Volcker, Stiglitz, Hussman….

Here’s some positive news from or about people who can help point us in the right direction. First there was the big news that Paul Volcker will finally take a key role in addressing economic reform, particularly with the reinstatement of some of the key features from the Glass-Steagall Act. Joseph Stiglitz touches upon that need as well as other issues in an extract from his new book, Freefall; Free Markets and the Sinking of the Global Economy in a piece entitled “Why we have to change capitalism”

We now know the true source of recent bank bonuses: “free money” profits: According to Stiglitz, “the alacrity with which all the major investment banks decided to become ‘commercial banks’ in the fall of 2008 was alarming – they saw the gifts coming from the federal government, and evidently, they believed that their risk-taking behaviour would not be much circumscribed. They now had access to the Fed window, so they could borrow at almost a zero interest rate; they knew that they were protected by a new safety net; but they could continue their high-stakes trading unabated. This should be viewed as totally unacceptable.” Also, Stiglitz puts the bailouts in the context of the bigger picture: “the failures in our financial system are emblematic of broader failures in our economic system, and the failures of our economic system reflect deeper problems in our society. We began the bailouts without a clear sense of what kind of financial system we wanted at the end, and the result has been shaped by the same political forces that got us into the mess. And yet, there was hope that change was possible. Not only possible, but necessary.” As a consequence he argues for “a new financial system that will do what human beings need a financial system to do.”

Meanwhile, the Financial Times carried an excellent piece on Paul Volcker now that he is again front-and-center, Man in the News: Paul Volcker. For too long now Volcker inexplicably had been pushed off the center stage. Last March, as the market was in complete free fall, my tongue-in-cheek piece about “the new era of the 177K” asked, “Where is Paul Volcker to lead the way back to the 401K?”. Per the Financial Times: “this week the towering former Fed chief stood by Barack Obama’s side as the president embraced what he dubbed the “Volcker rule” banning proprietary trading – over the reservations of some of his most senior economic advisers.”
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Then, John Hussman, the economist who runs his own mutual funds, and each Monday blogs about his views, published, today, a lengthy, carefully reasoned Blueprint for Financial Reform.
This is an extraordinarily detailed eight point plan/proposal and rather than giving the bullet points here, go to the link. It deserves careful consideration by our elected officials. Needless to say, he sides with Volcker. Hussman for Chairman of the Federal Reserve or bring back Volcker?
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I've argued that in addition to financial reform, the main economic focus must be job creation: “a true recovery requires jobs, jobs, jobs – and how are they going to be created – by banks trading energy futures? What happened to the commitment to the infrastructure? Our roads, utilities, and public transportation are falling apart. Alternative energy seems DOA. Aren’t these the areas our financial recourses should be focused on, ones that will create jobs, in construction, technology, and finance, and can lead a true economic recovery we can pass on with pride to future generations?”

Green shoots first, then…..

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Well Worth Noting…

Two interesting articles, one an interview with Richard Koo, a former economist with the Federal Reserve Bank of New York and now chief economist of Nomura Research Institute, which appeared in this week’s Barron’s Magazine, A Japanese Rx for the West: Keep Spending and the weekly commentary of the economist and mutual fund manager John Hussman, Timothy Geithner Meets Vladimir Lenin

Koo’s views might seem to be counterintuitive – government needs to increase deficit spending on a three to five year plan while the private sector is repairing its balance sheet. Japan failed to recognize the dangers of “a balance sheet recession” and the USA could make the same mistake. I would agree, provided spending is focused on our infrastructure or alternative energy, or on myriad other public projects that resonate in our economy, creating jobs while fixing our roads and public transportation, encouraging energy independence, reducing greenhouse gases, and improving our educational system. Such investments are aimed at Main Street, not Wall Street. I would imagine Koo would be the first to note that bailouts of irresponsible investment bankers do not constitute the kind of government borrowing he means.

