writes. This was consistent with Federalist #78, where Hamilton said it belongs to the courts "to ascertain [the Constitution's] meaning as well as the meaning of any particular act proceeding from the legislative body."

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Though Marbury v. Madison marks the birth of judicial review, the Hamiltonian idea that the government should be the sole judge of its own actions didn't prevail until it was imposed by force of arms — during the War between the States. HAMILTON'S DISCIPLES Following Hamilton's death, Kentucky senator Henry Clay, a wealthy slaveholder known as the "prince of hemp" for his huge hemp crops, joined Marshall and others in promoting statism and corporate privilege. As DiLorenzo tells us, Clay "spent decades, literally, advocating protectionist tariffs on foreign hemp; government-subsidized roads and canals, so that he could transport his hemp eastward; a nationalized bank that could inflate the economy." Clay wanted to force complete self-sufficiency on the country and deprive Americans of the benefits of the international division of labor — a good deal for Kentucky hemp growers, but not for consumers. Far from bringing about the harmonious relations Clay promised, his mercantilist agenda provoked sectional strife. The tariffs he championed "overwhelmingly favored northern states," inasmuch as there was little manufacturing in the South even by the 1860s. "To southerners, tariffs were all cost and no benefit." Protectionist tariffs, an essential part of Hamilton's scheme for a mercantilist America, would be a prime mover of the forces for war. When Lincoln became president, he moved quickly to implement Hamilton's system of corporate welfare. Not even his bloody war deterred him. He and his majority Republicans imposed tariff rates of 50 percent, authorized enormous subsidies to railroad corporations, and created a nationalized banking system. Greenbacks issued under the new system depreciated by more than half, and consumer prices in the North more than doubled between 1860 and 1865. Because of the inflation, real wages plummeted, and the war ended up costing northern taxpayers $528 million more, DiLorenzo says. The Credit Mobilier scandal of 1882 was the most notorious consequence of Hamiltonian corporate welfare, but, as DiLorenzo notes, "it was only the tip of the iceberg" of the predictable waste and corruption that results from government favors. The public was outraged over the scandal and called for more political control of business — they called, in other words, for more of what created the problem in the first place. As Gabriel Kolko showed in his 1963 ground-breaking work, The Triumph of Conservatism, "American businesses, far from resisting political control, sought such regulation because they could use it to their advantage," DiLorenzo explains. The railroad industry, for example, lobbied for creation of the Interstate Commerce Commission, which soon outlawed discounts to customers. Cornelius Vanderbilt had been engaging in this "ruthless" practice, but "[b]y making discounts illegal, the ICC relieved railroad companies from the pressure to compete for customers." Other businesses such as gas and electric utilities turned to the political arena for grants of monopoly — seeking to obtain from government what they failed to achieve on the market. THE HAMILTONIAN REVOLUTION OF 1913 In 1913, government acquired effective control of the country's wealth and strengthened its rule over the states by passing three laws: the income tax, the direct election of senators, and the federal reserve act. The first two arrived as the Sixteenth and Seventeenth Amendments; the "currency bill" was slipped in just before Christmas. All three, per Hamilton's rhetoric, were promoted under cover of "the public interest." All three were cons — abuses of confidence by public officials. All three "delivered a death blow to the old Jeffersonian tradition in American politics," and brought about "the final, decisive victory for the Hamiltonians." 215

Were these laws really so bad? Judge for yourself. Prior to the Seventeenth Amendment, US senators were "ambassadors of the states"; they were appointed by state legislatures. They would speak for their state governments, which would presumably have control over how they voted. Having senators appointed was intended as a check on the powers of the federal government. It limited "senators' ability to sell their votes to special-interest groups nationwide," DiLorenzo explains. Thanks to the Seventeenth Amendment, political corruption has "expanded by orders of magnitude," he says. "U.S. senators now travel all around the country seeking special-interest campaign contributions." An income tax was not popular in Hamilton's day, but he recognized the need for high taxes to fund the "energetic" government he wanted. The first federal income tax was imposed in 1862, and though it was abolished a decade later, "the experience had whetted the appetites of special-interest groups," DiLorenzo writes. By 1913, American farmers had made a deal wherein they would support an income tax in exchange for lower tariff rates. The income tax became law in 1916, and by 1930 tariff rates had soared to their highest level ever — 59.1 percent, on average. So much for the farmers' deal making. After the adoption of withholding in 1943, the income tax became entrenched, as Charlotte Twight has written, "both through its administrative apparatus and through its acceptance in the minds of most taxpayers." With its confiscation of enormous amounts of wealth and the army of bureaucrats and agents needed for collection, the income tax renders states as well as citizens hat-in-hand beggars when trying to influence the federal government. In their relationship to Washington, states have become Hamilton's "artificial beings." Loathing and fearful of competition, big businesses in the late 19th century tried to form voluntary cartels, but such arrangements are notoriously unstable, DiLorenzo points out, so they turned to government to make them work. What the big bankers wanted was a monopoly of the issue of bank notes so they could have a more "elastic currency." Previously, if an individual bank issued too many notes, depositors would get nervous and demand redemption in gold. Because all banks issued more notes or deposits than they had gold in reserve, they were all one bank run away from being exposed. The currency act that created the Fed in 1913 was a crucial step in eliminating this problem — for the bankers. Two decades later, the government took gold out of the picture, so that covering a member shortfall was no longer a problem. Through the magic of the printing press, the Fed could also provide instant revenue to the government to pay for military adventures. The Fed and the income tax provided the "funding mechanisms" for getting the United States into the European slaughterhouse called World War I. "Like all wars, World War I permanently ratcheted up the powers of government and fueled the urge among politicians to 'plan' American society in peacetime just as they had planned in war," DiLorenzo explains. The Fed has the power to do the one thing it shouldn't do: regulate the money supply. By doing so it distorts price relations and guarantees a correction, which, since 1929, the government regards as a clarion call to "do something." Ignoring economic wisdom, it does everything it can to prevent the necessary correction, thereby making the recovery longer and more painful. When the economy pulls out of the depression, government takes the credit, and the Fed begins inflating again, inaugurating another boom-bust-correction/intervention-crisis sequence that will bear heavily on almost everything we hold dear. Between 1789 and 1913, prices remained roughly stable, DiLorenzo notes, and government was little more than a footnote in people's lives. Since 1913, prices have increased twentyfold, while today government intrusion has no limits.

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CONCLUSION As with his two books on Lincoln, Thomas J. DiLorenzo has done a masterful job of exposing an American icon whose influence has been highly detrimental to the majority who live outside the rarefied reality of national politics.

$26 Is there any escape from Hamilton's world? It all depends on us. The book's last chapter, "Ending the Curse," calls for a "devolution of power." We need to shake up the ruling caste and strip the central government of its Hamiltonian features, which means, among other things, ending judicial tyranny, repealing the Sixteenth and Seventeenth amendments, outlawing protectionist tariffs, and abolishing the general-welfare clause. We should recall that the latter two measures were achieved in the Confederate Constitution of 1861 as well as state constitutions in the antebellum period. DiLorenzo also wants to dismantle "government's Hamiltonian monopoly on money," which would in itself be a major setback to despotic government. Hamilton's Curse is a pleasure to read and a must-read for anyone who values freedom and seeks a deeper understanding of the prevailing nonsense.

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News December 17, 2008, 10:17PM EST text size: TT

Chipmakers on the Edge AWASH IN INVENTORY, GLOBAL COMPANIES ARE IN DEEP TROUBLE—AND SOME ARE SEEKING BAILOUTS By Bruce Einhorn HONG KONG—Overcapacity. Looming bankruptcies. Government bailouts. The U.S. automobile industry? No, this is the global semiconductor industry, producers of the chips that power everything in today's economy from cell phones to smart infrastructure. While so much attention has been focused on American automakers, the convulsions in the chips business may have just as broad implications and possibly more strategic significance for countries around the world. In recent years, Intel (INTC), Samsung, and many lesser-known companies have pumped huge amounts of money into new production facilities. They saw rich opportunities in making chips for the growing crop of digital devices, from iPhones and BlackBerrys to electric utility monitoring systems. But now as the worldwide economy slows, demand for those chips has fallen off a cliff. Companies that sank billions into new factories are running them at half capacity or less, and losing a bundle. The situation is "desperate," says Daniel Heyler, head of global semiconductor research for Merrill Lynch (MER) in Hong Kong. The semiconductor industry has always been cyclical, and if these were normal times there would be a brutal shakeout with the weakest players shutting their doors or selling out. But this downturn looks different from those of the past. Chip production is more global than ever before, with many of the largest facilities in Asia. Many governments see semiconductor production as strategically important to their economies. So some governments are providing financial support to local companies. This will mean lower prices for chip customers, but it could cause serious pain for chip companies that compete without government support. "The last thing you want to see is governments rescuing less-competitive companies," says Avi Cohen, head of research at Avian Securities in Boston. "The supply never goes away." Overcapacity is a growing problem. On Dec. 16, the market research firm iSuppli issued an alert to clients that semiconductor inventories are likely to balloon to $10.2 billion at the end of December, up from $3.8 billion at the end of September. The government bailouts began this month. China's biggest chipmaker, Semiconductor Manufacturing International (SMI), cut a deal to receive $170 million from a state-owned company. In Germany, the state of Saxony offered Qimonda (QI) $206 million in support, although it's not clear the pact will be finalized. And in Korea, a consortium of state-owned and private banks are expected to provide Hynix Semiconductor with about $600 million in new loans. "One country starts considering a bailout, and then it kind of spreads," says Christian Heidarson, senior research analyst with Gartner (IT) in Hong Kong. "Nobody wants to see their industry being lost to another country."

Consolidation Inevitable? Taiwan may have the most at stake. The country has fostered a large and lucrative chip industry, with giants such as Taiwan Semiconductor Manufacturing (TSM) doing cutting-edge work on par with Intel and IBM (IBM). Now, however, several of the country's largest 218

chipmakers are in serious trouble. A handful of companies that make memory chips, which manage data on PCs and store information on digital cameras and mobile phones, may go out of business without a government bailout next year. "It's unbearable," says Frank Huang, chairman of Powerchip Semiconductor, Taiwan's largest memory manufacturer. "Right now no [chip] company can make a profit. The government must support this industry." On Dec. 16, Economic Affairs Vice-Minister Shih Yen-Shiang said the government is considering aid for chip companies. The stocks of memory chip makers have already been pounded by the twin concerns of the economic downturn and government bailouts. Singapore's Chartered Semiconductor Manufacturing (CHRT), Germany's Infineon Technologies (IFX), and Boise (Idaho)-based Micron Technology (MU) have all seen their shares tumble at least 75% this year. Competition is most brutal in memory chips because production is standardized and chips are considered commodities. Companies splurged on new production in recent years, investing a total of $33 billion in 2007. Because 70% of their costs are fixed, there's little reason to cut back production. So even as demand has fallen, the big Asian memory companies continue to flood the market. "That's why you are seeing rock-bottom prices," says Merrill Lynch's Heyler. For customers, plummeting memory prices may lead to more innovative products. Cheap chips, for example, could also make it easy for anyone to store an entire photo collection on a mobile phone. Semiconductor companies in the U.S. are a bit more insulated than those in Asia. Intel, the world's largest chip company by revenue, has been hit by the economic downturn, but it benefits from its focus on making microprocessors, the brains of PCs. Its only real competition in that business is Advanced Micro Devices (AMD), and AMD has struggled to keep up because it can't match Intel's heavy investments in the latest production technology. Texas Instruments (TXN) and Qualcomm (QCOM) don't compete in the commodity memory business, either. They produce chips that let cell phones make wireless calls, among other products. The turmoil in the global chips industry is likely to last a while. Still, consolidation looks inevitable, especially among the memory chip makers. In the meantime, if Taiwan, Germany, and others keep giving financial support to local companies, chipmakers elsewhere will be faced with a tough decision: They can either compete on an uneven playing field or cede the terrain. "There are no choices that do not involve significant pain at this point," says Dale Ford, senior vice-president at iSuppli. Business Exchange: Read, save, and add content on BW's new Web 2.0 topic network Chips: The New Economics Steep fixed costs are a big problem for chipmakers. So when demand falls, many keep cranking out chips to cover their overhead. In "The New Economics of Semiconductor Manufacturing," Harvard's Clayton Christensen looks at managing the pressures To read Christensen's article, go to http://bx.businessweek.com/semiconductors/reference/. With Arik Hesseldahl in New York, Cliff Edwards in San Francisco, and Jack Ewing in Frankfurt. Einhorn is Asia regional editor in BusinessWeek's Hong Kong bureau.

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Wednesday, December 17, 2008; A07

New Poll Shows 63% Are Already Hurt by Downturn By Michael A. Fletcher and Jon Cohen The deepening recession has eroded the financial standing and optimism of a broad swath of Americans, nearly two-thirds of whom say that they have been hurt by the downturn and that the country has slipped into long-term economic decline. A new Washington Post-ABC News poll also found that a rapidly increasing share of Americans -- 66 percent, up from just over half a year ago -- are worried about maintaining their standard of living. Nearly two in 10 said they or someone living in their household had lost a job in the past few months, and more than a quarter said they had their pay or hours reduced. And 15 percent said that at some point in the past year they fell behind on their rent or mortgage. The poll captures the widening fallout from the faltering economy that policymakers are struggling to contain. The Federal Reserve yesterday cut its target for the federal funds rate to a range of zero to 0.25 percent, the lowest on record. "They're getting to be about as low as they can go," President-elect Barack Obama said at a news conference yesterday before meeting with members of his economic team. "And although the Fed is still going to have more tools available to it, it is critical that the other branches of government step up. And that's why the economic recovery plan is so absolutely critical." Obama has pledged to enact a massive economic stimulus plan initiating publicly funded construction on a scale not seen since work on the interstate highway system began half a century ago. In all, economists have estimated that the plan could cost more than $700 billion over two years, increasing a federal budget deficit that is approaching $1 trillion. The poll found that nearly two-thirds of Americans support new federal spending to stimulate the economy, and majorities of both Democrats and Republicans back the idea. Concern about deficit spending, however, mutes enthusiasm for the stimulus plan. When respondents were asked whether they would back the plan if it increased the deficit, support dropped to 47 percent. Overall, nearly nine in 10 said they are worried about the size of the federal budget deficit, including nearly half who are "very concerned." Most, 55 percent, said Obama is off to a good start in dealing with the economy, which the vast majority of Americans call the No. 1 issue confronting the country. Ten percent said Obama is on the wrong track in terms of his economic vision. Nearly half expect Obama will be able to improve the economy "a great deal" or a "good amount." But the overall federal response to the economic situation gets low marks: Twenty-four percent approve of the way President Bush is handling the economy, and a similarly paltry 23 percent approve of the broader federal response to the crisis. Democrats, Republicans and independents alike are highly critical of the federal action to address the crisis -- among each group, more than seven in 10 disapprove. In part, the criticisms stem from skepticism that the government has put in place adequate controls to avoid waste and fraud in the use of federal money in the economic recovery effort. Only 30 percent are confident that proper regulations were enacted. 220

Sampling, data collection and tabulation by TNS of Horsham, Pa. Complete data at www.washingtonpost.com/polls. | The Washington Post - December 17, 2008

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Overall, 82 percent said the country is headed pretty seriously off on the wrong track, and 54 percent call the nation's financial predicament a "crisis." The number of those who said they have been hurt financially by the recession, 63 percent, is higher than the 53 percent who said they felt the pain of the 1991 recession. The stock market has added to the financial anxiety: More than half said their families have suffered because of the recent sharp drop on Wall Street, and nearly half lack confidence that they will have sufficient assets to last through retirement. More than half worry about being able to afford medical care for a sick family member, and nearly four in 10 are concerned about making house payments and heating their homes this winter. The unease is most palpable among those with annual family incomes less than $50,000. They are twice as likely as those with higher incomes to be "very concerned" about maintaining their lifestyles and are much more apt to be anxious about health care and housing. Across the board, women are more apt than men to express concern in these areas. The poll found that 10 percent of homeowners and 29 percent of renters said they have fallen behind on their mortgage and rent payments at some point in the past year. More than two in 10 of those with jobs said they think it is likely they will lose their position over the next year, higher than at any point in polls dating to 1975. The widespread financial anxiety will be felt across the holidays: Fifty-seven percent said they will spend less on Christmas shopping for family and friends this year than last. That is the most saying they plan to rein in shopping in polls going back to 1985. The poll was conducted by telephone Dec. 11-14 among a random national sample of 1,003 adults interviewed on conventional residential telephones or cellphones. Results from the full poll have a margin of sampling error of plus or minus three percentage points. Error margins for subgroups are larger. Polling analyst Jennifer Agiesta contributed to this report.

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Majority of Public Opposes Auto Rescue Poll Finds Most Blame Industry for Problems, Believe Failure Won't Hurt Economy By Jon Cohen and Jennifer Agiesta Washington Post Staff Writers Tuesday, December 16, 2008; D08 Most Americans continue to oppose a government-backed rescue plan for Detroit's Big Three automakers as majorities blame the industry for its own problems and are unconvinced failure would hurt the economy, according to a new Washington Post-ABC News poll. Overall, 55 percent of those polled oppose the latest plan that Chrysler, Ford and General Motors executives pitched to Congress last week, on par with public opposition to earlier, pricier efforts. But with 42 percent support, the new request for up to $14 billion in emergency loans has more backers than previous proposals to secure up to $34 billion in loan guarantees. But as with the earlier bids, those who strongly oppose the measure greatly outnumber those who are strongly supportive. Opposition to the automaker bailout is fueled by the widespread perception that the companies themselves are responsible for their predicament, not the faltering economy. In the new poll, three-quarters of Americans said Detroit's woes are mainly the fault of its own management decisions, and a sizable majority of those who blame the front office object to government help. Nor have Detroit's Big Three made significant progress persuading the public that bankruptcy proceedings would deepen the broader economic slowdown. Sixty percent said it would make no difference or would be good for the economy if one or more of the companies were forced to restructure under the protection of bankruptcy laws. Democrats are among the most wary of the economic impact of failure, with 42 percent saying it would hurt the economy. They are more apt to advocate federal aid -- 52 percent support it, up from 42 percent support for previous versions of the rescue bill. But they, too, are deeply critical of company managers -- 72 percent fault Detroit's strategies, not the overall economy. Republican opposition has grown stronger, with 69 percent now against the bailout, an increase of 12 points since chief executives from General Motors, Chrysler and Ford last appeared on Capitol Hill to plead their case. Half of all Republicans polled now strongly oppose the plan. Overall, independents continue to lean against the plan, with 57 percent opposing it and 41 percent supporting it. Regional differences remain sharp. About six in 10 of those in the South and West are opposed to the bailout, while those in the Northeast and Midwest, home to much of the affected manufacturing base, are split evenly on the idea. In many cases regional divisions appear to trump partisan sentiment. Among Democrats and Democratic-leaning independents, a 51 percent majority in the South oppose the plan, as do 223

49 percent of those in the West, while broad majorities of those in the Midwest (56 percent) and the Northeast (61 percent) support the loans. Union households are no more apt than those without a union member to favor the plan, 44 percent compared with 42 percent. However, the union householders who support the plan are more likely to be strongly behind the bailout. The poll was conducted by landline and cellphone from Dec. 11 to 14 among a random national sample of 1,003 adults. The results from the full poll have a margin of sampling error of plus or minus 3 percentage points. Error margins for subgroups are larger.

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SEC Didn't Act on Madoff Tips Regulator Was Warned About Possible Fraud as Early as 1999 By Binyamin Appelbaum and David S. Hilzenrath Washington Post Staff Writers Tuesday, December 16, 2008; D01 The Securities and Exchange Commission learned about what it describes as one of the largest securities frauds in history when Bernard L. Madoff volunteered his confession, raising questions about the agency's ability to police the financial marketplace. The SEC had the authority to investigate Madoff's investment business, which managed billions of dollars for wealthy investors and philanthropies. Financial analysts raised concerns about Madoff's practices repeatedly over the past decade, including a 1999 letter to the SEC that accused Madoff of running a Ponzi scheme. But the agency did not conduct even a routine examination of the investment business until last week. On Thursday, Madoff was charged with securities fraud after telling his sons that he had taken $50 billion from investors. The list of victims ranges from some of the world's largest banks to small charities. The Securities Investor Protection Corp., which offers limited protection to brokerage customers in cases of fraud, said yesterday that it would liquidate the company, Bernard L. Madoff Investment Securities. Multiple investigations are just beginning. Investigators have not said when they believe Madoff began the fraudulent practice of using new investments to pay existing investors. It is not clear how much money was lost or how many people were involved. But there is the beginning of an explanation as to how so many people failed to spot the alleged fraud. Madoff may have avoided scrutiny, regulatory experts said, in part because he simultaneously operated a legitimate, regulated and high-profile business as one of the largest middlemen between the buyers and sellers of stock. In that role, he helped to create Nasdaq, the first electronic stock exchange, and advised the SEC on electronic trading issues. He was a large campaign contributor and a familiar of senior regulators. "Bernie had a good reputation at the SEC with a lot of highly placed people as an innovator as somebody who speaks his mind and knows what's going on in the industry. I think he was seen as a valuable resource to the commission in its deliberations on things like market data," said Donald C. Langevoort, a Georgetown University law professor who specializes in securities regulation and served with Madoff on an SEC advisory committee. At the same time, Madoff's separate investment business operated on the outskirts of regulation, during a period when the government has intentionally allowed private, unregulated transactions. Private investment pools, such as hedge funds, are subject to limited oversight, and Madoff constructed his investment business to avoid most of it. The SEC said Madoff did not register with it as an investment adviser until September 2006. Finally, experts say the Madoff case may simply point to the inherent limits of regulation.

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"The SEC going back to its formation, and the Justice Department going back to its formation, are never adequate to crime at its time. It's simplistic to look back and say that this was the SEC's fault," said former SEC chairman Arthur Levitt, who knew Madoff when both worked on Wall Street and consulted with him while at the SEC. "A very skillful criminal can almost always outfox the regulator or the overseer." Ira Lee Sorkin, an attorney for Madoff, has said Madoff's firm is cooperating fully with the government in its investigation. Madoff has been released on bail. Madoff's business as a middleman, or broker-dealer, was subject to regular scrutiny by the SEC, including a routine examination in 2005 that identified some problems and a 2007 investigation that was closed without any further action. But Madoff's investment advisory business was never the primary subject of an SEC examination, according to people familiar with the case. Regulators now suspect that he may have run a second investment advisory business that was never registered with regulators, according to people familiar with the investigation. The SEC does not have the resources to examine investment advisers on a regular schedule. Instead, the agency prioritizes examinations of companies based on their risk profile, which is basically a process of judging books by their covers. People familiar with the process said the SEC tends to focus on high-risk investment strategies, such as trading in derivatives. Lori A. Richards, director of the SEC's Office of Compliance Inspections and Examinations, said that only 10 percent of the 11,300 investment advisers registered with the SEC are examined on a regular basis -- those with high-risk characteristics. They are examined every three years. Others might be examined randomly or where there is cause, Richards said. From 1998 to 2002, the SEC aimed to examine every adviser at least once every five years and to examine newly registered advisers during their first year, but a 50 percent increase in the number of advisers since 2002 ended that practice, Richards said. Richards declined to comment on Madoff's firm. Some experts said that the SEC's criteria made sense and that the fraud Madoff allegedly constructed was successful in part because it avoided the appearance of risk. It avoided the scrutiny of investors and regulators by claiming to engage in vanilla trading and reporting steady but unspectacular returns. "I think the SEC is going to have a PR issue to deal with, but I'm not sure you'd find that the SEC staff did anything wrong," said Barry Barbash, a partner at Willkie Farr & Gallagher and a director of the SEC's Division of Investment Management during the Clinton administration. "They've had to make judgments, and they decided to look at derivatives, short sales, insider trading, all the things that Madoff never had." Others said that the SEC should have flagged Madoff for examination no later than the moment he registered as an investment adviser, in 2006, because of the history of complaints against his firm and because of its unusual characteristics. These included Madoff's history of smooth earnings -- above 10 percent a year, every year -- and his company's reliance on a small auditing firm that had no other large Wall Street clients. Aksia, a New York-based consulting firm that advises institutional investors about hedge funds, found that Madoff's auditor worked out of a 13-foot-by-18-foot office in Rockland County, N.Y., with only three employees. The employees of the firm, which had only Madoff

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as a client, included a 78-year-old living in Florida and a secretary, Aksia said it discovered. The auditor, Friehling and Horowitz, did not respond to a request for comment. "If it's true that the SEC had begun receiving warnings in 1999, then even if they did nothing before then, surely when he registered with them in 2006, he should have gone to the top of their list," said Barbara Roper of the Consumer Federation of America. Madoff avoided scrutiny despite the dogged bell-ringing of a Boston accountant, employed by another investment firm, who repeatedly accused Madoff of breaking the law in a series of letters to the SEC that began in 1999. The accountant, Harry Markopolos, said he sent his most recent letter in April. A former SEC enforcement official said the letters should have raised red flags for regulators. "It is not common to get complaints about somebody who's running a large amount of money that it's a Ponzi scheme," said the former official, speaking on condition of anonymity. He said that investigating a Ponzi scheme is not difficult: The agency can simply demand proof that the investment adviser holds the amount of money he claims to hold. And he added that regulators also should have noticed that Madoff was audited by a tiny company with no reputation. He said there are only a few accounting firms with the sophistication to audit an investment adviser that, at the time of registration with the SEC, reported $17 billion on assets. Regulators should have noticed instantly, he said, that Madoff's auditor was not on the list. Staff researcher Meg Smith contributed to this story.

Letters What Did We Learn From Madoff? To the Editor: Re “S.E.C. Issues Mea Culpa on Madoff” (Business Day, Dec. 17): The Securities and Exchange Commission cannot predict fraud; it can only uncover fraud after it exists. While future investors can be grateful that Bernard L. Madoff has been accused, no enforcement agency could have prevented losses for early investors. To avoid disasters, investors must use common sense, and diversify. John Guy Indianapolis, Dec. 18, 2008 The writer is a financial planner and the author of a book about investing.

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Business December 16, 2008 DEALBOOK COLUMN

How the Fed Reached Out to Lehman By ANDREW ROSS SORKIN It’s a $138 billion mystery. In the early hours of Sept. 15, after the government refused to rescue the foundering Lehman Brothers, something odd happened. The Federal Reserve lent tens of billions of dollars to a subsidiary of the newly bankrupt bank. In other words, government officials who had refused to risk taxpayers’ money on Lehman before it collapsed did just that after it collapsed. On Monday the Fed lent the Lehman unit $87 billion through JPMorgan Chase. After being repaid on Tuesday, it lent another $51 billion — putting the bailout, arguably, in the same league as the initial $85 billion bailout for the American International Group. This mystery loan is just one piece of the larger Lehman puzzle. Who lost Lehman? Why, and how? Three months later, those questions still nag. A series of court documents that detail the Fed’s loan have dribbled out in recent weeks, but they raise more questions than they answer. Lehman might seem like ancient history by now, some ghost of a crisis past. Lehman — that was before A.I.G., before the Big Three, before Madoff Securities. But no one, least of all government officials, has fully explained why Lehman, one of the grand old names of Wall Street, was allowed to fail while so many others were rescued. Many people, at least on Wall Street, have come to view the decision to let Lehman die as one of the biggest blunders in this whole financial crisis. Christine Lagarde, France’s finance minister, called the decision “a genuine error.” Judge James Peck, who approved the sale of Lehman’s carcass to Barclays, the British bank, said it was a shame that Lehman had failed. “Lehman Brothers became a victim,” Judge Peck said in bankruptcy court when he approved the sale. “In effect, the only true icon to fall in the tsunami that has befallen the credit markets. And it saddens me.” The authorities are investigating whether Lehman executives misled investors about the firm’s financial condition before the firm failed. But the authorities might be asking similar questions about executives at other banks if, like Lehman, those institutions had been allowed to go under. The recently disclosed documents detailing the Fed’s loan to Lehman’s subsidiary cast some light on a failed effort to prevent Lehman’s implosion from cascading through the financial system. The loan, according to these documents, was a “carefully thought-out decision” to stabilize the market by propping up Lehman’s broker-dealer business, called LBI New York, so it could

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stay afloat long enough to “facilitate an orderly wind-down” of tens of thousands of trades with the other Wall Street firms. The unit was kept out of the Lehman bankruptcy. That might seem like a reasonable explanation. But Henry M. Paulson Jr., the Treasury secretary, and Ben S. Bernanke, the chairman of the Fed, have said that they did not have legal authority to lend any money to Lehman. The firm, officials said, did not have enough collateral. “We didn’t have the powers,” Mr. Paulson insisted. He also said Lehman’s bad assets created “a huge hole” on its balance sheet, adding that he had actually tried to find a way for the government to provide money to help support a deal between Lehman and Barclays, but legally could not. His explanation has evolved over time, however. He told reporters the day after Lehman went bankrupt: “I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers.” Whatever the case, the Fed’s loan to the Lehman subsidiary makes all these explanations increasingly hard to square. Mr. Paulson said Lehman had lacked the collateral for the government to backstop a deal between Lehman and Barclays. But then the Fed turned around and lent a Lehman subsidiary billions, based on that same collateral. People involved in the process said that the Fed only lent the money as part of “an orderly wind-down,” which would have been different from lending money to an ongoing, or in this case, insolvent concern. Fed officials are not talking much about the loan. Mr. Bernanke and Timothy F. Geithner, the president of the Federal Reserve Bank of New York and the Treasury secretary nominee, have kept quiet on the topic. A spokesman for the New York Fed, which orchestrated the loan, declined to comment. The Fed’s loans were made through JPMorgan Chase, which, as a clearing bank, acted as a conduit for the money. JPMorgan, if you recall, was the bank that bought Bear Stearns, with the government’s help, as that firm was collapsing last spring. If there’s a silver lining in this mysterious cloud, it is that Lehman paid the Fed back. Taxpayers did not lose a dime. As part of Barclay’s deal to buy Lehman out of bankruptcy, Barclays agreed to take over the Fed’s lending role and “step into the shoes of the Fed.” (The Depository Trust and Clearing Corporation ended up staying open late to make the transfer.) Still, Barclays and JPMorgan had a brief fight over the collateral posted for the loan, according to court documents. They eventually reached an agreement. The values of the collateral and the specifics are part of a confidential sealed agreement, making it difficult to determine exactly what happened. Maybe the Fed’s belated loan to Lehman helped avoid an even deeper crisis. As Representative Barney Frank, chairman of the House Financial Services Committee said on “60 Minutes” on Sunday: “The problem in politics is this: you don’t get any credit for disaster averted.” But until officials explain what happened, it will remain a mystery. The latest news on mergers and acquisitions can be found at nytimes.com/dealbook

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Investing December 16, 2008, 12:01AM EST

How to Make a Madoff SPECTACULAR INVESTING FRAUDS LIKE THE ONE ALLEGEDLY CREATED BY THE NEW YORK FINANCIER TYPICALLY HAPPEN DURING INVESTING BUBBLES—AND ONLY GET EXPOSED ONCE THEY POP By Ben Levisohn The popping of an asset bubble has a way of bringing investment fraud out of the shadows and into the light. It looks to be no different with the case of Bernard Madoff— respected financier, in-demand money manager, former NASDAQ chairman, and current poster boy for investment trickery. Madoff stands accused of operating an elaborate Ponzi scheme, using cash from new investors to pay off older ones, to the tune of $50 billion. The alleged offenses only came to light because he could no longer raise the money to keep his scheme going, according to the U.S. Securities & Exchange Commission. Sadly however, Madoff's alleged scam is not unique. Need proof? There's Richard Whitney—respected financier, in-demand money manager, and former head of the New York Stock Exchange (sound familiar?)— whose own investment company, circa 1938, turned out to be as empty as Madoff's 70 years later. Just as in the 2008 version, investors were wiped out by Whitney's scheme, which began when he started borrowing money to cover investment losses in penny stocks. His victims included the New York Yacht Club, the New York Stock Exchange, and his father-in-law.

