Macro Level Resolution Strategies per the Ongoing Financial Systems Crisis of 2008

Just a few thoughts and possible resolution strategies (in outline format) to consider per the current financial system crisis from a concerned long-term investor, citizen, and voter.  And from an Independent’s perspective, the political players from both parties don’t seem to be focusing on real solutions, just the problems and the resulting finger-pointing (or “blame game”) that occurs.  Note: In terms of presenting a macro causal analysis for this financial crises, private sector lenders issued risky home loans to buyers who could not afford them, which they then sold to Wall Street financial institutions as bundled, mortgage-backed securities that eventually became worthless with the downturn in the housing market. As a result, the heavily leveraged financial institutions became overly susceptible to the collapsing asset class, leading to a liquidity crisis, a disturbance of bank lending, and an overall global contagion.

I. Short-Term Macro Level Strategies to Mitigate Current Crisis (note that some of these strategies are now being implemented in some fashion) –

1). Continued Implementation of timely “lender-of-last-resort” measures by central banks are needed in order to mitigate the current credit crisis before it spirals completely out of control.      

1a). Immediate, large-scale damage-control measures are needed in order to restore the public’s confidence in financial markets and institutions.            

1b). Organized bailout programs by central banks across the globe are needed in order to reduce the overall amount of help and costs involved (i.e., the quicker the better in terms of lowering costs).

2). Aggressive actions required on the part of central banks and governmental agencies in order to mitigate the seizing global credit crisis include the following:

2a). Continued cutting of short-term interest rates and increasing the amounts of loans made available to banks via auctions in order to maintain fluid liquidity levels.            

2b). Force remaining lenders to extend low “teaser” rates on ARM based loans that have been given to sub-prime borrowers.           

2c). Force remaining lenders to restore partial homeowner equity to sub-prime mortgage holders having negative equity in order to forestall the foreclosure rates.           

2d). Continued swapping of Fed funds (e.g., Treasure bills, etc.) for “Level 3” securities from struggling financial institutions in order to provide them with necessary liquidity.            

2e). Permanent providing of emergency loans to the remaining investment banks, with the resulting increase in regulation that should go with it (i.e., like that required for commercial banks).           

2f). The establishment (ASAP) of an organization similar to the former Resolution Trust Corporation of the S&L days to use taxpayer funds to buy out the worst sub-prime loans.  Note: When the current credit crisis finally does ease up, central banks will then need to expedite reverse monetary actions designed to prevent the reintroduction of market speculation using “cheap” money.  

II. Long-Term Macro Level Strategies & Proactive Regulatory Measures –

1). Implementation of  stricter governmental regulations for securitized mortgage loans.            

1a). SEC directed revamping of underwriting standards to reduce the chances that credit risks will be underestimated, which in turn will reduce the overvaluing of securitized sub-prime loans.            

1b). SEC led mitigation of regulatory capital arbitrage attempts in the securitization process by enforcing the maintenance of minimum capital requirements by financial entities.            

1c). SEC led mitigation of “safety net” and risk transfer abuses in the securitization process.

2). Require that mortgage loan originators hold bigger equity positions in the securitized packages and that banks issue “covered” bonds backed by securitized mortgage loans in order to keep the risks on  their balance sheets.

2a). Increase involvement of criminal investigation agencies in the securities arena to mitigate the misrepresentation of the quality of mortgage loans in securities filings by financial entities. 

2b). Implementation of more stringent licensing requirements for mortgage brokers and tougher mortgage lending standards, including enhanced risk management practices by lenders.

2c). Implementation of more stringent disclosure and write-down requirements for financial institutions, as well as an increase in the monitoring of their “capital adequacy”.

2d). Consolidation of the different governmental finance agencies into a financial oversight “super” agency designed to rate sub-prime mortgages and financial securities per their safety levels.

2e). Establishment of well defined roles for the International Monetary Fund (IMF) in terms of its serving as a bailout agent for emerging market countries experiencing financial difficulties.            

2f). Need to mitigate any moral hazard issues that could arise due to IMF intervention (e.g., an increase in risk-taking activities by the governments of the countries being assisted, etc).            

2g). Complete banning of Alternative-A type mortgage loans, which require little or no documentation on a borrower’s wealth or income, resulting in abuses on the part of mortgage brokers.

3). Establishment of new generally accepted auditing standards (new FAS rulings) designed to force financial entities to start valuating their investment instruments (e.g., CDOs) using market based measures rather than their own pricing models, along with the reform of the credit rating agencies.

3a). Mortgage based securities should be strictly booked as “marked to market” from an accounting standpoint instead of “book” value in order to help mitigate the blatant overvaluation of the underlying collateral assets.