Koo contends that while the private sector repairs its balance sheet, writing down debt on devalued assets, it is imperative for the Federal government to borrow because even if interest rates are zero, the public sector cannot be induced to borrow: “The only way the government can turn this economy around is to do the opposite of the private sector -- borrow the money the private sector saved and spend it, which means fiscal stimulus. That's what saved Japan from entering a Great Depression.”

In effect we can’t make businesses borrow by giving capital to the banking system which only encourages more reckless economic behavior – it has to be spent elsewhere, and what better place than our infrastructure and energy independence?

John Hussman, meanwhile, writes about the very kind of borrowing we must eschew, especially as it is being done without our elected constituency’s input: the Treasury’s recent announcement that it would provide Fannie Mae and Freddie Mac UNLIMITED financial support for the next three years, reminding us that it was Vladimir Lenin who said: “The best way to destroy the capitalist system is to debauch the currency.”

As Hussman notes, “in a single, coordinated stroke, the Treasury and the Federal Reserve have encroached on spending powers that are enumerated for the Congress alone.” And perhaps worse, “…homeowners who have been diligently making their payments will keep their homes, and homeowners who took out mortgages they couldn't afford will keep their homes as well with no adverse consequence to the lenders – since the underlying loans are now owned largely by the Fed, and the Treasury has pledged its unlimited support. Why pay one's debts if it becomes optional, and the Treasury stands to absorb unlimited losses at public expense?”

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And to All a Good-Night!

How many times does one have to see a version of Dickens’ A Christmas Carol to say “enough?” Never, I say, as every generation can find it’s own version, just as Hollywood always seems to find another way to rework the story. Today, the tale could be a morality play about our financial times, Scrooge being played by a Wall Street Banker du jour, Tiny Tim by a child lacking health insurance, Bob Cratchit by someone in foreclosure, while the unemployed gather beneath the robes of the Ghost of Christmas Present. Past or present Chairmen of the Federal Reserve could play the ghosts. I pick Paul Volcker for the Ghost of Christmas Present, as he seems to see things the clearest. Naturally, Bernie Madoff must play the part of Jacob Marley wearing his chains forged of Ponzi links.

For me, the classic tale still elicits an emotional response, especially the versions that come closest to Dickens’ original text. So in that spirit, I offer a couple of photos of our Xmas past, in our home in Connecticut where the holiday really felt like Christmas:

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And this one from Florida Christmas Present, where it will be 80 degrees and one of the high points is the annual Christmas Boat Parade. It’s a Humbug, I say!

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Awash in Liquidity

Again (see last post) I defer to another insightful analysis about the economy and why we might be at an investment inflection point, this time turning to the world’s leading bond manager, Bill Gross at PIMCO. His monthly investment outlook, Midnight Candles, details why the investment “bubble” is a long standing one, that as a nation which once relied on the production of real things, we became focused on “paper asset” appreciation by the 1980’s. Governments have artificially influenced those prices since then. Gross distills this in an interesting observation: “How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down.”

That sets the macro economic scene, which has been compound with the crisis of the last couple years. More recently investors have flocked to riskier assets as the Fed has flooded the markets with liquidity and driven interest rates to nothing. Unless the real economy grows substantially, this has to end badly when the Fed reverses course. For this reason, Gross believes asset prices might be peaking.

Gross is certainly one of the more literate, philosophical money managers around, and his prefatory remarks set the stage in that venue. As one who is about Gross’ age, I identify with his feelings about being “Everyman.” I suspect he has read Philip Roth’s novel of the same title, but that’s another matter.

On a lighter side from my photo archives….

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Swimming against the deflationary tide

There was a small, unobtrusive article in today’s Wall Street Journal: “A Deflated Fed Battles to Keep Prices Up”

Here are the bullet points:

* “In March the consumer-price index slipped 0.4% below its year-earlier level, the first decline in over 50 years”

* “It is hard to imagine [consumers] returning to their spendthrift ways anytime soon”

* “Falling prices would make it tougher for borrowers to pay off debt, leading to even more defaults and even tougher lending standards”

* To fight back… “the Fed could buy the Treasuries issued to finance such moves. In practice, that is like printing money and handing it out to households, and it is pretty much what is happening now.”

