A Middle Finger to the American Savers

First, I would like to congratulate myself on two posts in two days. After a year of blogging, I realized that even my virtual free association on economic matters needs to take some time off every now and then. I sense that the blogging vacation is officially over, so back to work I go.

Business Week's article, Why American Savers Have Drawn the Short Straw tells us what we already know; sucks to be us. And by us I mean the savers, today's white unicorn.

Presumably right about now it's the savers who should be rewarded. We lived within our means and ignored the white noise of those big bad institutions who were trying to get us snookered into their own profit making scheme. We paid down/off credit card debt instead of punting it to the moon. We put a little away for retirement, for a rainy day, for a future purchase to be paid in full. And now when everything comes tumbling down, we should be basking in our glory, the proud but silent collective I told you so!

Fat chance.

Even with a current account deficit that, starved of domestic savings, requires $2 billion a day in foreign financing, economic policymakers are fixated on propping up credit and giving the participants in the housing bubble second chances. In order to do so, they are stripping the hides off of net savers.

Since August of last year, the Federal Reserve has slashed interest rates from 5.25% to 2.00%—wielding a blunt instrument that was swung enough to bend the yield curve in favor of suffering banks. You know, the institutions that screwed up but were too big and important to be deprived of an inalienable right to cheap deposits that they can loan out at several points higher.

My ING savings accounts are certainly not keeping up with inflation. I've tapered off what I save to the bare bones because things like groceries and gas are taking a noticeably bigger bite out of my monthly budget. And my Roth IRA is losing money as fast as I'm putting it in. So when I read this morning's WSJ headline announcing that the Federal government is taking over Fannie and Freddie, I'm having an apoplectic seizure in front of my laptop. Sure, I'm a just little guy (or gal, as it would be), my piddling savings isn't propping up nearly half of the outstanding mortgages in this country (like Fannie and Freddie, in case you were wondering why they get the bailout). But seriously. Moral Hazard anyone?

Moral Hazard is a term economists like to banter about; it basically means that if you don't hold companies in check, they think they can do whatever the heck they want. And they do. And the bailout of Fannie and Freddie, and previously Bear Stearns, pretty much fits the bill of creating a moral hazard. Joseph Stiglitz did an outstanding job of breaking down Fannie and Freddie's moral hazard in a recent article for the Financial Times.

Defenders of the bail-out argue that these institutions are too big to be allowed to fail. If that is the case, the government had a responsibility to regulate them so that they would not fail. No insurance company would provide fire insurance without demanding adequate sprinklers; none would leave it to “self-regulation”. But that is what we have done with the financial system.

Even if they are too big to fail, they are not too big to be reorganised. In effect, the administration is indeed proposing a form of financial reorganisation, but one that does not meet the basic tenets of what should constitute such a publicly sponsored scheme.

First, it should be fully transparent, with taxpayers knowing the risks they have assumed and how much has been given to the shareholders and bondholders being bailed out.

Second, there should be full accountability. Those who are responsible for the mistakes – management, shareholders and bondholders – should all bear the consequences. Taxpayers should not be asked to pony up a penny while shareholders are being protected.

Finally, taxpayers should be com­pensated for the risks they face. The greater the risks, the greater the compensation.

All of these principles were violated in the Bear Stearns bail-out...

But the proposed bail-out of Fannie Mae and Freddie Mac makes that of Bear Stearns look like a model of good governance. It sets an example for other countries of what not to do. The same administration that failed to regulate, then seemed enthusiastic about the Bear Stearns bail-out, is now asking the American people to write a blank cheque. They say: “Trust us.” Yes, we can trust the administration – to give the taxpayers another raw deal.

So, I would like my bailout, please. I would like the consumer savings account to have its own interest rate, and I would like it to be at least 1% higher than the rate of inflation. I'm sure this would cause all sorts of problems for Fannie and Freddie, and I'm sure that it is a suggestion only an economic neophyte could make. But think of it this way. Maybe American savers can bail out America, instead of China doing it for us. If only you'd stop giving us the middle finger.