Learning from History To experts, one thing is clear: "It happens every time there's an asset bubble," says Robert Wright, a financial historian at New York University. Bubbles provide the cover the crooked need to perpetrate their scams. When the market's heading up, any investment seems possible. Go back to 1720 and England's South Sea Bubble. Shares became so frothy, investors snatched up stock in a company whose business was so secret it could not be revealed in a prospectus. Banking stocks were the investment of choice in 1792, when William Duer, a respected investor close to Secretary of the Treasury Alexander Hamilton, rapidly drove up shares of the Bank of New York, only to be unable to meet his obligations. "The greediness of a bubble is a breeding ground for bad actors," says Jeff Marwil, a partner with law firm Winston & Strawn's Restructuring and Insolvency Group.

What was Madoff's Motivation? Complacent investors may enable the fraud. When the market's going up, they assume everyone else is making money and want to also. They have the option of investigating who they invest with, but many get seduced by the combination of stable returns and a stellar reputation. After the fact, many claim they simply trusted their advisers. But trust is a funny thing when it comes to money. "The financial system is not based on trust," NYU's Wright says. "Banks don't trust you—that's why they take collateral. You don't trust the bank—that's why we have the FDIC." 230

Still, no one knows what may have caused Madoff to turn his successful trading firm into an elaborate scam, as he is accused of doing. Here was a man who had money and respect and now is charged with bilking investors, from hedge funds to individuals to banks, of billions of dollars.

"The Easy Way Out" Madoff has company. Recent frauds include the $3 billion Ponzi scheme allegedly perpetrated by Tom Petters in Minneapolis—he is accused of using the money to fund a jet-setting lifestyle—or Samuel Israel's Bayou Hedge Fund Group, which created a dummy accounting firm to cover up trading losses. But while bubbles provide opportunity, it's ultimately the financial wizards themselves that create and perpetrate these schemes. "Sometimes the people at the wheel take the easy way out," says Gregory Hold, chief executive of brokerage firm Hold Brothers. Others are less forgiving. Says Marwil, who has worked on recovery at Bayou: "I don't think you can reach a conclusion other than they are bad guys." The investors—ranging from charities, universities, and individuals salting away money in 401(k) funds—who are left with massive losses as these schemes blow up might agree, albeit in harsher language. Levisohn is a staff editor at BusinessWeek covering finance and personal finance.

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Hedge Funds December 16, 2008, 6:40PM EST

Madoff Losses Will Change Hedge Funds MANY ARE SHUTTING DOWN. THE SURVIVORS WILL LIKELY HAVE FEWER ASSETS AND LOWER FEES. FUNDS OF HEDGE FUNDS ARE SUFFERING, TOO By Matthew Goldstein The arrest of Bernard Madoff, the financier who allegedly ran a $50 billion Ponzi scheme, could mark the end of the hedge fund industry as investors know it. Hedge funds have been in a downward spiral for months as the markets have cratered and wealthy investors have pulled some of their money out. Supposedly impregnable portfolios, such as those at Citadel Investment Group, have lost half their value in the past year. Even so, Wall Street stayed optimistic that investors would rescind their pending redemption requests if the markets stabilized, thereby buoying the industry's fortunes. But the Madoff mess, in which total losses could exceed $20 billion, has dashed any hope for hedge funds. As the list of investment managers, banks, charities, and celebrities allegedly fleeced by the former chairman of the Nasdaq stock market has grown, investor confidence has sunk to an all-time low. It could take years for managers to regain that trust. And the industry that emerges from the other side of this crisis will likely be far humbler, smaller, and cheaper than the one that began the year with nearly $2 trillion in assets. "The Madoff thing couldn't come at a worse time," says Sol Waksman, founder of industry tracking service Barclay Hedge.

Closing Their Doors Until now, the death toll of funds has been minimal as managers clung desperately to the notion that the chaos would subside. But with little chance of that happening soon, hundreds of hedge funds suffering double-digit losses have no choice but to shut their doors. The ensuing wave of liquidations would be a sober start to the New Year, further depressing prices of stocks, bonds, and commodities. It could mirror the tumult last fall when stocks dropped 30% in six weeks, driven largely by a sell-off in hedge funds. Hedge fund assets, already down 25% since the start of 2008, could drop to less than $1 trillion in a year. So-called funds of hedge funds, which buy stakes in multiple hedge funds, will be among the hardest hit. Besides offering a diversified investment that supposedly reduced the risk of a blowup in any single portfolio, fund-of-funds managers assured clients they had conducted deep research on the underlying hedge funds. But many funds of funds, including ones at Man Group (EMG.L) and Banco Santander (STD), plowed money into Madoff's firm. One of the biggest: Fairfield Greenwich Group, which invested nearly half of its $14.4 billion with Madoff. The mistakes have dealt a black eye to one of the group's main sales pitches. In the unlikely event investors give funds of funds a pass on this disaster, the banks that lend money to these portfolios may not. Even though banks started cutting back credit lines to funds of funds earlier this year, the Madoff scandal unfolded so quickly that many lenders have been blindsided and could be exposed to hefty losses as a result. For example, France's BNP Paribas (BNPP.PA), which provided credit to funds of funds, says it could take a $470 million hit. Lenders, still licking their wounds, may be reluctant to lend to funds of funds for

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quite a while. "Financial institutions that have felt pain don't quickly forget," says Charles Geisst, a finance professor at Manhattan College.

Long-Term Ramifications All that is raising serious doubts about the viability of funds of funds—and the long-term prospects for hedge funds in general. After all, funds of funds account for roughly 43% of the industry's assets. "There are going to be some tough questions," says Chris Addy, chief executive of Castle Hall Alternatives, a hedge fund due diligence firm. The ramifications will be felt for years to come. Without the huge source of ready money, both from funds of funds and bank credit lines, hedge fund returns will suffer even after the markets rebound. For one, it's hard to produce double-digit returns without borrowing money to leverage assets. And as expectations come down, fees most certainly will follow, since investors won't be willing to cough up 20% of profits. In the end, the industry may revert to its style in the 1980s, when hedge funds tried merely to outpace the market modestly. "Hedge funds became a disguised way to ramp up as much short-term profit as possible," says Geisst. "That's the exact opposite of what a traditional hedge fund was supposed to be." Goldstein is a senior writer at BusinessWeek.

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DAVID WEIDNER'S WRITING ON THE WALL

Madoff's police escort Commentary: Lack of regulation helped Madoff allegedly hide losses Last update: 12:01 a.m. EST Dec. 16, 2008 NEW YORK (MarketWatch) -- We're supposed to believe that Bernie Madoff is the Lee Harvey Oswald of Wall Street. As much as $50 billion has disappeared, according to some estimates, but it was a one-man job. Madoff acted alone. Not even his sons knew. OK, let's take that one at face value. The younger Madoff generation is either incredibly clueless or unbelievably corrupt. In any case, the fate of investors' money shouldn't hinge on the brains or honor of an investment manager's offspring. Some have suggested that the investors should have done better due diligence. But what would you do? Spend time and money researching a well-known Wall Street player of three decades and sterling reputation who already was servicing pension funds, endowments and the superrich? Madoff wasn't a household name. But on Wall Street he was an icon. Put it this way: If you said you were doing due diligence on Bernie Madoff, you might as well have been doing the same on J.P. Morgan Chase & Co. Sure, it sounds like a good idea these days, but even just a year ago, people would have considered it excessive. So yes, when it comes to people who we know had full knowledge of the scheme, Madoff did act alone because his reputation said he could. But there were a few people who were complicit. They were those who had the authority to stop Madoff, check his claims and monitor his actions. In fact, the people at the Securities Exchange Commission and Financial Industry Regulatory Authority had a responsibility to do it. See full story. Those organizations -- one run by the government, the other sponsored by the industry -- were complicit with Madoff in that they failed to follow through on even their most rudimentary checks. For instance, after taking investors' money for investment for years, Madoff suddenly decided to register as an investment adviser in 2006. This raises two obvious questions: Why did he not register sooner, and why did the SEC not examine the firm during the first year after Madoff registered? The idea that the government lacked the regulations to prevent the alleged fraud "is simply not true. There are plenty of laws and regulations out there," said Henry

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Bregstein, a partner and adviser to hedge funds at Katten Muchin & Roseman LLP. "The SEC's and FINRA's failure to detect this fraud in essence allowed its expansion." Madoff's investment business fell into a regulatory "gray zone for years," The Wall Street Journal's Kara Scannell wrote. That's close. Securities regulators like the SEC and FINRA actually are more gray zone than regulation, judging by the SEC's inability gauge risk on Wall Street and police rogue fund managers. Not everyone blames the regulators. Charles Gradante, an adviser to hedge-fund clients at Hennessee Group, said he thinks Madoff was using investors' funds to cover losses at his market-making business. Madoff didn't run a hedge fund, but he used the privacy protections granted to hedge funds to hide his own activities. Gradante's theory goes something like this: As Madoff took losses in highly leveraged marketmaking business, he began to siphon money off his investment-advisory clients such as Mort Zuckerman and Fred Wilpon. This gave Madoff the cash to keep buying. A market maker, after all, provides a "market" for a stock or security. It buys when no one else will and it sells when there aren't any sellers. Initially, Madoff probably didn't intend for it to go so far, but the market never recovered. This theory would answer a couple of nagging questions about the Madoff case: Why did a successful player such as Madoff need the money, and where did it go? Madoff didn't run a hedge fund, but he used the privacy protections granted to hedge funds to hide his own activities. "He was the only market maker that did not borrow from a prime broker or bank," Gradante said, adding that Madoff made using his "own money" a point of pride. The problem was "he's not supposed to be using investment money to fund a market-making business." Gradante believes that because Madoff was running separate business, it would be hard for regulators to find fraud. Madoff was a successful broker-dealer and market maker when he added investment management a few years ago. Though his theory makes sense, it doesn't really get regulators off the hook. Broker-dealers are supposed to be the most scrutinized of the investment community. If Madoff was running separate businesses, the SEC and FINRA should have been looking at all of them as a whole. It's not just the regulators. Where were the accountants? Bregstein said they may have fallen prey to the "checklist mentality" that allows wrongdoers to report or fudge basic information leaving room for fraud. The standard deadline for hedge-fund redemptions passed on Dec. 1. It won't be until April when many funds will open up again. It's scary to think how many Madoffs are running around, trying to cover up deep losses, hoping for the markets to go their way. With the SEC and FINRA out there, they've got plenty of help

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December 16, 2008

The conman, the dream - and the sharp suit BERNARD MADOFF IS THE LATEST IN A LINE OF BRAZEN FRAUDSTERS. THEY FIND THEIR VICTIMS AMONG THE BRIGHTEST OF PEOPLE Daniel Finkelstein What you need to understand about Charles Ponzi's scheme is that when he started it, it wasn't a Ponzi scheme. It all just, well, it sort of got out of hand. There's no denying that Ponzi was a crook. He'd been fired from his first job in America for short-changing the customers, he'd been jailed in Montreal for forging cheques and he'd gone back to prison in America almost immediately, this time for an illegal immigration scam. But in 1918 he came to Boston, married a nice Italian girl and tried to go straight. And that's when all the trouble started. You see, Ponzi realised that there was good business to be done selling postal reply coupons. These coupons went for four times as much money in America as they did in Italy. So Ponzi sent off to a friend in the old country, and got him to send over a big batch of the coupons. And then he sold them for a profit. Pretty soon he was attracting attention, and investors. He paid off the first few with real profits. But then the flaw in his plan became clear. The market for coupons - indeed the total number of coupons in circulation - simply wasn't large enough. As described in Joel Levy's invaluable little book The Con Artist Handbook, by July 1920 he was taking in £175,000 a day. To make a profit for all those investors there would have to be 160 million coupons in circulation. In reality there were just 30,000. So what did Ponzi do? He started paying off existing investors with the money from new investors, something that requires an endless, growing supply of new investors. It couldn't last. And it didn't. Ponzi's scheme collapsed and in August 1920 he was indicted on 86 counts of fraud. He went to jail, of course. But, strangely enough, he still had a large number of fans who were outraged by his imprisonment and subsequent deportation to Brazil. In the Italian immigrant community he was, for some, still a hero. The size, the sheer audacity, of Ponzi's fraud meant that his name became attached to the swindle. But his wasn't the first scheme of its kind - the whole thing had been tried, for example, just 20 years earlier by a book-keeper for a tea company known as William “520 per cent” Miller. And Miller had himself been uncovered by a savvy political fixer called T. Edward Schlesinger who said he knew what the book-keeper was up to, because he'd been doing it too. He got Miller to give him $240,000 to get the police off his back, then scarpered to Germany with the proceeds to live a comfortable life on the golf courses of Europe. Which is a long way of telling you some of the things you need to know about the antics of which Bernard Madoff has been accused. First, these kind of con jobs are nothing new; they've always gone on and they always will. Second, the conman is part knowing crook and part unwitting dupe. On the surface he is serene, authoritative, charming. At the same time he is increasingly helpless, sped along swiftly, arms

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flailing, on the current of their own fraud. And finally, the relationship between swindler and swindled, between the con artist and his mark, is complicated. The common assumption about victims of confidence tricks is that they must be stupid. Not at all. In fact the bigger the con, the more essential it is that they not be stupid. A big con relies on a sophisticated mark who can see the advantage to them of the scheme. A common feature of confidence tricks is that the mark is, at the very least, keen on money. They are ready to cut corners and deal with others who cut corners. But to understand why this is worthwhile, or at least why it is theoretically worthwhile, they have to be bright. In his classic book on confidence tricks, The Big Con, David Maurer writes: “It should not be assumed that the victims of confidence games are all blockheads. Very much to the contrary, the higher a mark's intelligence, the quicker he sees through the deal directly to his own advantage.” Carole Caplin's boyfriend, the conman Peter Foster, quickly realised that Cherie Blair was the perfect mark. In other words, the conman finds it easy to explain to bright people how they might benefit. Maurer thinks that it would be too much to expect them also to realise that the whole situation may be a set-up. After all, great care has usually been taken with preparation. As it was with Madoff. The key moment in the criminal career of Frank Abagnale - the conman played by Leonardo DiCaprio in Catch Me if You Can - came when he saw the way a Pan Am pilot in uniform was treated. He obtained a uniform and a fake ID card and set to work. It proved much easier to get money, girls, food, free flights when wearing a uniform. Want to know how Madoff managed to ply his trade without being properly questioned? Want to know why the regulators didn't bring him to book? He was dressed in the city equivalent of a pilot's uniform. The authority of his big company and his intimidating reputation clothed him. But it was the maths that undid him. He chose the wrong con. Ponzi schemes collapse. It is almost mathematically impossible for them to keep going for ever. They are, incidentally, a particular feature of rising markets and come unstuck in downturns. Not all cons come unstuck like this. The mark doesn't like to be thought an idiot or greedy or a crook. So they often keep quiet or even side with the con artist. Even Ponzi himself kept some of his fans. I bet Madoff does too. Before anyone is too censorious about the victims of this latest scam, consider this. The picture of Nicola Horlick accompanied many of the first Madoff stories. It was coupled with some words she doubtless now regrets. Last summer she said of Madoff: “He is very, very good at calling the US equity market. This guy has managed to return 1 per cent to 1.2 per cent per month, year after year after year.” Ridiculous, no? How could anyone believe that such returns would go on year after year? Well, anyone could really. You could, for instance. Or I could. For the past ten years we have believed that the growth in our economy was magical, that it would go on for ever. It was different this time, we told ourselves, as Gordon Brown told you, me and Nicola Horlick that he had abolished boom and bust. So we went merrily on our way, funding our public services by getting new entrants to the workforce to pay out benefits to existing members. A Ponzi scheme. And we're the mark.

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Business December 16, 2008

S.E.C. Image Suffers in a String of Setbacks By STEPHEN LABATON WASHINGTON — The Securities and Exchange Commission, a once-proud agency with an impressive history as Wall Street’s top cop, finds itself increasingly conducting autopsies of leading financial institutions after failing, in the first instance, to perform adequate biopsies. The latest black eye for the commission came when inspectors and agency lawyers missed a series of red flags at Bernard L. Madoff Investment Securities. If it had checked out the warnings, the commission might well have discovered years ago that the firm was concealing its losses by using billions of dollars from some investors to pay others. The firm was the subject of several inquiries over the years, including one last year that was closed by the agency’s New York office after it received a referral of potentially significant problems from the Boston office. Similarly, the agency’s chairman, Christopher Cox, assured investors nine months ago that all was well at Bear Stearns. It collapsed three days later. Between those two events, H. David Kotz, the commission’s new inspector general, has documented several major botched investigations. He has told lawmakers of one case in which the commission’s enforcement chief improperly tipped off a private lawyer about an insidertrading inquiry. Another report criticized investigators in the commission’s Miami office who inexplicably had dropped an important inquiry involving securities sold by Bear Stearns. A third report documented the lack of any significant oversight by the commission over Bear Stearns in the months leading to its collapse. The enforcement division has been hamstrung by budget cuts and changes adopted by the S.E.C. that make it harder to impose penalties on corporations, even when there has been egregious wrongdoing, Arthur Levitt Jr., the S.E.C. chairman from 1993 to 2001, told Congress in October. The result has been “a demoralizing of the enforcement staff,” Mr. Levitt said. There are other difficulties plaguing the agency. A recent report to Congress by Mr. Kotz is a catalog of major and minor problems, including an investigation into accusations that several S.E.C. employees have engaged in illegal insider trading and falsified financial disclosure forms. The report said that a senior employee had used her position in violation of agency policy when dealing with a dispute with a broker about a family member’s account. It said that a commission lawyer had not maintained his status as a member of the bar for 14 years. And it found repeated instances of the failure by officials to pursue investigations. Some experts said that appointees of the Bush administration had hollowed out the commission, much the way they did various corners of the Justice Department. The result, they say, is hobbled enforcement and inspection programs.

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“You are dealing with a commission whose effectiveness in fraud deterrence is open to serious question after cases such as Bear Stearns and Madoff,” said Joel Seligman, the president of the University of Rochester and a leading authority on the history of the commission. Mr. Seligman said there were three causes to the current problems at the commission: “A Congress that’s been comfortable with vast unregulated areas, such as hedge funds and creditdefault swaps, which sends a message to enforcement. The failure since 2005 to increase the enforcement budget. And some commissioners whose skepticism about enforcement may have undermined the S.E.C.’s effectiveness.” Mr. Seligman and other experts said that there had been many signs for investigators, as well as investors, that the Madoff firm had been manipulating returns. The firm posted consistently smooth returns even in periods that were turbulent for the overall market. There was no independent custodian for the securities that the investment management firm was said to be holding. The auditors were Friehling & Horowitz, a tiny storefront operation based in New City, N.Y. “This case says volumes about the need to re-evaluate our ability to inspect broker-dealers and advisers,” said James D. Cox, a securities law expert at Duke University. “There has been a terrific series of misfires.” John Nester, a commission spokesman, declined to provide details about the 2007 investigation, which was closed by the New York office. Investigators from the commission and the United States attorney’s office in Manhattan have been examining the firm’s books since Mr. Madoff told others that his firm had been one huge Ponzi scheme. The company was registered by Mr. Madoff as an investment adviser in September 2006. The commission as a practice tries to examine advisers within a year of registration, and then at least once every five years afterward. But commission officials said Mr. Madoff’s firm had never been examined. Sixteen years ago, the agency sued two Florida accountants who had collected more than $440 million from investors to be managed by Mr. Madoff. The agency sued the accountants, but not Mr. Madoff, who said he did not know that the accountants were selling securities that had not been registered. The agency said at the time that a court-appointed trustee had concluded all the money invested was accounted for. Former commission officials recalled that they closely examined the firm at the time and did not uncover evidence that Mr. Madoff had broken any rules. In 2005, an examination by the commission’s office of compliance, inspections and examinations scrutinized the broker-dealer unit of the firm. It found that the unit had three relatively minor technical violations.

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Business December 16, 2008

Investors With Madoff May Get Tax Relief By LYNNLEY BROWNING For the legions of investors who appear to have been swindled in Bernard L. Madoff’s giant Ponzi scheme, there may be a little relief. Tax rules allow investors who fall prey to criminal theft perpetrated by their investment advisers or brokers to claim a tax deduction stemming from their losses. The rules, which are in part tied to definitions under state theft laws, could potentially put hundreds of millions or even billions of dollars, in the form of tax breaks, back into the pockets of Mr. Madoff’s stunned investors, including the publishing magnate Mort Zuckerman; the owner of the New York Mets, Fred Wilpon; and wealthy investors from Palm Beach to Europe. But it is unclear whether the Internal Revenue Service will see things that way. The agency, which never comments on issues specific to individual taxpayers or cases, declined on Monday to discuss whether it would allow Mr. Madoff’s investors to use the theft-loss rule. Gary A. Zwick, a tax lawyer at Walter & Haverfield in Cleveland, said, “It’s fair to say that many people will take the position that the theft loss rules will apply, but the government may not take that approach.” Under the rules, investors can deduct their losses against 90 percent, and in some cases all, of their adjusted gross income. So an investor who lost $1 million to Mr. Madoff and whose adjusted gross income is $600,000 can claim a tax loss of $939,900. That is the result of $1 million reduced by 10 percent of the adjusted gross income, and minus a $100 fee that is applicable under I.R.S. rules, according to Robert Willens, a tax and accounting authority who provided the example. The rules permit losses stemming from theft to be deducted in the year in which the loss is discovered by the investor. They also allow investors to carry back such losses for three years — one more year than under the rules for capital losses — and to carry forward losses for 20 years. Investors must compute losses according to the adjusted basis in their investment, not the fair-market value. For elite clients, the tax write-off may be the only positive outcome from what prosecutors have charged may be the biggest financial pyramid in history. But before investors can claim the deduction, they have to pass several hurdles. First, they have to be reasonably certain that they will not recover their losses. Because proving that could take months, if not years, investors may have to wait until next year or later to be able to claim any losses on their federal income tax returns. Investors who file claims for reimbursements are typically deemed to be in the process of seeking monetary recoveries. It is not known whether Mr. Madoff put any of his investors’ money in personal bank accounts overseas or used it underwrite a lavish lifestyle. Any such assets could be a source of recovery for investors that the court-appointed receiver for Mr. Madoff’s operations would try to find — and that could dilute any tax write-offs.

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A formal declaration that Mr. Madoff’s funds were bankrupt would help investors on the tax front. “Embezzlement followed by bankruptcy is a pretty good indication that you’re not going to get your money back and have a theft-loss claim,” said Mathew Richardson, a tax lawyer at Sheppard Mullin Richter & Hampton in Los Angeles. Investors who paid taxes on their Madoff investments in previous years might also try to seek refunds from the I.R.S.

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Madoff's $50bn Ponzi Scheme Fraud: Tracking The Fallout Dec 16, 2008 o

Capital Chronicle Dec 15: Disclosed losses amount to $24.1bn and counting and over 25 companies around the world and investors. Largest losses reported so far include: Fairfield Greenwich ($7.5bn) whose agreement to merge with Swiss private bank Benedict Hentsch is now terminated; Banco Santander ($3.1bn); Kingate ($3.1bn); Ascot and Access partner, each $1.8bn; HSBC and Tremont, each $1bn

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In a regulatory filing in January, Madoff’s firm listed $17 billion in assets under management. Madoff told his sons last week he had as much as $300 million left, according to an SEC lawsuit filed in federal court in Manhattan.

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Dec 15: The cost of protecting corporate bonds from default rose on concern that the confessed 'at least' $50 billion fraud (Lex) by investment manager Bernard Madoff may trigger forced selling by hedge funds and reinforce the run on hedge fund assets as clients seek to close investments.

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Bloomberg: Dec 15: Federal investigators found evidence Madoff ran an unregistered money-management business alongside his firm’s brokerage and investment-advisory subsidiaries. Clients of the undisclosed unit may have included hedge funds.

Regulatory Issues o

Supposition is that Madoff's fund was a giant Ponzi scheme, with returns funded by new investors. But if that is the case, Madoff must have been raising hundreds of millions of dollars a month to achieve his alleged returns of about 10% a year (Lex)

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Downfall came when some investors actually asked for their money back, as they now will from a host of other funds.

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naked capitalism: The SEC, via its own protocols, should have inspected the Madoff Ponzi operation prior to end of 2007 and failed to. Why? Evidently, due to Madoff's good reputation in the industry

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Securities Investor Protection Corp (SIPC) - a nonprofit funded by the securities industry to aid investors affected by failed firms - could start process of liquidating the Madoff brokerage firm any day. SIPC covers some losses up to $500,000 per customer in liited cases, but it's unclear the extent to which SIPC will cover investment adviser accounts

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Who's affected? o

Largest losses reported so far include: Fairfield Greenwich ($7.5bn); Banco Santander ($3.1bn); Kingate ($3.1bn); Ascot and Access partner, each $1.8bn; HSBC and Tremont, each $1bn

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French bank BNP said it could lose as much as €350 million; it is exposed through its trading business and lending to hedge funds that had invested in Madoff's funds

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Royal Bank of Scotland and Man Group outlined potential exposures of £400m and $360m, respectively, to Madoff’s alleged $50bn fraud

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Swiss private bank Reichmuth & Co. said its clients had an exposure of some 385 million Swiss francs to Madoff funds. The bank said Reichmuth Matterhorn, a fund that invests in other hedge funds, faced a potential loss of about 8.6% on its exposure to Madoff funds.

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EIM Group, European investment manager with about $11 bn in assets, reportedly had a number of non-U.S. investors in funds overseen by Madoff. EIM assets at risk are reportedly less than 2% of what it manages

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Mr. Zuckerman, the chairman of real-estate firm Boston Properties and owner of the New York Daily News and U.S. News & World Report, had significant exposure through a fund that invested substantially all of its assets with Madoff

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Spielberg charity, Wunderkinder Foundation, appears to have invested a significant portion of its assets with Mr. Madoff, based on past regulatory filings

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Jewish schools and charities (authorities estimate losses at $50 billion)

Background o

Bernard L. Madoff Investment Securities, founded in 1960, has long handled stock trades for banks and investment houses. In recent years, the firm has also expanded its business managing money for wealthy individuals and institutions - and it's that operation now swept up in scandal. Despite common ownership, the two businesses were reportedly largely kept separate (WSJ)

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Satyajit Das's Blog - Fear & Loathing in Financial Products

Banking on Steriods Posted At : December 15, 2008 3:49 AM | Posted By : Satyajit Das

Earlier in 2008, CitiGroup announced that it was seeking Board members who had “expertise in finance and investments”. What was the experience and expertise of the Citi Board and senior management that has registered over US$50 billion in losses? Shareholders and taxpayers, that have provided over billions in new capital, will be hoping that the new recruits also possess “magic” to restore Citi’s fortunes. The same applies to the banking sector generally. Until the late 1970s/ early 1980s, banking was highly regulated. It was the world of George Bailey (played by Jimmy Stewart) in It’s A Wonderful Life. Community banking was the rule. The banker could dip into his “honeymoon money” to stave of a potential bank run. It also fueled jokes - the “3-6-3” rule; borrow at 3%; lend at 6%; hit the golf course at 3 p.m. Once de-regulated, banks evolved into complex organisations providing varied financial services. De-regulation brought benefits for the economy (better access to capital and more varied investment opportunities) and the banks (growth and higher profits). Over the last 15 years, increased competition (within the industry and increasingly from nonbanking institutions) and the reduction of earning from the commoditisation of products forced banks to rely on “voodoo banking” - performance enhancement to boost returns. Traditionally banks made loans that tied up their capital for long periods e.g. up to 25/30 years in a mortgage. In the new “originate to distribute” model, banks “underwrote” the loan, “warehoused” it on balance sheet for a short time and then parceled them up with other loans and created securities that could be sold to investors (“securitisation”). The bank tied up capital for a short time (until the loans were sold off) and then the same capital could be reused and the process repeated. Interest earnings over the life of the loan could be discounted back and recognised immediately. Banks increased the “velocity of capital” – effectively sweating the same capital harder to increase returns. In the traditional model, banks earned the net interest rate margin over the life of the loan – “annuity” income. When loan assets are sold off and the earnings recognised up-front, banks need to make new loans to be sold off to maintain earnings. This created pressure on banks to find “new” borrowers. Initially, creditworthy borrowers without access to credit in the regulated banking environment entered the market. Over time, banks were forced to “innovate” to maintain lending volumes. Banks created substantial new markets for borrowing: ? Retail clients – expanding traditional lending (housing and car finance) and developing new credit facilities (credit cards and home equity loans). ? Private equity – providing borrowings in leveraged buyouts and sundry other highly leveraged transactions. ? Hedge funds/ private investors – providing (often) high levels of debt against the value of assets. 244

Banks increasingly also out sourced the origination of the loans to brokers, incentivised by large “upfront” fees. The expansion in debt provision relied increasingly on quantitative models for assessing risk. It also relied on collateral - the borrower put up a portion of the price of the asset and agreed to cover any fall in value with additional cash cover. The model allowed banks to expand the quantum of loans and allowed extension of credit to lower rated borrowers. Banks did not plan to hold the loan long term and were only exposed to “underwriting” risk in the period before the loans were sold off. Where the loan was collateralised, the value of the asset and the agreement to “top up” the collateral where the asset value fell was considered to provide ample protection. Favorable regulatory rules (the capital required was modest), optimistic views of market liquidity and faith in models underpinned this growth in lending. Banks also increased their trading activities, especially in derivatives and other financial products. Initially, this was targeted at companies and investors seeking to manage financial risk. Over time it increasingly focused on creating risk allowing investors to increase returns and companies to lower borrowing costs or improve currency rates. As profits margins eroded, banks created ever more complex exotic products, usually incorporating derivatives. Derivatives also increasingly became a way to provide additional leverage to customers. The development of hedge funds was especially important. They borrowed money (against securities offered as collateral) and were extensive users of derivatives. They also traded frequently and aggressively boosting volumes. Prime broking services (bundling settlement, clearing, financial and capital raising) emerged as a major source of earnings for some banks. Banks also increased their own risk taking. Traditionally, banks took little or no risk other than credit risk. Over time, banks increasingly assumed market risk and investment risk. Originally, banks traded financial products primarily as “agents” standing between two closely matched counterparties. Over time banks became principals in order to provide clients with better, more immediate execution and also increase profit margins. Increased risk taking was also dictated by business contingencies. Advisory mandates (mergers and acquisition; corporate finance work) were conditional on extension of credit. Banks increasingly “seeded” or invested in hedge funds to gain preferential access to business. Clients often sought “alignment” of interests requiring banks to take risk positions in transactions. This evolved into the “principal” business as banks increasingly made high risk investment in transactions. In some banks, this evolved into a model where the bank acted purely as “principal” rolling back the clock to the days of J.P. Morgan. Banks convinced themselves of the strategy on the basis that the risks were acceptable (it was their deal after all!), the risk could be always sold off at a price (market were liquid) and (the real reason) high returns. Enhanced revenues (growing volumes and increasing risk) were augmented by increased leverage and adroit capital management. “Regulatory arbitrage” evolved into a business model. Required risk capital was reduced by creating the “shadow” banking system – a complex network of off balance sheet vehicle and hedge funds. Risk was transferred into the “unregulated” shadow banking system. The strategies exploited bank capital rules. Some or all of the real risk remained indirectly with the originating bank. Banks reduced “real” equity – common shares – by substituting creative hybrid capital instruments that reduced the cost of capital. The structures generally used high income to attract investors, especially retail investors, while disguising the (less obvious) equity