* “When the fight is between falling prices and the Fed, it is hard to predict which will prevail.”

Add to this mix, 30-day T-Bills now yield nearly zero (0.02%). Soon, one may have to pay the Treasury to hold short-term deposits, but nonetheless if deflation persists or worsens, equities and bonds will not be able to compete with cash. Everyone is expecting inflation as a consequence of government spending, but prolonged deflation would be a Black Swan with potentially serious consequences. Gold fell more than $13 an ounce today, below a technical support level, another indication that inflation may not be the main worry.

It’s All a Mystery

We were away the last few days, visiting Ann’s friend in Tampa, Arlene, to celebrate her 70th birthday, and then my cousin Joan and family in Sarasota the next day and my dear friend, Martin (my former English professor) the following day in his new Sarasota “digs.” Meanwhile, the economic scene continued to go from mildly inexplicable to downright unfathomable during the same short period of time.

The Federal Reserve is now buying up to $300 billion in Treasury securities, and $750 billion of mortgage-backed securities using the “Supplementary Financing Program” which in effect gives it the ability to raise its own debt: “The Treasury has in place a special financing mechanism called the Supplementary Financing Program, which helps the Federal Reserve manage its balance sheet. In addition, the Treasury and the Federal Reserve are seeking legislative action to provide additional tools the Federal Reserve can use to sterilize the effects of its lending or securities purchases on the supply of bank reserves.”

Then, the Congressional Budget Office claims the national debt under the president’s budget could be $2.3 trillion worse than the White House estimates. This could result in a $9.3 trillion dollar deficit over the next ten years, which would nearly double the present deficit. All this depends on so many variables that it really is impossible to forecast what they (the deficits) will be. (It is rumored that in the 1960’s Senator Everett Dirksen once said “A billion here, a billion there, and pretty soon you're talking real money,” something he later said he was misquoted on. Still this quote has persisted until recently when trillion has become the “new” billion. How long will it be before “quadrillion” becomes the new “trillion?”)

On Monday, while driving back from Sarasota, the Dow surged by almost 500 points, a Pavlovian response to the long-awaited Geithner “plan” of creating an auction mechanism for removing the toxic assets from banks’ balance sheet “Essentially the Geithner plans creates a vehicle in which private equity accounts for 3%, public equity for 12%, and the rest is provided as debt by the public sector (through the Federal Deposit Insurance Corporation, FDIC).” The latter is from Eurointelligence, which also has a number of good links with views on this development as well as an explanation of the proposed auction formula. It seems like another excellent opportunity to privatize gains and socialize losses.

As a respite from this financial turmoil, I include a few photographs of our visit, first from Arlene’s 70th birthday party (the lady standing), her childhood friend, Arleen, on the left and Ann on the right.

Then we visited my favorite cousin, Joan, in her Sarasota home. As the unofficial family historian she gave me two photos, which I promptly scanned once I returned home. The first was taken in 1944 while my Dad was in Europe as a Signal Corps photographer. My mother is at the upper left, Joan is in the middle and my Aunt Lillian is on the right, while Joan’s mother, Marion, is seated on the left and our (Joan and my) grandmother is at the right.

The second photograph was probably taken on Long Beach, LI, in the mid 1920’s, with my Aunt Lillian on the left, then my father, my Uncle Phil, my Aunt Ruth, and then my grandmother and grandfather. I look at my grandfather and see a resemblance while my father has the same endearing smile he had as an adult. Joan and I speculate that her mother, my Aunt Marion, was not there as she was probably dating my Uncle Walter.

Enough for family history, but we concluded out Sarasota visit the next morning with my dear friend, Martin, my former English professor who is still actively writing poems and plays. Here we are in his new home in Sarasota.