Concisely Painful Economic Forecast

I'm sure it'll be blogged to death, but the NY Times' Uncomfortable Answers to Questions on the Economy is really, really good. And not in its positive outlook, but in its format. Simple questions, concise yet broad answers. What the average person really wants to know about what the hell is going on out there, but was afraid to ask.

Is This a Recession? Who knew some private institution was the semantic god of the big "R" word, no wonder economists are arguing over are we or aren't we ad nauseum. So the Economic Bureau of Economic Research says no, most others say yes. The article breaks down why.

How Bad is Housing? The article is fantastic when it talks about housing. They break it down, and the gravitational free fall isn't over yet. Economists expect another 10-15% drop in housing prices, and there's currently enough homes on the market to satisfy 2+ years of demand, without ever having to build another. I'm no real estate guru, but that sucks tailpipe.

When Will Banks Revive? $300 billion in write offs with an expected ceiling of $1 trillion. Those numbers are so off the charts they mean nothing to me. Other than someone made a $h*tload of money f@ck*ng up. Again, the article does a short and sweet breakdown, but you read stuff like that and you just want to go out and kick some banker butt.

Is My Job Safe? It aint over 'til the fat lady sings, and she's not even warming up yet. We're workers in an economic Jenga, and pile that on with wallet busting gas prices, 5% overall inflation, lower wages-- it's a bleak picture. That said, "only" a few hundred thousand more workers will lose their jobs. “In every dimension, people are worse off than they were,” said Mr. Roubini, the New York University economist. In a market of millions, cross your fingers and hope your job has nothing to do with the housing market.

Are Consumers Done? and the last question, an American favorite, Who's to Blame? This is the part that's horrifying. Consumer spending counts for nearly 70% of all economic activity. Are ya kidding me?? My take is, you can't have your cake and eat it too. I don't care where you got your MBA from. You can't feed the American consumer indigestible food, watch them puke it up, and blame them for the mess. Look, obviously as a PF blogger I have my issues with those who spend beyond their means. But get real. The blame goes high and low, and pretty much nobody is unscathed. And that's the part of the article most painful. Yes, we all did this to ourselves, but we sure had some help along the way.

Income Gap By State

An article in today's Times, Income Gap in Connecticut Growing Fastest, Study Finds, marks CT as the place not to be if you are poor. Put NY up there as well (highest income gap among 50 states), and certainly DC (highest income gap, period).

The newly released study took family incomes from 2004 to 2006, and compared them to an inflation adjusted period of 1987 to 1989. The study is not so surprising; everyone knows that minimum wage hasn't moved in tandem with market wages. While CT's spike of a 45 percent increase for its top fifth of households is not a shocker (I've seen those Land Rovers on the Merritt Parkway), it is a little bit of a WTF that the bottom fifth actually dropped 17 percent.

Some other sobering stats:

New York had the highest income gap among the 50 states in 2004 to 2006, according to the study, with the top fifth earning an average of $148,200 a year, or 8.7 times the $17,100 income at the bottom. Connecticut ranked seventh and New Jersey, where the rich earned 7.5 times what the poor did, was 14th. (The rankings did not include Washington, D.C., which had by far the biggest income gap, with the rich earning an average of $188,500, the highest income in the country, 13.5 times the poor’s $14,000 average.)

The study’s authors adjusted family income for federal taxes but not state and local taxes. So the study may not accurately capture the gap in high-tax states like New York that tax high earners for the benefit of those who are struggling.

Of course, the article goes on to make brief mentions on tax policy. I am no expert on taxes, but I like that NY taxes its high earners. What I don't like is that NY state spends more of its tax dollars on its prison industry than its universities. See, the thing about tax policy chatter is that it fills the room with a lot of talk about how a state gets money, rather than what the state does with it. And that's one stunted conversation on tax policy.

Credit Crisis: A Who's Who Guide

The San Francisco Chronicle recently listed A Rogues' Gallery of Credit Crisis, for those of us confused as to who, exactly, is burning down the house of cards.

