Greenspan comments right before Lehman's failure

ABC interview on Sunday 9/15/08 with former Fed chair Alan Greenspan. This was before the effective collapse of Merrill Lynch, AIG, and Washington Mutual:

George S.: "Is this the worst that you've ever seen?"
Greenspan: "Oh, by far...."

If I were a member of Congress...

Greg Mankiw was the chairman of Bush's Council of Economic Advisors from 2003 to 2005 and is the author of an excellent principles of economics textbook. In this post he, indirectly, explains his view of the proposed bailout.

The Crisis of Global Capitalism?

"The Crisis of Global Capitalism?" Gary Becker, a Nobel prize winner and proponent of the Chicago school of thought, answers "no."

CNBC debate about over the urgency of government action

To get a sense of the intensity of the current financial situation, and of how passionately people view the situation, look at this, especially starting about 4 minutes into it.

CNBC video: Credit Crunch Fear

Credit Crunch Fear

Financial Times video summary of the events of the week of September 15th-19th

Financial Times video summary of the events of the week of September 15th-19th

9/22/08 Liesman: 2nd Vote Not Possible ($700 b "bailout"

9/18/08 Market reaction to first reports of a Treasury plan

This clip shows how the market reacted to the first report that a Treasury plan was in the works. During the 5 minute clip the DOW went up 90 points.


"Paulson's RTC-Type Solution"

The End of a Tumultuous Week

"The End of a Tumultuous Week" 3 minute CNBC overview of the week

Taking Revenge on the Rich Will Not Bring Recovery

WSJ SEPTEMBER 20, 2008

By AMITY SHLAES

Police short sales and block them, says Securities and Exchange Commission Chairman Christopher Cox. Fire the SEC chairman, says John McCain. Investigate those short sellers, say state attorneys general. Hold hearings to grill Wall Streeters says Nancy Pelosi. "Fire the whole Trickle-Down, On-Your-Own, Look-the-Other-Way crowd" says Barack Obama, and "get rid of this whole do-nothing approach to our economic problems." The Democratic presidential candidate wants public affirmation of his argument that the whole free-market philosophy of economics has been wrong.

Some of this talk carries an implicit suggestion: Do what I say or we will have another Great Depression. And no wonder: This September feels a lot like autumn 1929.

But there's an important fallacy here. The stock market crash of October 1929 and the Great Depression were not the same thing. What made the depression great was not magnitude but duration -- the fact that unemployment was still 20% 10 years later. In the 1930s, policies like the ones described above did not speed recovery; they impeded it.

Not long after the market crashed to 199 from its 381 high at the end of the summer of 1929, President Herbert Hoover turned on short sellers. Like our SEC, he demanded a curb on short sales. "Bear raids" or "bear parties" were to be stopped; the blame for the crash all belonged to "certain gentlemen."

Then, as now, there was a lengthy discourse on the difference between "normal" short sales and "naked" ones. New York Stock Exchange President Richard Whitney argued that curtailing such sales postponed unavoidable pain -- or even made it greater.

It was wrong, he said, to vilify shorts. "Such a contract to deliver something in the future which a person does not own is common to many types of business," Whitney carefully spelled out in layman's language. "When a builder contracts to build a skyscraper he is literally short of every bit of material." Yet the anti-short and anti-Street mood grew. In a spirit every bit as zealous as Sen. McCain, lawmakers assigned attorney Ferdinand Pecora to lead a commission hunting for wrongdoing on Wall Street.

Most observers have concentrated on the corruption that was indeed uncovered by investigators. Whitney, for example, discredited his own argument when he emerged later as a trickster and embezzler.

But the most important fact about this early period is the Dow's movement. Clean-up pronouncements cheered voters, and momentarily, the Dow Jones Index rose a bit later in 1929. But the hostility whipped up by politicians scared a market already well spooked by monetary, banking and international challenges. By summer 1932 the Dow plummeted to the 50s range. This was the year Hoover created the Reconstruction Finance Corp., after which Washington's rescue entity of today is supposedly modeled.

In 1933 there was a moment when the U.S. really did seem poised for recovery -- the moment of Franklin Roosevelt's inauguration. Confronting the banking crisis, President Roosevelt did what President Bush, Congress and the Treasury are likely to do in coming days: create a mechanism to sort out banks and their holdings, to separate good assets from bad.

Such an office can shorten a crisis -- the Resolution Trust Corporation, created to deal with the 1980s Savings and Loan debacle did. There was nothing necessarily partisan about the process. Hoover's Treasury secretary, Ogden Mills, and Roosevelt's new Treasury secretary, William Woodin, sat together at the task, just as Republicans and Democrats presumably will now. The establishment of the SEC in 1934 likewise set the country up for recovery.