Upon our return I checked some of my favorite blogs and was touched by my friend Emily’s mention of me in her “Your Blog is Fabulous” entry. Her words are humbling, particularly as I have a high regard for her writing abilities and the passion she brings to her love of literature. I worked with Emily and her husband, Bob, who is now a minister in Amish country. They were the kind of co-workers I admired the most, completely committed to excellence.

Her words made me think about why I do this and I responded in her comments section as follows: Oh, Emily, I am honored and humbled by your acknowledgement and more than slightly embarrassed by any notoriety, as my blog is such an unfocused botch of stuff. As I think I once said to you, I’ve always thought of myself as a jack-of-all-trades, master of none. I wish I could have lived many different lives, and among the ones I would like to have pursued, besides publishing which is the one I did out of economic necessity (but, loved nonetheless), is music (specifically jazz piano), writing, economics and investing (have always been fascinated by markets ever since I read Gustave Le Bon’s The Crowd: A Study of the Popular Mind in college – a pioneering work in social psychology -- which has applicability to “the market”), photography (I think of Diane Arbus or Alfred Stieglitz as role models). In fact, at one time I almost left the publishing business as I had developed a VisiCalc (the precursor of Lotus 1-2-3 which was the precursor of Excel) template to evaluate Convertible Bonds (best if you Wiki the term so I don’t have to explain here). Sometimes I feel like Mozart’s Salieri, having merely attained a measure of mediocrity. My on-and-off-again blog reflects my incongruous interests and of course, over the last year the historical presidential election encroached as well. So, I’m afraid your readers may be disappointed by the content. You have a central passion and your blog reflects that focus so well. Your blog IS fabulous.

Finally, my friend Bruce emailed me, “Did you read the Updike poems in the March 16th New Yorker? He writes these strange unrhymed sonnets. They are at times prose but become poetry on the strength of their emotions and concision.” I had not seen these but Updike mentioned his excitement about publishing again in the New Yorker in his last interview. I had heard that these new poems would be included in the collection Random House is about to publish, Endpoint and Other Poems, and some are about his final illness. I wonder whether this collection will include his 1990 masterpiece or others will match it in its stunning clarity about the mystery of life and death:

Perfection Wasted

And another regrettable thing about death
is the ceasing of your own brand of magic,
which took a whole life to develop and market -
the quips, the witticisms, the slant
adjusted to a few, those loved ones nearest
the lip of the stage, their soft faces blanched
in the footlight glow, their laughter close to tears,
their warm pooled breath in and out with your heartbeat,
their response and your performance twinned.
The jokes over the phone. The memories packed
in the rapid-access file. The whole act.
Who will do it again? That's it; no one;
imitators and descendants aren't the same
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On the Mark

Here are two must read entries recently posted by a fellow blogger, someone I’ve mentioned before. As Mark states in his mission statement: “Raise $7M from readers to launch a real mutual fund. By providing a transparent platform for a virtual growth mutual fund, I'll create a mechanism by which readers can view my thought process & results in creating a 3-year return. I'll invest in 30-50 positions with secular growth trends with economic commentary thrown in.” He’s been doing this for more than a year now but the recent economic turmoil has delayed the launch. In the meantime, his readers have benefited from his interesting commentary and frequently prescient predictions.

The posts below were written before yesterday’s Federal Reserve announcement of historic interest cuts to near zero and its pledge to buy stressed securities and perhaps even long-term treasuries. The question is whether this will indeed lead to borrowing and spending, especially if unemployment rates continue to ramp up and if business confidence does not improve. If successful, we then have to deal with the inflationary implications of money creation and a deficit in the untold $ trillions. (Is borrowing good? Isn’t that one of the reasons we got into this mess in the first place?)

In spite of FDR’s attempt to work our way out of the Depression with the New Deal, it finally took the enormous deficit spending of WWII and of course the employment of millions by the military and by the industries needed to support the war effort, thereby ending the worst economic downturn in our history. It also required people to rally, sacrificing, working towards a common goal.

