Economic Policy

Listen Up Investors: You’ve Been Very, Very Bad

The President’s Working Group on Financial Markets has figured out who is to blame for our current financial turmoil, and it turns out it’s you! That’s right. Buried deep in the twenty-one page report are several paragraph chastising investors for not disciplining the markets. Spare the rod, spoil the boom!
“Although market participants had economic incentives to conduct due diligence and evaluate risk-adjusted returns, the steps they took were insufficient, resulting in a significant erosion of market discipline,” the PWG report states.
To remedy that situation, the PWG would like regulators to require investors to “obtain from sponsors and underwriters of securitized credits access to better information about the risk characteristics of such credits, including information about the underlying asset pools, on an initial and ongoing basis.”
Masked under that bureaucrat-speak is a bit of government planning. It may now be clear that investors undervalued information about structured credits. But that tells us preciously little about what the “right” level of information should be in the future. And it’s trickier than you might think to get an answer. Require too little information, and you risk another round of malinvestment from investors made over-confident by false bureaucratic assurances. Require too much information, and you wind up damaging returns on investment by increasing the cost needlessly.
It’s a shame we can’t have some kind of market process to work out this kind of thing.
Policy Statement on Financial Market Developments [Wall Street Journal; pdf file]

stock market dow.jpgBetween the weather and recent volatility, the roads out to the Hamptons today are unusually free of traffic. It’s seems lots of people are still at their desks trying to figure out what to do in a market that swings back and fourth hundreds of points in just a few hours.
While the stock market this morning has rallied from it’s initial downward plunge, some traders are worried the rally is too coming too early. “There’s still time for a huge dive,” one nail-biting trader who says he was buying this morning’s dip told us today. “I should have taken the whole day off. Fridays are miserable.”
Others are more confident. “Look, the Fed statement and all the central banks injecting liquidity are changing Mr. Market’s state of mind. People are confident that the powers that be are watching. Cramer can stop screaming. They’re listening,” one small-caps equity trader told us.
But not everyone thinks that recent central bank moves are a good sign. Some are worried that it may be a sign that the central bankers know things are even worse than they seem. “There’s no liquidity problem, as far as I can see. There’s plenty of money out there. This talk of ‘unusual funding requirements’ makes me think the Fed expects a run on the banks,” said yet another source who asks us not to name him.
Others have cited a quite different concern: that promises of additional liquidity to stabilize markets may create unrealistic expectations of moves like an emergency rate-cut. These expectations could inflate asset prices, it is feared, and lead to an even bigger crash when they prove unfounded.
The head of the Ludwig Von Mises Institute thinks that recent events may bolster the prospects of Republican presidential hopeful Ron Paul. “Now we are at the beginning of a worldwide financial crisis, of exactly the sort that Ron Paul has warned about,” Lew Rockwell writes. “Will the Fed and the other central banks be able to delay the inevitable, or will this be a worldwide washout? I fear the latter, and if so, it is Ron Paul’s secret weapon.”
He continues:

In a global economic crisis, who do you want in charge of the White House? One of the crazy commies in the Democratic party, or one of the spendthrift fascists in the Republican party?
Or do you want a sober, learned doctor who knows why we’re sick, and just the cure for us? That is: sound money, balanced budgets, lower taxes, less government.
We are in for a wild ride, thanks to Greenspan, Bernanke, and the rest of the gang, not to speak of much suffering.

Rockwell is obviously an enthusiast for Paul. But even he has to admit that back-testing theory that an economic crisis leads to libertarian politics doesn’t quite work.
“The last time this happened, Americans chose our first fascist president, who took us to welfare, central planning, and war,” Rockwell writes.
Ron Paul’s Secret Weapon []

Well that didn’t last long.
Yesterday when Fox News business guy Neil Cavuto asked President George Bush about the sub-prime mortgage market meltdown, the president replied that the US was “suffering from an excess of capital, I mean, liquidity.”
But the president sounded a very different note when he was asked a similar question just moments ago in the press conference now underway at the White House, Instead of citing excess liquidity, the president focussed on the question of whether there was enough liquidity.
“Another factor one has got to look at is whether there is another liquidity in the system to enable markets to correct,” Bush said. “And I’m told there is enough liquidity to enable markets to correct.”
As we noted in Opening Bell this morning, yesterday’s remarks from the president echoed the arguments of the Austrian school of economics. Many economists working in the Austrian school have argued that the boom-and-bust business cycle is set off by central bank monetary expansion.
For a few hours, it seemed that America had suddenly discovered it was being led by a president schooled in the Austrian theory of the business cycle. “Has Dub-Yuh broken his habit of never reading anything, even the newspapers, and picked up a copy of America’s Great Depression by Murray Rothbard for his summer vacation reading?” economist Thomas DiLorenzo asked on the blog at
Or perhaps he has been reading Barron’s, which recently described the Austrian theory:

In the Austrians’ staunchly free-market ideal, if central banks peg the cost of credit below its natural rate, it results in an excessive credit expansion and inflation, which includes asset prices. Rising asset prices result in bubbles and malinvestments, which invariably lead to busts in direct proportion the preceding bubble. The only solution to the bust is to ride it out, allowing prices to fall and the assets to liquidate, permitting the capital that has been misallocated to be put to more productive uses.