My personal favorite;

Wall Street's Nero: Bear Sterns' gruff ex-CEO James Cayne made a big bet on the mortgage market and then fiddled around at bridge tournaments while his company burned through billions of shareholder value. JPMorgan Chase & Co. steals the company once worth $169 a share for $2 a share after it helps with the government bailout.

It mentions Greenspan as the "Ultimate Fall Guy", but I'm not so sure about that. I need to finish reading his book, and maybe brush up on some economic theory (who said life is without its small pleasures) before I get off the fence on that debate.

Shop 'til you Drop- A Lesson in Math

Barbara Ehrenreich's article at The Nation, The Fall of the American Consumer, is a requiem for the world's number one economic piston.

While Americans search for interview outfits in consignment stores and switch from Whole Foods to Wal-Mart for sustenance, the world watches tremulously. The Australian Courier-Mail, for example, warns of an economic "pandemic" if Americans cut back any further, since we are responsible for $9 trillion a year in spending, compared to a puny $1 trillion for the one billion-strong Chinese. Yes, we have been the world's designated shoppers, and, if we fall down on the job, we take the global economy with us.

Wow, nine trillion dollars. Let's hazard a guess and say there are approximately 217 million Americans 19 and older. That's an average of $41,475 in spending per year per adult; that's a lot of spending. Of course, it's not an accurate illustration for obvious reasons (adjust the number for age and class), but nine trillion is too hard a number to comprehend. Our consumer spending is about 70% of our GDP, a standard measure of the size of an economy.

GDP = consumption + gross investment + government spending + (exports − imports), or,
GDP = C + I + G + (X-M)

Don't say I never told you nothin'!

Well, patriot that I am, I'm going to an outlet mall with a friend on Tuesday :)

US to China- My Dollars Are Your Dollars...

In honor of The Atlantic.com now free, I thought I'd bring you a recent James Fallows article, The $1.4 Trillion Question. It's an article about China, and that age old story about the Chinese buying our debt so we can live beyond our means. The article is intriguing, though, because it questions just who, exactly, is getting hustled, and how like all good hustles, it can't last forever.

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China. Like so many imbalances in economics, this one can’t go on indefinitely, and therefore won’t. But the way it ends—suddenly versus gradually, for predictable reasons versus during a panic—will make an enormous difference to the U.S. and Chinese economies over the next few years, to say nothing of bystanders in Europe and elsewhere.

My favorite part is how is breaks down the process by which dollars go from the US, to China, and back-- personified in an Oral B toothbrush purchased at a CVS. The flow of currency is fascinating, and Fallows does a great job of keeping it that way.

While the article is long (4 web pages, so longer than Kiplinger's but shorter than the Sunday NY Times Magazine...), it is easy to understand. When it comes to currency policy and politics, easy to understand is good by me.

1881 US Silver Dollar photo by Lone Primate via flickr

Our Work Is Not Done

Now, when I say questioning the whole society, it means ultimately coming to see that the problem of racism, the problem of economic exploitation, and the problem of war are all tied together.

-- Dr. Martin Luther King speech at the 11th Convention of the Southern Christian Leadership Conference on August 16th, 1967

Dear Foreign Investors- We're on Sale!

In today's NY Times there is a great article-- Overseas Investors Buy Aggressively in U.S.

For much of the world, the United States is now on sale at discount prices. With credit tight, unemployment growing and worries mounting about a potential recession, American business and government leaders are courting foreign money to keep the economy growing. Foreign investors are buying aggressively, taking advantage of American duress and a weak dollar to snap up what many see as bargains, while making inroads to the world’s largest market.

We're talking huge sums here, last year alone was $414 billion, or a quarter of "all announced deals". Frankly, I think it's globalizations karmic retribution that's kicking us in the pants right now, and thank god because clearly our economy needs money from somewhere. After years of American companies snapping up factories, labor, and land in currency depressed nations, the world is returning the favor. And in economic irony- NAFTA, that trade agreement that allowed the US to bum rush Canadian and Mexican markets with it's big bad dollar and superpower-like economy, is now luring foreign investors into our market. If they own our companies, they enjoy the same open trade borders.