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price risk. In some cases, banks used these new forms of capital to repurchase shares to boost returns. For example, CitiGroup repurchased US$12.8 billion of its shares in 2005 and an additional US$7 billion in 2006. Banks increasingly “hollowed out” capital and liquidity reserves – that is, they reduced these to minimum levels. Concepts of “purchased” capital and “purchased” liquidity gained in popularity. The theory was that banks did not need to hold equity and cash buffers as these items could always be purchased in the market at a price. Bank profits in recent history were driven by rapid and large growth in lending, trading revenues and increased risk taking. Banking returns were underwritten by an extremely favourable economic environment (a long period of relatively uninterrupted expansion, low inflation, low interest rates and the “dividends” from the end of communism and growth in international trade) Bankers would argue that the source of higher returns was “innovation”. John Kenneth Galbraith, in A Short History of Financial Euphoria, noted that: “ Financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design . . . The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.” Elite athletes often use performance enhancement drugs to boost performance. Voodoo banking operated similarly enabling banks to enhance short-term performance whilst risking longer-term damage. © 2008 Satyajit Das All Rights reserved. Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

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Opinion December 15, 2008 OP-ED COLUMNIST

European Crass Warfare By PAUL KRUGMAN So here’s the situation: the economy is facing its worst slump in decades. The usual response to an economic downturn, cutting interest rates, isn’t working. Large-scale government aid looks like the only way to end the economic nosedive. But there’s a problem: conservative politicians, clinging to an out-of-date ideology — and, perhaps, betting (wrongly) that their constituents are relatively well positioned to ride out the storm — are standing in the way of action. No, I’m not talking about Bob Corker, the Senator from Nissan — I mean Tennessee — and his fellow Republicans, who torpedoed last week’s attempt to buy some time for the U.S. auto industry. (Why was the plan blocked? An e-mail message circulated among Senate Republicans declared that denying the auto industry a loan was an opportunity for Republicans to “take their first shot against organized labor.”) I am, instead, talking about Angela Merkel, the German chancellor, and her economic officials, who have become the biggest obstacles to a much-needed European rescue plan. The European economic mess isn’t getting very much attention here, because we’re understandably focused on our own problems. But the world’s other economic superpower — America and the European Union have roughly the same G.D.P. — is arguably in as much trouble as we are. The most acute problems are on Europe’s periphery, where many smaller economies are experiencing crises strongly reminiscent of past crises in Latin America and Asia: Latvia is the new Argentina; Ukraine is the new Indonesia. But the pain has also reached the big economies of Western Europe: Britain, France, Italy and, the biggest of all, Germany. As in the United States, monetary policy — cutting interest rates in an effort to perk up the economy — is rapidly reaching its limit. That leaves, as the only way to avert the worst slump since the Great Depression, the aggressive use of fiscal policy: increasing spending or cutting taxes to boost demand. Right now everyone sees the need for a large, pan-European fiscal stimulus. Everyone, that is, except the Germans. Mrs. Merkel has become Frau Nein: if there is to be a rescue of the European economy, she wants no part of it, telling a party meeting that “we’re not going to participate in this senseless race for billions.” Last week Peer Steinbrück, Mrs. Merkel’s finance minister, went even further. Not content with refusing to develop a serious stimulus plan for his own country, he denounced the plans of other European nations. He accused Britain, in particular, of engaging in “crass Keynesianism.” Germany’s leaders seem to believe that their own economy is in good shape, and in no need of major help. They’re almost certainly wrong about that. The really bad thing, however, isn’t

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their misjudgment of their own situation; it’s the way Germany’s opposition is preventing a common European approach to the economic crisis. To understand the problem, think of what would happen if, say, New Jersey were to attempt to boost its economy through tax cuts or public works, without this state-level stimulus being part of a nationwide program. Clearly, much of the stimulus would “leak” away to neighboring states, so that New Jersey would end up with all of the debt while other states got many if not most of the jobs. Individual European countries are in much the same situation. Any one government acting unilaterally faces the strong possibility that it will run up a lot of debt without creating much domestic employment. For the European economy as a whole, however, this kind of leakage is much less of a problem: two-thirds of the average European Union member’s imports come from other European nations, so that the continent as a whole is no more import-dependent than the United States. This means that a coordinated stimulus effort, in which each country counts on its neighbors to match its own efforts, would offer much more bang for the euro than individual, uncoordinated efforts. But you can’t have a coordinated European effort if Europe’s biggest economy not only refuses to go along, but heaps scorn on its neighbors’ attempts to contain the crisis. Germany’s big Nein won’t last forever. Last week Ifo, a highly respected research institute, warned that Germany will soon be facing its worst economic crisis since the 1940s. If and when this happens, Mrs. Merkel and her ministers will surely reconsider their position. But in Europe, as in the United States, the issue is time. Across the world, economies are sinking fast, while we wait for someone, anyone, to offer an effective policy response. How much damage will be done before that response finally comes?

Negocios PAUL KRUGMAN 21/12/2008

La insensible guerra europea Esta es la situación: la economía se enfrenta a la peor depresión que ha sufrido en décadas. La respuesta habitual a una crisis económica, recortar los tipos de interés, no está funcionando. Las ayudas gubernamentales a gran escala parecen la única forma de parar la caída en picado de la economía. Pero hay un problema: los políticos conservadores, aferrándose a una ideología pasada de moda, y puede que apostando [equivocadamente] por que sus electores están relativamente mejor situados para capear el temporal, están impidiendo que se tomen medidas. En Europa, como en EE UU, el problema es el tiempo y las economías se hunden con rapidez Merkel se ha convertido en 'Frau Nein': no quiere formar parte de un plan de rescate europeo No, no estoy hablando de Bob Corker, el senador de Nissan (perdón, de Tennessee) y sus amigos republicanos, que torpedearon el intento de la semana pasada de ganar tiempo para el sector del automóvil estadounidense. [¿Por qué se ha bloqueado el plan? Un mensaje de correo electrónico a entre los republicanos del Senado afirmaba que negar al sector 248

automovilístico un préstamo era una oportunidad para que los republicanos "lanzasen un primer ataque contra el sindicalismo organizado"]. A quien me estoy refiriendo es a Angela Merkel, la canciller alemana, y a su equipo económico, que se han convertido en el principal obstáculo para un muy necesario plan europeo de rescate económico. En Estados Unidos no se le está prestando mucha atención al caos económico europeo porque, comprensiblemente, estamos centrados en nuestros propios problemas. Pero se puede decir que la otra superpotencia económica mundial (Estados Unidos y la Unión Europea tienen aproximadamente el mismo PIB) está en los mismos apuros que nosotros. Los problemas más graves se dan en la periferia europea, donde numerosas economías más pequeñas están experimentando crisis que recuerdan mucho a las pasadas crisis de Latinoamérica y Asia: Letonia es la nueva Argentina; Ucrania es la nueva Indonesia. Pero el dolor ha llegado a las grandes economías de Europa occidental: Reino Unido, Francia, Italia y la mayor de todas, Alemania. Como en EE UU, la política monetaria de rebajas de los tipos de interés en un intento de reanimar la economía está llegando rápidamente a su límite. Esto deja una única vía para prevenir el peor desplome desde la Gran Depresión: un uso agresivo de la política fiscal consistente en aumentar el gasto o recortar los impuestos para impulsar la demanda. Ahora mismo todo el mundo ve la necesidad de un gran estímulo fiscal paneuropeo. Mejor dicho, todo el mundo excepto los alemanes. Merkel se ha convertido en Frau Nein: si tiene que haber un rescate de la economía europea, no quiere tomar parte en él y ha dicho en una reunión de su partido que "no vamos a participar en esta carrera sin sentido por los billones". La semana pasada, Peer Steinbrueck, el ministro de Economía de Merkel, fue todavía más lejos. No contento con negarse a desarrollar un plan serio de estímulo económico para su propio país denunció los planes de otros países europeos. Concretamente, el ministro acusó al Reino Unido de embarcarse en un "keynesianismo craso". Los dirigentes alemanes parecen creer que su propia economía está en buena forma y no necesita grandes ayudas. Están, casi con toda seguridad, equivocados respecto a eso. Sin embargo, lo verdaderamente malo no es la valoración errónea de su propia situación, sino la forma en que la oposición de Alemania está impidiendo una acción común europea ante la crisis económica. Para entender mejor el problema, piensen en lo que pasaría si, por ejemplo, Nueva Jersey intentase impulsar su economía mediante rebajas de impuestos u obras públicas sin que este esfuerzo estatal formase parte de un programa nacional. Evidentemente, gran parte del estímulo se "fugaría" hacia los Estados vecinos, de forma que Nueva Jersey terminaría cargando con toda la deuda, mientras que otros Estados se quedarían con muchos de los puestos de trabajo, si no con todos. Los países europeos están en una situación muy parecida. Cualquier gobierno que actúe de forma unilateral se enfrenta a una posibilidad considerable de contraer una enorme deuda sin crear demasiados puestos de trabajos en el país en cuestión. Sin embargo, para la economía europea en su conjunto esa clase de fuga supone un problema mucho menor: dos terceras partes de las importaciones de un miembro medio de la Unión Europea proceden de otros países europeos, por lo que el continente en su conjunto no es más dependiente de la importación que Estados Unidos. Esto significa que una iniciativa coordinada para estimular la economía, en la que cada país cuente con que sus

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vecinos harán un esfuerzo similar al suyo, le proporcionaría al euro un impulso mucho mayor que unos esfuerzos individuales y descoordinados. Pero no es posible tener un esfuerzo europeo coordinado si la economía más grande de Europa no sólo se niega a participar, sino que además menosprecia los intentos de sus vecinos por frenar la crisis. El gran nein de Alemania no durará eternamente. La semana pasada, el Ifo, un instituto de investigación muy respetado, advertía de que Alemania se enfrentará pronto a su peor crisis económica desde los años cuarenta. En el caso de que esto suceda, seguramente Merkel y sus ministros reconsiderarán su postura. Pero en Europa, como en Estados Unidos, el problema es el tiempo. En todo el mundo las economías se hunden con rapidez mientras esperamos que alguien, cualquiera, proponga una respuesta política eficaz. ¿Cuántos destrozos más habrá antes de que esa respuesta llegue al fin? Paul Krugman es columnista del diario The New York Times. Traducción de News Clips. (c) New York Times News Service, 2008.

December 17, 2008, 4:01 pm

Do we need the middle class? Kevin Drum writes that One way or another, there’s really no way for the economy to grow strongly and consistently unless middle-class consumers spend more, and they can’t spend more unless they make more. This is a widely held view, and I’m as much in favor of a strong middle class as anyone. Nonetheless, I’d say that in terms of strict economics it’s wrong. There’s no obvious reason why consumer demand can’t be sustained by the spending of the upper class — $200 dinners and luxury hotels create jobs, the same way that fast food dinners and Motel 6s do. In fact, the prosperity of New York City in the last decade — largely supported off of super-salaried Wall Street types — is a demonstration that you can have an economy sustained by the big spending of the few rather than the modest spending of large numbers of people. December 17, 2008, 7:24 am

A whiff of inflationary grapeshot Greg Mankiw suggests that the Fed respond to the crisis by committing to substantial inflation over the next decade. Great idea, wish I’d thought of it. Oh, wait … Actually, Greg has arrived at the same conclusion I did more than a decade ago (http://web.mit.edu/krugman/www/bpea_jp.pdf ), when I tried to model the problems then facing Japan, and now facing us. As I pointed out back then, the essence of a liquidity trap (http://web.mit.edu/krugman/www/trioshrt.html) is that the real interest rate is too high, even

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when the nominal rate is zero. So the theoretically “correct” answer, if you can swing it, is to create expected inflation, pushing the real rate down. As I put it, perhaps too glibly, the central bank needed to “credibly promise to be irresponsible.” The thing is, at the time my analysis was widely treated as somehow wild and crazy, even though it came straight out of an extremely buttoned-down theoretical model. Japan was supposed to suffer for its sins, not inflate its way out of them. I wonder if similar proposals for the United States will receive the same reception. Update: I should add that my initial paper led to a fairly extensive literature on the subject of creating inflationary expectations. See, for example, the references here: http://www.nber.org/papers/w10679 December 17, 2008, 6:41 am

Other people’s wit Hmm. The AP has a list of the top ten quotes of 2008, and two lines from me are tied for #10. But here’s the thing: neither of them was original. The line about atheists in foxholes = libertarians in financial crises came from Jeff Frankel. (If I’d put it in a column, I would have given credit; but citations don’t work when you’re live on Bill Maher). “Cash for trash” also wasn’t original, but I don’t know where I got it from. On a related note, Tom Friedman has sent me an email to the effect that his use of my book title was an unconscious quote. I fully understand. It wasn’t until years later that I realized that an earlier title of mine had been unconsciously borrowed from Christopher Lasch. If there’s a moral here, it’s that people should read Jeff Frankel’s blog. As you can see, I do. December 16, 2008, 2:47 pm

ZIRP! That’s zero interest rate policy. And it has arrived. America has turned Japanese. This is the thing I’ve been afraid of ever since I realized that Japan really was in the dreaded, possibly mythical liquidity trap. You can read my 1998 Brookings Paper on the issue here. Incidentally, there were a bunch of us at Princeton worrying about the Japan problem in the early years of this decade. I was one; Lars Svensson, currently at Sweden’s Riksbank, was another; a third was a guy named Ben Bernanke. I wonder whatever happened to him? Seriously, we are in very deep trouble. Getting out of this will require a lot of creativity, and maybe some luck too. December 16, 2008, 1:33 pm

Matthew Yglesias is shrill And also right. The harsh reality is that this was not a noble undertaking done for good reasons. It was a criminal enterprise launched by madmen cheered on by a

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chorus of fools and cowards. And it’s seen as such by virtually everyone all around the world — including but by no means limited to the Arab world. Right now, there’s a major effort underway to flush the sheer crazy/vileness of the Bush years — and the cravenness of those who enabled it — down the memory hole. We shouldn’t let that effort succeed. The fact is that an American president deliberately misled the nation into war, probably for political gain — and most of the country’s elite went cheerfully along with the scam. December 16, 2008, 1:28 pm

Depression discussion There’s an ongoing discussion of The Return of Depression Economics over at TPM Cafe. Lots of good people weighing in. Book Description Winner of the Nobel Prize in Economics Product Description In 1999, in The Return of Depression Economics, Paul Krugman surveyed the economic crises that had swept across Asia and Latin America, and pointed out that those crises were a warning for all of us: like diseases that have become resistant to antibiotics, the economic maladies that caused the Great Depression were making a comeback. In the years that followed, as Wall Street boomed and financial wheeler-dealers made vast profits, the international crises of the 1990s faded from memory. But now depression economics has come to America: when the great housing bubble of the mid-2000s burst, the U.S. financial system proved as vulnerable as those of developing countries caught up in earlier crises and a replay of the 1930s seems all too possible. In this new, greatly updated edition of The Return of Depression Economics, Krugman shows how the failure of regulation to keep pace with an increasingly out-of-control financial system set the United States, and the world as a whole, up for the greatest financial crisis since the 1930s. He also lays out the steps that must be taken to contain the crisis, and turn around a world economy sliding into a deep recession. Brilliantly crafted in Krugman's trademark style--lucid, lively, and supremely informed--this new edition of The Return of Depression Economics will become an instant cornerstone of the debate over how to respond to the crisis. From: TPMCafe Book Club

WHY DID WORLD WAR II "WORK"? By Paul Krugman - December 17, 2008, 11:34AM Since all of us in this discussion seem to be big-spending types of guys, a lot of our discussion has been about what comes after-- about when and whether the economy can stand on its own. There are, I think, two historical models for this. On one side, World War II put a definite end to the depression economics of the 30s. On the other, Japanese stimulus efforts helped the economy while they were on, but it's not clear that they ever provided a long-term solution. So here's a question I haven't seen discussed (I'm sure someone has, but I haven't seen it): why did WWII "work", why did it prove the secular stagnationists wrong? I can think of several possible reasons. In no particular order: (1) Pent-up demand: after 16 years of Depression and war, business was starved of capital and consumers starved of durable goods. Once there was full employment, everyone had a lot of catching up to do. (2) Baby boom: a lot of us place at least partial blame for Japan's difficulties on the negative population growth among the working-age. There was a bit of that in the 30s, too -- low births because nobody could afford them. The postwar baby boom may have helped perk up demand. (3) Inflation: from WWII on, persistent if mild inflation was the norm, helping keep real interest rates low. (4) Government spending: the big thing here was the Cold War, which meant that the United States persistently spent 8-10% of GDP on defense. It paid for this with taxes, but old-fashioned Keynesianism tells us that there's a

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"balanced budget multiplier" because some of taxes comes out of saving, not spending. Bob Reich, if I understand him, is saying that to sustain demand we need the moral -- or at least fiscal -- equivalent of a new Cold War. Will the Obama stimulus plan set us up for a replay of the postwar success, with demand remaining high even after the stimulus is gone? I'm thinking, I'm thinking ...

DECEMBER 14, 2008, 6:42 PM

EUROPEAN MACRO ALGEBRA (WONKISH) I’ve been on the warpath over Germany’s refusal to play a constructive role in European fiscal stimulus. But what does the math look like? Here’s a simple analysis — well, simple by economists’ standards — of the reason coordination is so important for the EU. We start from the proposition that Europe is, or soon will be, in a position where interest rates are up against the zero lower bound. This means both that fiscal policy is the only game in town, and that we can use ordinary multiplier analysis. Let m be the share of a marginal euro spent on imports — either for an individual county, or for the EU as a whole (I’ll explain in a minute). I’ll assume that m is the same for government spending and for domestic demand. Let c be the marginal propensity to consume. And let t be the share of an increase in GDP that accrues to the government in increased taxes or reduced transfers. Consider the effects of an increase in government purchases dG. This will raise GDP directly, to the extent that it falls on domestic goods and services, and indirectly, as the rise in GDP induces a rise in consumer spending. We have: dY = (1-m)dG + (1-m)(1-t)c dY or dY/dG = (1-m)/[1 - (1-m)(1-t)c] Since governments are worried about debt, it’s also important to ask how much the budget deficit is increased by an increase in government spending. It’s not one-for-one, because higher spending leads to higher GDP and hence higher tax revenue. We have dD = dG - tdY A crucial number is “bang for euro”: the ratio of the increase in GDP to the increase in the deficit. After a bit of grinding, it can be shown to be dY/dD = (1-m)/[1 - (1-t)(1-m)c - t(1-m)] OK, some numbers. The average EU country spends about 40 percent of GDP on imports, and collects about 40 percent of GDP in taxes. Let me cut corners and assume that the marginal rates are the same as the average, and also assume that the marginal propensity to consume is 0.5. That is, for an average EU country, m = 0.4, t= 0.4, c = 0.5. We can represent a coordinated fiscal policy by looking at the numbers for the EU as a whole. The only difference is that m falls to 0.13, because two-thirds of the imports of EU members are from other EU members. And we get the following results: UNILATERAL FISCAL EXPANSION Multiplier Bang per euro = 1.03

=

0.73

COORDINATED EXPANSION

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Multiplier Bang per euro = 2.23

=

1.18

The bang per euro is what matters: the tradeoff between increased debt and effective stimulus is MUCH better for the EU as a whole than it is for any one country. You can play with these numbers, but I don’t think that conclusion is very sensitive to the details as long as you keep the large intra-EU trade effects in there. The lesson of this algebra is that there are very large intra-EU externalities in fiscal policy, making coordination really important. And that’s why German obstructionism is such a problem.

http://krugman.blogs.nytimes.com/2008/12/14/european-macro-algebrawonkish/#more-1147 December 11, 2008, 5:58 am

The economic consequences of Herr Steinbrueck There’s an extraordinary — and extraordinarily depressing — interview in Newsweek with Peer Steinbrueck, the Germany finance minister. The world economy is in a terrifying nosedive, visible everywhere. Yet Mr. Steinbrueck is standing firm against any extraordinary fiscal measures, and denounces Gordon Brown for his “crass Keynesianism.” You might ask why we should care. Germany’s economy is the biggest in Europe, but even so it only accounts for about a fifth of EU GDP, and it’s only about a quarter the size of the US economy. So how much does German intransigence matter? The answer is that the nature of the crisis, combined with the high degree of European economic integration, gives Germany a special strategic role right now — and Mr. Steinbrueck is therefore doing a remarkable amount of damage. Here’s the issue: we’re rapidly heading toward a world in which monetary policy has little or no traction: T-bill rates in the US are already zero, and near-zero rate will prevail in the euro zone quite soon. Fiscal policy is all that’s left. But in Europe it’s very hard to do a fiscal expansion unless it’s coordinated. The reason is that the European economy is so integrated: European countries on average spend around a quarter of their GDP on imports from each other. Since imports tend to rise or fall faster than GDP during a business cycle, this probably means that something like 40 percent of any change in final demand “leaks” across borders within Europe. As a result, the multiplier on fiscal policy within any given European country is much less than the multiplier on a coordinated fiscal expansion. And that in turn means that the tradeoff between deficits and supporting the economy in a time of trouble is much less favorable for any one European country than for Europe as a whole. It is, in short, a classic example of the kind of situation in which policy coordination is essential — but you won’t get coordination if policymakers in the biggest European economy refuse to go along. And if Germany prevents an effective European response, this adds significantly to the severity of the global downturn. In short, there’s a huge multiplier effect at work; unfortunately, what it’s doing is multiplying the impact of the current German government’s boneheadedness.

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December 10, 2008, 3:52 am

The German problem A brief note on real economic issues. Everyone here seems to be talking about two things: the fate of the auto industry, which is in almost as much trouble in Sweden as it is in the United States, and the German problem. At a time when expansionary policies are desperately needed, the leaders of Europe’s largest economy seem to have their heads in the sand. This is a huge problem: there are large spillovers in fiscal policy among EU nations — that is, a significant fraction of, say, French fiscal expansion ends up promoting employment in Germany or Italy rather than France. So there’s a crying need for a coordinated policy. But the Germans aren’t participating. December 10, 2008, 4:04 am

Q From Bloomberg: http://www.bloomberg.com/apps/news?pid=20601087&sid=aKNSK0gYlqB0&refer=home#

A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said. The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, indicates the Standard & Poor’s 500 Index is still too expensive relative to the cost of replacing assets, said Napier. December 4, 2008, 9:00 am

Real balance effects (wonkish) I’m continuing to indulge myself over Depression economics. So here’s a reply to people wondering why I dismissed the real balance effect — the fact that a fall in the price level raises the real value of the money supply (or more strictly the monetary base) and hence makes people wealthier, possibly raising aggregate demand even if interest rates are stuck at zero. The answer is, think about the numbers. Since I’m rushing off to class, let me do this from memory. Before the world went crazy, the US monetary base was about $800 billion. Suppose that the price level fell 20 percent. This would raise the real value of that base by $160 billion. Right there you can see the problem — the housing bust has wiped out something like $6 trillion of wealth; compare that with the effects of even a drastic fall in the aggregate price level. But let’s pursue this. A rather high estimate of the marginal propensity to spend out of wealth is .05. So our 20% price level fall might increase spending by .05 times $160 billion or $8 billion, which is .06% of GDP. Give me a multiplier of 2, again on the high side, and we’ve got a 20% fall in the price level raising aggregate output by .12%. That looks pretty near vertical to me. Then add in the debt deflation issue: deflation redistributes wealth from debtors to creditors. If the debtors have a higher marginal propensity to spend out of wealth than the creditors, which is what Irving Fisher thought, then this could easily swamp the tiny real balance effect. Bottom line: without the usual interest rate channel, forget about the downward-sloping AD curve.

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Q Ratio Signals ‘Horrific’ Market Bottom, CLSA Says (Update4) By Patrick Rial in Tokyo at [email protected]. December 10, 2008 16:15 EST Dec. 10 (Bloomberg) -- A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said. The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, shows the Standard & Poor’s 500 Index is still too expensive relative to the cost of replacing assets, said Napier. While the 39 percent drop in the index this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to 400 by 2014, Napier said. “The Q has come down to its average, however it’s not always stopped at the average,” said Napier, Institutional Investor’s top-ranked Asia strategist from 1997-1999. “It has tended to go significantly below that in long bear markets.” Shares have fallen this year as the worst financial crisis since the Great Depression caused almost $1 trillion of bank losses and dragged the world’s largest economies into recessions. The MSCI World Index has tumbled 44 percent in 2008, set for the biggest annual decline in its four-decade history. The S&P 500 today increased 1.2 percent to 899.24.

Bear-Market Scholar Napier, who teaches at Edinburgh Business School and advised clients to buy oil in 2002 before it tripled, based his S&P 500 forecast on the Q ratio for U.S. equities as well as the 10year cyclically adjusted price-to-earnings ratio, another measure of long-term value. Before the trough in 2014, investors are likely to see a so- called bear market rally for the next two years as central bank actions delay the onset of deflation, Napier said. “In the long run, stocks will become even cheaper,” said Brian Shepardson, who helps manage $1.9 billion at Xenia, Ohio- based James Investment Research. The firm’s James Balanced Golden Rainbow Fund beat 98 percent of similar funds this year. “There’s a likelihood of some type of rally and further pullback surpassing the lows we’ve already set.” The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, 44, the author of “Anatomy of the Bear,” a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years. When the gauge is more than one, it indicates the market is overvaluing company assets, while a Q ratio of less than one signifies shares are undervalued because it is cheaper to buy companies than to build them from the ground up.

Previous Bottoms At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat, said Napier. From the 1982 trough, the S&P 500 grew more than 14-fold to the middle of 2000, when Napier says the last bull market ended.

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Napier started his career in 1989 as a fund manager for the Scottish firm Baillie Gifford & Co. As CLSA’s Asian strategist he called the bottom of Asian equity markets in mid-1998. This year, he predicted gains in Japanese stocks prior to a 38 percent decline in the Nikkei 225 Stock Average. Napier’s prediction for a plunge in the S&P 500 hinges on deflation that is unlikely to materialize, according to Bob Brusca, president of Fact & Opinion Economics and a former chief of international markets at the New York Federal Reserve. Consumer prices dropped 1 percent in October. So-called core prices, which exclude food and energy, dropped just 0.1 percent, and prices will probably increase 0.7 percent in 2009, according to the median estimate of economists surveyed by Bloomberg. No Deflation “Oil and commodity prices have fallen, but we’re not seeing a widespread deflation like he’s talking about,” Brusca said in an interview in New York. “To have what he discusses, we’d have to have terrible deflation.” Measures such as Tobin’s Q ratio and a 10-year price-to- earnings ratio are “valuable tools,” said Andrew Milligan, the Edinburgh-based head of global strategy at Standard Life Investments, which oversees about $190 billion. Milligan said he is bullish on U.S. equities for now as central bank efforts to fight deflation will push the market higher. Awaiting Signals “For those who are worried about losing much of their investment almost overnight, very clearly you’d want to wait for those signals to give a much stronger case,” he said. “The bear market will have “a painful resolution, it’s just a question of how painful, over what period of time and for what parties.” Federal Reserve Chairman Ben S. Bernanke’s indication that he will use “quantitative easing” to prevent deflation points to a stock market rally that may last for the next two years, Napier said. With quantitative easing, a tool pioneered by the Bank of Japan, central banks can stimulate inflation by printing money and flooding the market with cash in order to encourage consumers to spend. The government’s efforts will eventually fail as ballooning government debt devalues the dollar, causes investors to flee U.S. assets and takes the S&P 500 to its eventual bottom in 2014, Napier said. “Bear markets always end for exactly the same reason, and that is the market begins to price in deflation,” he said. “The results are always horrific.”

Q Ratio (Tobin's Q ratio) http://www.investopedia.com/terms/q/qratio.asp?viewed=1 What Does Q Ratio (Tobin's Q ratio) Mean? A ratio devised by James Tobin of Yale University, Nobel laureate in economics, who hypothesized that the combined market value of all the companies on the stock market should be about equal to their replacement costs. The Q ratio is calculated as the market value of a company divided by the replacement value of the firm's assets:

Investopedia explains Q Ratio (Tobin's Q ratio)... For example, a low Q (between 0 and 1) means that the cost to replace a firm's assets is greater than the value of its stock. This implies that the stock is undervalued. Conversely, a high Q (greater than 1) implies that a firm's stock is more expensive than the replacement cost of its assets, which implies that the stock is overvalued. This measure of stock valuation is the driving factor behind investment decisions in Tobin's model.