This morning’s remarks, while not calling for a credit expansion, clearly pointed away from the risks of too much liquidity to the risks of too little liquidity. It was a change of emphasis. Someone, it seems, has given Bush a stern talking to. With the European Central Bank injecting $130.5 billion of Euros into the markets and the Fed making smaller moves to increase liquidity, the message of the central bankers is certainly not of the Austrian school.

Hedge Funds, Private Equity Under International Pressure

globe1.jpgIt’s no secret that political pressure to regulate some of our more high-flying financiers has been mounting recently. From recent Senate hearings on hedge funds, a Justice Department investigation into private equity club deals, the Connecticut Attorney General’s hedge fund task force, the Connecticut banking regulators new hedge fund unit to legislation recently passed ordering a study into new federal hedge fund regulation, the writing has been on the wall. And hedge funds and private equity shops are starting to respond by forming their own advocacy groups to lobby regulators and lawmakers and launching law suits in US courts.
That’s all well and good. It’s the normal process of American politics. Politicians, regulators and lobbyists were bound to respond to the opportunities presented by events like the Amaranth collapse to enhance their power and prestige. Public ignorance of financial markets and government operations would allow the fear-mongering exploitation by political jobbers. Some of the larger and wealthier financiers would sense an opportunity to burden smaller competition with ungainly regulatory costs. And, of course, enough money is being made in New York and Connecticut that eventually some of it is going to have to get siphoned off to campaign funds and lobbying groups. This is, after all, still a democracy.
But what is the financial community going to do about the new pressure for regulation starting to emerge from international bodies? In the last two-days we’ve heard concerned noises about hedge funds and private equity from both the future head of the G8 economic group—Germany—and the United Nations. As it turns out, in many parts of the world the increase in foreign investment and cross-border deals isn’t seen as universally enhancing efficiency and spreading wealth. In Germany, for instance, private equity shops are affectionately known as “locusts.”
So how do you lobby the G8 or the UN? Where do you go to court to get international regulations overturned on constitutional grounds? Who do you pay off to keep these political jobbers out of your coffers? Does the rise of global finance require the rise of some sort of global governance? There are (or will be) answer to these questions. Answers we all may be discovering soon enough.
Private Equity Has Few Friends Abroad, Report Finds [DealBook]

Germany Wants G8 Summit to Consider Hedge Funds

President George Bush has hunkered down with people who are not in charge or war or foreign policy for a couple of days. They’re meeting at Camp David because, well, probably because no-one wants to go to Texas in August. We weren’t invited to the event but we’ll be covering it anyway.
11:00. It’s Friday in August. Why is George Bush making any sort of appearance at all today, much less comment on economic policy? We’re pretty sure we’re the only ones watching this thing right now.
11:17. Running behind schedule. Bush was supposed to step up to the podium already. This is getting weird. Bush is usually pretty punctual. Is he running on Clinton time these days?
11:22. Hey. It’s inching toward noon. Doesn’t Bush know people have places to go? It’s going to rain in New York on Sunday. We’ve got to get to the beach tonight or the whole weekend is going to be a bust.
11:32. There he is. No tie. Crisp shirt and pale grey suit. Hair is looking a bit shaggy. George Bush is an ordinary guy. Like the rest of us, he lets things like haircuts go by the wayside during the summer.
11: 35. We’re paranoid today so we are having trouble listening to George talk. Instead we’re thinking about the start time of this thing. What’s significant about 11:32. Well, 1+1=2. So let’s say he began at 232. Now reshuffle those numbers and notice that they are 322. These numbers are famously code for Skull & Bones, the secret society at Yale feared by conspiracy theorists everywhere. Is George sending a secret message to the kids at Deer Island? Hello, boys. I haven’t forgotten you!
11:38. Bush looks very unhappy. Furrowed brow. Frown. What has the econ team been doing to him this morning?
11: 40. Time for questions. First up: Lebanon. George seems very subdued. He wanted to talk about the economy but all anyone wants to talk about is the Middle East and terrorism.

Bush keeps using the word ‘sober.’ What’s that all about? Did someone show up at Camp Econ smelling like last night’s party?

We’re on to Syria and Iran. Someone shouts a questions about whether France will send troops to Lebanon. Bush responds: “France is a friend. France is an ally. France has got a great steak.” Who knew Bush had a taste for Freedom cuisine?
11:43. Wait. He said a “great stake.” As in France has a stake in what happens to Lebanon.
11:45. It’s all war and foreign policy now. That’s all the press corp is asking about? No taxes, no entitlements, no trade or immigration policy? What’s that about?
11:46. What happened to George’s eyes? We swear he used to have them. Now it’s just tiny slits.
11:47. Over already. Fourteen minutes and done. George seems annoyed that the reporters kept asking about the middle east. Clearly Bush wanted to talk about the economy and the press corp couldn’t care less. As he walks away he’s flanked on his left by Dick Cheney and on his right by Hank Paulson. Hank, by the way, is wearing a snazzy blue blazer and khaki pants. You can take the banker out of the bank, but you can’t take the bank out of the banker.

Bush Discovers He Has An Economic Team

bushandpaulson2.jpg“Good guy, Hanky-panky,” Bush no doubt began this morning’s economic summer camp meeting at Camp David. “I assume you all know each other. I won’t bother with the names. Rummy says it’ll just distract me from Iraq/Lebanon/Syria/Iran.”

Bush to Meet With Economic Team
[Washington Post]