I wrote about sovereign welath funds a while ago, and certainly there is a ton of this foreign government investment vehicle in the mix, but it is not the majority of the money. The article refers to it as a trickle. Still, the nationality of foreign investors can ruffle some Buy American feathers. In an attached multi media graphic, the top spenders in announced mergers and acquisitions last year were (in descending order) Canada, Britain, Australia, Spain, Germany. The UAE follows, then Saudi Arabia, with China ranked 14- all of whom invested significantly less than the top three. The bruhaha about these three countries may be that in 2000 they were not even on the charts.

For many, it is a complicated pill to swallow.

Five million Americans now work for foreign companies set up in the United States, Mr. Kimmitt said, and those jobs pay 30 percent more than similar work at domestic companies. Nearly a third of such jobs are in manufacturing, which explains why Rust Belt states have been wooing foreign investment.

“We’ve lost 400,000 manufacturing jobs,” said Michigan’s governor, Jennifer M. Granholm, a Democrat, who has traveled three times to Europe and twice to Japan in pursuit of investment since taking office in 2003. “I’ve got to get jobs for our people.”

Some labor unions see the acceleration of foreign takeovers as the latest indignity wrought by globalization.

“It’s the culmination of a series of fool’s errands,” said Leo W. Gerard, international president of the United Steelworkers. “We’ve hollowed out our industrial base and run up this massive trade deficit, and now the countries that have built the deficits are coming back to buy up our assets. It’s like spitting in your face.”

Given the state of our economy, this level of foreign investment will only rise. The fact is, we need the money, and it's a prudent long term investment for them. They're buying blue chip companies in a blue chip market at a seriously steep discount. And honestly, it doesn't bother me. What does bother me are the economic and political forces that tanked our economy to begin with. And for that, the US has nobody to blame but itself.

NASA photo by TopTechWriter.US' via flickr

Battle of the Sweaters

I'm reading yesterday's WSJ because yesterday I got sucked into the virtual vortex known as Facebook. Yes, I exert no self control over my laptop. So this morning I'm catching up on the news, and I came across an interesting article on the battle of two cashmere (a fancy word for Mongolian goat hair) sweaters. One is Land's End and cost $99.50 before shipping and handling. The other is Brunello Cucinelli and cost $950 before tax and valet parking at Saks Fifth Avenue in Beverly Hills.

While quality and feel is marginally better with the more expensive cashmere sweater, the cut and style is far better with the $950 sweater. Also, the author received no compliments on the Land's End sweater. Which, really, comes as no surprise. It's not like Land's End makes an appearance in Bryant Park during Fashion Week. And while neither do places like H&M, their bread and butter is knocking off the runways.

I was fascinated with the re-tracing of the journey from Mongolian goat, to bales, to auction blocks, to Chinese factory floor or 17th century castle in Italy. Land's End made opaque references to quality control and high standards, without offering information on the exact whereabouts and specific conditions of its factories in China. Small nation that it is. On the other hand, Cucinelli details the work hours, 90 minute lunch break, and invites the author to visit the factory.

I have to continually remind myself that while I am paying for the quality of item purchased, I am also paying for the quality and conditions of those who make what I buy. Grotesquely large CEO compensation aside.

photo by nozomiiqel via flickr

The Federal Reserve, What Is It Good For!

I was reading the headlines this morning, and I can save you the trouble of doing so yourself. Economically speaking, it's all in the crapper. Dollar disappoints, growth will be slower than expected (and you can be assured those expectations weren't exactly Himalayan), various big companies report disappointing earnings, another bank is feeling the pain of sub-prime mortgage hangover, and the Fed is doing this and that. Which got me thinking, what exactly does the Fed do and why does everyone care so much?