But like today's politicians, Roosevelt also used the downturn as a weapon to trash markets generally. The New Dealers even used the same mocking phrases Mr. Obama does today. The rich might think that wealth trickled down, Roosevelt's speechwriter Sam Rosenman would later note, but "Roosevelt believed that prosperity did not 'trickle' that way."

In 1933 and 1934, Roosevelt went on the attack. The Sergey Brin of the 1920s was Samuel Insull, the Chicago utilities magnate who created the format for the modern electrical grid, taught housewives about refrigerators, employed thousands and proved it was possible for the private sector to raise the prodigious amounts of cash necessary for utilities, the most capital-hungry of industries. But the credit crunch killed off Insull's leveraged companies, rendering shareholder portfolios worthless.

Insull was extradited from Greece and hauled back to Chicago. A jury refused to convict him of fraud. But federal or state prosecutors continued to harry him until he died of a heart attack or stroke in 1938.

The deity of the markets, the Alan Greenspan of the 1929s, was Andrew Mellon. He served as Treasury secretary to Presidents Harding, Coolidge and Hoover. In 1932, while Mellon was still in office, a young Democratic Congressman from Texas -- Wright Patman -- launched a campaign to impeach him.

The Roosevelt administration was more systematic. Treasury Secretary Henry Morgenthau instructed a staff lawyer, Robert Jackson, to prosecute Mellon for tax evasion. Jackson hesitated. Morgenthau, anticipating New York's Eliot Spitzer, insisted, saying, "You can't be too tough in this trial to suit me." Jackson then jumped up, exclaiming, "Thank God I have that kind of boss," as Morgenthau recounted in his memoirs.

A grand jury declined to indict Mellon. The government then began multiple actions against him. Exoneration came, but only after Mellon's death. Roosevelt put Jackson on the Supreme Court.

In these years, the market was trying to recover, but prosecutors and tax collectors kept getting in the way. Mrs. Pelosi might note that even after the Pecora Commission finally completed its hearings, unemployment was still 20% rather than 10%.

Roosevelt's first effort at raising wages to revive the economy, the National Recovery Administration, was declared unconstitutional. Next came the Wagner Act, which led to massive unionization. Wages increased and unemployment even dipped a bit, but productivity did not rise in commensurate fashion. This contributed to companies' struggles, as Lee Ohanian of UCLA has shown. Industrial production plunged. In 1938, John L. Lewis of the CIO attained the apogee of his power, but unemployment was again at that appalling two in 10.

The signal Washington emitted in these years was clear: Not Open for Business. A poignant moment came in August, 1937, when Mellon died in Southampton, N.Y. When this star of their old firmament winked out, investors felt themselves in uncharted waters. Other negatives -- rising labor costs, regulatory tightening, a doubling of reserve requirements for banks -- suddenly seemed insurmountable. The market dropped from 189 in August to 120 by the next February, well below the lowest ebb in 1929.

A desperate Treasury Secretary Morgenthau traveled to New York to placate a crowd of 1,000 economists and businessmen at the Hotel Astor in November, 1937. The audience laughed at him for daring to try. By the next year the New Dealers were quietly telling themselves their anti-wealth experiment was over -- and turning to the impending war in Europe.

The point for us in our own fragile moment is clear. To be sure, clean up is necessary. It can even help the market -- some. But in the long run what works politically is different from what works economically. Revenge, however sweet, cannot bring recovery.

Ms. Shlaes, a senior fellow at the Council on Foreign Relations, is author of "The Forgotten Man: A New History of the Great Depression" (HarperCollins, 2007).

Please add your comments to the Opinion Journal forum.

WSJ SEPTEMBER 20, 2008

Maybe the Banks Are Just Counting Wrong

By JOHN BERLAU

In the year since the credit crunch began, reading the financial pages has become a bit like perusing a medical journal. Market epidemiologists speculate where the financial "contagion" will strike next.

First it hit subprime mortgages and mortgage-backed securities. Then asset-backed commercial paper and auction-rate securities. Then the epidemic spread to whole financial firms like Bear Stearns, Fannie and Freddie and Lehman Brothers. This week the insurance giant American International Group got the inoculation of a $85 billion federal loan, and now there is talk of creating a giant government agency to buy billions of dollars of illiquid debt from various financial firms.

The method of disease transmission is still somewhat of a mystery. The latest mortgage delinquency rate is just 6.4% -- historically high, but not anywhere close to the mortgage default rate of over 40% in the depths of the Great Depression.