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Business December 15, 2008

Fleeing Investors Put a Strain on Funds By GERALDINE FABRIKANT The game ended for Bernard L. Madoff when some of his investors finally asked for their money back. He did not have it, and his suspected Ponzi scheme collapsed. But many other money managers — ones who, unlike Mr. Madoff, have not been accused of wrongdoing — confront a similar problem. Their investors are racing for the exits too, and the managers are struggling to cope with the rush. A growing number of hedge funds are trying to slow the exodus, because that could force them to dump investments into already shaky markets. They are temporarily preventing clients from withdrawing a lot of money at once, a practice known as gating. But investors are not merely fleeing funds that have done poorly. Many are exiting funds that have done well in order to cover losses on their other investments. “We have become the A.T.M. machines for people that need cash,” said George Weiss, who heads a $3 billion hedge fund. Mr. Weiss, who has been a hedge fund manager for 20 years, said that his fund was down about 7.5 percent so far this year — far less than the broad stock market. Even so, his investors have withdrawn about 35 percent of their money. The Citadel Investment Group said in a letter sent on Friday that it was halting redemptions at its two largest hedge funds through March 31. Mr. Madoff, whose suspected $50 billion fraud sent shock waves through the financial world last week, apparently did not put up gates. If he had, the scheme portrayed by the authorities might have gone on for even longer. But money is also pouring out of other funds that have not imposed gates. “The managers that had the most investor-friendly provisions, regardless of performance, but the more flexible you were, got the most redemptions,” said Katie Hall, whose firm, Hall Capital Management, acts as an investment adviser for about $20 billion in assets. Wealthy individuals, endowments and funds that invest in hedge funds have struggled to raise cash and stay liquid this year given the tumult in the markets. Many hedge funds require clients to give notice of 90 days or more before withdrawing money. And some funds permit investors to take out only a percentage of their holdings at one time. Gates can create friction between money managers and their investors. “The idea is, in theory, that gates protect ongoing investors from too much liquidation,” said Robert Rosenkranz, the founder of Acorn Partners, a fund of hedge funds that is more than two decades old. But gates also enable managers to collect lucrative fees for longer periods of time. Investors, particularly funds of funds, have been scrambling to exit whatever hedge funds they can. There are several explanations, Ms. Hall said. The withdrawals have been gathering steam for months as the markets have collapsed. But then many funds whose returns supposedly are not correlated to the stock market, or so-called market neutral funds, ended up sinking, too. 258

“So investors wanted to reduce their exposure,” she said. In other cases, investors sold to realign their portfolios. When a fund does well, investors often sell a portion of their investment to avoid having too much of their portfolios exposed to a single fund. But funds and funds of funds that use high levels of leverage, or borrowed money, have come under the greatest pressure. Leverage can fuel returns on the way up, but it can be devastating on the way down. As these funds started to plummet, the borrowers “blew through margin requirements,” as one money manager put it. In order to pay off the debt, investors sold funds that were the most liquid. “The deleveraging has been going on for more than a year,” said Charles J. Gradante, the cofounder of Hennessee Group, which advises investors about hedge funds. “Many investors were using leverage, and as the market started to drop in price, the leverage they were using went against them. They had to generate cash. Much of the cash came out of their stock portfolios, but some of it came from liquid hedge funds,” he said. Private equity funds were another problem, particularly among endowments. As buyout funds called on investors to provide cash for new investments, at a time when returns from older investments were minimal, endowments and foundations too sought to raise cash. In some cases that came from hedge funds.

A LOOK AT MADOFF TRADING RECORDS December 15, 2008, 4:23 pm

Updated: One major question in the scandal surrounding Bernard L. Madoff is how one man could fool even highly sophisticated investors for decades. A possible answer could be that Mr. Madoff always seemed to send out timely and detailed reports to investors showing all of the trading and other investments that were done in their accounts over the past month. Some individual clients of Mr. Madoff also got numerous trade confirmations on single stock and bond transactions, showing the price and time of the trade. One investor, who had about $1.8 million with Mr. Madoff at the end of November and asked to remain anonymous, received as many as 40 trade confirmations every month. Dealbook has obtained copy’s of the investor’s November monthly statement and one of the trade confirmations. The trade confirmation shows Mr. Madoff sold 760 shares of Qualcomm for $33.77 a share on Nov. 6. Qualcomm shares that day traded as high as $35.07 and closed at $32.89, making Mr. Madoff’s trade appear legitimate even if it was never executed. The technology required for his giant market making operation may have enabled Mr. Madoff to print out thousands of fictitious reports and trade confirmations that he then sent to investors. However, a spot check of the November statement shows some discrepancies. Google, for example, is listed at a price of $337.40 on Nov. 12. Yet according to Yahoo Finance, the Internet search giant’s stock only traded between $312.49 and $287.76. Peruse the documents at your leisure below. Update: It isn’t clear whether the dates on the documents refer to settlement dates or trading dates. If they are the former, as a commenter below suggests, then the prices are correct. –Zachery Kouwe

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Business December 15, 2008

The 17th Floor, Where Wealth Went to Vanish By DIANA B. HENRIQUES and ALEX BERENSON The epicenter of what may be the largest Ponzi scheme in history was the 17th floor of the Lipstick Building, an oval red-granite building rising 34 floors above Third Avenue in Midtown Manhattan. A busy stock-trading operation occupied the 19th floor, and the computers and paperwork of Bernard L. Madoff Investment Securities filled the 18th floor. But the 17th floor was Bernie Madoff’s sanctum, occupied by fewer than two dozen staff members and rarely visited by other employees. It was called the “hedge fund” floor, but federal prosecutors now say the work Mr. Madoff did there was actually a fraud scheme whose losses Mr. Madoff himself estimates at $50 billion. The tally of reported losses climbed through the weekend to nearly $20 billion, with a giant Spanish bank, Banco Santander, reporting on Sunday that clients of one of its Swiss subsidiaries have lost $3 billion. Some of the biggest losers were members of the Palm Beach Country Club, where many of Mr. Madoff’s wealthy clients were recruited. The list of prominent fraud victims grew as well. According to a person familiar with the business of the real estate and publishing magnate Mort Zuckerman, he is also on a list of victims that already included the owners of the New York Mets, a former owner of the Philadelphia Eagles and the chairman of GMAC. And the 17th floor is now an occupied zone, as investigators and forensic auditors try to piece together what Mr. Madoff did with the billions entrusted to him by individuals, banks and hedge funds around the world. So far, only Mr. Madoff, the firm’s 70-year-old founder, has been arrested in the scandal. He is free on a $10 million bond and cannot travel far outside the New York area. According to charges against Mr. Madoff, his firm paid off earlier investors with money from new investors, fitting the classic definition of a Ponzi scheme. It unraveled as markets declined and many investors who lost money elsewhere sought to withdraw money from their investments with Mr. Madoff. But a question still dominates the investigation: how one person could have pulled off such a far-reaching, long-running fraud, carrying out all the simple practical chores the scheme required, like producing monthly statements, annual tax statements, trade confirmations and bank transfers. Firms managing money on Mr. Madoff’s scale would typically have hundreds of people involved in these administrative tasks. Prosecutors say he claims to have acted entirely alone. “Our task is to find the records and follow the money,” said Alexander Vasilescu, a lawyer in the New York office of the Securities and Exchange Commission. As of Sunday night, he

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said, investigators could not shed much light on the fraud or its scale. “We do not dispute his number — we just have not calculated how he made it,” he said. Scrutiny is also falling on the many banks and money managers who helped steer clients to Mr. Madoff and now say they are among his victims. Mr. Madoff was not running an actual hedge fund, but instead managing accounts for investors inside his own securities firm. While many investors were friends or met Mr. Madoff at country clubs or on charitable boards, even more had entrusted their money to professional advisory firms that, in turn, handed it to Mr. Madoff — for a fee. Investors are now questioning whether these paid advisers were diligent enough in investigating Mr. Madoff to ensure that their money was safe. Where those advisers work for big institutions like Banco Santander, investors will most likely look to them, rather than to the remnants of Mr. Madoff’s firm, for restitution. Santander may face $3.1 billion in losses through its Optimal Investment Services, a Genevabased fund of hedge funds that is owned by the bank. At the end of 2007, Optimal had 6 billion euros, or $8 billion, under management, according to the bank’s annual report — which would mean that its Madoff investments were a substantial part of Optimal’s portfolio. A spokesman for Santander declined to comment on the case. Other Swiss institutions, including Banque Bénédict Hentsch and Neue Privat Bank, acknowledged being at risk, with Hentsch confirming about $48 million in exposure. BNP Paribas said it had not invested directly in the Madoff funds but had 350 million euros, or about $500 million, at risk through trades and loans to hedge funds. And the private Swiss bank Reichmuth said it had 385 million Swiss francs, or $327 million, in potential losses. HSBC, one of the world’s largest banks, also said it had made loans to institutions that invested in Madoff but did not disclose the size of its potential losses. Calls to Mr. Zuckerman and his representatives were not returned on Sunday night. Losses of this scale simply do not seem to fit into the intimate business that Mr. Madoff operated in New York.By the elevated standards of Wall Street, the Madoff firm did not pay exceptionally well, but it was loyal to employees even in bad times. Mr. Madoff’s family filled the senior positions, but his was not the only family at the firm — generations of employees had worked for Madoff and invested their savings there. Even before Madoff collapsed, some employees were mystified by the 17th floor. In recent regulatory filings, Mr. Madoff claimed to manage $17 billion for clients — a number that would normally occupy far more than the 20 or so people who worked on 17. One Madoff employee said he and other workers assumed that Mr. Madoff must have a separate office elsewhere to oversee his client accounts. Nevertheless, Mr. Madoff attracted and held the trust of companies that prided themselves on their diligent investigation of investment managers. One of them was Walter M. Noel Jr., who struck up a business relationship with Mr. Madoff 20 years ago that helped earn his investment firm, the Fairfield Greenwich Group, millions of dollars in fees. Indeed, over time, one of Fairfield’s strongest selling points for its largest fund was its access to Mr. Madoff. But now, Mr. Noel and Fairfield are the biggest known losers in the scandal, facing potential losses of $7.5 billion, more than half the firm’s assets.

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Jeffrey Tucker, a Fairfield co-founder and former federal regulator, said in a statement posted on the firm’s Web site: “We have worked with Madoff for nearly 20 years, investing alongside our clients. We had no indication that we and many other firms and private investors were the victims of such a highly sophisticated, massive fraudulent scheme.” The huge loss comes at a time when the hedge fund industry has already been wounded by the volatile markets. Several weeks ago, Fairfield had halted investor redemptions at two of its other funds, citing the tough market conditions as dozens of hedge funds have done. The firm reported a drop of $2 billion in assets between September and November. Fairfield was founded in 1983 by Mr. Noel, the former head of international private banking at Chemical Bank, and Mr. Tucker, a former Securities and Exchange Commission official. It grew sharply over the years, attracting investors in Europe, Latin America and Asia. Mr. Noel first met Mr. Madoff in the 1980s, and Fairfield’s fortunes grew along with the returns Mr. Madoff reported. The two men were very different: Mr. Madoff hailed from eastern Queens and was tied closely to the Jewish community, while Mr. Noel, a native of Tennessee, moved in the Greenwich social scene with his wife, Monica. “He was a person of superb ethics, and this has to cut him to the quick,” said George L. Ball, a former executive at E. F. Hutton and Prudential-Bache Securities who knows Mr. Noel. Fairfield boasted about its investigative skills. On its Web site, the firm claimed to investigate hedge fund managers for 6 to 12 months before investing. As part of the process, a team of examiners conducted personal background checks, audited brokerage records and trading reports and interviewed hedge fund executives and compliance officials. In 2001, Mr. Madoff called Fairfield and invited the firm to inspect his books after two news reports questioned the validity of his returns, according to a person close to Fairfield. Outside auditors hired to inspect Mr. Madoff’s operations concluded that “everything checked out,” this person said. The Fairfield Greenwich Group “performed comprehensive and conscientious due diligence and risk monitoring,” Marc Kasowitz, a lawyer for Fairfield, said in a statement. “FGG, like so many other Madoff clients, was a victim of a highly sophisticated massive fraud that escaped the detection of top institutional and private investors, industry organizations, auditors, examiners and regulatory authorities.” Now, Fairfield is seeking to recover what it can from Mr. Madoff. “It is our intention to aggressively pursue the recovery of all assets related to Bernard L. Madoff Investment Securities,” Mr. Tucker said in a statement. “We are also committed to the operation of our continuing funds. We hope to have a better idea of the entire situation as the facts develop.” Working alongside the federal investigators on Madoff’s 17th floor, staff workers for Lee S. Richards 3d, the court-appointed receiver for the firm, are trying to determine what parts of the firm can keep operating to preserve assets for investors. “We don’t have anything to report to investors at this time,” he said. “We are doing everything we can to protect the assets of the Madoff entities that are subject to the receivership, and to learn what we can about the operations of those entities.” Eric Dash, Jennifer 8. Lee, Zachery Kouwe, Michael J. de la Merced and Nelson D. Schwartz contributed reporting.

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U.S. December 15, 2008

States’ Funds for Jobless Are Drying Up By JENNIFER STEINHAUER With unemployment claims reaching their highest levels in decades, states are running out of money to pay benefits, and some are turning to the federal government for loans or increasing taxes on businesses to make the payments. Thirty states are at risk of having the funds that pay out unemployment benefits become insolvent over the next few months, according to the National Association of State Workforce Agencies. Funds in two states, Indiana and Michigan, have already dried up, and both states are borrowing from the federal government to make payments to the unemployed.

Unemployment taxes are collected by states from employers, but the rate varies from state to state per employee. In good times states build up trust funds so that when unemployment is high there is enough money to cover the requests for benefits, which are guaranteed by the federal government. “You don’t expect the loans to happen this early in a jobs slump,” said Andrew Stettner, the deputy director of the National Employment Law Project, an advocacy organization for lowwage workers. “You would expect that the states should, even when they are not well prepared, to have savings.” 263

The Labor Department said last week that initial applications for jobless benefits rose to 573,000, the highest reading since November 1982. It is recommended that states keep at least one year of peak-level benefits in their trusts, but many have not, and already some states are far worse off than others. Indiana’s unemployment trust fund went insolvent last month, and has borrowed twice from Washington since then — the first such loans to the state since 1983. It also expects to request an additional $330 million early next year. Michigan, which has been borrowing money from the federal government for the past few years to replenish its fund, is now $508.8 million in the hole and unable to repay it. Next month the state, where the unemployment rate is more than 9 percent, will begin levying a special “solvency tax” against some employers to replenish its trust fund. California, New York, Ohio, Rhode Island and other states are inching toward insolvency as well, and may have to borrow from the federal government to get through at least the first quarter of 2009. In South Carolina, officials recently requested a $15 million line of credit. “Right now we have $40 million in our trust fund, and we are paying out around $11 million a week,” said Allen Larson, deputy executive director for the unemployment insurance program at the South Carolina Employment Security Commission. “So we think it is going to be very close as to whether or not we can get through this year. We have never experienced anything like this.” Officials in New York said the state’s trust fund has about $314 million, compared with $595 million last year, and will most likely have to borrow from the federal government in January. The situation puts states, many of them facing huge deficits, in an even tighter vise. As more people lose their jobs, the revenue base that the benefits are drawn from shrinks, making it harder to pay claims. Adding to that burden is that states will eventually have to pay back what they borrow. Some states are worried about next year because the lion’s share of unemployment taxes are collected early in each year, and they are not sure the money will stretch through the end of the next year. The maximum amount of income the federal government can tax employers for each worker is $7,000. (The amount ranges from about $7,000 to about $25,000 for state taxes.) “It is something that we are concerned about,” said Kim Brannock, a spokeswoman for the Office of Employment and Training in Kentucky, where the unemployment trust fund balance now sits at $133 million, compared with $250 million a year ago. The fund has not borrowed money from the federal government since the 1980s. “At this point we are solvent,” she said, “but we are monitoring the situation.” States that come up short have the option of borrowing from the federal government, but if the loan is not paid back within the federal fiscal year, 4.7 percent interest is accrued, which cuts into states’ general funds. “With longer term solvency issues due to the sharp increase in unemployment, federal borrowing quickly becomes expensive,” said Loree Levy, a spokeswoman for the Employment Development Department in California, which is already facing a multibillion dollar budget gap. “We are anticipating interest payments of $20 million in 2009-10 and if nothing is done to revise the revenue generation model the interest would be $150 million in 2010-11.”

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As such, they are then forced to raise taxes or cut services, or both. Robert Vincent, a spokesman for the Gtech Corporation, a technology company for the lottery industry based in Rhode Island, said, “Unemployment taxes are one of a number of taxes that make it difficult to do business here.” In many cases, states that have kept unemployment tax rates artificially low — or in some instances decreased them — find themselves in the worst pickle now. Indiana legislators, for example, reduced the tax rates to businesses by 25 percent in 2001. “So, frankly, they created the perfect storm,” said John Ruckelshaus, the deputy commissioner for the Indiana Department of Workforce Development. “The Legislature will have to go in and look at the whole unemployment trust find first thing when they begin their session.” At the same time payments have gone up in some states. To recalibrate the balance, several states are raising taxes on businesses — often through an automatic increase that is triggered when fund levels are endangered — to keep the unemployment checks flowing. An example is the Michigan solvency tax, which will be levied against employers whose workers have received more in benefits than the companies have contributed in unemployment insurance taxes, to the tune of $67.50 per employee. In Rhode Island, where the unemployment rate is 9.3 percent, the taxable wage base will go to $18,000 from $14,000 in 2009, the highest rate in a decade. “There is a possibility that we might be slightly under the funds we need come the end of the first quarter,” said Raymond Filippone, the assistant director of income support at the Rhode Island Department of Labor and Training. The state has not borrowed from the federal government since 1980, he said. “Many states have not raised that tax in years,” said Scott Pattison, executive director of the National Association of State Budget Officers in Washington. “Some states have automatic triggers. But then of course you have businesses saying, ‘Whoa, you are raising taxes on me when we are having a tough time and it is a recession, too.’ ” Still, some said they were thinking beyond the dollars. “In these times of financial stress every extra cost is a concern,” said Linda Shelton, the spokeswoman for Lifespan, a large health care system in Rhode Island. “However there are many things that worry us even more. We are much more concerned about Rhode Island’s budget crisis, about rising unemployment, the rising number of uninsured and the continuing cuts to health care.”

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Evidence that the Fed Caused the Housing Boom Daily Article by Robert P. Murphy | Posted on 12/15/2008 12:00:00 AM In this forum I have argued that Alan Greenspan's low-interest-rate policy after the dot-com bust and 9/11 attacks sowed the seeds for our current recession and the housing bubble. I have also criticized the alternate theory that a foreign "savings glut" was the true culprit, rather than the Fed. In the present article, I want to deal with a few empirical objections to the case against Greenspan. That is, several different economic analysts are familiar with the theory that "the Fed did it," and they claim that the facts just don't add up. In the space below, I hope to demonstrate that the evidence against Greenspan is indeed damning. GREENSPAN'S "SMALLISH" INJECTION? One argument advanced in the attempted exoneration of Greenspan is that he didn't really pump that much money into the credit markets. For example, popular blogger Megan McArdle writes, Both right wing Austrians and many liberals have a common theory of how all this happened: Alan Greenspan dunnit. The mechanisms by which he accomplished his foul task are different in the two cases, of course. Austrians, and many other free-market types, believe that by lowering short-term interest rates after 9/11, Alan Greenspan made the housing bubble, and its eventual bust, inevitable… Here's the problem: if markets are so great, how come the entire system can be brought low by a smallish injection of short-term capital? (emphasis added) Brad DeLong makes a similar claim in his critique of Larry White, whom DeLong praises as the "best of the Austrians." (DeLong does not tell us who the best-looking Austrian is, though I hope to at least be nominated.) DeLong writes, Moreover, I do not think that Larry White has gotten the part of the story that he does cover right…. From the start of 2002 to the start of 2006 the Federal Reserve bought $200 billion in Treasury bills for cash. This $200 billion reduction in outstanding bonds and increase in cash surely did lead to an increase in demand for private bonds. But recall the magnitudes here. We have $2 trillion of losses on $8 trillion in face value of mortgages that ex post should not have been made. Are we supposed to believe that $200 billion of openmarket purchases by the Fed drives private agents into making $8 trillion of privately unprofitable loans? Not likely. I can see how monetary contraction can make previously profitable loans unprofitable. But I see no way that this amount of monetary expansion can force private agents to make that amount of unprofitable loans. The magnitudes just do not match. Similarly, David Henderson and Jeff Hummel[1] write that monetary growth was tamed during the years of the housing boom, and so Greenspan can't be the culprit: A better, although now unfashionable, way to judge monetary policy is to look at the monetary measures: MZM, M2, M1, and the monetary base. Since 2001, 266

the annual year-to-year growth rate of MZM fell from over 20 percent to nearly 0 percent by 2006. During that same time, M2 growth fell from over 10 percent to around 2 percent and M1 growth fell from over 10 percent to negative rates. Admittedly the Fed's control over the broader monetary aggregates has become quite attenuated, for reasons elucidated below. But even the year-to-year annual growth rate of the monetary base since 2001 fell from 10 percent to below 5 percent in 2006 and by June of 2008 was around 1.5 percent, despite Ben S. Bernanke's alleged reflation. When all of these measures agree, it suggests that monetary policy was not all that expansionary during 2002 and 2003 under Greenspan, despite the low interest rates. GREENSPAN PRESENTED IN A LESS FLATTERING LIGHT I realize that these disputes may just further convince some readers that economics is not a science but rather an ideological contest in which each side throws its own set of lying statistics at the other. But even so, I will now use the same underlying data as the writers above, to reach the opposite conclusion: Greenspan allowed the monetary base to grow quite rapidly precisely when the housing boom shifted into high gear, and precisely when interest rates collapsed. Before proceeding, I want to remind readers that my story is the textbook explanation of how the Fed operates. It is the writers above who are downplaying the Fed's ability to push down interest rates or to "stimulate" (however temporarily and artificially) the economy. During the boom years, Greenspan and his fans wanted to take credit for his "merciful" low rates which allowed the United States to avoid a painful recession, but now Greenspan and his defenders want to claim that he was an innocent bystander in the face of Asian thrift and shortsighted bankers. In any event, on to the data, this time presented by the "prosecution" as it were. First, let's take McArdle and DeLong's discussion of the injection of base money, and how it was too insignificant to cause the effects we have seen. According to DeLong, there was a $200 billion injection through open-market operations, and yet we have to explain $2 trillion in losses. Well, my first thought is that — as DeLong no doubt teaches his principles-of-macro students — our fractional-reserve system has a built-in multiplier. In particular, if the required reserve ratio is 10 percent, then a given injection of new reserves (through Fed purchases of securities) allows up to a tenfold increase in the quantity of new money. So with that rule of thumb, a $200 billion injection would be expected to have an impact of … $2 trillion. Now let me anticipate an obvious response from DeLong. He could say, "OK fine, but that still makes no sense. Why would expanding the quantity of money by $2 trillion lead private investors to make so many bad loans?" That's a good question, but it's different from the issue of magnitudes. Even if Greenspan flooded the economy with $100 trillion in new money, it doesn't automatically follow that investors should make dumb lending decisions. My point here is simply that this alleged (by McArdle and DeLong) quantitative mismatch is in fact perfectly adequate; Greenspan injected a lot more than a "smallish" amount of short-term capital, once we recall the nature of our fractional-reserve system. Now when it comes to Henderson and Hummel, look again at their actual quotation above: they are trying to prove that monetary expansion was nothing unusual in 2002 and 2003, and to do this they quote the starting and ending annual rates of expansion in 2001 and then in 2006. But this is a bit like saying Keanu Reeves in the movie Speed didn't drive recklessly, because, after all, the bus's velocity was lower when he got off than when he first got on. To know if Greenspan had a tight or loose monetary policy during 2002 and 2003, it's not enough to know that the policy in 2006 (when the boom was winding down, after all!) was lower than in 2001. 267

For the following chart, I have taken the annual averages of the monetary-base series (as compiled by the St. Louis Fed), and plotted the growth rates:

There are a few interesting features of the above graph. First, note that the growth rate in 2002 (8.7%) was higher than in 2001 (5.6%). (Henderson and Hummel may have given the opposite impression, because of the units involved. The base bounced around like crazy because of huge injections and then drainages because of Y2K and 9/11.) Second, note that the base growth in 2002 was about as high as any year from the 1970s, except 1979 (when base growth was 9.2%).[2] Everybody in this debate agrees that the 1970s were characterized by excessively loose monetary policy. It is hard to see then how Greenspan's behavior during the serious onset of the housing boom can be described as moderate. Before leaving this section, I should acknowledge that the graph above does seem puzzling in one respect: the growth in the base during the early 2000s is admittedly large by historical standards (even compared to the 1970s), but it is obviously not unprecedented. In particular, there were larger spikes during the 1980s and 1990s. This is true, but I would remind the reader that there was a massive real-estate bust and stockmarket crash in the 1980s as well, and of course the dot-com bubble in the late 1990s. The Austrians would blame those unfortunate events on the Fed (as well as other contributing causes) too. MORTGAGE RATES NOT UNUSUAL? The last claim we'll analyze in this article is made by the excellent Chicago economist Casey Mulligan, who writes, Another version of the subsidy hypothesis says that public policy encouraged low mortgage rates, which raised housing prices. I believe that housing prices would not have gotten so high if mortgage rates had been higher, but low mortgage rates may not explain why 2006 housing prices were so high relative to housing prices in 2003 or 2008. 30-year fixed-mortgage rates were around six percent per year for most of the boom, and continue to be about six percent.

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No one is denying that there must be some endogeneity to the explanation of the housing bubble; after all, the federal-funds rate right now is just as low as under Greenspan, and nobody expects a housing bubble to develop. But again, I think Mulligan's breezy claims about mortgage rates might give the reader a false impression. He is making it sound as if mortgage rates really have nothing to do with the onset of the boom, because after all they "were around six percent for most of the boom." But in fact, the fall in mortgage rates fits in very well with the serious onset of the boom. The following chart plots the 30-year conventional mortgage rate against year-over-year increases in the S&P/Case-Shiller Home Price Index:

Conventional 30-Year Mortgage Rates (Blue, Left) vs. Year/Year Percentage Growth in Home Prices (Red, Right) (monthly data) Thirty-year mortgage rates plummeted from about 8.5% in mid-2000 to below 5.5% three years later. The connection certainly isn't robotic, but this period also saw a spike in monetary base growth (thus leading us to suspect Greenspan's influence, not just Asian savers) and the acceleration in the housing boom. On this last point, consider that mortgage rates dropped from about 7% down to about 5.5% from April 2002 to April 2003. Even with perfectly rational neoclassical consumers, that would be expected to raise home prices about 17%.[3] And lo and behold, over this same period the home price index rose about 14.5%. In a follow-up post in the same Cato Unbound symposium, Mulligan makes an odd claim in his disagreement with White: Perhaps Professor White would argue that market participants expected short term interest rates to remain low for much longer than a couple of years. If so, he is on shaky ground. First, such a claim is at odds with long-term interest-rate data. As I indicated in my article, long-term mortgage rates were not low during the housing boom. It's not hard to find commentary from those years recognizing the low short-term rates were not expected to last. (emphasis added) Again, this is one of those casual claims in the debate over the housing bubble that is liable to mislead some readers. Check out the following chart of 30-year mortgage rates:

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As the chart above indicates, mortgage rates during the peak of the housing bubble were the lowest in the entire 37 years for which the St. Louis Fed keeps records. Perhaps Mulligan had in mind inflation-adjusted mortgage rates, but if so we're stuck, because we don't yet know what the correct, inflation-adjusted rates on 30-year mortgages were for any mortgages granted after 1978. I ask the reader to once again look at the chart above. Is it really such a leap to think that perhaps Fed manipulation of interest rates might have something to do with the housing bubble? CONCLUSION Some Austrians are concerned that empirical exercises such as I have performed above will fall into the mainstream habit of aping the physicists, rather than developing a priori theories. However, we all know what the logical, verbal arguments of Mises and Hayek are, regarding the boom-bust cycle caused by central banks. The critics are claiming that this story doesn't fit the facts. Hence, the only way to respond is to argue that the Misesian theory really does fit the facts. Despite claims to the contrary, it appears that Alan Greenspan's ultralow interest rates — which went hand in hand with monetary growth rates comparable to those of the 1970s — were at the very least a large contributing factor to the housing boom. I feel confident in claiming that the housing boom would not have occurred if money and banking had been left in the hands of the private sector, as opposed to the state-organized cartel that we currently "enjoy." Robert Murphy runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism. Comment on the blog. Notes [1] Incidentally, in my critique of Henderson and Hummel, I used some strong language that irked some readers. Let me state for the record that I did not intend to accuse these two authors of intentionally distorting the data. I apologize if my article gave that impression. [2] Technically, the second- and third-highest annual growth rates in the 1970s were in 1973 (8.9%) and 1974 (8.8%), and these were also higher than the 2002 figure of 8.7%. But surely these growth rates are virtually equivalent for our purposes.

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[3] At an interest rate of 7%, a $200,000 principal on a 30-year mortgage would require monthly payments of $1,330.60. At an interest rate of 5.5%, monthly payments of $1,331.47 would support an initial home price of $234,500.