In other words, it takes more than spending. Perhaps that is another distinction between today’s economic crisis and what we faced during the Depression. Can President-elect Obama successfully make our decaying infrastructure and need for energy independence our “war?” Will we pull together or pull apart?

http://www.fundmymutualfund.com/2008/12/13-outlier-2009-predictions.html
http://www.fundmymutualfund.com/2008/12/recovery.html

It’s Different This Time

Those are the famous words that have been used to explain any stock market anomaly. They were used in the dot.com era as the NASDAQ approached 5,000 to justify the heady prices at the time, or when oil was leaping towards $150 per barrel. But any parabolic rise or fall must regress to the mean. Or so it’s been in my lifetime

I need not go into detail here concerning all the dominant economic undercurrents of today, the toxic assets the TARP program was thought to be resolving, the government’s support of the Bear Stearns takeover, the collapse of Lehman Brothers, the bailouts of AIG, Freddie and Fannie, the discussions of bailing out Detroit’s automakers, the reverberations in the financial markets throughout the globe. However, as a child of depression era parents, I guess subliminally I’ve always feared the unspeakable: a deflationary spiral with no bottom in sight. And somehow if does FEEL different this time.

Having lived through several economic cycles and piloting a business through them, the implosion of equity values in the 70’s, the subsequent threat of hyperinflation, the high interest rates of the early 80’s, the collapse of real estate in the 90’s, the dot.com run-up on the heals of dire Y2K warnings, and finally the easy money that led to this decade’s real estate run up and the interconnected toxic financial instruments engineered by financial institutions and hedge funds to make them rich, leaving someone else (us) to hold the proverbial bag. But as a society we were willing participants, eagerly spending what we didn’t have; let future generations do the worrying! Our entire culture cried out buy, why postpone what you can have today, so we bought McMansions, Hummers, luxury goods, vacations, whatever our consumptive libidos desired, using our homes and credit cards as piggy banks.

And that is why this economic era does feel different than prior ones, at least to me, someone who has lived through these various cycles but only in the shadow of the Great Depression. We are just beginning to embark on the convulsive purging of these excesses. How it will end is anyone’s guess. Even Secretary of the Treasury, Hank Paulson, looks like a deer in the headlights, changing his mind about using the $700 billion to buy bad mortgage debt securities (the very $$ Congress had to immediately authorize as financial Armageddon was imminent), probably because he knows it’s not enough. And humbled Alan Greenspan, looking completely bewildered in his testimony to Congress in late October: “I made a mistake in presuming that the self-interests of organizations, specifically banks, were such as that they were best capable of protecting their own shareholders and their equity in the firms. Free markets did break down, and I think that, as I said, that shocked me. I still don't fully understand how it happened or why it happened.”

We had long placed Mr. Greenspan on a pedestal, trying to decipher “Greenspeak,” looking for little nuggets of wisdom to reassure ourselves that this time it was different as he ratcheted down interest rates for our borrowing pleasure. Now he is clearly admitting he has no clue why the present economic catastrophe has devolved. At least he can afford to admit his misjudgments, as he is no longer the Chairman of the Federal Reserve. But we now listen to Mr. Bernanke and Mr. Paulson, desperately clinging to the hope THEY know what they’re talking about. The only certainty now is nothing is predictable. It’s different this time.

Political Cynicism

Here is one way to define the concept. Lead our country to the brink of economic disaster. Have the very administration which brought us there propose an emergency $700 billion “fix” to provide liquidity so our economic circulatory system does not seize up, the plan proposed by the Secretary of the Treasury and the Chairman of the Federal Reserve, with our President finally making a speech to the nation in which he warns of the dire consequences of congress not acting immediately. Congressional hearings immediately ensue, with the Democratic majority buying into the need for action. Both sides of the isle agree to the basic principles, including oversight protection, and we are told a deal is imminent. But wait, the Republican presidential candidate returns to Washington, on his white horse, his pearl handle pistol at his side and suddenly there is no agreement. A dangerous game of chicken unfolds: “If the Democrats and the President want the plan, let them pass it” the Republican choir sings. Heads we win, tails you lose. America or politics first?