3b). Mortgage securities packages should be categorized and split into different “tranches” based on their differing levels of certified risk for both investing and auditing purposes.

3c). Tighter regulation of credit rating agencies (e.g., Moody’s, S&P, et al.) by the SEC and Congress.

3d). Credit rating agency reform acts are needed to mitigate the overrating of tenuous capital structures being passed as investment grade securities &d to enhance agency quality control measures.

3e). Recourse measures should include the suspending of credit rating agencies that continuously propagate inaccurate (“pumped up”) ratings due to the conflicts of interest involved with the issuers.

3f). The compensation method for credit rating agencies needs to be changed from that of being paid by the issuers of structured debt products to that of being paid by investors to eliminate conflicts of interest.

3g). Credit rating agencies should be required to decline credit rating services for exotic types of securities that have no performance records to track.

3h). Credit rating agencies should also be precluded from having exclusive access to non-public investment information.

Agency Note:  SEC chief Mary Schapiro has now called for sweeping industry changes at a roundtable meeting as credit ratings agencies have been thoroughly blasted for not warning about the risks of subprime mortgage securities. Moody’s, Standard & Poor’s, and Fitch dominate the industry: one proposal calls for a governmental ratings agency that would compete with these three firms.

3i). Central banks should have quickly executable, pre-approved contingency plans “in place” for when unexpectedly large write-downs by financial institutions occur in the future.  The immediate availability of liquidity measures and the continued identification of potential merger partners for failing financial institutions is key here.

3j). Tighter regulation of the corporate auditing function by the SEC & Congress.  If necessary, the corporate auditing function may even need to be “nationalized” to become entirely a governmental function in order to eradicate the inherent conflicts of interest that currently exist between corporations & the private auditing/consulting firms that they employ on a high-fee basis (i.e., need to reduce the risk of over-inflated equity valuations based on creative accounting measures, etc).

Note: These macro strategies were initially conceived of as part of my section of responsibility for a group project/presentation in a graduate level finance course at the University of Houston (i.e., FINA 7340 – Financial Markets & Institutions).

Click on URL to link to a recently published NYU Stern working group paper that provides excellent insights on viable, real-time solutions for financial reform:  http://govtpolicyrecs.stern.nyu.edu/docs/whitepapers_ebook_full.pdf

Administration Vows to Get Tough with China?

Due to the large amount of U.S. government debt currently being held by China, we are pretty much at its mercy and remain beholden to it as one of our largest (i.e., most manipulative) debt holders.  This is not a good position to be in!  We can make demands and issue hollow threats all we want, but when we need to borrow more money or refinance the huge debt of ours that the Chinese currently holds, then we end up having to acquiesce to doing things their way again (i.e., the same old broken record).  Insisting  that China should implement the same types of labor laws, products pricing mechanisms, and currency regulations that put us in an uncompetitive position in the global economy is laughable when they are the major holder (i.e., manipulator) of the U.S. government’s debt.  The U.S. dollar itself is also a potential hostage here as China’s large $2.45 trillion collection of foreign exchange reserves consists of a tranche of U.S. dollars that makesup approximately 67  percent of the entire collection, giving China some absolute leverage over the USD’s value should it decide to make significant “policy” changes.

So, per the old saying “Those who pay ($) have the say”, China is definitely in the driver’s seat in terms of driving the global economy; they are definitely beating us at our own game.  I assume that Richard Nixon and Henry Kissinger never foresaw this in their wildest dreams when they implored Maoist China to open up to the West in the early 1970’s.  The recent paradigm shift over there has been amazing; I just keep waiting for their oversized (and state induced)  bubble to pop.  If and when it does, then watch out rest of world as the resulting collateral economic damage will be widespread!

For Teens, Bleak Job Picture Not Looking Brighter?

American teen jobless rate hits 26 percent in worst summer season since 1940s –

In taking a trip through the Boston and Cape Cod areas this summer, I was amazed to see that just about all of the restaurants and bars (and hotels as well) were being manned by eastern European youths.  With our unemployment rate being so high these days (and getting worse), why are we allowing young people from eastern European countries to come in and take away jobs (and training) that traditionally have gone to our American high-school and college aged youths (i.e., who remain unemployed and untrained)?  Either we resolve to train and employee our American youth for these types of jobs, or we should quit all of the complaining about their high unemployment rate and let the folks from overseas continue to come in and run everything in the hotel/restaurant industries, etc.

Click on URL below for link to referenced msnbc.com’s business story:

http://www.msnbc.msn.com/id/38666248/ns/business-eye_on_the_economy/

Cuba Updating the State’s Role in the Economy?