Okay, so I know a vague answer. But not enough to post on it, so I thought I'd take a stab at it. And hours of online research later, here we go... The US Federal Reserve was started by my buddy, historically speaking, Alexander Hamilton. You gotta love a guy that was an orphan and an immigrant (just like me!), a born-out-of-wedlock leading architect for both the US Constitution and the US economy, a Revolutionary War hero who fought alongside George Washington at a time when wars were fought with bayonets, and a New Yorker with a gun and a slow draw at an inconvenient time. Nevermind the fact that the Federalist Papers are nothing to sneeze at. I bring up Hamilton because the beginnings point to the present.

The American Revolution was largely fought over economic reasons, one of which was the right of the colonies to print their own currency (denied). To say that after the American Revolution the economy was in shambles is putting it lightly. To fight the war, practically starving minutemen were robbing and stealing from households as they marched along. The war was financed by the printing of Continentals, and to keep up with expenses they just kept printing and printing like the Energizer bunny. By the end of the war a Continental was worth one thousandth of its nominal value. It's like leaving home to go shopping with a thousand dollars in your pocket, and by the time you get ready to pay it's magically been reduced to a one dollar bill. The chaos between creditors and lenders was more than dramatic, it was often violent. During colonial times, actual British currency was scarce (hence wampum and certificates for tabacco), the Spanish peso was widespread, and after the flood of Continentals it was all a mess. The US Federal Reserve was created to bring peace and harmony to an economic mudslide. It is a role it competes for to this day.

The Federal Reserve is the central banking system of the United States, who first and foremost directs the traffic of money flow. And here's the part where you can lose interest. So let's talk about the here and now.

Open market operations- If the Fed sells US Treasury bonds, people like your grandma will buy a bond and for the next fifty years, or however long it takes you to find where you hid it, that money she handed over to the gov't for your bond is out of circulation. This would help curb inflation's enthusiasm. The formula goes like this, when the Fed buys government securities (ie you finally found Grandma's bond and want to cash it in) it is putting money into circulation, so there's more money around, interest rates go down, and more money is borrowed and spent. The reverse- when the Fed sells a bond to your grandma, Grandma's money is taken out of circulation, interest rates go up so it's harder to borrow money and spend. Substitute Grandma's bonds with China's US Treasuries, and we're talking our entire federal budget for years on end. In other words, some unfathomable amounts of currency are put in and out of circulation.

The alteration of reserve requirements. Yikes, there's a mouthful! The Fed decides what percentage of a bank's (ie Citibank) deposits must be held in reserve at a Federal Bank (there are 12 scattered around the country). The percentage only applies to transaction accounts, like your checking account, not savings and time deposits (CDs). The reserve requirement is currently 10% for big banks- so again it is a way to remove money from circulation, which theoretically means lower inflation. I say theoretically because banks can pay the Fed a premium to borrow the reserves it needs, but that's another story.

And most famously, the Fed decides key interest rates. I won't get into them all because my poor brain is tired by now (and hooray to you for reading this far!), but the most famous one is the recent spotlight hog, the nominal federal funds rate. Remember that previous 10% I mentioned? Private banks lend money to to each other, yes it's just a one night stand, and it's that interest rate that has everyone's panties in a jam. Which is why you hear phrases like key short term interest rate that impacts consumer loans.

So what's the big deal? Well, if you lower the rate at which a consumer can borrow money you supposedly let us all go hog wild and shop until we drop. Which is exactly what we've seem to have done (that would be the headlines about consumer spending slowing down). The other thing, banks make big money loaning each other money overnight. And you thought it was your direct deposits. So when things like "credit crunch" and "liquidity fears" are tossed around, you better believe that the rate at which they can borrow money is important.

So that's the long and the not at all short of it. Now you know why the news just says "The Fed lowered the interest rate"! There are much more informed individuals out there who can wax mathematical poetic on the rate cut (feel free to chime in), and there's plenty of basics I still don't get. But with an unkempt economy, any action of the Federal Reserve is both an ongoing discussion and, apparently, a lesson for me in economics.

The Haves and Have Nots

The leading factoid in The Atlantic's "Primary Sources" reveals that more and more Americans are Doubting the Dream.