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Asian Tools to Fight Global Credit Crisis: Liquidity Injections, Rate Cuts, Swap Lines Dec 14, 2008 o

Dec 12: South Korea and Japan have agreed to increase an existing unconditional KRWJPY swap arrangement to $20bn from $3b effective until April 2009. This supplements a $10b agreement that can be used in times of crisis.China and South Korea agreed to a new bilateral KRW-CNY swap agreement worth $28b for three years. The swap agreements give South Korea access to an additional $35bn equivalent of foreign currencies (adding to the $30bn swap agreements made by the Fed to Korea and Singapore each on Oct 29) a major source of strength for KRW. They reflect closer co-ordination of economic and exchange rate policies within Asia particularly as Japan and China want to increasingly anchoring other weaker Asian currencies to JPY and CNY.(Danske)

o

Swap agreements are a workable short-term solution for the poorest countries, as they boost tappable reserves. But Asia still has to tackle the larger issue of why the world’s biggest surplus countries cannot hold on to their own savings - most investment goes abroad (Lex)

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Asian central banks have been injecting liquidity into banking system and cutting rates (discount/policy rate) and/or bank reserve requirements to ease liquidity squeeze and spike in short-term rates (swap, overnight, inter-bank rates and spreads) Some banned shortselling, narrowed trading bands in stock market, guaranteed deposits, provided fiscal stimulus packages, introduced stabilization funds to contain market volatility, intervened to contain currency depreciation due to capital outflows, declining external balances

Outlook o

Indonesia, and perhaps Philippines, might also seek the IMF's new short-term liquidity facility as an endorsement of its sound macro policies (Citi)

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In spite of limited exposure to US bank losses, risks from external funding crunch, higher borrowing costs, bank panics and deposit withdrawals are growing for banks and corporates in S.Korea, Hong Kong, Taiwan

Individual Country Responses o

Australia: $7.3bn stimulus for pensioners, middle and low-income groups, first-time home buyers; additional stimulus may follow; deposit guarantees; cut overnight cash rate to 6% from 7%, offering 6-mo/1-yr repos; Term Deposit lending facility, expanded types of collateral, loan maturity under bank lending facility as difference b/w inter-bank and overnight indexed swap rate surged; tripled swap agreement with Fed from $10bn to $30bn; banned short selling; to purchase $3.2 bn in residential-backed mortgage securities to help small lenders offer home loans

o

Japan: $51bn fiscal stimulus; providing unlimited dollar funds to banks at a fixed rate against pooled collateral until Jan-09 under swap agreement with Fed; eased rates under lending facility, expanded range of bonds under repos, suspended program of selling bank shares; Injecting liquidity amid spike in Yen overnight LIBOR; banks' exposure to Lehman had led to decline in stock prices and short halt in trading on Sep 15

o

India: Raised cap and credit cost on external borrowing of firms; cut interest rate 100pbs to 8%; conducting 14 day Repos to help banks provide credit to MFs; allowed banks to

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lend to MFs against CDs; Allowed Savings bond holders to borrow from banks against govt paper; to infuse capital into commercial banks to raise CAR up to 12%; cut bank reserve ratio thrice in Oct from 9% to 6.5% (first time in 5 yrs); raised FII limit in corporate bonds; raised interest rate on non-resident deposits by 50bps following similar move in Sep; eased limits on banks to raise foreign capital, restrictions on FII equity investment; eased Liquidity Adjustment Facility; continues to sell FX reserves o

Hong Kong: to use forex reserves to guarantee bank deposits, set up a fund for banks to access capital. Plans additional fiscal stimulus. Cut base rate by 150bps to 2% twice in Oct to contain jump in HIBOR; providing additional liquidity to banks via 3-mo repo window, expanded acceptable collateral

o

S.Korea: $30bn swap line facility with Fed to boost dollar liquidity; cut 7-day repo rate 100bps to 3% in face of high commercial paper and loan refinancing costs, household debt; up to $100 bn to guarantee maturing foreign currency debt; to use forex reserves to inject $30 bn liquidity in won-dollar swap market after an initial $10bn; might buy govt bonds from the market to reduce USD shortage; temporary ban on short selling

o

Taiwan: Guaranteed bank deposits; Cut discount rate on 10-day loans 75bps to 2% in December, cut reserve ratio (first time in 8 yrs), plans fiscal stimulus; injecting liquidity into foreign-currency interbank market; lending via repos to insurance companies w/ extended maturity up to 180 days; banned short selling; instructed 4 major funds and stateowned banks to buy shares

o

Indonesia: agreed to buy back govt bonds, ordered state firms to keep their foreign currency in on-shore banks; allowed commercial banks to use central bank debt and govt bonds as secondary reserves; extended FX Swap tenor to 1 month; passage of foreign currency via banks for firms; abolished limit of daily balance position; eased foreign currency min reserve req; Cut bank reserve ratio 1.58bps to 7.5%; exempted banks from mark-to-market rule, eased rules/cap for firms to buy back shares; Suspended trading on Oct 8/9 following 10% slide in stock market; banned short selling for Oct; injected over 3bn via 6-day repo; lowered overnight repo rate, adjusted rate of liquidity facility; might increase infrastructure spending, fiscal stimulus for exporting firms, households

o

New Zealand: Overnight Cash Rate cut 100bps to 6.5%; introduced opt-in deposit guarantee scheme; accepting (longer term) bank paper in daily market operations, ABSs from local banks for swapping foreign cash into NZ dollars

o

China: cut 1-yr lending rate 108bps to 6.66% from 5.58% and deposit rate to 2.52% in Nov; Chinese banks reluctant to extend loans to foreign banks in the interbank market; cut bank reserve requirements by 50bp to 17%; eliminated stamp duty on stock purchases with plans to buy shares in state-owned banks; to introduce short selling and margin trading to ease pressure on share prices

o

Singapore: $30bn swap line facility with Fed to boost dollar liquidity; guaranteed deposits; Injecting liquidity via market operations for banks to deposit or borrow Singapore dollar funds against govt securities collateral; sufficient liquidity but prepared to provide further liquidity if necessary and also to individual banks amid spike in SIBOR, CDS also rising but rates have eased somewhat following central bank measures

o

Malaysia: guaranteed deposits; Might inject liquidity, move interest rates if necessary; planning for an economic stabilization stimulus

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Pakistan: Declining capital inflows/outflows in inter-bank and open market causing currency depreciation; central bank injected $100-200 bn, raised limit on investment bonds and term finance certificates under banks' statutory requirement

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Business December 14, 2008

The Man Who Is Unwinding Lehman Brothers By JONATHAN D. GLATER THESE days, it’s awfully hard to get on Harvey R. Miller’s calendar. A 75-year-old lion of the bankruptcy bar, Mr. Miller has been consumed by the largest corporate liquidation in American history: Lehman Brothers, the storied investment bank that set off one of the most harrowing episodes in the financial crisis when it collapsed in midSeptember. Mr. Miller’s workdays begin around 8 in the morning and, if he is lucky, end near 11 at night. This combative, outspoken lawyer says that some days don’t seem to end at all, but merely expand into the next, dissolving into tense meetings and complicated hearings in overheated courtrooms. Although Mr. Miller has been involved in landmark bankruptcy cases before — including those of Eastern Airlines, R. H. Macy and Global Crossing — Lehman’s is in a class by itself because of volatile markets, continuing government investigations, the involvement of federal regulators and a possible wave of other corporate implosions. From his perspective as Lehman’s undertaker, Mr. Miller believes that the fallout from the firm’s messy bankruptcy could have been avoided. Regulators could have stepped in, he says, not necessarily to save Lehman, perhaps, but to head off the meltdown that followed. “They totally missed it,” he says. “Look what happened.” When companies rushed to terminate contracts with Lehman, he says, investor confidence plummeted in just about everything — securities and the markets they trade on, corporate debts and the assets backing them, the power of the government and its readiness to use it. In the days after Lehman filed for bankruptcy, he notes, demand for corporate debt utterly evaporated. The failure of a Wall Street firm poses its own special risks, because other companies that rely on it — such as counterparties to complex financial contracts known as derivatives — are all financially exposed to its collapse. That’s why Mr. Miller says it was crucial for the government to head off the wholesale termination by counterparties of all their transactions with Lehman before the firm was forced into bankruptcy. “If the Fed or the Treasury said, ‘Let’s say to Lehman, there’s no bailout, we’re not going to save the company,’ they could have supported an orderly unwinding of all the transactions over a period of months,” he says. “It probably would’ve cost the economy a lot less money.” THE severity of the economic downturn is leading many analysts to predict a wave of bankruptcies over the next year. And for bankruptcy experts and lawyers who specialize in the trade, all the bad news may be good news for their own business. For one firm in particular, it represents a windfall. Weil Gotshal & Manges, the firm where Mr. Miller is a partner, is widely believed to be first on a short list to represent General Motors if it seeks bankruptcy protection. Ira M. Millstein, another partner at the firm, has long been a trusted adviser to G.M.’s board.

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Weil is also handling bankruptcy filings by Washington Mutual, Pilgrim’s Pride, Sharper Image and others, and Weil lawyers say representatives of other teetering companies are calling all the time. In addition to advising the American International Group, the insurance giant that needed a huge federal bailout to stave off collapse, Weil is handling 13 bankruptcy filings this year alone. Still, none of the failures so far compare to Lehman’s. The combined debt of the 13 bankrupt companies represented by Weil totals $684 billion, according to the firm, but a stunning $640 billion is owed by Lehman alone. Lawyers involved in the case say it has been a brutal sprint, in which any delay can result in billion-dollar losses. “Events move with the velocity that almost defies comprehension,” Mr. Miller said in midSeptember at a hearing at the United States Bankruptcy Court for the Southern District of New York. In one 24-hour period, he pointed out, Lehman lost $1.6 billion when the Chicago Mercantile Exchange closed out all of Lehman’s positions. Since Lehman filed for bankruptcy protection early in the morning of Sept. 15, the Dow Jones industrial average has fallen more than 18 percent. Investors worldwide have watched helplessly as billions of dollars they sank into stock markets have evaporated. Tens of thousands of people have already lost jobs in sweeping corporate cutbacks, and countless additional jobs are at risk. With the fate of whole industries — financial services, automaking, airlines, retailers, real estate, media — looking shaky, demand for bankruptcy gurus is likely to remain high for some time. For Mr. Miller, this moment offers an opportunity, but he does not want for glory, says Sandra E. Mayerson, head of the New York restructuring practice at Holland & Knight. “His reputation was secure without Lehman, but I think he lives for the thrill of his work,” Ms. Mayerson says. “He didn’t need a moment.” MR. MILLER says there is no place he would rather be than where he is now. Asked why, he pauses an instant, then says he loves the excitement, the risk and the potential reward. Under Chapter 11 of the federal bankruptcy code, companies receive protection from creditors and an opportunity to reorganize so they can become productive again, preserve jobs and, ideally, eventually pay back their debts. “If you’re successful, there’s nothing like reorganizing a company,” Mr. Miller says. Although Lehman filed for Chapter 11 protection, the firm is not expected to emerge from proceedings. Even so, he says, there are still advantages to Lehman if its bankruptcy is wellmanaged. It can produce “a result which benefits people,” he says. In this case, that would mean finding buyers for Lehman’s businesses that were willing to continue employing its workers. Mr. Miller says the first bankruptcy case he handled by himself involved a small lithograph company that was to be liquidated. Instead, it was able to reorganize. “We had a dinner party, and the look on the employees’ faces whose jobs had been saved, you can’t compare that,” he recalls of that case. Mr. Miller, tall, gray-haired and well dressed, is one of those hyperarticulate lawyers able to speak in complete paragraphs, offering off-the-cuff, for example, his detailed critique of the government’s response to Lehman’s collapse.

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He was born in 1933, and after graduating from Columbia Law School in 1959, joined a small law firm. In 1963, he joined Seligson & Morris, an eight-lawyer firm that also employed Martin Lipton, Leonard Rosen and George Katz, who went on to be co-founders of Wachtell, Lipton, Rosen & Katz. In 1969, Mr. Millstein brought Mr. Miller aboard at Weil. Mr. Miller created the firm’s finance and restructuring department. Weil bankruptcy lawyers have taken on some of the biggest, messiest cases of their time, representing Continental Airlines, Bethlehem Steel, the Sunbeam Corporation, the Marvel Entertainment Group and Carmike Cinemas. The firm also represented creditors of Donald Trump when the developer’s holdings ran into problems in the early 1990s. Along the way, Mr. Miller helped to assemble a team of younger lawyers, many of whom are now heavyweights in the bankruptcy bar. Martin J. Bienenstock, who spent 30 years at Weil, mostly alongside Mr. Miller, recalled how intimidating it was for a young lawyer to work with Mr. Miller. “He seemed to forget long ago what it is like to only have the knowledge of a beginner,” says Mr. Bienenstock, who is building a unit at Dewey & LeBoeuf in New York that specializes in restructuring and corporate governance. Mr. Miller pushed young lawyers to improve their skills, often having them prepare and make presentations, Mr. Bienenstock says. He says Mr. Miller, who for years has been a lecturer at Columbia Law School, is also a gifted tutor. The first time he attended a court hearing with Mr. Miller in the late 1970s, Mr. Bienenstock says, “I basically copied down on a legal pad everything Harvey did, from the time he stood up to go to the lectern.” He says Mr. Miller would tell a bankruptcy judge what he wanted, listen closely to the judge’s response and then try to show that the judge’s own thinking supported doing what Mr. Miller wanted. “To this day, I basically follow that template because it’s so effective,” Mr. Bienenstock says. In 2002, after 33 years at Weil, Mr. Miller left to join Greenhill & Company, a boutique investment bank started in 1996 by Robert F. Greenhill. In 2004, Greenhill went public, presumably making Mr. Miller an even wealthier man. At Greenhill, he advised Loral Space and Communications in a Chapter 11 proceeding, and got to know Bernard L. Schwartz, then Loral’s chief executive. “I developed a very strong respect for his professionalism and the way he approached the issue of restructuring Loral,” says Mr. Schwartz, who now runs BLS Investments in New York. “He spoke with confidence, with knowledge, and he was always constructive.” Loral emerged from Chapter 11 with its management team intact, as Mr. Schwartz desired. The two men became friends, Mr. Schwartz says, and now meet for lunch at least once a month. Mr. Miller left Greenhill last year and returned to Weil, a move that generated headlines in trade publications. It is not clear what prompted the move; in a statement at the time, Mr. Miller said that “Weil is where I grew up, and it’s always felt like home to me.” Lawyers at other firms say the timing of his return now seems a masterstroke, given the amount of bankruptcy work. Mr. Miller can be decidedly old-school in his approach, says Luc A. Despins, chairman of the restructuring practice at Paul, Hastings, Janofsky & Walker in New York. Mr. Despins recently represented Lehman creditors, and has faced Mr. Miller in other cases.

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“There’s a whole generation thing there,” says Mr. Despins, who is 48. “When he goes to court, he has a text that is typed in front of him about what he’s going to say. It is rare to see lawyers of my generation have prepared, typed text. We are more likely to have bullet points scribbled on a legal pad.” And Mr. Miller seems indefatigable, Mr. Despins says. In the Lehman case, he observes, Mr. Miller “doesn’t flinch.” “He did all-nighters and all that,” Mr. Despins adds. “It’s pretty incredible.” But even as lawyers express admiration for Mr. Miller, some also describe him as a hard man to get along with, a man whose temper has sometimes gotten the better of him. In one wellknown instance, while representing Eastern Airlines in its reorganization effort nearly 20 years ago, he turned in frustration to a lawyer representing a potential buyer of the company and grabbed him by the collar — while both were in a judge’s chambers. Mr. Miller said afterward that he regretted the lapse, but the story stuck. Joel B. Zweibel, a well-known retired bankruptcy lawyer who says he physically restrained Mr. Miller at that meeting, chuckles at the memory. He describes Mr. Miller as a difficult but very worthy opponent. Mr. Zweibel squared off with Mr. Miller many times over the years, including the Macy’s bankruptcy. He says that while he was able to become good friends with courtroom opponents, Mr. Miller was the exception. “That was not my experience with Harvey,” Mr. Zweibel says. “The relationship was strictly adversarial.” People whom Mr. Miller perceives as adversaries outside the courtroom are treated accordingly on the inside. During court proceedings in the Lehman bankruptcy, Mr. Miller leveled a snide comment at his former partner, Mr. Bienenstock, questioning his comprehension of a proposed deal. Mr. Miller wanted speedy court approval of a sale of Lehman’s domestic capital markets business to Barclays, the British bank. Mr. Bienenstock was worried that the sale of the subsidiary could block creditors from recovering money the Lehman unit owed them. “I’m a little bit shocked, having practiced with Mr. Bienenstock for years, that he doesn’t understand an agreement,” Mr. Miller said at a hearing in September. The presiding judge, James M. Peck, headed off any possible bickering, observing, “Oh, he understands.” (Mr. Bienenstock says he did not respond to Mr. Miller’s comment in light of the judge’s words.) Mr. Miller, who is so busy that he limited an interview to a 15-minute phone call, describes himself as a zealous advocate, because, he says, that is exactly what his clients want and expect when they hire him. Mr. Miller’s work costs nearly $1,000 an hour, according to a court filing in another case. “When I represent a client, I represent the client, and I do the best for the client,” no matter who represents the other side, Mr. Miller says. “And I am not into back-scratching.” RIVALS of Mr. Miller ask if so many companies turn to Weil’s bankruptcy practice because of him or because of ties to other partners at the firm who schmooze and network more readily. For example, Mr. Millstein’s ties to G.M., and in the past to other companies, have been of enormous help to Weil’s practice. Still, Mr. Miller is probably the best-known bankruptcy lawyer in the country. At an annual conference on distressed investing, his name is on an award given to a professional in the restructuring business. 278

No corporate meltdown has posed the combination of challenges that the Lehman case does, not just because the company is so large but also because it operates within an intricate financial web in which spooked investors can move money nearly instantaneously. Lawyers say the case most like Lehman’s is that of Drexel Burnham Lambert, the investment bank that filed for Chapter 11 protection in 1990 after a client, Ivan F. Boesky, paid $100 million to settle charges of insider trading and agreed to testify against the firm and its junkbond impresario, Michael Milken. Mr. Milken later went to prison for violating federal securities laws. Regulators accused Drexel of, among other things, insider trading and manipulation of stock prices. Lehman has not been charged with any crimes, but it and some of its employees face investigations of events before the collapse. Drexel, like Lehman, was liquidated, and Drexel also turned to Mr. Miller to help sell its pieces for as much money as could be gotten to satisfy creditors. Lehman’s fall was tied to derivatives and complex mortgage securities. Blame for Drexel’s collapse was assigned to a newfangled financial tool of the earlier era, the junk bond. Those high-yield, high-risk instruments helped feed mega-takeovers of the ’80s. But figuring the worth of Drexel’s assets didn’t present the problem it does at Lehman, which holds billions in securities backed by home loans and other assets of uncertain worth. And Drexel’s collapse wasn’t seen as a potential harbinger of financial apocalypse. In any event, every bankruptcy case is different. The federal bankruptcy code doesn’t come close to covering every twist and turn that arises when companies fail. The best lawyers think creatively in these situations and bring specialized areas of expertise to bear on myriad vagaries of a corporate collapse. The Weil team working on Lehman’s bankruptcy includes lawyers who are experts in tax, real estate, litigation and mergers and acquisitions, said Lori R. Fife, a partner at the firm. “I’ve worked pretty much past midnight, every night, and every Saturday and Sunday since Sept. 15,” when Lehman filed for bankruptcy, Ms. Fife said, adding that she had not worked as hard in previous cases, including the huge bankruptcy of WorldCom. “We have so many transactions going on at the same time, litigations going on,” Ms. Fife says. “It’s overwhelming. I don’t get a lot of sleep.” Neither, these days, does Mr. Mil- ler.

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Steve Keen’s Oz Debtwatch Analysing the Global Debt Bubble

The World’s Biggest Ponzi Scheme? Published in December 13th, 2008 Posted by Steve Keen in USA Two days ago the FBI indicted Bernie Madoff, principal of Bernard L. Madoff Investment Securities LLC, on securities fraud. Though the case has yet to run, in the indictment the FBI reported that Madoff confessed that his was “basically a giant Ponzi Scheme” that may have lost some extremely high net worth individuals over US$50 billion. Madoff’s firm was famous for returning constant positive results, even on a month by month basis, for decades. As Henry Blodget on Yahoo’s Tech Ticker reports below, many Wall Street professionals were incredulous of these results, but invested in his firm anyway–because they thought his returns must be coming from him exploiting his “market maker” role on the Nasdaq to do insider trading. This in itself is a delicious commentary on the oxymoron of self-regulating financial markets. Insider trading is illegal, but many bigwigs on the Street were quite willing to risk their money with someone whom they thought could only be making that much money if he were breaking the law. In fact, he was breaking the law, but not that way: rather than making profits from insider trading and then funnelling part of the proceeds to those who gave him the funds with which to do it, he was simply taking in principal from “investors” and paying it back to them as interest. This is what qualifies his (alleged) activities as Ponzi Scheme, named after Charles Ponzi,* whose dream of a means to get rich quick by arbitrage on International Reply Coupons (IRC) turned into a giant financial fraud. * Incidentally, while I link to the Wikipedia entry on Ponzi and his scheme, it’s somewhat inaccurate on Ponzi’s early history, and also leaves out important attenuating facts about him. By far the best reference is the brilliantly researched and beautifully written Ponzi’s Scheme: The True Story of a Financial Legend by Mitchell Zuckoff. Read it and you will learn that, in addition to turning into a somewhat inadvertent but large scale swindler, Ponzi also literally gave the skin off his own back–and on two separate occasions–to save the life of a nurse who had suffered horrific burns. I can’t see many of those accused of running a Ponzi Scheme these days giving anyone the shirt off their backs, let alone their own skin. Ponzi believed he had stumbled on a path to riches when he received an IRC in the mail and then found that it was mispriced around the world. IRCs were designed to facilitate communication. Person A in country X could write to person B in country Y, and enclose an IRC that person B could then exchange for a postage stamp for the reply. Great idea, except that the prices were set before the First World War, and not adjusted after it. For argument’s sake, let’s say the price for an IRC was 1 dollar in the USA and 1 lira in Italy, and the exchange rate in 1910 was 1 dollar for 1 lira.

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Then along comes WWI and currencies go haywire–say now that a lira is only worth ten cents. But it still buys one IRC in Italy, which if shipped to the USA will then be exchangeable for a $1 stamp. Ponzi thought that he could: 1. Raise dollars in the USA 2. Ship them to Italy 3. Exchange them for Italian Lira–$1 buying 10 lira (let’s say) 4. Buy 10 IRCs with the 10 Lira 5. Ship the IRCs back to America 6. Sell them to people who were going to buy them at the Post Office for (say) half price 7. Make a fortune… Great idea, except that the great financial journalist Clarence Barron calculated that, to support the scale of investments in Ponzi’s Scheme towards its end, there would need to be 160 million IRCs in circulation; but there were in reality only 27 thousand to be had. An awareness that this might be the case was probably why Ponzi couldn’t convince the big end of town to invest–remember the old adage “If it sounds too good to be true, it probably is”? (something the “investors” in Madoff’s firm obviously forgot). So he set up a shop front, promising retail investors a 50 percent return on their money in 45 days. Some people who didn’t know the adage took a punt, and within days Ponzi had his first funds–well before he worked out the mechanics of his arbitrage scheme. When 45 days elapsed and the first “investor” turned up expecting his $50 return on a $100 investment, Ponzi gave him money the only way he could–by handing over some of the money initially deposited by those early investors. “Wow! Ponzi makes good on his promise: invest $100, and seven weeks later earn $50. Why if I left that $100 with him–or better still, left that AND added the $50 he’s just given me (minus say $25 for a good night out in celebration), then in another seven weeks I’ll have $187.50. And if I re-invest that…” So went the word, as successful investors in Ponzi’s Scheme bragged to their friends about how much money the nice Mr Ponzi had made them. Ponzi never got the mechanics of the IRC arbitrage scheme worked out–and he continued to dream up schemes that, if they succeeded, would mean his apparent dividends were actually legitimately earned–and stuck with the practice of paying out principal deposited by later investors as interest to earlier ones. Ultimately, he took in something close to US$15 million from about 40,000 people. Some of them who got out early walked away a lot wealthier, but at the end of the scheme, those still in it could only recoup $5 million–the other $10 million had gone to the early escapees, and to fund Ponzi’s temporarily luxurious lifestyle and minimal operating costs. On some scales, Madoff’s is a more modest scheme than Ponzi’s–rather than promising 50% every 45 days (which works out at an annual rate of return of 2,680%), Madoff returned investors roughly 1% a month. As a result, the Big End of Town could persuade itself that the returns were initially the result of a successful investment strategy–and then later as the sheer volume grew, that they were the result of insider trading.

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So Madoff attracted really wealthy investors: it appears that his firm “managed” over US$17 billion for less than 100 investors–though Madoff himself allegedly estimated his total losses at US$50 billion. And the scheme ran for almost half a century–far longer than Ponzi’s brief time in the financial sun (less than a year). So is this the World’s Biggest Ponzi Scheme, as some headlines are trumpeting? It’s certainly the biggest of what I call Type I Ponzi Schemes: direct, undisguised schemes in which principal is paid out as interest. But the biggest Ponzi Schemes by far are what I call Type II: here, instead of a direct “principal in, interest out” pump, we have “borrow money, buy assets with it, drive up the asset price, sell the assets, pay off the debt plus interest, and keep part of the asset price appreciation as profit”. That, of course, describes margin lending on the stock market, and above all, leveraged speculation on house prices. It works a treat while asset prices continue to rise, but a fundamental precondition for this is that the level of debt has to rise even faster–since interest on the debt compounds it, and no real money is being made (by doing boring stuff like producing widgets and flogging them for a profit–the legitimate equivalent to Ponzi’s never-practised arbitrage scheme). It falls over when the next entrant into the scheme looks at the level of debt required to enter, compares it to his/her income, says to self “there’s no way I could ever repay this out of my income” and decides not to play. In reality, the world’s financial system has become one giant Type II Ponzi Scheme, and we are now reaping the whirlwind of that fiasco. While some made a fortune by getting out early, others are locked into the downward spiral as asset prices plummet for lack of buyers, excessive debt, and distressed selling to meet interest payments, and margin calls. Madoff’s (alleged) Ponzi Scheme may be the most dramatic Ponzi Scheme, but in reality we’ve all been for a ride in Ponzi’s Magical Mystery Machine. Part of the appeal of it all is the sheer fun of the boom. As Ponzi himself put it when interviewed on his deathbed in a Brazilian hospital for the destitute: “Even if they never got anything for it, it was cheap at that price. Without malice aforethought I had given them the best show that was ever staged in their territory since the landing of the Pilgrims! It was easily worth fifteen million bucks to watch me put the thing over.” Below are some early reports on Madoff’s Scheme. I’ll continue adding to them as they come in–though at some stage there will doubtless be a flood that I can’t keep pace with. December 12: Yahoo Finance Tech Ticker: “I Knew Bernie Madoff Was Cheating; That’s Why I Invested with Him“. “So why did these smart and skeptical investors keep investing? They, like many Madoff investors, assumed Madoff was somehow illegally trading on information from his market-making business for their benefit. They didn’t consider the possibility that he was clean on that score but running a good old-fashioned Ponzi scheme.” December 12: More on Madoff and the world’s biggest explicit Ponzi Scheme (in reality both the stock market and housing market bubbles were also Ponzi Schemes) The World’s Biggest Ever Heist. “Right now, there are a handful people whose world has suddenly been turned upside-down: who have, overnight, suddenly lost billions of dollars of dynastic wealth to a Wall Street con man. I’m sure that their names will appear sooner or later. But there really is no precedent that I can think of: when has one man ever managed

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to steal $50 billion dollars? If the $100 million Harry Winston heist in Paris was the “steal of the century”, what’s this?.” December 11: Henry Blodget on Clusterstock: Bernie Madoff: The Indictment. “The criminal indictment of Bernie Madoff is embedded below. The good stuff starts at the bottom of page 2, when the FBI agent begins talking about his interview with two of Bernie’s senior employees. According to the WSJ, these two employees are Bernie’s sons. Also don’t miss the last paragraph, where the agent interviews Bernie himself.” December 11th: Prominent Trader Accused of Defrauding Clients, NY Times. “On Wall Street, his name is legendary. With money he had made as a lifeguard on the beaches of Long Island, he built a trading powerhouse that had prospered for more than four decades. At age 70, he had become an influential spokesman for the traders who are the hidden gears of the marketplace. But on Thursday morning, this consummate trader, Bernard L. Madoff, was arrested at his Manhattan home by federal agents who accused him of running a multibillion-dollar fraud scheme — perhaps the largest in Wall Street’s history…” “Mr. Madoff invited the two executives to his Manhattan apartment that evening. When they joined him there, he told them that his money-management business was “all just one big lie” and “basically, a giant Ponzi scheme.” “The senior employees understood him to be saying that he had for years been paying returns to certain investors out of the cash received from other investors.”

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DECEMBER 13, 2008

Fund Fraud Hits Big Names MADOFF'S CLIENTS INCLUDED METS OWNER, GMAC CHAIRMAN, COUNTRY-CLUB RECRUITS By ROBERT FRANK, PETER LATTMAN, DIONNE SEARCEY and AARON LUCCHETTI New potential victims emerged of Wall Street veteran Bernard Madoff's alleged giant Ponzi scheme, with international banks, hedge funds and wealthy private investors among those sorting out what could amount to tens of billions of dollars in losses. New York Mets owner Fred Wilpon, GMAC LLC Chairman J. Ezra Merkin and former Philadelphia Eagles owner Norman Braman were among the dozens of seemingly sophisticated investors who placed money on what could prove to be history's largest financial scam. Giant French bank BNP Paribas, Tokyo-based Nomura Holdings Inc. and Neue Privat Bank in Zurich are also exposed, according to people familiar with the matter. And at least three funds of hedge funds -- which raise money from investors and farm it out to hedge funds -- may have significant losses. Fairfield Greenwich Group and Tremont Capital Management of New York placed hundreds of millions of their investors' dollars into funds overseen by Mr. Madoff. On Friday, Maxam Capital Management LLC reported a combined loss of $280 million on funds they had invested with Mr. Madoff. "I'm wiped out," said Sandra Manzke, Maxam's founder and chairman. The Darien, Conn., fund of hedge funds will have to close as a result of the losses, she said. Mr. Madoff, the founder and primary owner of Bernard L. Madoff Investment Securities LLC in New York, was arrested and charged Thursday. Prosecutors allege that the 70year-old Mr. Madoff hid losses, paying certain investors returns using principal he received from other investors. Prosecutors and regulators have yet to determine how much has been lost, or the amount in assets still held by Mr. Madoff's business. The alleged fraud has "swept up some of the most prominent and wealthy Americans, along with many people who thought they were embarking on a comfortable retirement and have now been left destitute," says Brad Friedman, a lawyer at Milberg LLP, which with Seeger Weiss LLP represents more than 30 investors with losses they believe could total more than $1 billion. In criminal and civil complaints, Mr. Madoff is quoted as saying the losses could amount to $50 billion. "This is a real tragedy," Mr. Madoff's attorney, Ike Sorkin, said Friday. "We're going to fight through these events and do what we can to minimize the loss." Splash News Bernard Madoff leaving court after his arrest late Thursday.

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Details emerged Friday of how Mr. Madoff ran the alleged scam, fostering a veneer of exclusivity and creating an A-list of investors that became his most powerful marketing tool. From New York and Florida to Minnesota and Texas, the money manager became an insider's choice among well-heeled investors seeking steady returns. By hiring unofficial agents, tapping into elite country clubs and creating "invitation only" policies for investors, he recruited a steady stream of new clients. During golf-course and cocktail-party banter, Mr. Madoff's name frequently surfaced as a money manager who could consistently deliver high returns. Older, Jewish investors called Mr. Madoff " 'the Jewish bond,' " says Ken Phillips, head of a Boulder, Colo., investment firm. "It paid 8% to 12%, every year, no matter what." As his reputation grew, Mr. Madoff gained the trust of prominent businessmen, including ex-Eagles owner Mr. Braman, who owns a chain of Florida auto dealers. A voicemail message left with Mr. Braman's office was not immediately returned. Mets owner Mr. Wilpon, who also owns real-estate investor Sterling Equities, often raved about Mr. Madoff's investment prowess and invested tens of millions of dollars of both his own money and the team's with his company, say financiers who have worked with him. Mr. Madoff handled investments for the Judy & Fred Wilpon Family Foundation, which distributed about $1 million a year in 2005 and 2006 to charities, according to its most recent federal tax returns.. Associated Press People flocked to the lobby of Mr. Madoff's office building Friday.