Helping to spread the contagion is a relatively new accounting method called "mark to market." For decades, lenders used historical cost accounting, meaning that a loan would be booked at its cost at the time it was made. Payments would be recorded as they came in, and the book value of the loan would only change if it was sold or became impaired, perhaps because of default.

The pressure to change this method came after the collapse of U.S. savings and loans in the 1980s, and the Japanese banking crisis of the '90s. Regulators and accounting bodies argued that traditional accounting allowed banks to "hide" bad assets on their books, and that financial instruments needed to be valued based on what they would trade for in a market today.

So over the past decade, various mark-to-market accounting rules became part of the official U.S. Generally Accepted Accounting Principles (GAAP), and began to be required by the Securities and Exchange Commission, bank regulatory agencies, credit rating agencies and in the Basel II international framework for measuring bank solvency.

This supposed "reform" is exacerbating the current crisis. Markets for individual loans are still much thinner than for stocks and bonds. The market for securitized loans with unique features is even thinner, and a disruptive event can cause these markets to virtually disappear. As a result, if a highly leveraged bank sells a mortgage-backed security at a steep discount, this becomes the "market price."

Financial Accounting Standard 157, which U.S. regulatory agencies put into effect last November, requires accountants to look at market "inputs" from sales of similar financial assets even if there isn't an active trading market. That means that less-leveraged banks holding mortgages that haven't been impaired often have to adjust their books based on another bank's sale -- even if they plan to hold their loans to maturity. Yale finance Prof. Gary Gorton wrote in a paper presented last month at the Federal Reserve's summer symposium: "With no liquidity and no market prices, the accounting practice of 'marking-to-market' became highly problematic and resulted in massive write-downs based on fire-sale prices and estimates."

These write-downs, based on accounting standards, can jeopardize balance sheets and solvency -- much like a spreading contagion. In effect, a single bank's fire sale can decrease the "regulatory capital" (or the total dollar value of assets that government regulations require banks and other financial institutions to keep as a reserve to immediately make good on their obligations to depositors and other creditors) of others. So "partly as a result of GAAP capital declines, banks are selling . . . billions of dollars of assets -- to 'clean up their balance sheets,'" notes Mr. Gorton, creating a "downward spiral of prices, marking down -- selling -- marking down again."

These rules also affect credit insurance of the type that AIG was providing. As Barron's reported earlier this year, because of the ongoing fire sales of mortgage instruments, "accountants were forcing AIG to boost its fourth-quarter write-down of the value of its credit insurance on a large mortgage security portfolio from $1.6 billion to $5.2 billion." Barron's also noted that AIG was "likely looking at even bigger mark-to-market hits" later on.

Treasury Secretary Henry Paulson has pushed through many creative measures attempting to shore up the financial system. But he won't budge on mark-to-market accounting. "I think it's hard to run a financial institution if you don't have the discipline which requires you to mark securities to market," he declared in a speech at the New York Public Library in July. Financial firms, he said, shouldn't expect much relief.

But relatively simple changes to mark-to-market rules, like suspending the rules for illiquid but performing loans if a firm meets other solvency requirements, would lead to more accurate information and could quell demands for more "emergency" bailouts such as that of AIG. This kind of reform should be a top priority of any new administration promising "change."

Mr. Berlau is director of the Center for Entrepreneurship at the Competitive Enterprise Institute. CEI associate Al Canata contributed to this article.

Please add your comments to the Opinion Journal forum.

Want to understand what a bank run is?

The crisis we're experiencing in the financial markets is, in many ways, the 21st century version of a bank run or panic. It'll be a few weeks before we're ready to cover banking in class, but you can learn a lot about bank runs by watching this 7 minute clip from the 1940s movie "It's a Wonderful Life."

Investors Flee Money Funds, Moving Cash to Safer Spots

WSJ SEPTEMBER 19, 2008

Investors pulled more cash out of money-market funds, prompting a second large fund to close to investors, amid concern that these onetime safe harbors are now too risky.

In an effort to stem such withdrawals, the U.S. government Thursday night was working toward taking the unprecedented step of covering money-market funds with a variation of the federal deposit insurance provided to banks.

Until now, the $3.4 trillion money-market-fund industry largely hasn't offered the same type of insurance provided for bank deposits. The plan being discussed likely would cap the amount insured, just as bank accounts are insured up to a certain sum, usually $100,000.

The moves highlight how concerned regulators have become about the rapid outflows from money funds in recent days. Money funds serve as buyers for so-called commercial paper, which companies use to help finance daily operations.