PS Washington Mutual was just closed by the US Government, the largest failure of a US bank.

Friedman for President

It is not surprising that the most emailed article from yesterday’s New York Times, is Thomas Friedman’s “Dumb as We Wanna Be”
http://www.nytimes.com/2008/04/30/opinion/30friedman.html?em&ex=1209787200&en=c74689f177717558&ei=5087%0A.

I’ve missed reading Friedman who just completed a sabbatical book-writing project that expands an article he wrote for the magazine section a year ago:
http://www.nytimes.com/2007/04/15/magazine/15green.t.html?_r=1&oref=slogin
The book version, Hot, Flat, and Crowded: Why We Need a Green Revolution--and How It Can Renew America, will be published in August.

Why not start a write-in campaign to elect Friedman President? He always seems to have the right perspective on foreign policy and our economic and energy crisis. I also like his even-tempered demeanor. Someone once said you have to be crazy to want to be the President of the United States. Maybe that is the problem with a plan for his Presidency. Friedman is not crazy.

He calls Clinton and McCain’s proposal for a summer gas tax “holiday” political pandering (Amen) and a form of money laundering, borrowing from China, moving it to the oil producing nations, leaving a little in our gas tanks as the broker for the transaction, but also leaving our children with the debt. The analogy would be funny if it were not so sadly true.

But the rest of the article goes to the core of the problem, not having a game plan to achieve energy independence, and helping to repair our decaying environment along the way, something I’ve also ranted about: http://lacunaemusing.blogspot.com/2007/12/politics-as-usual-where-is-leader.html

The ongoing political shenanigans over this issue and the lack of a plan are enough to make me sick. I had thought our current administration was just too clueless to grasp the importance of leading our nation to energy independence through alternative solar, wind, and geothermal technologies. Imagine my shock at seeing Laura Bush recently conducting a TV tour of their home in Crawford, Texas, which is replete with geothermal heating and cooling and a system for capturing rainwater and household wastewater for irrigation. I would have expected this from Al Gore, but George Bush?

His public environmental policies are in direct contrast to what he has done in his own home. So it is not a question of not knowing better, it’s knowing better but not leading our country to a better place, an immoral travesty of the public trust. Where would we be today if we had thrown down the gauntlet at the beginning of his Presidency? By delaying a commitment to energy independence, we have made the goal even more difficult as we must now start with massive debt, and a devalued dollar.

Instead, we pour resources into ethanol with the unintended consequences of food shortages and burgeoning food prices. Sounds like a good plan, subsidize the farmers to buy seeds and fertilizer (at triple the cost vs. last year), squeeze out food crops and tax our water resources, buy oil for the energy needed to convert crops to ethanol (be sure to take on more debt to get that oil), and continue to watch fuel prices escalate in spite of increasing ethanol additives, while paying much more for all food staples (hoarding rice along the way).

Yesterday the Federal Reserve laughably said, “readings on core inflation have improved somewhat” (which excludes food and energy). Maybe it’s time we go back to the Consumer Price Index as a fairer measurement of inflation so government has to face the real facts.

Tautological Economics

After the Federal Reserve successfully contributed to a real estate bubble which has yet been allowed to completely unwind, Congress could not resist scoring political points, approving a $168 billion economic “rescue” package, the majority of which will be given to taxpayers as rebate checks. The political tag team of President Bush and House Speaker Nancy Pelosi said the following:

Bush: “This plan is robust, broad based, timely, and it will be effective.”
Pelosi: “We are making history. What has passed the Congress in record time is a gift to the middle class and those who aspire to it in our country.”

While the part of the package that increases the level of expenses that businesses can immediately write off would seem to make sense, as this incentive is almost certain to guarantee investments in new capital equipment and is sure to stimulate job creation, the “gift” part is tantamount to handing a drunk a cheap bottle of wine.