Americans doubt that they live in a land of equal economic opportunity, according to a new study from the Pew Research Center. It reports that Americans are nearly twice as likely as they were 20 years ago to describe the country as divided between haves and have-nots. This change is particularly significant, the authors argue, since Americans have traditionally “turned a deaf ear” to narratives of class warfare, seeing individuals— not society—as responsible for their economic fate.

It used to be that middle class meant comfortable. In 1988, 68 percent of middle class Americans counted themselves among the haves. Today, that number has dipped to less than half, resting at 43 percent. But as the article points out, it's a poll on self-perception. The middle class hasn't shrunk as much as their ego has. What is more interesting to me is to ask why the categorical shift?

You can read the Pew report here.

Performance Pay, Irregardless of Performance

The New Yorker's latest Financial Page article, Performance Pay Perplexes, looks into the obscenely large amounts of pay market movers and shakers are raking in. A quick glance at the headlines will let you know that performance pay isn't quite working right now.

The havoc on Wall Street following the collapse of the subprime-mortgage market boils down to a simple truth: for years lots of very smart people took lots of very foolish risks, betting borrowed billions on dubious mortgage derivatives, and eventually the odds caught up with them. But behind that simple truth is a more surprising one: the financial whizzes made bad decisions in part because that’s what they were paid to do.

The article is interesting because it breaks down just how things get paid out. Hedge fund managers, for example, get 2% of asssets under management as their fee, plus they get to keep 20% of the profit (above a certain benchmark). Problem is, their bonuses are obviously not exactly return to sender, and so the next year when the fund tanks they're sitting pretty on forty million. He also breaks down CEO compensation pay.

Not surprisingly, a recent study of almost a thousand companies by the management professors W. Gerard Sanders and Donald Hambrick found that C.E.O.s whose compensation was made up mostly of stock options tended to “swing for the fences,” making investments and acquisitions that were riskier than those made by other executives. As a result, the performance of the companies run by the risk-takers was far more volatile, and not for the good of the companies: the risky strategies were more likely to end in a big failure than a big gain.

Essentially, the payoff for hitting that big score is so astronomical, and the chance of financial risk hitting their own pockets is pretty nominal. Hello, market cluster f*¢k. In this day and age, I'm sure we would all love those odds.

Sovereign Wealth Funds

I have long assumed that foreign governments use their trillions of US dollar currrency to buy our debt. China (whom the US consumer throws dollars at like money really does grow on trees) buys approximately one billion dollars of US treasury bills a day. However, this morning I was reading an article online by Joshua Kurlantzick that detailed what he referred to as "the next big market catastrophe"- sovereign wealth funds.

Governments have piles of US dollars and US consumers pretty much drive the world economy. Our voracious appetite for objects and oil is not going anywhere. When we buy goods in US dollars, foreign companies, and therefore banks and therefore governments, then have trillions of US dollars that are worthless as is. So they invest it. US treasury bills are issued by our government to pay for the things we can't/won't afford. They are secure and have various interest rates. Not high, but high enough that interest on a few trillion dollars worth will fund your own government quite nicely.

Sovereign-wealth funds, however, are using their monetary reserves to buy shares of foreign companies. Kurlantzick notes that they have an estimated worth of two times that of every hedge fund put together. The government used funds of Norway have transparency. The government used funds of Russia do not. Imagine China having its own hedge fund, investing trillions of dollars and euros without any international regulatory control, accountability, or transparency. The world markets suddenly look three sheets to the wind in unpredictability.

"If a fund backed by the Chinese government invests in an oil deal in Africa or Asia, is it making the same profit/loss calculations as, say, ExxonMobil, or is it investing because Beijing's leaders desire that asset, making it impossible for another company to compete for the deal? Did Russia buy into Airbus because it thinks the aerospace firm is a good deal or because the Kremlin wants to have more power over Western Europe through this company? If the fund owned by the United Arab Emirates invests in a defense company, is it trying to gain military technology for the UAE, potentially upsetting the balance of power in the Middle East?"

We should all be thankful that the US government has no room in its budget to do the same.