If the Cuban government (i.e., Castro) is really serious about taking a stab at state capitalism, then let’s offer to close out the Guantanamo Bay Naval Base and convert it into a mega-resort and cruise ship terminal complex for Caribbean destined tourists.  The idle Cuban work force could be employed as laborers for the project and then trained as hospitality workers to be employed at the complex once it has been completed.  Cuba has a lot of potential as a Caribbean tourist destination and the Cuban government needs to recognize this fact and start trying to “capitalize” on it in order to pull the nation out of its current state of economic malaise.  The conversion of the Guantanamo Bay Naval Base (which is no longer needed these days) into a pristine resort complex by a top-flight entrepreneurial group would be a “win-win” proposition for all parties involved. And communist countries such as China (and now Viet Nam) are proving that state capitalism is far better than no capitalism at all, so the Cuban government needs to take heed and take action before it is too late.

Wall Street Bankers’ Bonus Abuse Issue!

The notion that Wall Street keeps its gravy train rolling by lining the pockets of our top-tier politicians with money and other influence-peddling gifts in order to condone the financiers’ actions is quite disturbing. In fact, the financiers’ claims per the paramount importance of their work as an excuse to enable them to get away with whatever they deem appropriate for themselves (e.g., awarding of excessive tax-payer financed bonuses, etc.) is very disturbing as it smacks of greed and self-centered conceit.  But the biggest rub is that these absurd bonuses were largely financed via the billions of dollars in taxpayer-financed funds from the Troubled Asset Relief Program (TARP) and trillions in loans from both the Federal Reserve and the FDIC.  These sources of aid money were designed to help the Wall Street financial institutions deemed too big to fail to survive their own terrible misdeeds, not to excessively reward their executives for jobs NOT well-done.  This has got to be perhaps the biggest misappropriation of our hard-earned tax money that has ever transpired in the history of this country. 

Finally, as long as big money talks and remains the primary influence driver in the current socio-political (or cultural) climates across the globe, then people in power will apparently continue to walk in the direction deemed appropriate  by the big money purveyors (e.g., Goldman Sachs, George Soros, et al.).  The condoning by governments of  their large scale market manulation shenanigans for their personal gain at the expense of the taxpayers of the world speaks for itself.  And their latest ploy of shorting the Euro while playing credit default swaps (CDOs) shows that there’s no shame on their part.  Finally, even President Obama is softening up his tone towards the big banking entities and their actions. And speaking of being “too big to fail’, perhaps the US socio-economic system and federal government is falling under this same exact definition.  This splitting up (i.e., per the splitting up of  giant oil corporation Standard Oil over 100 years ago) is becoming a more realistic option over time in terms of gaining more value and growth opportunities from the resulting smaller entities that would result.

Massive Government Control of Free Markets Debate!

Quote of the Day  –
“The case for free markets never was that markets are perfect … [but] that government control of markets, especially asset markets, has always been much worse.”

University of Chicago professor John Cochrane, per criticism from Paul Krugman, New York Times columnist and proponent of massive government intervention policies (click on URL below for his full rebuttal).

http://faculty.chicagobooth.edu/john.cochrane/research/Papers/krugman_response.htm

The Proposed Financial-Transaction Tax Bill Issue!

There is a financial-transaction tax bill being proposed by the U.S. Congress that intends to levy a 0.25% tax on all equity trading transactions.  The passing of this bill would severely marginalize the financial trading industry, making our financial markets even less efficient than they have already become.  The end result would be the loss of untold numbers of jobs, and financial markets would become even more susceptible to crashes due to the resulting lack of  liquidity. Obviously the passing of this absurd bill would negatively impact the financial trading (and related) industries; but it would also severely curtail a critical market capitalization vehicle used by small to medium sized companies, thus rendering them less able to compete and grow.  And with banks and other financial service entities either unable or unwilling to capitalize small to medium sized businesses these days (but able and willing to pay out absurd bonuses to undeserving executives), taxing financial trade transactions would only serve to make the current economic downturn more pronounced, possibly leading to even more disastrous consequences down the road. The resulting dissipation of market liquidity, trading volumes, and market price discovery, along with widened bid/ask price spreads, would destroy the positive aspects afforded by arbitrage and speculative trading.  Along with the addition of other possible government regulatory actions, this problem would then be further exacerbated by the resulting mass migration of American based trading volumes over to foreign (i.e., non-taxable) exchanges.