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Mets spokesman Jay Horowitz declined to comment Friday. Mr. Wilpon's Sterling Equities said in a statement: "We are shocked by recent events and, like all investors, will continue to monitor the situation." Mr. Merkin, the chairman of former General Motors Corp. financing arm GMAC, is also a money manager at Ascot Partners LLC in New York. Ascot, which had $1.8 billion under management as of Sept. 30, had substantially all of its assets invested with Mr. Madoff, according to a letter to Mr. Merkin sent to clients Thursday night. Mr. Merkin said as one of the largest investors in Ascot, he believed he had personally "suffered major losses from this catastrophe." Mr. Merkin could not be reached for comment. Mr. Madoff tapped social networks in Dallas, Chicago, Boston and Minneapolis. In Minnesota, he attracted investors from Hillcrest Golf Club of St. Paul and Oak Ridge Country Club in Hopkins, investors say. One of them estimated that investors from the two clubs may have invested more than $100 million combined. One of the largest clusters of Madoff investors was in Florida, where losses could be substantial. Mr. Madoff relied on a network of friends, family and business colleagues to attract investors. According to investors and agents, some of these agents were paid commissions for harvesting investors. Others had separate, lucrative business relationships with Mr. Madoff. "If you were eating lunch at the club or golfing, everyone was always talking about how Madoff was making them all this money," one investor says. "Everyone wanted to sign up." Jeff Fischer, a top divorce attorney in Palm Beach, says many of his clients were also Mr. Madoff's clients. "Every big divorce that came through my office had portfolio positions with Madoff," he says. Two of his investors said that among his clients, Mr. Madoff was considered a moneymanagement legend; they would joke that if Mr. Madoff was a fraud, he'd take down half the world with him. Richard Spring, a Boca Raton resident and former securities analyst, says he had about $11 million -- or 95% of his net worth -- invested with Mr. Madoff. "That's how much I believed in him," Mr. Spring said. Another large-scale scandal rocks Wall Street as Bernard Madoff, a Wall Street titan and investment advisor was arrested for an alleged $50 billion dollar fraud against investors, WSJ's Kelsey Hubbard and Amir Efrati discuss. Mr. Spring said he was also one of the unofficial agents who connected Mr. Madoff with dozens of investors, from a teacher who put in $50,000 to entrepreneurs and executives who would put in millions. Mr. Spring said Mr. Madoff didn't want people to put in large amounts right away. "Bernie would tell me, 'Let them start small, and if they're happy the first year or two, they can put it more.' " Mr. Spring says he never was paid a commission, but he received fees from a small investment-research firm that counted Mr. Madoff as a client; he declined to say how much he received. He said investors would always come to him asking to invest with Mr. Madoff. "I never solicited anyone," he says. Mr. Spring says he never detected signs of impropriety with Mr. Madoff's investing, but he concedes that he may receive some blame from some investors. "I can understand

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where people who lost money are looking for a scapegoat," he says. "I'm heartbroken that so many people have been hurt so badly." Mr. Madoff's main go-between in Palm Beach was Robert Jaffe, say several investors. Mr. Jaffe is the son-in-law of Carl Shapiro, the founder and former chairman of apparel company Kay Windsor Inc. and an early investor and close friend of Mr. Madoff's. Mr. Jaffe, a philanthropist in Palm Beach, attracted many investors from the Palm Beach Country Club in Palm Beach, Fla. A spokeswoman for Mr. Jaffe's family said several family members were investors with Mr. Madoff and were "significantly adversely impacted" by recent events. There are no indications that Mr. Jaffe or Mr. Spring are implicated in the alleged fraud. Mr. Jaffe didn't return messages yesterday. Other investors stand to lose through their investments with the likes of Fairfield Greenwich Group and Tremont Capital Management, funds of hedge funds that invested their cash with Mr. Madoff. "Needless to say, our level of anger and dismay over the apparent betrayal by Mr. Madoff and his organization of his 14-year relationship with Tremont is immeasurable," Tremont told clients in a letter Friday. Fairfield Greenwich said in a statement late Friday that it is trying to assess the extent of potential losses. The firm said that on Nov. 1, it had $7.5 billion in investments connected to Mr. Madoff's firm, slightly more than half of its total assets. Founding partner Jeffrey Tucker said the firm had no indication of any potential wrongdoing. "We are shocked an appalled by this news," he said. Ms. Manzke, 60, of Maxam Capital Management, said she met Mr. Madoff through investors in the mid-1980s and introduced him to Tremont, where she was then chief executive. That introduction led to Tremont's decision to market Mr. Madoff as a money manager to its own investors, she adds. In November, she says, Maxam asked to pull $30 million from Mr. Madoff, and he returned the money. "He was a low-key guy," Ms. Manzke says. "He would say, 'Look, I'm a market-maker, and I don't want anyone to know I'm running money.' It was always for select people. He was always closed, he wasn't taking new money." Several European investors were also apparent victims. Bramdean Alternatives in the U.K. said it had more than 9% of its portfolio invested in Madoff funds. Geneva-based Banque Benedict Hentsch, a white-glove private bank, said it is exposed for $47.5 million. BNP Paribas's exposure, the extent of which is not clear, may stem from BNP's lending relationship with a fund of funds that was a big Madoff client, said people familiar with the matter. A BNP spokeswoman declined to comment. Nomura and Neue Privat Bank, meanwhile, together marketed access to Fairfield Sentry Ltd., a fund overseen by Mr. Madoff and sold through Fairfield Greenwich. The shares offered by Neue Privat and Nomura were leveraged three times -- meaning $3 of borrowed money was added to every $1 of capital invested in order to magnify returns, greatly increasing the potential losses for those investors. A Nomura spokesman declined to comment. A message left with Neue Privat was not returned.

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The federal complaints against Mr. Madoff allege his fraudulent activities came through a secretive private wealth-management wing of Bernard L. Madoff Investment Securities, the investment firm he founded in 1960. On Wall Street, his company was perhaps better known for its operations in market-making -- the business of serving as a middleman between buyers and sellers -- and proprietary trading. Through those higher-profile parts of his operation, Mr. Madoff was a pioneer in trading New York Stock Exchange shares away from the exchange. He is a past chairman of the board of directors of the Nasdaq Stock Market as well as a member of the board of governors of the National Association of Securities Dealers and a member of numerous committees of the organization, according to his firm's Web site. Mr. Madoff owns a home in Roslyn, N.Y., records show, and an elaborate beachfront home and grounds in Montauk on Long Island. Mr. Madoff and his wife live in an apartment building on Manhattan's Upper East Side where property records list individual apartments valued at more than $5 million. One property database estimated the 2008 market value of Mr. Madoff's two-floor unit to be roughly $9 million. For years he has served as president of the building's co-op board, according to a tenant. Tenants say he appeared down-to-earth, friendly and always greeted everyone by their first name. Colleagues of Mr. Madoff said he was fair to those he dealt with and generous to charities including the Special Olympics. Mr. Madoff treated employees well and loved to take friends and colleagues on his 55-foot fishing boat, called Bull, said Frank Christensen, a retired New York Stock Exchange broker. "I really think very highly of him," said Mr. Christensen. "People make mistakes." —Matthew Futterman, Jenny Strasburg, David Enrich, and Craig Karmin contributed to this article. Write to Robert Frank at [email protected], Peter Lattman at [email protected], Dionne Searcey at [email protected] and Aaron Lucchetti at [email protected]

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DECEMBER 13, 2008

Fees, Even Returns and Auditor All Raised Flags By GREGORY ZUCKERMAN Bernard L. Madoff is alleged to have pulled off one of the biggest frauds in Wall Street history. But there were multiple red flags along the way, including a series of accusations leveled against Mr. Madoff's operation. Now some are asking why regulators and investors didn't pick up on the alleged scheme long ago.

Bernard Madoff "There's no smoking gun, but if you added it all up you wonder why people either did not get it or chose to ignore the red flags," says Jim Vos, who runs Aksia LLC, a firm that advises investors and came away worried after examining Mr. Madoff's operation. On Thursday, Mr. Madoff was arrested for what federal agents described as a massive Ponzi scheme, which could leave investors with billions in losses. A spokesman for Mr. Madoff said: "Bernie Madoff is a longstanding leader in the financial services industry and we are cooperating fully with the government and regulators investigations into this unfortunate set of events." The first tip-off for some was the steady returns generated by the firm in every kind of market. Mr. Madoff would buy a basket of stocks resembling an S&P index while simultaneously selling options that pay off for the buyer if these stocks soar, while also buying options that pay off if the index tumbles. The supposed goal was to have smooth, steady returns. Harry Markopolos, who years ago worked for a rival firm, researched Mr. Madoff's stockoptions strategy and was convinced the results likely weren't real. "Madoff Securities is the world's largest Ponzi Scheme," Mr. Markopolos, wrote in a letter to the U.S. Securities and Exchange Commission in 1999. •

Mr. Markopolos pursued his accusations over the past nine years, dealing with both the New York and Boston bureaus of the SEC, according to documents he sent to the SEC reviewed by The Wall Street Journal.

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In a statement late Friday, the SEC said "staff from the Division of Enforcement in New York completed an investigation in 2007, and did not refer the matter to the Commission for enforcement action." The SEC said it reopened the investigation Thursday. It's not clear what the focus of the 2007 investigation was, or why it was closed. A person familiar with the matter said it related to issues raised by Mr. Markopolos. Also striking some as odd: Mr. Madoff operated as a broker dealer with an asset management division. Why not simply act as a hedge fund and pocket big gains, rather than profit from trading commissions as the firm seemed to be doing, they asked. Joe Aaron, for long a hedge fund professional, found that structure suspicious and in 2003 warned a colleague to steer clear of the fund. "Why would a good businessman work his magic for pennies on the dollar?" Conflicts of interest also proved a concern. "There was no independent custodian involved who could prove the existence of assets," says Chris Addy, founder of Montreal-based Castle Hall Alternatives, which vets hedge funds for clients seeking to invest money. "There's a clear and blatant conflict of interest with a manager using a related-party broker-dealer. Madoff is enormously unusual in that this is not a structure I've seen." Some trading pros said Mr. Madoff's purported strategy couldn't be pulled off profitably while managing tens of billions of dollars. "It seemed implausible that the S&P 100 options market that Madoff purported to trade could handle the size of the combined feeder funds' assets which we estimated to be $13 billion," Mr. Vos says. Recent securities filings showed that the firm held less than $1 billion of shares, raising questions about where the rest of the money was. Some of Mr. Madoff's investors say they were told the firm put the bulk of its money in cash-equivalents at the end of each quarter, explaining why the public filings showed so few shares, but raising questions about where the proof was for all the cash. Another large-scale scandal rocks Wall Street as Bernard Madoff, a Wall Street titan and investment advisor was arrested for an alleged $50 billion dollar fraud against investors, WSJ's Kelsey Hubbard and Amir Efrati discuss. Until at least November, 2006, the firm, which claimed to manage billions of dollars and be among the largest market makers in the stock market, used as its auditor Friehling & Horowitz, a small New City, New York firm. Mr. Vos says his firm hired a private investigator and determined that the accounting firm had only three employees, one of whom was 78 and lived in Florida, and another was a secretary, and that it operated in a 13 foot by 18 foot office. His firm felt that was too small an operation to keep an eye on such a large firm operating a complicated trading strategy. A message left for the accounting firm was not returned. Meanwhile, a series of media stories also raised questions about Madoff's operations, including a piece entitled "Madoff Tops Charts; Skeptics Ask How" in industry publication MAR/Hedge in May, 2001, and a subsequent story in Barron's. Mr. Madoff generally brushed off reporters' questions, citing the audited results and arguing that his business was too complicated for outsiders to understand.

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Business December 13, 2008

Questions Are Raised in Trader’s Massive Fraud By ALEX BERENSON and DIANA B. HENRIQUES For years, investors, rivals and regulators all wondered how Bernard L. Madoff worked his magic. But on Friday, less than 24 hours after this prominent Wall Street figure was arrested on charges connected with what authorities portrayed as the biggest Ponzi scheme in financial history, hard questions began to be raised about whether Mr. Madoff acted alone and why his suspected con game was not uncovered sooner. As investors from Palm Beach to New York to London counted their losses on Friday in what Mr. Madoff himself described as a $50 billion fraud, federal authorities took control of what remained of his firm and began to pore over its books. But some investors said they had questioned Mr. Madoff’s supposed investment prowess years ago, pointing to his unnaturally steady returns, his vague investment strategy and the obscure accounting firm that audited his books. Despite these and other red flags, hedge fund companies kept promoting Mr. Madoff’s funds to other funds and individuals. More recently, banks like Nomura, the Japanese firm, began soliciting investors for Mr. Madoff internationally. The Securities and Exchange Commission, which investigated Mr. Madoff in 1992 but cleared him of wrongdoing, appears to have been completely surprised by the charges of fraud. Now thousands, possibly tens of thousands, of investors confront losses that range from serious to devastating. Some families said on Friday that they believed they had lost all their savings. A charity in Massachusetts said it had lost essentially its entire endowment and would have to close. According to an affidavit sworn out by federal agents, Mr. Madoff himself said the fraud had totaled approximately $50 billion, a figure that would dwarf any previous financial fraud. At first, the figure seemed impossibly large. But as the reports of losses mounted on Friday, the $50 billion figure looked increasingly plausible. One hedge fund advisory firm alone, Fairfield Greenwich Group, said on Friday that its clients had invested $7.5 billion with Mr. Madoff. The collapse of Mr. Madoff’s firm is yet another blow in a devastating year for Wall Street and investors. While Mr. Madoff’s firm was not a hedge fund, the scope of the fraud is likely to increase pressure on hedge funds to accept greater regulation and transparency and protect their investors. On Thursday, the Federal Bureau of Investigation and S.E.C. said that Mr. Madoff’s firm, Bernard L. Madoff Investment Securities, ran a giant Ponzi scheme, a type of fraud in

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which earlier investors are paid off with money raised from later victims — until no money can be raised and the scheme collapses. Most Ponzi schemes collapse relatively quickly, but there is fragmentary evidence that Mr. Madoff’s scheme may have lasted for years or even decades. A Boston whistle-blower has claimed that he tried to alert the S.E.C. to the scheme as early as 1999, and the weekly newspaper Barron’s raised questions about Mr. Madoff’s returns and strategy in 2001, although it did not accuse him of wrongdoing. Investors may have been duped because Mr. Madoff sent detailed brokerage statements to investors whose money he managed, sometimes reporting hundreds of individual stock trades per month. Investors who asked for their money back could have it returned within days. And while typical Ponzi schemes promise very high returns, Mr. Madoff’s promised returns were relatively realistic — about 10 percent a year — though they were unrealistically steady. Mr. Madoff was not running an actual hedge fund, but instead managing accounts for investors inside his own securities firm. The difference, though seemingly minor, is crucial. Hedge funds typically hold their portfolios at banks and brokerage firms like JPMorgan Chase and Goldman Sachs. Outside auditors can check with those banks and brokerage firms to make sure the funds exist. But because he had his own securities firm, Mr. Madoff kept custody over his clients’ accounts and processed all their stock trades himself. His only check appears to have been Friehling & Horowitz, a tiny auditing firm based in New City, N.Y. Wealthy individuals and other money managers entrusted billions of dollars to funds that in turn invested in his firm, based on his reputation and reported returns. Victims of the scam included gray-haired grandmothers in Florida, investment companies in London, and charities and universities across the United States. The Wilpon family, the main owners of the New York Mets, and Yeshiva University both confirmed that they had invested with Mr. Madoff, and a Jewish charity in Massachusetts said it would lay off its five employees and close after losing nearly all of its $7 million endowment. Other investors included prominent Jewish families in New York and Florida. On Friday afternoon, investors and lawyers for investors with Mr. Madoff packed Judge Louis L. Stanton’s courtroom at federal court in Manhattan, hoping to question lawyers for Mr. Madoff and the S.E.C. But a deputy for Judge Stanton canceled the hearing, leaving investors with few answers. Several investors said they were planning to file lawsuits against the firm in the hope of recovering some money. Based on the vagueness of the complaints against Mr. Madoff, his confession, as detailed in court filings, seems to have taken the F.B.I. and S.E.C. by surprise. Investigators have not explained when they believe the fraud began, how much money was ultimately lost and whether Mr. Madoff lost investors’ money in the markets, spent it, or both. It is not even clear whether Mr. Madoff actually made any of the trades he reported to investors. The F.B.I. and S.E.C. have also not said whether they believe Mr. Madoff acted alone. According to the authorities, Mr. Madoff told F.B.I. agents that the scheme was his alone. He worked closely with his brother, sons and other family members, many of whom have retained lawyers. Also likely to face very difficult questions are the hedge funds, investment advisers and banks that raised money for Mr. Madoff. At least some big investment advisers steered clients away from putting money with Mr. Madoff, believing the returns could not be real.

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Robert Rosenkranz, principal of Acorn Partners, which helps wealthy clients choose money managers, said the steadiness of the returns that Mr. Madoff reported did not make sense, and the size of his auditor raised further concerns. “Our due diligence, which got into both account statements of his customers, and the audited statements of Madoff Securities, which he filed with the S.E.C., made it seem highly likely that the account statements themselves were just pieces of paper that were generated in connection with some sort of fraudulent activity,” Mr. Rosenkranz said. Simon Fludgate, head of operational due diligence for Aksia, another advisory firm that told clients not to invest with Mr. Madoff, said the secrecy of his strategy also raised red flags. And Mr. Madoff’s stock holdings, which he disclosed each quarter with the Securities and Exchange Commission, appeared to be too small to support the size of the fund he claimed. Mr. Madoff’s promoters sometimes tried to explain the discrepancy by explaining that he sold all his shares at the end of each quarter and put his holdings in cash. “There were no smoking guns, but too many things that didn’t add up,” Mr. Fludgate said. However, the S.E.C. had already investigated Mr. Madoff and two accountants who raised money for him in 1992, believing they might have found a Ponzi scheme. “We went into this thing just thinking it might be a huge catastrophe,” an S.E.C. official told The Wall Street Journal in December 1992. Instead, Mr. Madoff turned out to have delivered the returns that the investment advisers had promised their clients. It is not clear whether the results of the 1992 inquiry discouraged the S.E.C. from examining Mr. Madoff again, even when new red flags surfaced. Lawyers at the S.E.C. did not return calls. Meanwhile, Fairfield Greenwich Group, whose clients have $7.5 billion invested with the Madoff firm, said it was “shocked and appalled by this news.” “We had no indication that we and many other firms and private investors were the victims of such a highly sophisticated, massive fraudulent scheme.” At the court hearing, an individual investor, who declined to give his name to avoid embarrassment, expressed a similar sentiment. “Nobody knows where their money is and whether it is protected,” the investor said. “The returns were just amazing and we trusted this guy for decades — if you wanted to take money out, you always got your check in a few days. That’s why we were all so stunned.” Zachery Kouwe and Stephanie Strom contributed reporting.

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Business December 13, 2008

For Investors, Trust Lost, and Money Too By DIANA B. HENRIQUES and ALEX BERENSON The zoning lawyer in Miami trusted him because his father had dealt profitably with him for decades. The officers of a little charity in Massachusetts respected him and relied on his advice. Wealthy men like J. Ezra Merkin, the chairman of GMAC; Fred Wilpon, the principal owner of the New York Mets; and Norman Braman, who owned the Philadelphia Eagles, simply appreciated the steady returns he produced, regardless of market conditions. But these clients of Bernard L. Madoff had this in common: They chose him to oversee much of their personal wealth. And now, they fear, they have lost it. While Mr. Madoff is facing federal criminal charges, accused by federal prosecutors of operating a vast $50 billion Ponzi scheme, many of his clients are facing an abrupt reversal of fortune that is the stuff of nightmares. “There are people who were very, very well off a few days ago who are now virtually destitute,” said Brad Friedman, a lawyer with the Milberg firm in Manhattan. “They have nothing left but their apartments or homes — which they are going to have to sell to get money to live on.” From New York to Palm Beach, business associates of Mr. Madoff spent Friday assessing the damage, the extent of which will not be known for some time. Many invested with Mr. Madoff through other funds and may not know that their money is at risk. Emergency meetings were being held at country clubs, schools and charities to assess the potential losses on their investments and to look for options. There is not much guidance available yet from regulators. On Friday, a federal judge appointed a receiver to oversee the Madoff firm’s assets and customer accounts. A Web site is being set up to keep customers informed, but no one is sure yet whether any sort of safety net will catch the most vulnerable investors. For Stephen J. Helfman, a lawyer in Miami whose father had opened an account with Mr. Madoff more than 30 years ago, the news on Thursday came as a hammer blow. “The name ‘Madoff’ has overnight gone from being revered to reviled in the Helfman family,” Mr. Helfman said on Friday. His grandmother, at 98, relied on her Madoff money to pay for round-the-clock care, he said, and his two children’s college funds were wiped out. “Thirty-six years of loyalty, through two generations, and this is what we get,” he said. The news was equally devastating for the Robert I. Lappin Charitable Foundation in Salem, Mass., which works to reverse the dilution of Jewish identity through intermarriage

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and assimilation by sending teenagers to Israel and supporting other Jewish education efforts. The foundation was forced on Friday to dismiss its small staff and shut down its programs to cope with its losses in the Madoff funds, according to Deborah Coltin, its executive director. “We’ve canceled everything as of today, everything,” she said tearfully. Ms. Coltin said she did not know how the little foundation came to be so exposed to the Madoff firm. Its most recent tax filings show that it had $7 million at the end of 2006, with $143,344 in stocks and the rest in “government securities.” It reported the sale that year of “Bernie Madoff” securities, but did not explain what those securities were. Sam Englebardt, a media investor in Los Angeles, said several relatives had entrusted virtually all of their assets to Mr. Madoff — and he understood why. “It seems like a huge over-allocation, I know,” Mr. Englebardt said. “But remember, they had started out small and invested over 5 years, 15 years, 30 years — and every year they got a great return, and they could always take money out without ever having a problem.” As that track record lengthened, his relatives gradually entrusted more of their savings to Mr. Madoff, he said. “I suspect that is what has happened across the board,” he added. “People came to trust him so much that, eventually, they trusted him with everything.” Such stories were repeated in e-mail messages and telephone calls throughout the day on Friday. A woman in Brooklyn whose father died just weeks ago found that his entire estate and a substantial portion of her stepmother’s money was invested with Mr. Madoff. A law school official in Massachusetts fears he has lost millions in the collapse of the Madoff operation. Some wealthy victims, of course, can afford to seek redress on their own. But for them, litigation seems the only certainty. Throughout the rumor-fueled hedge fund world on Friday, money managers were comparing notes and assessing losses. By all accounts, they run broad and deep — in the billions. Mr. Merkin, a prominent philanthropist and the founder of several hedge funds, including one called Ascot Partners, jolted his clients on Thursday with a letter announcing that “substantially all” of that fund’s $1.8 billion in assets were invested with Mr. Madoff. “As one of the largest investors in our fund, I have also suffered major losses from this catastrophe,” Mr. Merkin said in the letter. “We have retained counsel to determine what our next steps should be.” Some of Mr. Merkin’s investors have also “retained counsel.” Harry Susman, a lawyer in the Houston office of Susman Godfrey, said he was talking with several clients about legal options. “These investors were never aware that all of their money was invested with Madoff,” Mr. Susman said. “They are obviously shocked.” Sterling Equities and the Wilpon family acknowledged on Friday that they had money at risk in the Madoff scandal.

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“We are shocked by recent events and, like all investors, will continue to monitor the situation,” said Richard C. Auletta, a spokesman for Sterling and the Wilpons. The Mets organization issued a statement saying that the scandal would not derail its new Citi Field stadium project in Queens or “affect the day-to-day operations and long-term plans of the Mets organization.” A lawyer for Norman Braman of Miami, a wealthy retired retailer and the former owner of the Philadelphia Eagles football team, confirmed that Mr. Braman, too, had money locked up and perhaps lost in the Madoff mess. And Bramdean Alternatives, a London asset manager run by Nicola Horlick, saw its share price plummet nearly 36 percent on Friday after it announced that nearly 10 percent of its holdings were caught in the Madoff scandal. Mr. Madoff has resigned from his positions at Yeshiva University, where he was treasurer for the university’s board and deeply involved in the business school. “Our lawyers and accountants are investigating all aspects of his relationship to Yeshiva University,” said Hedy Shulman, a spokeswoman for the university. The most recent tax filings for the university show that its endowment fund, a separate charity, was heavily invested in hedge funds and other nontraditional alternatives at the end of its fiscal year in 2006. The school paper, the Yeshiva Commentator, recently reported that its endowment’s value had dropped to $1.4 billion from $1.8 billion — before the scandal broke. Reporting was contributed by Stephanie Strom, Julie Creswell, Eric Konigsberg, Zachery Kouwe and Charles Bagli.

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Business December 13, 2008

Hedge Funds Are Victims, Raising Further Questions By MICHAEL J. de la MERCED Frauds on Wall Street aren’t unheard of. But a $50 billion Ponzi scheme, one that prosecutors say struck at boldface names on several continents, is a bombshell by any standard. The case against Bernard L. Madoff, the respected longtime trader accused of running one of the biggest frauds in Wall Street history, has been Topic A in the investor community. But close behind is a heated discussion of how the sordid drama will affect the alreadybattered community of hedge funds and other investment firms — many of which invested with Mr. Madoff. Mr. Madoff’s case could hardly have come at a worse time for hedge funds. The whipsawing markets and suddenly unfriendly lenders have already taken their toll on high financiers, and many have already suffered what amounts to runs on the bank by investors clamoring to withdraw their investments. “It can’t help but have the effect of further chipping away at the confidence that the investor community has in the hedge fund industry,” said Ralph L. Schlosstein, the chief executive of Highview Investment Group, a money management firm and a former president of BlackRock. “But like many things that come at moments of fragility, its impact is magnified.” The collapse of Mr. Madoff’s firm took the vast majority of investors by surprise. Mr. Madoff, once the largest market maker on the Nasdaq stock market, was known for his modest demeanor and, perhaps more important, his steady and overwhelmingly positive returns. That in turn appears to have attracted scores of investors, from Palm Beach country clubs to Manhattan social circles. It is difficult to map out the swath of damage that the Madoff firm’s collapse is likely to cut through the hedge fund industry, not to mention a wide range of other investors. But among its biggest investors were funds of funds, firms that invest in several hedge funds and are nominally among the most sophisticated judges of character in the industry. Because Mr. Madoff reported consistently positive returns for more than a decade — some say impossibly so — he drew vast amounts of business from them. Now, the collateral damage is likely to add to the chaos that has already been ravaging hedge funds. Spooked by losses and forced to raise cash quickly as the financial crisis ballooned, investors have sought to pull out their money from hedge funds, causing serious pain, and even some forced closures. A growing list of large, well-known firms have sought to block redemption requests in an effort to stem a mass exodus of investors who now desperately want to get into cash. In a letter sent Friday, the Citadel Investment Group said it was halting redemptions at its two largest hedge funds through March 31.

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Confidence will only weaken further with the Madoff firm scandal, intensifying pain for the industry. “If you couple this with the deleveraging already, this means one thing: more redemptions,” said Campbell R. Harvey, a professor at the Fuqua School of Business at Duke University. The losses from the Madoff firm will also raise more questions about how well funds of funds perform due diligence, a concern already magnified by losses in the hedge fund industry. “Funds of funds that invested in Madoff will get a double whammy,” said Whitney Tilson, who runs the T2 Partners hedge fund. “Not only will they have to take a loss, but they are going to have to do an awful lot of explaining for how they ever got fooled here.” Indeed, while many investors are asking how regulators could have missed a towering Ponzi scheme, some are beginning to question the whole process of due diligence. Several potential investors had raised questions about Mr. Madoff’s claims of steady returns over the years, but regulators apparently took few steps to investigate. “Where were the auditors?” asked Bill Grayson, the president of Falcon Point Capital, a hedge fund based in San Francisco. “Where was his chief compliance officer? Where was the S.E.C.?” Already under heightened scrutiny, the collapse of the Madoff firm is likely to propel calls for greater regulation of the hedge fund industry, beyond the current optional registration with the Securities and Exchange Commission. What’s more, many investors in hedge funds are likely to ask tougher questions of the managers of these firms. Executives who are loath to disclose their investment strategies — instead running a “black box” model, as Mr. Madoff infamously did — will probably come under increased pressure to open the lid on their operations, at least a little bit. “I suspect that many investors are going to start asking many more questions of their managers,” Mr. Tilson said. “They will be much less tolerant of black box managers.” Still, some disagree that Mr. Madoff’s arrest will lead to widespread contagion throughout the industry. Mr. Tilson argued that most investors would see the case as an unusual circumstance whose breadth and brazenness is unlikely to be duplicated. “This is not a Lehman Brothers,” he said.