As credit markets locked up world-wide, investors have started moving their cash from money funds to safer locales, such as U.S. Treasurys and bank certificates of deposit. A run on money funds would have implications for corporations that depend on short-term funding such as commercial paper. If the funds don't buy this paper, it could cause a cash crunch, rippling through the wider economy. (See related Credit Markets story.)

Some $78.7 billion was withdrawn from large money funds Wednesday, following a $13 billion outflow Monday and $33.7 billion Tuesday, according to Crane Data LLC. Investors continued to pull money out of some funds Thursday.

Putnam Prime Money Market Fund (Institutional) announced it had closed Wednesday and would distribute assets to customers because of "market-wide liquidity issues." That apparently meant it was having trouble trading the short-term debt instruments in its portfolio due to the credit crunch. The $12.3 billion fund, available only to clients with a $10 million minimum investment, said it held no paper from such problem issuers as Lehman Brothers Holdings Inc., Washington Mutual Inc. or American International Group Inc.

The run on money funds was touched off earlier this week with the closing of Reserve Primary Fund, thanks to its soured Lehman securities. Two-thirds of the Reserve fund's assets were cashed out Monday and Tuesday.

The Reserve offering jolted the investment world when it "broke the buck" -- that is, losses pushed its net asset value below the $1-per-share standard for these funds. In a statement Thursday evening, The Reserve said that investors who want to redeem from its nearly 20 remaining money funds wouldn't get their money back for as many as seven days. It wasn't clear whether investors would be paid $1 per share.

Breaking the buck remains rare. Bank of New York Mellon Corp.'s $22 billion BNY Institutional Cash Reserve Fund, which isn't registered as a money fund, said its net asset value slipped to 99 cents Tuesday, though it says it since has isolated Lehman assets that helped drag it down. Putnam Prime, though, didn't break the buck.

Putnam's board of trustees was to meet to come up with a plan for distribution to customers, mostly corporations and other institutions. Although the plan hasn't been finalized, said Robert Reynolds, the president and chief executive officer of the Boston firm, customers likely will be offered a choice. One choice would be to allow Putnam to sell debt securities in the portfolio over time, in a methodical way, and eventually cash out investors with the proceeds. Or they could get stable debt securities from the portfolio, such as from Bank of America Corp.

Mr. Reynolds, the former Fidelity Investments chief operating officer who joined Putnam 10 weeks ago, said the company became concerned Wednesday when corporate customers began pulling cash from the fund. He said he believed the pressure would get worse.

Departing holders of Reserve Primary Fund could get out Monday at the full $1 per share, Tuesday at 97 cents and after that would have to wait, and may receive much less. A representative for The Reserve said the net asset value hasn't been calculated since Tuesday.

Some of the money in the Reserve fund and others is tied to mutual funds' securities lending. Another source of fund money comes from "sweep accounts," through which brokerage customers' spare cash is automatically deposited in a money fund.

That was the case for Rob Hotchkiss, 47 years old, a founding member of the Grammy-winning band Train. He has about $52,000 stuck in Reserve Primary, because of his sweep account with broker TD Ameritrade Inc. "How much money can I end up losing here?" he asked. A spokeswoman for TD Ameritrade said it is working with The Reserve to redeem client assets.

Unlike Reserve, larger financial companies, like Putnam, are able to bolster their money funds by pumping in capital to maintain the $1 net asset value.

Because of this size advantage, some of the bigger money-fund managers say investors aren't panicking. Vanguard Group and JPMorgan Funds are seeing inflows in their large money-market funds, representatives said.

Commercial-Paper Market Seizes Up

Commercial-Paper Market Seizes Up

By ANUSHA SHRIVASTAVA

The commercial-paper market, where companies go for short-term funding, broke down Thursday as credit fears paralyzed investors.

These investors include money-market funds, which face redemptions from customers concerned that their money is no longer safe.

"We are not functioning in the short-term credit market," said Howard Simons, a strategist with Bianco Research in Chicago. "We have issuers who can't issue and buyers who won't buy. How can this market function?"

Earlier this week, troubles at American International Group Inc. caused many investors to concentrate their buying in extremely short-term paper that carried a one-day maturity. By Thursday, however, even that buying dried up.

There is a "buyers' strike," one trader at a primary dealer said. "There is a snowballing effect when people get nervous and want to get their money out of money-market funds," he said, noting that these funds then can no longer invest in the commercial-paper market.

Tuesday's announcement that the Reserve Primary Fund "broke the buck" -- its net asset value fell below $1 -- sent a shudder through the money-market community. Thursday, Putnam Funds said it has closed its institutional Putnam Prime Money Market Fund following a surge of redemption requests.