The one thing that really irks me about the proposed financial-transaction tax bill is that it is being framed as a so-called “sin” tax by its partisan proponents in order to appeal to the current populist mindset that the financial industry as a whole is guilty for the current state of the economy (i.e., high unemployment levels, etc.). Basically, the transgressions of a few that were enabled by the lack of understanding by government officials and regulators per the complex financial-engineering instruments being utilized are the primary culprits here. The imposing of a financial-transaction “sin” tax by the government is not a good substitute for developing an understanding of the new financial order and obtaining the level of competency necessary to effectively regulate the industry, thus establishing a stable (level) playing field for the economy as a whole.  So in my mind, this proposed financial-transaction “sin” tax is nothing more than an attempt to sweep a certain portion of the blame (or responsibility) for the current state of the economy under someone else’s rug.  In addition, the potentially negative impact of this “sin” tax would be exacerbated by the resulting changes in premium requirements by investors across the board due to the tax costs being passed on to them.  The potential drain on market liquidity and the resulting decrease in the capital available for struggling small-to-medium sized businesses would be hard to justify, especially for reasons of partisan politics.  So this proposed tax is not a viable solution or option in my mind, as it conceivably could lead to even more problems down the road as the state of our economy continues to evolve (or unwind). 

Finally, perhaps the biggest question in my mind is why do some of our elected government officials seem “hell bent” at times to make things worse for us rather than better (i.e., at both the micro and macro levels) in order to pursue partison based agendas?  This potentially dangerous bill needs to be dismissed (or vetoed) ASAP before it has a chance to cause serious long-term damage to our still frail (and unwinding) economy.  Click on the URL below to sign the revised “Financial-Transaction Tax is Detrimental to Many Industries” petition and have it forwarded to your representatives:

http://www.rallycongress.com/greentradertax-traders-association1/2720/a-financial-transaction-tax-is-detrimental-to-many-industries’

Need for Massive Government Intervention Policies?

At a sporting event, having no officiating at all would result in a very chaotic situation, whereas having  too much officiating would result in a game that might as well not be played.  Extending this analogy to the regulation of the American economy and securities industry, we  will always need a certain amount of “officiating” in order to maintain a level (and efficient) playing field for all players and to keep things from getting chaotic.  But a “massive” amount of officiating on a permanent basis (per Paul Krugman’s latest mantra) can result in the total fettering of the financial systems and the capital markets that they propagate, possibly resulting in societal chaos. The governmental approaches of the late1920s through the entire 1930’s should serve as a good case study (in general) of what works and what does not work in terms of particular actions taken and not taken (Ben Bernanke’s expertise), while keeping in mind that the playing field is now a lot bigger, faster, and more complicated (which again reinforces the need for some officiating, but not “massive” officiating). The premise here is that we want to continue to propitiate the competitive creativiity within the American financial industry, but we also need to define and enforce certain reasonable boundaries at the same time in order to keep the markets as efficient and seemless as possible.  Overall, my basic premise is that “enough” regulation needs to be in place in order to keep the speculation side of the coin from overwhelming (i.e., destroying) the risk management side of the coin, but not to the point where the markets become grossly inefficient due to a paucity of speculation.  So Paul Krugman’s “throwing out the baby with the bath water” mantra is not a good policy mandate in my book.

Quote: “The case for free markets never was that markets are perfect … [but] that government control of markets, especially asset markets, has always been much worse”. 

University of Chicago professor John Cochrane, in response to criticisms from Paul Krugman, New York Times columnist and proponent of massive government intervention policies (click on link to peruse “How did Paul Krugman get it so Wrong?”). 

http://faculty.chicagobooth.edu/john.cochrane/research/Papers/krugman_response.doc

The Political/Economic Costs of Being a Debtor Nation

Per President Obama’s trip to the People’s Republic of China, Karl Marx did say that we free-capitalists would sell his ideologues the rope they would use to hang us with.  Perhaps he was right in that we are doing that exact thing with China right now.  By being our primary financial benefactor these days, China pretty much owns us and is also beating us at our own game via its controlled (or state) version of capitalism (i.e., definitely a competitive edge for the Chinese government-owned businesses).  So in the end, it might take the “nationalizing” of China’s huge investments in US Treasury securities and Dollars in order to get the rope removed from the vicinity of our proverbial neck.  And if things do take a turn for the worse, then why not;  other debtor nations tend to invoke the “nationalizing” card on our investments in them quite frequently once the timing is right.

Ford Motors: Still Doing Things the Right Way!

Speaking of a continuing American success story, Ford Motors is still doing things the right way and deserves all of the kudos that it has been getting as of late.  From a company standpoint, the Ford name still invokes American pride, workmanship, and quality, and shows that free-enterprise can still get the job done both efficiently and effectively. On the flip side, the fiasco with GM is an embarrassment and, quite frankly, it is probably best that it has been pawned off to the government types to determine its final fate.