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Citadel Halts Withdrawals From Two Hedge Funds After 50% Drop By Saijel Kishan and Katherine Burton: Last Updated: December 13, 2008 00:01 EST Dec. 13 (Bloomberg) -- Citadel Investment Group LLC, enduring its biggest losses since starting in 1990, halted year- end withdrawals from its two biggest funds after investors sought to take out $1.2 billion, or 12 percent of assets. Withdrawals may resume as early as March 31 for the Kensington and Wellington funds, the Chicago-based firm said in a letter yesterday to clients. The funds, which together manage about $10 billion, have lost 49.5 percent of their value this year through Dec. 5. “We have not made this decision lightly,” Citadel founder Kenneth Griffin, 40, wrote. “We recognize how a suspension impacts our investors, especially those with current financial obligations of their own to meet.” Firms including Fortress Investment Group LLC and Tudor Investment Corp. also have limited redemptions to avoid dumping securities to raise cash. As of October, 18 percent of the industry’s assets, or about $300 billion, were subject to withdrawal restrictions, according to Peter Douglas, principal of Singapore-based hedge-fund consulting firm GFIA Pte. The limits have been imposed by about 5 percent of managers. Hedge funds declined 18 percent on average through Nov. 30, according to data compiled by Chicago-based Hedge Fund Research Inc. That’s the most in a year since the firm began tracking the data in 1990. Citadel has among the strictest redemption rules. It normally allows clients to take out up to 1/16th of their money quarterly. If redemptions in any quarter exceed 3 percent of fund assets, investors incur a fee ranging from 5 percent to 9 percent. Withdrawals have never before surpassed the limit. Easing Expenses The firm will also absorb “a substantial portion” of the funds’ expenses this year, the letter said. Citadel clients usually pay these charges, which have traditionally amounted to about 3 percent to 4 percent of assets. The fund is holding between 25 percent and 30 percent of its assets in cash. Katie Spring, a spokeswoman for Citadel, declined to comment. Before 2008, Citadel had posted just one losing year, dropping 4 percent in 1994. Three Citadel funds, whose returns are tied to the firm’s market-making business, have climbed about 40 percent this year. Those funds manage about $3 billion. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested. To contact the reporters on this story: Katherine Burton in New York at [email protected]; Saijel Kishan in New York at [email protected]

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Madoff Told Sons of $50 Billion Fraud Before Telling FBI Agents By David Voreacos and David Glovin Dec. 13 (Bloomberg) -- Bernard Madoff, before two FBI agents showed up at his Manhattan apartment this week, confessed to two sons that his investment advisory business was “a giant Ponzi scheme” that cost clients $50 billion. “We’re here to find out if there’s an innocent explanation,” Agent Theodore Cacioppi told Madoff, who founded Bernard L. Madoff Investment Securities LLC and was once chairman of the Nasdaq Stock Market. “There is no innocent explanation,” Madoff, 70, told the agents, saying he traded and lost money for institutional clients. He said he “paid investors with money that wasn’t there” and expected to go to jail. With that, agents arrested Madoff, according to an FBI complaint that provided a timeline. The 8:30 a.m. arrest on Dec. 11 capped the downfall of Madoff and businesses bearing his name that specialized in trading securities, making markets, and advising wealthy clients. Many questions remain unanswered in this family drama, including whether his customers lost $50 billion. The complaint and a civil lawsuit by regulators describe a man spinning out of control. Madoff’s sons, Andrew and Mark, turned him in to U.S. authorities on the night of Dec. 10 after his confession, according to Martin Flumbenbaum, an attorney for the brothers. “Mark and Andrew Madoff are not involved in the firm’s asset management business, and neither had any knowledge of the fraud before their father informed them of it on Wednesday,” according to a statement by Flumenbaum of Paul, Weiss, Rifkind, Wharton & Garrison in New York. Brothers Mark Madoff, 42, ran the proprietary trading business and Andrew Madoff, 40, is a director of that unit, according to a person familiar with the matter. Their father is free on a $10 million bond after appearing on Dec. 11 in federal court in Manhattan, wearing a white- striped shirt and dark-colored pants. Madoff’s firm had about $17.1 billion in assets under management as of Nov. 17, according to NASD records. At least half of its clients were hedge funds, and others included banks and wealthy individuals, according to the records. The firm was the 23rdlargest market maker on Nasdaq in October, handling an average of about 50 million shares a day, exchange data show. The biggest loser may be Walter Noel’s Fairfield Greenwich Group, whose $7.3 billion Fairfield Sentry Ltd. invested with Madoff’s firm, three people familiar with the matter said. Another was Kingate Management Ltd., whose $2.8 billion Kingate Global Fund Ltd. invested with Madoff, they said. Dozen Inspectors

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Prosecutors joined the Securities and Exchange Commission, which filed a civil lawsuit, in unraveling the collapse of Madoff’s investment advisory firm. More than a dozen SEC inspectors assembled the day of his arrest at the company, housed in a lipstick-shaped building at 885 Third Ave. A U.S. judge appointed a receiver to oversee the business. A series of events in early December preceded the firm’s demise, according to the arrest complaint and SEC lawsuit. The arrest complaint discusses Senior Employee Nos. 1 and 2, which refers to Madoff’s sons, said a person familiar with the matter. In the first week of December, Madoff told Senior Employee No. 2 that clients had requested $7 billion in redemptions, he was struggling to find liquidity, and he thought he could do so, according to the FBI and SEC. Senior employees “previously understood” that the investment advisory business managed from $8 billion to $15 billion in assets, according to the documents. ‘Under Great Stress’ On Dec. 9, Madoff told a Senior Employee No. 1 that he wanted to pay bonuses in December, or two months earlier than usual. The next day, Madoff got a visit at his offices from the employees. They said he appeared “under great stress” in prior weeks, according to the documents. Madoff told the visitors that “he had recently made profits through business operations, and that now was a good time to distribute it,” according to the FBI complaint. When the workers challenged that explanation, Madoff said he “wasn’t sure he would be able to hold it together” at the office and preferred to meet at his apartment, Senior Employee No. 2 told investigators. He ran his investment advisory business from a separate floor of his firm’s offices, keeping financial statements “under lock and key,” prosecutors said. At his apartment, Madoff told the employees that his investment advisory business was a “fraud” and he was “finished,” according to the FBI complaint. ‘One Big Lie’ He said he had “absolutely nothing,” that “it’s all just one big lie,” and that it was “basically, a giant Ponzi scheme,” Agent Cacioppi wrote in the complaint. The senior employees understood Madoff to be saying he had paid investors for years out of principal from other investors, the agent wrote. The business had been insolvent for years, said Madoff, who then estimated losses at more than $50 billion. Madoff said he had $200 million to $300 million left, and he planned to pay employees, family, and friends. Madoff, who had also confessed to a third senior employee, said he planned to surrender to authorities within a week, according to the complaint. Cacioppi and another agent beat Madoff to the punch. After saying he had no “innocent explanation,” Madoff confessed “it was all his fault,” Cacioppi wrote. “Madoff also said that he was ‘broke’ and ‘insolvent’ and that he had decided that ‘it could not go on,’ and that he expected to go to jail,” the agent wrote. “Madoff also stated that he had recently admitted what he had done to Senior Employee Nos. 1, 2, and 3.” Firm’s Founder

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Madoff founded the firm in 1960 after leaving law school, according to the company’s Web site. His brother, Peter, joined the firm in 1970 after graduating from law school, it said. Bernard Madoff was influential with the Nasdaq Stock Market, serving as chairman of the board of directors in 1990, 1991 and 1993, according to a Nasdaq spokeswoman. He was chief of the Securities Industry Association’s trading committee in the 1990s and earlier this decade. He represented brokerages in talks with regulators about new stockmarket rules as electronic-trading systems and networks grew. Madoff won an assignment to manage a $450,000 stock offering for A.L.S. Steel Corp. of Corona, New York, two years later, according to an SEC news digest. He was an early advocate for electronic trading, joining roundtable discussions with SEC regulators considering trading stocks in penny increments. His firm was among the first to make markets in New York Stock Exchange listed stocks outside of the Big Board, relying instead on Nasdaq. Madoff resigned yesterday as a trustee of Yeshiva University, North America’s oldest Jewish educational institution. His firm’s Web site touts its “high ethical standards.” “In an era of faceless organizations owned by other equally faceless organizations, Bernard L. Madoff Investment Securities LLC harks back to an earlier era in the financial world: The owner’s name is on the door. Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm’s hallmark.” The case is U.S. v. Madoff, 08-MAG-02735, U.S. District Court for the Southern District of New York (Manhattan). To contact the reporter on this story: David Voreacos in New York at [email protected] and David Glovin in U.S. District Court in New York at [email protected]. Last Updated: December 13, 2008 00:01 EST

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Your Money December 13, 2008 YOUR MONEY

Be Smart, but Don’t Think That You’re Special By RON LIEBER and TARA SIEGEL BERNARD When wealthy investors are willing to hand over a sizable sum to a single money manager they heard about at the country club, certain first principles of investing bear repeating. That manager, Bernard L. Madoff, is accused by the Securities and Exchange Commission of running a fraud scheme that may be the biggest in Wall Street history. But if it ends up in the record books, it will be because scores of people made outsize bets on his prowess without taking the time to fully understand what they were investing in. All investors, but especially those with a high net worth, need to maintain a healthy sense of humility about their level of ignorance. Alternative investments, whether they are hedge funds or venture capital or private equity, can be complicated. They contain unpredictable levels of risk. But all too often, people are willing to overlook those risks because, well, everyone else is doing it. Or they simply place too much trust in too few hands. Thankfully, outright fraud is pretty rare. It is not every day that a Wall Street legend like Mr. Madoff is arrested and accused of running a multibillion-dollar Ponzi scheme. And by the time something like that happens, it is too late for investors with their life savings caught in the mess to escape the impact. But there are plenty of strategies you can employ to lessen that impact or, better yet, avoid getting ensnared in this kind of situation in the first place. Here are a few: 5 PERCENT Any investment has at least a remote possibility of going to zero or close to it. But when you are dealing with hedge funds and other exotic fare, the risks can be bigger, for reasons like leverage and strategy or lying and stealing. That means that you should never put more money in than you can afford to lose. Say, 5 percent of your net worth, or better yet, 5 percent of your liquid net worth. Losing that will hurt, but it will not maim. “We have always gone with 5 percent or less because if it is a total wipeout, someone can still sustain themselves with 95 percent of their capital intact,” said Ian Weinberg, president of Family Wealth and Pension Management in Woodbury, N.Y. HUMILITY Investing, in general, requires humility. Few people have enough of it. It is the reason so few people put most of their money in index funds, which track various asset classes rather than trying to pick the winners in each. One problem with hedge funds is that they appeal to all the wrong instincts. They are for the privileged. Investors need to have a minimum net worth to qualify. In the case of the

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money managed by Mr. Madoff, many people seemed to have gotten in on it by belonging to the right country club. “He was dealing with extremely wealthy individuals,” said Harold Evensky, president of Evensky & Katz, a financial planning firm in Coral Gables, Fla. “All too often, they make relatively easy marks because the pitch is, ‘You’re special, you can get something that other people can’t get.’ ” But you are probably not special. Bill Gates is special, and he is the beneficiary of the best investment opportunities from the smartest people in the business. The Ford Foundation is special. The people who run Harvard and Stanford and Yale’s endowments are special. You, however, are probably hearing about the second- or third- or fourth-tier ideas in the world of alternative investments. That does not mean the managers pitching them cannot make them work. But be honest with yourself: if you are in on them, how special could they really be, given the enormous demand for truly unique investment opportunities? SMARTS You may be rich and you may be smart. But smart about this sort of investing? Not so much. “I think a lot of millionaires, maybe they inherited a couple of million or they didn’t earn their money through any investment savvy,” said Milo M. Benningfield, a San Francisco financial planner. “A lot of those people have money and are extremely vulnerable, in part because they’re supposed to be smart because they have money. It’s a paradox.” There is no shame in not understanding Mr. Madoff’s split strike conversion strategy. Admit your ignorance, question your investment adviser’s certainty and seek a plain English explanation of the opportunity that is in front of you. RESEARCH Doing your homework on a sophisticated investment opportunity is not always easy. Your financial planner or wealth manager may not have the time or the skills to do a thorough investigation, either. On Thursday, a hedge fund research and advisory firm called Aksia L.L.C., sent a letter to clients reminding them of all of the red flags it had uncovered about Mr. Madoff’s operation long before his arrest. Aksia was not the only entity to sound the alarm, and its note has a bit of a chest-beating, self-congratulatory vibe to it. Still, it is a great read. (It is linked to the version of this article at nytimes.com/yourmoney.) And it is a reminder that having some sort of expert on your team, or your investment firm’s team, is a pretty good idea. If you are game, you may even accompany your designated experts as they visit the entity that is promoting the opportunity. “We encourage them to join us,” said Simon Fludgate, the head of operational due diligence at Aksia. “We were told explicitly that you cannot go to see Madoff.” The barring of such field trips was one of many bad signs. SECRETS One hard part about investing in hedge funds is that some of the most successful ones will not say much about how they work. If they disclose too much about their tactics, others will copy them and their investors will be hurt. (So will the managers’ take-home pay.) Not all of them behave this way, though. “Most of them are willing to be very open with us,” said Thomas Ruggie, a certified financial planner in Tavares, Fla. “If they are not willing to be fairly open, that typically causes us to shy away from moving forward with that company. We have two hedge funds that send us quarterly audited reports on everything they’ve done.”

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While Mr. Madoff’s supposed returns were fully available to all, investment advisers were less successful in understanding how he did what he did. “I knew that their returns were always good, but I knew that nobody could explain how they made their money,” said Mr. Weinberg. “In our attempts to look under the hood, it was impossible to ascertain what they were doing.” That kind of secrecy may soon prove to be less of an issue, though. Given the billions of dollars that may have disappeared under Mr. Madoff’s watch, regulators are likely to take an interest in what went on behind the scenes — and make it easier for investors to find out for themselves in the future.

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La gestora de 'hedge funds' del Santander, entre las víctimas del fraude masivo S. P. - Nueva York - 13/12/2008 Un club secreto. Así es como manejaba Bernard Madoff lo que se suponía era un lucrativo fondo de inversión. Algunos de sus clientes, sin embargo, empezaban a sospechar que algo no iba del todo bien. Ayer se materializaron sus temores. Entre los afectados por este masivo fraude que vuelve a hacer temblar los pilares de Wall Street hay inversores españoles. Madoff era una firma popular entre las gestoras de fondos especulativos o hedge funds, y fuentes financieras indican que varios de los productos de este tipo que se comercializan en España pueden tener inversiones en la entidad. La cadena de televisión estadounidense citó ayer como una de las víctimas a Optimal, la gestora de hedge funds o fondos especulativos del Banco Santander. La CNBC especulaba con que los fondos gestionados por dicha firma podrían haber invertido "cientos de millones". La entidad declinó hacer comentarios al respecto. Banif, la red de banca privada del Santander cuyos clientes se vieron sacudidos por la quiebra de Lehman, ha distribuido productos de Optimal. Por su parte, fuentes del BBVA indicaron que "no ha comercializado en su red de clientes minoristas ni a través de su banca privada ningún producto ni de gestión ni de depósitos" en la firma de Madoff, sin pronunciarse sobre otras posibles operaciones. Fuentes financieras indican que hay más hedge funds comercializados en España con inversiones en la firma estadounidense. Una filial de Madoff figura en los registros de la CNMV, si bien está domiciliada en Londres. También está registrada la firma Fairfield, una de las que distribuía los productos de Madoff, posiblemente también entre inversores españoles.

Asociaciones de caridad En Estados Unidos, entre los exclusivos clientes de Madoff se encuentran adinerados inversores particulares que le conocían personalmente, organizaciones caritativas, además de los hedge funds, los principales afectados. El mayor perdedor del fraude podría ser Fairfield Sentry, junto al fondo Kingate Management. Los dos pusieron en torno a 10.000 millones de dólares en manos de Madoff, que les prometió altos retornos. También se cita al fondo británico Bramdean Alternatives y al vehículo inversor Pioneer Alternative que gestiona el banco Unicredito, y a las firmas Nomura, Tremont, UBP, Wilpon, Kingsgate y Bank SYZ.

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Bernard L. Madoff

Ruby Washington/The New York Times On Wall Street, his name is legendary. With money he had made as a lifeguard on the beaches of Long Island, he built a trading powerhouse that had prospered for more than four decades. At age 70, he had become an influential spokesman for the traders who are the hidden gears of the marketplace. But on Dec. 12, this consummate trader, Bernard L. Madoff, was arrested at his Manhattan home by federal agents who accused him of running a multibillion-dollar fraud scheme — perhaps the largest in Wall Street’s history. The single count of securities fraud carries a maximum penalty of 20 years in prison and a maximum fine of $5 million. Regulators have not yet verified the scale of the fraud. But the criminal complaint filed against Mr. Madoff on Thursday in federal court in Manhattan reports that he estimated the losses at $50 billion. According to the most recent federal filings, Bernard L. Madoff Investment Securities operated more than two dozen funds overseeing $17 billion. These funds have been widely marketed to wealthy investors, hedge funds and other institutional customers for more than a decade, although an S.E.C. filing in the case said the firm reported having 11 to 23 clients at the beginning of 2008. The Madoff funds attracted investors with the promise of high returns and low fees. One of Mr. Madoff’s more prominent funds, the Fairfield Sentry fund, reported having $7.3 billion in assets in October 2008 and claimed to have paid more than 11 percent interest each year through its 15-year track record. Founded in 1960, by the early 1980s, his firm was one of the largest independent trading operations in the securities industry. The company had around $300 million in assets in 2000 at the height of the Internet bubble and ranked among the top trading and securities firms in the nation. Mr. Madoff ran the business with several family members, including his brother Peter, his nephew Charles, his niece Shana and his sons Mark and Andrew.

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Economist's View DECEMBER 02, 2008

"Frequentists vs Bayesians" Steve Hsu: Frequentists vs Bayesians, by Steve Hsu: Noted Berkeley statistician David Freedman recently passed away. I recommend the essay below if you are interested in the argument between frequentists (objectivists) and Bayesians (subjectivists). I never knew Freedman, but based on his writings I think I would have liked him very much -- he was clearly an independent thinker :-) In everyday life I tend to be sympathetic to the Bayesian point of view, but as a physicist I am willing to entertain the possibility of true quantum randomness. I wish I understood better some of the foundational questions mentioned below. In the limit of infinite data will two Bayesians always agree, regardless of priors? Are exceptions contrived? Some issues in the foundation of statistics Abstract: After sketching the conflict between objectivists and subjectivists on the foundations of statistics, this paper discusses an issue facing statisticians of both schools, namely, model validation. Statistical models originate in the study of games of chance, and have been successfully applied in the physical and life sciences. However, there are basic problems in applying the models to social phenomena; some of the difficulties will be pointed out. Hooke’s law will be contrasted with regression models for salary discrimination, the latter being a fairly typical application in the social sciences. ...The subjectivist position seems to be internally consistent, and fairly immune to logical attack from the outside. Perhaps as a result, scholars of that school have been quite energetic in pointing out the flaws in the objectivist position. From an applied perspective, however, the subjectivist position is not free of difficulties. What are subjective degrees of belief, where do they come from, and why can they be quantified? No convincing answers have been produced. At a more practical level, a Bayesian’s opinion may be of great interest to himself, and he is surely free to develop it in any way that pleases him; but why should the results carry any weight for others? To answer the last question, Bayesians often cite theorems showing "inter-subjective agreement:" under certain circumstances, as more and more data become available, two Bayesians will come to agree: the data swamp the prior. Of course, other theorems show that the prior swamps the data, even when the size of the data set grows without bounds-- particularly in complex, high-dimensional situations. (For a review, see Diaconis and Freedman, 1986.) Theorems do not settle the issue, especially for those who are not Bayesians to start with. My own experience suggests that neither decision-makers nor their statisticians do in fact have prior probabilities. A large part of Bayesian statistics is about what you would do if you had a prior.7 For the rest, statisticians make up priors that are mathematically convenient or attractive. Once used, priors become familiar; therefore, they come to be accepted as "natural" and are liable to be used again; such priors may eventually generate their own technical literature. ...

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It is often urged that to be rational is to be Bayesian. Indeed, there are elaborate axiom systems about preference orderings, acts, consequences, and states of nature, whose conclusion is-- that you are a Bayesian. The empirical evidence shows, fairly clearly, that those axioms do not describe human behavior at all well. The theory is not descriptive; people do not have stable, coherent prior probabilities. Now the argument shifts to the "normative:" if you were rational, you would obey the axioms, and be a Bayesian. This, however, assumes what must be proved. Why would a rational person obey those axioms? The axioms represent decision problems in schematic and highly stylized ways. Therefore, as I see it, the theory addresses only limited aspects of rationality. Some Bayesians have tried to win this argument on the cheap: to be rational is, by definition, to obey their axioms. ... How do we learn from experience? What makes us think that the future will be like the past? With contemporary modeling techniques, such questions are easily answered-- in form if not in substance. ·The objectivist invents a regression model for the data, and assumes the error terms to be independent and identically distributed; "iid" is the conventional abbreviation. It is this assumption of iid-ness that enables us to predict data we have not seen from a training sample-- without doing the hard work of validating the model. ·The classical subjectivist invents a regression model for the data, assumes iid errors, and then makes up a prior for unknown parameters. ·The radical subjectivist adopts an exchangeable or partially exchangeable prior, and calls you irrational or incoherent (or both) for not following suit. In our days, serious arguments have been made from data. Beautiful, delicate theorems have been proved; although the connection with data analysis often remains to be established. And an enormous amount of fiction has been produced, masquerading as rigorous science. [!!!]

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Scientific American Magazine - November 21, 2008

After the Crash: How Software Models Doomed the MarketsScientific American Magazine OVERRELIANCE ON FINANCIAL SOFTWARE CRAFTED BY PHYSICS AND MATH PHDS HELPED TO PRECIPITATE THE WALL STREET COLLAPSE By The Editors If Hollywood makes a movie about the worst financial crisis since the Great Depression, a basement room in a government building in Washington will serve as the setting for a key scene. There investment bankers from the largest institutions pleaded successfully with Securities and Exchange Commission (SEC) officials during a short meeting in 2004 to lift a rule specifying debt limits and capital reserves needed for a rainy day. This decision, a real event described in the New York Times, freed billions to invest in complex mortgage-backed securities and derivatives that helped to bring about the financial meltdown in September. In the script, the next scene will be the one in which number-savvy specialists that Wall Street has come to know as quants consult with their superiors about implementing the regulatory change. These lapsed physicists and mathematical virtuosos were the ones who both invented these oblique securities and created software models that supposedly measured the risk a firm would incur by holding them in its portfolio. Without the formal requirement to maintain debt ceilings and capital reserves, the commission had freed these firms to police themselves using risk tools crafted by cadres of quants. The software models in question estimate the level of financial risk of a portfolio for a set period at a certain confidence level. As Benoit Mandelbrot, the fractal pioneer who is a longtime critic of mainstream financial theory, wrote in Scientific American in 1999, established modeling techniques presume falsely that radically large market shifts are unlikely and that all price changes are statistically independent; today’s fluctuations have nothing to do with tomorrow’s—and one bank’s portfolio is unrelated to the next’s. Here is where reality and rocket science diverge. Try Googling “financial meltdown,” “contagion” and “2008,” a search that reveals just how wrongheaded these assumptions were. This modern-day tragedy could be framed not only as a major motion picture but also as a train wreck or plane crash. In aviation, controlled flight into terrain describes the actions of a pilot who, through inattention or incompetence, directs a well-functioning airplane into the side of a mountain. Wall Street’s version stems from the SEC’s decision to allow overreliance on risk software in the middle of a historic housing bubble. The heady environment permitted traders to enter overoptimistic assumptions and faulty data into their models, jiggering the software to avoid setting off alarm bells. The causes of this fiasco are multifold—the Federal Reserve’s easy-money policy played a big role—but the rocket scientists and geeks also bear their share of the blame. After the crash, the quants and traders they serve need to accept the necessity for a total

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makeover. The government bailout has already left the U.S. Treasury and Federal Reserve with extraordinary powers. The regulators must ensure that the many lessons of this debacle are not forgotten by the institutions that trade these securities. One important take-home message: capital safety nets (now restored) should never be slashed again, even if a crisis is not looming. For its part, the quant community needs to undertake a search for better models— perhaps seeking help from behavioral economics, which studies irrationality of investors’ decision making, and from virtual market tools that use “intelligent agents” to mimic more faithfully the ups and downs of the activities of buyers and sellers. These number wizards and their superiors need to study lessons that were never learned during previous market smashups involving intricate financial engineering: risk management models should serve only as aids not substitutes for the critical human factor. Like an airplane, financial models can never be allowed to fly solo. Note: This article was originally printed with the title, "After the Crash".

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EUROINTELLIGENCE

GLOBAL LIQUIDITY & CAPITAL FLOWS – GRAND ILLUSIONS By: Satyajit Das

In recent years, money was cheap and other assets were expensive. As each of the global economy’s credit creation engines breaks down and systemic leverage reduces, money becomes scarce and expensive triggering adjustments in asset prices in a reversal of this process. In the current financial crisis, the quantum of available capital, the munificent resources of central banks and sovereign wealth funds and the globalisation of capital flows may be some of the accepted "facts" that are revealed to be grand illusions. As Mark Twain once advised: " Don't part with your illusions. When they are gone you may still exist, but you have ceased to live". Reserve Illusions In recent years, there has been speculation about the amount of capital or liquidity available for investment globally. The substantial reserves of central banks and, their acolytes, sovereign wealth funds were frequently cited in support of the case for a large pool of "unleveraged" liquidity, that is "real" money. In reality, the available pool of money may be more modest than assumed. For example, China has close to $2 trillion in foreign exchange reserves. The reserves arise from dollars received from exports and foreign investment into China that are exchanged into Renminbi. The central bank generates Renminbi by printing money or borrowing through issuing bonds in the domestic market. On China’s "balance sheet", the reserves are essentially "leveraged" using domestic "liabilities". In order to avoid increases in the value of the Renminbi that would affect the competitive position of its exporters, China undertakes " currency sterilisation" operations where it issues bonds to mop up the excess liquidity. China incurs costs – effectively a subsidy to its exporters - of around $60 billion per annum (the difference between the rate it pays on its Renminbi debt and the investment income on it reserves). The dollars acquired are invested in foreign currency assets, around 60% in dollar denominated US Treasury bonds, GSE paper (such as Freddie and Fannie Mae debt)

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and other high quality securities. China is exposed to price changes in these investments and currency risk because of the mismatch between foreign currency assets funded with local currency debt. Deterioration in the US economy and the need to issue additional debt to support the financial sector may place increasing pressure on the US sovereign rating and the dollar. US Government support for financial institutions is already approaching 6% of GDP compared to less than 4% for the Savings and Loans crisis. Deterioration in the credit quality of the United States results in losses on investment through falls in the market value of the debt and a weaker dollar. The credit default swap ("CDS") market for sovereign debt is increasingly pricing in increased funding costs for the US. The fee for hedging against losses on $10 million of Treasuries was about 0.40% pa for 10 years (equivalent to $40,000 annually) in October 2008. This is an increase from 0.01% pa ($1,000) in 2007. It is also not easy to tap this liquidity pool. Given the size of the portfolios, it is difficult for large investors like China to rapidly mobilise a large portion of these funds by liquidating their investments and converting them into the home currency without substantial losses. This means that this money may not, in reality, be available, at least at short notice. If the dollar assets lose value or cannot be accessed then China must still service its liabilities. It can print money but will suffer the economic consequences including inflation and higher funding costs. The position of emerging market sovereign investors with large portfolios of dollar assets is similar to that of a bank or leveraged hedge fund with poor quality assets. China’s Premier Wen Jiabao recently expressed concern: "If anything goes wrong in the U.S. financial sector, we are anxious about the safety and security of Chinese capital…" There are other factors affecting the availability of the reserves at central banks and sovereign wealth funds. In recent years, sovereign wealth funds have also suffered losses on some of their investments, most notably in US and European financial institutions. Some central banks have been forced to utilise some of the reserves to support the domestic economy and banking system. For example, South Korea has used a portion of its reserves to provide dollars to banks unable to re-finance short-term dollar borrowings in international money markets. Russia has similarly used a significant portion of its reserves to support financial institutions and also its domestic markets. Russia’s reserves, which rank third after China’s and Japan’s reserves in size, have fallen $122.7 billion, or 21 percent, since August 2008. The reserves, including oil funds that exclusively act as a safety cushion for the budget, stood at $475.4 billion on November 2008. Capital Illusions The substantial build-up of foreign reserves in central banks of emerging markets and developing countries, as identified by David Roche (see David Roche and Bob McKee (2007) New Monetarism; Independent Strategy Publications), is really a

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liquidity creation scheme that relies on the dollar's favoured position in trade and as a reserve currency. Many global currencies are pegged to the dollar at an artificially low rate, like the Chinese Renminbi to maintain export competitiveness. This creates an outflow of dollars (via the trade deficit that is driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase US debt with dollars to mitigate upward pressure on their domestic currency. Large, liquid markets in dollars and dollar investments capable of accommodating the very large investment requirements and the historically unimpeachable credit quality of the US sovereign assets facilitated the process. The recycled dollars flow back to the US to finance the spending. This merry-go-round is a significant source of liquidity creation in financial markets. It also kept US interest rates and cost of capital low encouraging further borrowing to finance consumption and imports to keep the cycle going. This process increased the velocity of money and exaggerated the level of global liquidity. The large build-up in reserves in oil exporters from higher oil prices and higher demand from strong world growth was also re-cycled into US dollar debt. The entire process was reminiscent of the "petro-dollar" recycling of the 1970s. The central banks holding reserves were lending the funds used to purchase goods from the country. In effect, the exporter never got paid at least until the loan to the buyer (the vendor finance) was paid off. As the debt crisis intensifies and global growth diminishes with increased defaults, it is increasingly likely that this debt will not be paid back in it entirety. This liquidity circulation process supported, in part, the growth in global trade. This too may have been an illusion as the underlying process is a gigantic vendor financing scheme. Trade Illusions An accepted article of economic faith is that failure of economic co-operation and resurgent nationalism in the form of trade protectionism (for example, the SmootHawley Act) contributed to the global financial crisis of the 1930s. The stock market crash of 1929 and the subsequent banking crisis caused a collapse in financing and global demand resulting in a sharp of the US trade surplus. SmootHawley was passed in 1930 to deal with the problem of over-capacity in the U.S. economy through higher tariffs designed to increase domestic firms’ market share. The higher US tariffs led to retaliation from trading partners affecting global trade. The slowdown in central bank reserve re-circulation affects global trade through the decrease in the availability of financing for purchasers to buy goods and services. This is apparent in the sharp slowdown in consumer consumption in the US, UK and other economies. The availability of cheap finance also helped drive up the prices which, in turn, allowed excessive borrowing against the inflated value of these assets that fueled consumption. Weakness in the global banking system (in particular, loan losses, the lack of capital and concerns about counterparty risk between large financial institutions) contributes to restricted availability of trade letters of credit, guarantees and trade finance

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generally. This exacerbates the problem. The restrictions, in turn, further impact on the level of trade flows and capital re-circulation resulting in a further decrease in trade activity that in turn further slows down international credit creation. It is not easy to fix the problem. Redirection of capital held in central banks and sovereign wealth funds to domestic economies affects the global capital flows needed to finance the debtor countries, such as the US and re-capitalise the banking system. Maintenance of the cross border capital flows to finance the debtor countries budget and trade deficits slows down growth in emerging countries and also perpetuates the imbalances. Trade has become subordinate to and the handmaiden of capital flows. As capital flows slow down, global trade follows. Indirectly, the contraction of cross border capital flows and credit acts as a barrier to trade. In each case, de-leveraging is the end result. This opens the way to "capital protectionism". Foreign investors may change their focus and reduce their willingness to finance the US. Wen Jiabao, the Chinese Prime Minister, indicated that China’s "greatest contribution to the world" would be to keep it’s own economy running smoothly. This may signal a shift whereby China uses its savings to invest in the domestic economy rather than to finance US needs. China and other emerging countries with large reserves were motivated to build surpluses in response to the Asian crisis of 1997-98. Reserves were seen as protection against the destabilising volatility of short term capital flows. The strategy has proved to be flawed. It promoted a global economy based on "vendor financing" by the exporting nations. The strategy also exposed the emerging countries to the currency and credit risk of the investments made with the reserves. Significant shifts in economic strategy are likely. As Chinese President Hu Jintao recently noted: "From a long-term perspective, it is necessary to change those models of economic growth that are not sustainable and to address the underlying problems in member economies." There is also the risk of "traditional" trade protectionism. The end of the current liquidity cycle, like the one in the 1930s, may cause a sharp fall in exports. Exporting countries, seeking to maintain domestic growth may try to boost exports by devaluation of the currency or subsidies. Import tariffs are less effective unless there is a large domestic market. Recently Zhou Xiaochuan from the People’s Bank of China did not rule out China depreciating its currency. The change in these credit engines also distorts currency values and the patterns of global trade and capital flows. The current strength in the dollar particularly against the Euro reflects repatriation of capital by investors and the shortage of dollars from the slowdown in the dollar liquidity re-circulation process. It is also driven by the reliance on short-term dollar financing of some banks and countries and the need for re-financing. This is evident in the persistence of high inter-bank dollar rates and dollar strength. The strength of the dollar is unhelpful in facilitating the required adjustment in the current account and also financing of the US budget deficit.