True, it is in keeping with Keynesian economics, the theory being that this handout will be spent by the consumer and will reverberate throughout the economy. As noted in a footnote in a speech given by Ben Bernanke in 2002 before he was Chairman of the Federal Reserve, “Keynes once semi-seriously proposed, as an anti-deflationary measure, that the government fill bottles with currency and bury them in mine shafts to be dug up by the public.” Of course, that was before helicopters so we now have a better method of distributing money to the masses without having to haul our sorry butts off to a mine shaft.

At least Keynes might have been referring to currency already earned, but where is this $168 billion coming from? We’re going to print it or borrow it at the expense of future generations. We will simply increase the deficit. Where will the money go? Maybe we’ll buy some plasma TVs or other electronics at our local Wal-Mart, most of which is made in China, the country that will be lending us the money so we can make those purchases. This would seem to be a form of tautological economics but if it works, why not borrow $1.68 trillion instead of a mere $168 billion? We can use the larger refund as down payments on new mortgages to buy some depressed real estate. Everybody wins!

But getting back to reality, most of the money will probably go to pay off debt, but given the extent of sub prime and foreclosure issues, the rebates will only briefly push back the inevitable. In the 1980s we were able to deal with The Savings and Loan Crisis through the formation of the Resolution Trust Corporation. Shouldn’t Congress be busy addressing our fragile economic system with a more permanent solution than just throwing money at the problem, a temporary fix at best?

A Perfect Financial Storm?

The downgrade of AMBAC’s financial-strength rating, and the possibility of downgrades of other bond insurers, including MBIA, could be the beginning of a perfect financial storm. These companies jumped onto the sub-prime lending train, along with major Wall Street financial institutions, to profit from the practice of providing credit to less than creditworthy customers, and with the encouragement of Washington to bring the American dream of homeownership to everyone. While the latter is a nice politically correct thought, greedy investors went along for the ride too, buying up “investment property” and homeowners indulged in the practice of using their homes as a piggy bank to buy luxury items. They used cheap money (thanks to the Federal Reserve) and exotic no money down, no interest payment loans, the repayment of which was dependent on future appreciated real estate values. This pot was mixed by mortgage brokers who could now sell off these loans in neat packages through Wall Street firms, with guarantees from the likes of AMBAC and MBIA. Which brings us to the point of this post.

The bond insurers strayed from their main businesses in their greedy pursuit of a piece of the action, and that is their role insuring new municipal bonds. Cities and counties are dependent on reasonably priced debt to make investments in education and infrastructure. The bond insurers made it possible for many municipal bonds to attain AAA ratings, keeping their borrowing costs relatively low. Whether the bond insurers could actually cover a financial Armageddon, even without the CDO mess, is another issue, but so much of finance and investment is really about confidence, and this is what AMBAC and MBIA insurance conveyed.

Now, we are on the edge of a recession or we are already in one, and how deep it will be and how long, no one can tell, even by our Federal Reserve Chairman, Mr. Bernanke (who has not yet acknowledged we are in a recession). Municipal revenues are already under pressure due to falling property values. Add to that mix a severe recession, uncontrolled energy costs (http://lacunaemusing.blogspot.com/2007/12/politics-as-usual-where-is-leader.html) and their inability to raise capital, or at least at a reasonable cost without the bond insurers, and one has the perfect financial storm for dramatically decreased spending, loss of jobs, and lack of confidence in the financial system all of which just feeds upon itself in a deepening crisis.

Our chicken little representatives on both sides of the isle are clucking an economic stimulus package such as throwing a few hundred dollars at everyone to spend immediately. Maybe we’ll borrow the money from China or one of the other BRIC countries. Why not, we seem to be content to mortgage our future for immediate gratification.

It seems that a better thought out plan is needed to fix the present structural deficiencies of the financial system. It also wouldn’t hurt to find sounder ways to fund this beginning with reducing the financial hemorrhaging of the Iraq war, not to mention getting our troops home. The “guns and butter” approach has failed us before.