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The slowdown in the credit and liquidity processes outlined may have long-term effects on global trade flows. As Mark Twain also observed: "History does not repeat but it rhymes." End of "Candy Floss" Money Gillian Tett of the Financial Times coined the phrase (see "Should Atlas still shrug?" (15 January 2007) Financial Times) "candy floss money". New financial technology spun available "real" money into an exaggerated bubble that, like its fairground equivalent, collapses ultimately. The global liquidity process was multi-faceted. There was traditional domestic credit creation system built on the fractional reserve system that underpins banking. The leverage in the system was pushed to extreme levels. Losses and renewed regulation are forcing this system of credit creation to shut down. The foreign exchange reserve system was another part of the global credit process. Dollar liquidity re-circulation has also slowed as a result of reduced trade flows (driven by falls in US consumption and imports), losses on dollar investments, domestic claims on reserves and the inability to readily mobilise large amount of reserves. Another credit process - the export of Yen savings via the Yen carry trade and acquisition of foreign assets by Japanese investors) - has also slowed. The focus of the November 2008 G-20 meeting was firmly on financial sector reform. Stabilisation of global capital flows in the short term and addressing global imbalances over the medium to long term barely merited a mention. It may well come to be seen in coming weeks and months as a major missed opportunity to address these issues. Markets placed great faith in the volume of money available to support asset prices and assist in alleviating shortages of liquidity. The perceived abundance of liquidity was, in reality, merely an illusion created by high levels of debt and leverage as well as the structure of global capital flows. As the financial system de-leverages, it is becoming clear, unsurprisingly, that available capital is more limited than previously estimated. As Sigmund Freud once observed: "Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces." © 2008 Satyajit Das Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

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Risky business THE ROOT OF THIS FINANCIAL CRISIS IS THE TENSION BETWEEN WANTING TO SPREAD RISK AND NOT UNDERSTANDING ITS CONSEQUENCES

Kenneth Arrow guardian.co.uk Wednesday 15 October 2008 18.00 BST The current financial crisis, the loss of asset values, the refusal to extend normally-given credit and the great increase in defaults on obligations ranging from individual mortgages to the debts of great investment banks presents, of course, a pressing challenge to the fiscal authorities and central banks to take measures to minimise the consequences. But they also present a challenge to standard economic theory, a challenge all the more important since the development of policies to prevent future financial crises will depend on a deeper understanding of the processes at work. That economic decisions are made without certain knowledge of the consequences is pretty self-evident. But, although many economists were aware of this elementary fact, there was no systematic analysis of economic uncertainty until about 1950. There have been two developments in the economic theory of uncertainty in the last 60 years, which have had opposite implications for the radical changes in the financial system. One has made explicit and understandable a long tradition that spreading risks among many bearers improves the functioning of the economy. The second is that there are large differences of information among market participants and that these differences are not well handled by market forces. The first point of view tends to argue for the expansion of markets, the second for recognising that they may fail to exist and, if they do come into being, may fail to work for the benefit of the general economic situation. The value of spreading risks has, of course, been recognized as the basis of conventional insurance as well as the issue of company shares that spread corporate risks widely. The central element of standard economic analysis since the 1870s has been the concept of general economic equilibrium, which, under competitive conditions, leads to an optimal allocation of resources. In the 1950s, it was shown how to incorporate uncertainty into general equilibrium, which suggests, at least, that increasing the number and coverage of risk-bearing instruments would improve the running of the economy. Not only would risks be more efficiently borne, but, more importantly, additional socially valuable risky enterprises would be undertaken. Research showed how derivative securities should be priced, how individuals should choose portfolios to minimise their variability, and how individual contracts, such as mortgages, could be bundled so as to distribute the risks for different parts of the market with different risk tolerances.

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The second strand of analysis was a growing recognition of the importance of information in governing reactions to uncertainties. If individuals in the market have different degrees of information, the ability to create securities or engage in other forms of contracts becomes limited; the less informed understand that the more informed will take advantage and react accordingly. This situation was long recognized by insurance companies under such terms as, "moral hazard" (when the insurer cannot tell how well the insured is avoiding risks) and "adverse selection" (when the insurer cannot distinguish among differentially risky insured, so that, at any given premium, the more risky insure themselves most extensively). Economists began to realise that "asymmetric" information was the key to understanding the limits of health insurance and the incentive problems of socialism and then that these concepts found their most important application in financial markets, precisely in the complex securities that the first strand of analysis had called for. There is obviously much more to the full understanding of the current financial crisis, but the root is this conflict between the genuine social value of increased variety and spread of risk-bearing securities and the limits imposed by the growing difficulty of understanding the underlying risks imposed by growing complexity.

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Elogio tardío de Mariano Rubio y del Banco de España

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Breve historia del éxito que explicaremos en Washington Por ANA R. CAÑIL (SOITU.ES) Actualizado 14-11-2008 21:21 CET Nos admiran en Washington, nos reconocen ingleses y franceses. La regulación bancaria que debe tomarse como referencia para afrontar la gravísima crisis financiera es la que aplica el Banco de España. Lo dicen los protagonistas del crack mundial. Pero esa legislación costó salud, sudor y lágrimas. Desde 1977 hasta bien entrados los años 80, en este país desaparecieron 51 bancos —el 50% de los que había—, 14 cajas de ahorro y 20 cooperativas de crédito. En los despachos del Banco de España y de la Corporación Bancaria, un grupo de hombres desconocidos para el público, tan brillantes de cerebro como grises de aspecto, fueron acuñando sobre la marcha el nombre de las píldoras que, poco a poco, pararon la sangría.

(EFE) ¡Gracias, Sarkozy! Este sábado 15 de noviembre, España acudirá a la reunión del G-20, gracias a la generosidad de Nicolás Sarkozy y al aval del 'sistema de regulación aplicado a la banca española', esas leyes que han evitado —hasta ahora— que la banca española siguiera el desagradable camino que sus colegas norteamericanos o europeos. Ha habido que esperar a que el primer ministro británico, Gordon Brown, confesara hace semanas su admiración por la legislación reguladora de España y apoyara la legitimidad de nuestro país para acudir a la Cumbre de este sábado, y, después, que el venerable Wall Street Journal llevara a su portada que el modelo español era el que había que seguir para paliar la debacle, para que, de pronto, los más escépticos, esos que militan en el papanatismo —"lo de dentro siempre es lo peor"— se pusieran al

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frente de la manifestación. Unos cuantos políticos, otros cuantos economistas y varios listillos se apuntan ahora al éxito. Quizá sea éste el momento para recordar que ese modelo se forjó a golpe de sustos y de la pericia de unas docenas de hombres, la mayoría de ellos situados alrededor del Servicio de Estudios del Banco de España. Sus nombres no merecen quedar en la segunda fila Cuando el 25 de octubre de 1977 se firmaron los pactos de La Moncloa —la clave de la Transición para afrontar una situación económica gravísima—, a la reforma del sistema financiero se la despachó con nueve puntos, el primero de los cuales establecía que, antes del 31 de marzo de 1978, el Gobierno remitiría a las Cortes un proyecto de ley para la "nueva regulación de órganos rectores del Banco de España y del crédito oficial". Falta hacía esa nueva regulación, y con todo, no llegó a tiempo. Entre 1978 y 1983, en plena Transición (y unido a las tensiones políticas de aquellos tiempos) de los 110 bancos que había en 1977, 51 entraron en crisis, ya fuera por problemas de solvencia, mala gestión, decadencia de varias de las familias de la antigua oligarquía del régimen o todo a la vez.

Todos muy jovencitos en los famosos 'Pactos de La Moncloa'. APELLIDOS ARISTOCRÁTICOS Quizá sea más fácil de comprender lo que significó si ponemos nombre a algunos de aquellos bancos que, o se fueron al garete, o bien fueron comprados por otros más grandes. Banca Catalana, Banco Urquijo, Banco de Levante, Banco Occidental encabezaban los agujeros más grandes, y bastaba bucear en sus consejos de

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administración para encontrar todo tipo de apellidos rimbombantes de la aristocracia de toda la vida, pero también de muchos nuevos ricos que literalmente se habían 'forrado' en la década de los 60, con el despegue económico español. Toda esta tormenta tenía lugar en plena Transición, con una crisis económica de caballo, atentados terroristas día sí y día también, y la amenaza de los espadones (el 23F el más sonado) en los periódicos Por seguir con los apellidos sonoros (algunos de cuyos herederos hoy se encuentran fácilmente en las páginas del papel couché), se puede mencionar también la quiebra o los problemas de entidades como la Banca Mas Sardá, la Banca López Quesada, los bancos de los Coca, de los Masaveu y de los Fierro. Esos 51 bancos gestionaban unos 9.500 millones de euros (de los de entonces) y empleaban a 35.660 personas. Pero no sólo la mitad del sistema bancario se fue al garete. Catorce cajas de ahorro y 20 cooperativas de crédito dieron también con sus huesos en el suelo. Y toda esta tormenta tenía lugar en plena Transición, con una crisis económica de caballo, atentados terroristas día sí y día también, y la amenaza de los espadones (el 23-F el más sonado) en las primeras páginas de los periódicos. LOS QUE DABAN LA CARA Cuando esta tormenta también perfecta estalló, el Banco de España se encontró con que no tenía, ni de cerca, las armas, los instrumentos necesarios para hacer frente a la hecatombe. Y trabajaron sobre la marcha, a veces improvisando, a veces "con mucho ingenio y siempre metiendo muchas horas", reconoce quien fuera primer director del Fondo de Garantía de Depósitos, Aristóbulo de Juan, luego director general del Banco de España.

'Simplemente, Mariano'.

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En 1977, aunque el gobernador del Banco de España era José María López de Letona, aparece un subgobernador, alguien que durante décadas puso la cara adusta a la crisis bancaria y se convirtió en el terror de los malos gestores. Se llamaba Mariano Rubio, y a su sombra se forjó el equipo que gestionó la debacle de 75 entidades que se hundieron. Nadie entonces podía prever que con los años, Rubio pasaría de ser el hombre del poder absoluto al 'apestado absoluto'. El escándalo Ibercorp, que le convirtió en cómplice de todo contra lo que había luchado durante su etapa de subgobernador, puso un triste broche final a su vida. En 1999, el día de su entierro, víctima de un cáncer de colon, pocos de sus amigos de la época gloriosa acompañaron a Carmen Posadas, su segunda esposa, al cementerio de La Almudena. EL BECERRO DE ORO ARRUINA UNA ETAPA Dicen sus viejos amigos que a 'Simplemente Mariano' (como tituló un famoso artículo el entonces redactor jefe de El País, Martínez Soler) se lo llevó por delante un empacho de poder absoluto, las grandes fusiones bancarias y el lujo, el glamour y los delitos de cuello blanco de los 80. Los Mario Conde, De la Rosa, la foto de la Chávarri sin bragas, las Koplowitz, los Albertos. Eran los años locos del becerro de oro, que arrastraban la suciedad que engendraron asuntos como Banesto e Ibercorp, el negocio de su amigo, Manolo de la Concha, ex síndico de la Bolsa, que le llevó a los tribunales y al oprobio. Pero hasta llegar aquellos postreros días de locura que tan mal acabaron, Rubio fue un subgobernador de mano de hierro, que gestionó la transición del sistema financiero rodeado por un grupo de personajes únicos y aburridos de puertas afuera, que diseñaron la legislación hoy tan admirada. A la cabeza de uno de esos grupos estuvo un tipo de nombre Ángel Madroñero, un director general calvo, redondo, denso en la expresión y afable en el trato, que tenía a sus ordenes a otros personajes algo más jóvenes, como José Luis Núñez, un subdirector del Banco de España, trabajador inagotable, el ideólogo de un documento del que hoy muy pocos se acuerdan (si acaso, en alguna cátedra de Economía) y que se llamó 'la Pastoral', el embrión que daría lugar a la legislación que en 1980 permitió la creación del Fondo de Garantía de Depósitos. Aunque 'la Pastoral' estructurada por Núñez en su esqueleto no era de obligatorio cumplimiento, "nos las arreglábamos para implantarla", recuerda Aristóbulo de Juan, primer director del Fondo de Garantía de Depósitos . Así se acuñaron conceptos como clasificación de riesgos, provisiones, mínimos de capital y concentración de riesgos. A medida que se van saneando los bancos, los responsables de la Corporación Bancaria y del Banco de España "vamos aprendiendo "latín", recuerda De Juan con una sonrisa algo nostálgica. Luego, en 1982 , desde la Dirección General de Supervisión, dio un empujón, gracias a todo lo aprendido en la gestión de los bancos en crisis. EL 'COCINERO DE CIRCULARES' Un día de abril de 1982, cuando la tormenta iba amainando, José Luis Núñez se quedó seco de un infarto en su despacho. La muerte del padre de Soledad Núñez, la actual directora general del Tesoro, y Susana Núñez, uno de los cerebros ocultos en el edifico de la Plaza de Cibeles (sede del Banco Central), impactó profundamente en los

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solemnes pasillos y columnas neoclásicas del Banco de España, tan poco dados al sentimentalismo. Las circulares de Poveda eran unos folios que hacían temblar a los gestores más chapuzas de la banca, temiendo la nueva ocurrencia de los "chicos de la élite de Ángel Rojo" para jorobarles los resultados Pero para entonces ya estaba en primera fila Raimundo Poveda, un hombre de Madroñero y Rojo, a cuyas manos pasó toda la regulación, cuando ya tenía experiencia en la inspección de instituciones financieras. Con la regulación en manos de Poveda, cerebro sólido y brillante desde el punto de vista jurídico y financiero pero con fama de aburrido y gris para la época, la regulación que hoy causa admiración se fue cocinando a golpe de circular. Las circulares eran unos folios que, cada vez que se anunciaba su nacimiento desde el Banco de España a las entidades, hacían temblar a los gestores más chapuzas de la banca, temiendo qué nueva ocurrencia habrían tenido los "chicos de la élite de Ángel Rojo, los del Banco de España" para jorobarles los resultados, tal y como recuerda otro bancario jubilado de uno de los dos grandes grupos que hoy han sobrevivido. Porque a ese 'cocinero de circulares', de nombre Raimundo Poveda, poco amigo de periodistas, pero estimado por sus jefes, desde el propio Rubio, pasando por el economista de referencia del keynesianismo español, el que fuera gobernador, Luis Ángel Rojo; desde el gobernador Jaime Caruana a los últimos subgobernadores, como Miguel Martín o Gonzalo Gil, nadie se ha atrevido a discutirle el grueso de los méritos de esos conceptos ahora tan respetados. La mayoría tienen su base en el 'coco' de Poveda. Un tipo tan serio, sesudo y formal a quien de nada le sirvió su discreción en los tiempos de los locos años 80, cuando personajes como Javier de la Rosa pagaban para hacerle seguir, y le fotografiaban en los paseos del Retiro, hablando con algún periodista a quien De la Rosa consideraba su enemigo. LOS PIONEROS Hace ocho años que Poveda se jubiló. En las últimas semanas, los medios económicos con memoria histórica le han buscado otra vez. En una reciente entrevista en Cinco Días, el ideólogo que impuso términos como 'provisiones contracíclicas', que irritaban tanto a los bancos, que les costaron críticas nacionales e internacionales, reconoció que "hemos sido pioneros en muchas cosas". No en vano se chupó 25 años en el área de Regulación Financiera del Banco de España, viendo marchar a muchos de sus mentores, como el propio Mariano Rubio o Luis Ángel Rojo. En 1993, cuando el gobernador Rojo, el subgobernador Miguel Martín y el propio Poveda pensaban que ya lo habían visto todo —ellos mismos desde diferentes atalayas de la Administración habían seguido la intervención de la Rumasa de Ruiz Mateos el 23 de febrero de 1982— pusieron desenlace a lo que había comenzado en 1978. El 28 de diciembre de 1993, día de Los Santos Inocentes, se anunció la intervención de Banesto, el banco 'pata negra' durante décadas del sistema financiero español. El de Aguirre Gonzalo y los Garnica, para entonces en manos de otro personaje que haría historia económica y política del dorado al negro, resultado directo de la etapa del 'becerro de oro': Mario Conde. Fue la última vez en que la estructura reguladora, la

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previsión y las provisiones previstas, el trabajo de prudencia llevado a cabo durante dos décadas, se puso a prueba. Y resistió más allá de la política, de la corrupción, de una fea etapa que condujo a la decadencia al último Gobierno de Felipe González. FIN DE LA HISTORIA. POR AHORA Esta breve historia —muy larga para muchos de nuestros lectores— en la que nos habremos dejado aparcados decenas de nombres que fueron claves en aquellos años, es la que hoy y mañana permitirá a un presidente de nombre José Luis Rodríguez Zapatero, socialista, que en 1978 tenía 18 años, presumir y defender en Washington lo que han asumido el primer ministro británico, Gordon Brown, y el periódico económico más influyente del mundo, The Wall Street Journal: que el modelo regulador español es el mejor. Hasta ahora. Hace años que los sesudos y grises señores del Banco de España lo predican por el mundo —incluido el gobernador Jaime Caruana cuando participaba en la elaboración de las normas insufribles para superexpertos de Basilea II—, pero ya se sabe que nadie es profeta en su tierra. Por último, un ex consejero de la gran banca, humanista y jubilado —no prejubilado— bromeaba al asesorar para este artículo: "Sí, es verdad. Esta es la mayor crisis económica de la historia, puede que peor que la depresión del 29. Pero estamos en un país en donde hace 30 años quebraba un banco al mes, moría un guardia civil por día, había una amenaza velada de golpe de Estado cada día en los periódicos y una crisis económica de caballo. ¿Por qué me voy a llevar ahora las manos a la cabeza? Qué lo hagan estos jóvenes para los que escribís en internet. Ahora les toca a ellos. Veremos lo que dan de sí."

Pro memoria Fallece Mariano Rubio, el gobernador del Banco España que pilotó la transición de la banca El responsable del banco emisor abandonó su cargo tras verse implicado en el "caso Ibercorp" EL PAÍS - Madrid / Barcelona - 05/10/1999 Mariano Rubio Jiménez, que fue gobernador del Banco de España entre 1984 y 1992 y subgobernador entre 1977 y 1984, falleció ayer en Madrid a la edad de 67 años víctima de un cáncer de colon. Rubio pilotó durante 15 años la profunda transformación registrada por el sistema financiero español desde su grave crisis y el status quo bancario a la competencia y la integración en Europa. Sentó las bases de la independencia del banco emisor, pero su carrera quedó truncada en 1992, cuando el Gobierno no renovó su mandato como consecuencia de su implicación en el escándalo Ibercorp. Mariano Rubio estaba divorciado de Isabel Azcárate y casado por segunda vez con la escritora uruguaya Carmen Posadas. Rubio accedió al cargo de subgobernador del Banco de España en julio de 1977, nombrado por el entonces gobernador, José María López de

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Letona.De hecho, no era la primera vez que Rubio ocupaba un alto cargo en la institución. Entre 1965 y 1970 había desempeñado las funciones de subdirector del servicio de Estudios y subdirector general. En esos años tuvo bajo su responsabilidad un destacado equipo del que formaron parte dos futuros ministros socialistas: Carlos Solchaga y Miguel Boyer. El nombramiento de Rubio como subgobernador se produjo justo en el inicio de la profunda crisis bancaria que afectó al sistema financiero español hasta mediados de los años ochenta y que fue la más grave de Europa. La crisis engulló una cincuentena de instituciones financieras y el Banco de España debió utilizar mecanismos especiales para hacer frente a la situación como el Fondo de Garantía de Depósitos en Establecimientos Bancarios (FGD) o la intervención directa de algunos bancos. El papel destacado de Rubio en esa crisis condujo a su nombramiento como gobernador en julio de 1984 por el Gobierno del Partido Socialista. Su intervención destacada en la crisis generó algunas críticas contra él por su supuesta discrecionalidad. En cualquier caso, esa fase, definió tanto su carácter de hombre duro como su política de intervencionismo extremo en la vida del sector bancario, críticas ambas que le acompañarían hasta el final de su gestión. Camino de la liberalización Sin embargo, una de sus prioridades, tras superar la crisis, fue la de forzar la reducción de los coeficientes bancarios, que afectaban al inicio de su mandato a casi un 40% del pasivo bancario y al 4,5% en el momento de su marcha del Banco de España.La política de reducción de coeficientes no le hizo olvidar a Rubio las principales conclusiones de la crisis, en especial la necesidad de que los bancos contasen con una elevada solvencia a través del establecimiento de unos rígidos coeficientes de capitalización. Hoy, la banca española está considerada como una de los más solventes del mundo. Gracias a ello, el sistema financiero español pudo asimilar sin sobresaltos la profunda liberalización y desregulación del sector que se puso en marcha a partir de los años ochenta. Desde la superación del statu quo, que limitaba severamente la competencia, hasta la asimilación del desembarco de la banca extranjera en España, pasando por la liberalización del movimiento de capitales o la irrupción de las cajas de ahorros en todos los ámbitos del negocio. Uno de los jalones más significativos de este proceso tuvo lugar en 1989, cuando el ministro de Economía del Gobierno socialista, y antiguo colaborador suyo, Carlos Solchaga, aprobó la entrada de España en el Sistema Monetario Europeo (SME). La etapa de Rubio al frente de la máxima institución financiera quedó también marcada por el control directo sobre las prácticas de la operativa bancaria, a través de las circulares del Banco de España, que establecían una rigurosa política de dotaciones, y la creación de un reputado cuerpo de inspectores encargados de aseguar el rigor contable de las entidades y una mayor transparencia de sus actividades. El banco emisor jugó asimismo un papel capital en el desarrollo de los mercados monetarios, gracias a los cuales España pudo desarrollar los mecanismos necesarios para ejecutar una política monetaria en el contexto de la lucha contra la inflación, objetivo prioritario de aquellos años. Una de las actuaciones más controvertidas de Mariano Rubio fue su apuesta por las concentraciones bancarias, opción que le granjeó acusaciones de favoritismo e intervencionismo excesivo. En 1987 Rubio apoyó abiertamente la oferta de compra del entonces Banco de Bilbao, que presidía, José Ángel Sánchez Asiaín, sobre Banesto. Del 327

fracaso de la operación emergió la figura de Mario Conde, nuevo presidente de Banesto, y uno de los principales enemigos de Rubio. El enfrentamiento entre el gobernador y el nuevo banquero marcó los últimos años de la gestión de Rubio al frante del Banco de España. Como defensor de la ortodoxia bancaria, Rubio mantuvo una férrea política de oposición a la entrada en la banca de los nuevos protagonistas de la ingeniería financiera que comezaron a surgir en España a mediados de los años ochenta, uno de cuyos más conspicuos representantes era Conde, aunque no el único. También se opuso a personajes como Javier de la Rosa, a quien tuvo ocasión de calibrar cuando se ocupó de la crisis del Banco Garriga Nogués, filial catalana de Banesto, y del que De la Rosa fue vicepresidente ejecutivo. Lo mismo cabe decir de su actitud hacia el ex presidente de Rumasa, José María Ruiz Mateos, a quien el recién estrenado Gobierno del PSOE expropió en 1983. Ruiz Mateos consideró desde entonces al ministro de Economía de la época, Miguel Boyer, y al gobernador del Banco de España como grandes enemigos.

Acceder a los testimonios recogidos a su muerte a través de estos enlaces Periplo judicial: http://www.elpais.com/articulo/economia/RUBIO/_MARIANO/BANCO_IBERCORP/GRUPO_FINANCIERO_IBERCOR P/IBERCORP/SISTEMAS_FINANCIEROS/BANCO_DE_ESPANA/CASO_IBERCORP/Periplo/judicial/elpepieco/199910 05elpepieco_5/Tes

Luis Ángel Rojo afirma que fue "un gobernador importante": http://www.elpais.com/articulo/economia/CALVO_SOTELO/_LEOPOLDO_/EX_PRESIDENTE_DEL_GOBIERNO/VILA RASAU_SALAT/_JOSEP_/LA_CAIXA/GARCIA_ANOVEROS/_JAIME/ROJO/_LUIS_ANGEL_/EX_GOBERNADOR_ DEL_BANCO_DE_ESPANA/RUBIO/elpepieco/19991005elpepieco_6/Tes

Un buen gobernador http://www.elpais.com/articulo/economia/RUBIO/_MARIANO/BANCO_DE_ESPANA/buen/gobernador/elpepieco/199910 05elpepieco_7/Tes

Mariano http://www.elpais.com/articulo/economia/RUBIO/_MARIANO/BANCO_DE_ESPANA/Mariano/elpepieco/19991005elpepi eco_8/Tes

Trayectoria ejemplar http://www.elpais.com/articulo/economia/RUBIO/_MARIANO/BANCO_DE_ESPANA/Trayectoria/ejemplar/elpepieco/199 91005elpepieco_9/Tes

Constancia de gratitud http://www.elpais.com/articulo/economia/RUBIO/_MARIANO/BANCO_DE_ESPANA/Constancia/gratitud/elpepieco/1999 1005elpepieco_10/Tes

La generación de la banca http://www.elpais.com/articulo/economia/RUBIO/_MARIANO/BANCO_DE_ESPANA/generacion/banca/elpepieco/19991 005elpepieco_11/Tes

La ortodoxia en blanco y negro http://www.elpais.com/articulo/economia/RUBIO/_MARIANO/BANCO_DE_ESPANA/ortodoxia/blanco/negro/elpepieco/1 9991005elpepieco_12/Tes

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18/10/2008

CincoDias.com Raimundo Poveda

'ES RAZONABLE ELEVAR LA PROVISIÓN POR HIPOTECAS' Diseñó los cimientos del sistema de provisiones de la banca española, incluida la provisión anticíclica. Ahora ve a las entidades en buena posición ante la crisis

'Es razonable elevar la provisión por hipotecas'. Raimundo Poveda, ex director general de Regulación Financiera del Banco de España. •

'Hemos sido pioneros en muchas cosas'

Nuria Salobral - 18/10/2008 Antes de entrar en materia, Raimundo Poveda prefiere retroceder en el tiempo y recordar la época en que la banca española era prácticamente un páramo regulatorio. La crisis de los 70 y 80 -que se llevó por delante a más de 20 entidades- marcó un antes y un después para la banca española y Poveda estuvo desde entonces cocinando las circulares que hoy, pese a la crisis, permiten a la banca española presentar unos niveles de provisiones y unos ratios de morosidad que despiertan la envidia de las entidades europeas y estadounidenses. Han sido más de 25 años en el área de Regulación Financiera del Banco de España, hasta su jubilación hace ocho años. Ahora, desde la barrera, Poveda advierte que las exigencias de capitalización bancaria que marcan las actuales normas internacionales deberían ser más elevadas y apunta el eterno desafío que plantea la 329

regulación financiera: el mercado siempre creerá en el espejismo de haber encontrado la fórmula mágica con la que ganar dinero sin apenas asumir riesgos. ¿En qué medida cree que la provisión anticíclica va a ayudar a la banca española a afrontar el problema de la morosidad? ¿Va a ser suficiente con ese colchón? Se hizo un trabajo que ha sido muy útil para el sistema bancario español. En su momento, siempre que haces una norma prescriptiva, la banca se rebela, las entidades insisten en que no es para tanto, que el mundo a partir de ahora va a ir mucho mejor, que ya no es necesario… Y uno, que ha visto cosas, no se lo acaba de creer. Creo que han sido realmente útiles esas provisiones, dan un margen muy interesante a la banca española. Eso, más unos niveles de capitalización más altos que la media, más una inspección que es muy pesada y cumple con su trabajo... Por eso cuando dicen que la banca española está en buena posición, yo creo que sí. A la vista del crecimiento del crédito en los últimos años y de la exposición tan alta de la banca al sector inmobiliario, ¿piensa ahora que se deberían haber endurecido más los coeficientes para el cálculo de la provisión anticíclica? Lo que se tuvo que endurecer fueron los tipos de interés. No era tanto una cuestión de supervisión como una cuestión monetaria. España, más Islandia y algún otro país, estaba en una fase de coyuntura muy viva mientras que otros países tenían una coyuntura muy apagada. Y la política del BCE para la situación española fue demasiado laxa por demasiado tiempo. Eso provocó un crecimiento del crédito que se concentró en el sector hipotecario y que es la causa de todos estos problemas. Va a haber sin duda un alza de la morosidad, hasta ahora los niveles son los esperables. Aun así, a la vista de lo que está sucediendo, estaría justificado un pequeño ajuste en las exigencias de provisiones en capítulos como el crédito hipotecario. ¿Qué decisiones se deberían tomar a partir de ahora en la regulación bancaria internacional? Para mi gusto, el coeficiente de capitalización de los bancos que salió de Basilea II se quedó un poco corto, permitió un excesivo apalancamiento. Y, al margen de que se puedan ajustar algunas cosas (cómo se tratan las titulizaciones o las carteras de negociación, los puntos que al parecer están reconsiderando en los esquemas), creo que plantearse una elevación de los niveles generales de capitalización de los bancos sería bastante lógico. En Estados Unidos tienen más cosas que hacer. No han supervisado ni han regulado con el mismo rigor. Pero ese no es el problema de Europa. ¿Fue demasiado permisiva la Fed? Supongo que los supervisores estadounidenses que estaban en primera línea de fuego deberían haber sido más rigurosos con el tratamiento de todo ese papel que estaban comprando los bancos. Pero ¿quién quita la música cuando el baile está tan divertido? ¿En qué medida puede la regulación bancaria anticiparse a las crisis? Es un proceso continuo que he tenido que vivir durante toda mi carrera. Como regulador cubres un agujero, en ese sentido te quedas satisfecho, pero el mercado está siempre ahí. Las crisis siempre han surgido con un nuevo producto, que crece como la espuma, que no parece que vaya a dar problemas hasta que los da. Esta vez ha sido el asunto de originar y distribuir riesgos de los estadounidenses, ese sistema que todo el mundo decía que era fantástico porque atraía nuevos capitales al mercado y diseminaba perfectamente los riesgos según el apetito de cada cual. Mentira, la gente que compró

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no tenía ni idea de lo que estaba comprando. Los productos son tan complicados que es dificilísimo analizarlos con detalle y quienes tenían que hacerlo, las agencias de calificación, no lo hicieron bien.

¿El mercado sabe rectificar? Aprende porque el castigo ha sido muy duro. Y los bancos saben rectificar, se van a fijar mucho en el papel que compren. Y con el modelo de originar y distribuir va a pasar lo mismo. Ahora todo el mundo ha aprendido. Y evidentemente que los supervisores tienen que aprender de lo que ha pasado, y parece que están haciéndolo. ¿Cree que ha fracasado el modelo interno de control de riesgos que propone Basilea II? Basilea II no ha podido fracasar por la sencilla razón de que no se estaba aplicando cuando se generó este problema. Lo que realmente pudo fracasar es una línea de supervisión introducida en la década de los 90, la supervisión cuantitativa, una supervisión de los métodos, del buen gobierno de la empresa. Era una línea de trabajo nueva y ahora lo mirarán con otra luz. ¿Están las autoridades tomando las medidas adecuadas para solucionar la crisis? Creo que en conjunto las medidas son sensatas y habiéndolas adaptado todo el mundo en bloque y sin fisuras, conseguirán lo que se pretende. Hay que cruzar los dedos. Los mercados son muy suyos, hay que suponer que se resolverá el tema. ¿Es esta crisis peor que la del 29? Sólo se sabrá al final. 'Hemos sido pioneros en muchas cosas' No todos los bancos supervisores han sido tan activos como el Banco de España en las últimas décadas. Raimundo Poveda apunta a una característica fundamental frente a otros países y es que 'el Banco de España, a diferencia de otros supervisores, es el que dicta las normas contables de las entidades'. Explica que 'en general, las normas contables las dan las autoridades contables, que tienden a ideas generales que valgan para cualquier situación. Mientras que cuando las normas las da una autoridad supervisora que sabe dónde están los problemas, las normas son mucho más concretas'. Hasta el punto de que la regulación financiera marcada por el Banco de España ha ido a veces mucho más allá de la recomendación general. 'En varias ocasiones, cuando hemos tenido que adaptarnos a las normas internacionales, nos han obligado a rebajar nuestro nivel de exigencia'. La banca se resiste a aceptar normas que la dejen en desventaja competitiva frente a bancos de otros países. 'A veces es cierto, a veces no. A veces puedes mantener parte de lo que has introducido y otras veces tienes que aceptar que hay que igualarse. Fuimos muy ambiciosos en riesgos que considerábamos muy altos, como las concentraciones, como consecuencia de nuestra crisis de los 70 y 80. O en los activos muy volátiles, como las acciones. Ahí pusimos coeficientes más altos que los de la norma internacional'. http://www.cincodias.com/articulo/D/razonable-elevar-provisionhipotecas/20081018cdscdicnd_4/cdspor/

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