"With money-market funds having redemption issues and big dealers disappearing, this market cannot work," Mr. Simons said, adding that some of the big dealers on Wall Street, such as Lehman Brothers Holdings Inc., are gone, too.

"It's symptomatic of the chaos that's going on," he said. "We are taking institutions apart."

Investors have demanded higher premiums for investing in commercial paper, and even then, mainly bought paper that matured in just one day. Rates shot up to between 5% and 8% on overnight paper, from a little more than 2% the week before.

Even triple-A-rated companies, such as International Business Machines Corp., had to pay 6% in the overnight commercial-paper market, said Thomas Corona, a senior vice president at Tradition Asiel Securities Inc.

The commercial-paper market shrank by $52.1 billion in the week ended Wednesday, according to data from the Federal Reserve. This is the largest weekly decline since December.

Alan Greenspan on Treasury's rescue plan

http://www.cnbc.com/id/15840232?video=861295870

Overview of the week's events - David Faber (CNBC)

Overview of the week's events - David Faber (CNBC)

Resurrect the Resolution Trust Corp. - Paul Volcker

You may remember that I mentioned Paul Volcker in class. He was Fed chairman before Alan Greenspan and was the key figure in bringing inflation under control in the early 1980s. This is his assessment of the current financial crisis and his recommendation for dealing with it.

WSJ September 17, 2008

Resurrect the Resolution Trust Corp.

By NICHOLAS F. BRADY, EUGENE A. LUDWIG and PAUL A. VOLCKER

We are in the midst of the worst financial turmoil since the Great Depression. Absent bold action, matters could well get worse.

Neither the markets nor the ordinary diet of regulatory orders, bank examinations, rating downgrades and investigations can do the job. Extraordinary emergency actions by the Federal Reserve and the Treasury to date, while necessary, are also insufficient to resolve the crisis.

Fannie Mae and Freddie Mac, the giants in the mortgage market, are overextended and now under new government protection. They are not in sufficiently robust shape to meet all the market's needs.

The fact is that the financial system needs basic, long-term reform, but right now the system is clogged with enormous amounts of toxic real-estate paper that will not repay according to its terms. This paper, in turn, is unable to support huge quantities of structured financial instruments, levered as much as 30 times.

Until there is a new mechanism in place to remove this decaying tissue from the system, the infection will spread, confidence will deteriorate further, and we will have to live through the mother of all credit contractions. This contraction will undercut the financial system, and with it, the broader economy that so far has held up reasonably well.

There is something we can do to resolve the problem. We should move decisively to create a new, temporary resolution mechanism. There are precedents -- such as the Resolution Trust Corporation of the late 1980s and early 1990s, as well as the Home Owners Loan Corporation of the 1930s. This new governmental body would be able to buy up the troubled paper at fair market values, where possible keeping people in their homes and businesses operating. Like the RTC, this mechanism should have a limited life and be run by nonpartisan professional management.

Such a stabilizing mechanism would accomplish four much-needed tasks:

- First, by buying paper that otherwise is effectively not trading, it would help restore liquidity to the marketplace and help markets to function more fluidly again.

- Second, by warehousing the troubled paper for a longer period than, for instance, the Fed's discount window typically should or could, it would allow for a more orderly liquidation of this paper, and the chance for much of it to recover a portion of its value.

- Third, by giving the agency the ability to manage mortgages with flexibility to keep people in their homes and businesses running, it should lessen the number of foreclosures. This, in turn, would help moderate the decline in real estate values and the deterioration of neighborhoods, thus supporting house prices that in fact lie at the heart of the crisis.

- Fourth, where necessary, like the RTC of the 1980s, this new mechanism can assist the Federal Deposit Insurance Corporation in resolving sick institutions that are so clogged with the troubled paper they cannot continue as independent entities. However, we would hope that purchasing the mortgage-related paper will minimize the need to provide emergency, short-term assistance to solvent banking institutions.

It is certainly the case that the new institution we are proposing will in the short run require serious money. That will involve a risk to the taxpayer; but the institution, administered by professionals, means that ultimate gains to the taxpayer are also possible.

Moreover, a failure to act boldly in the fashion we are suggesting would cost the taxpayer and the country far more. The pathology of this crisis is that unless you get ahead of it and deal with it from strength, it devours the weakest link in the chain and then moves on to devour the next weakest link. A deteriorating financial system, diminished economic activity, loss of jobs and loss of revenues to the government is enormously costly. And the cost to our citizens' well-being is incalculable.

Crisis times require stern measures. America has done well in the past to face up to economic turmoil, take strong measures, and put our problems behind us. RTC-like mechanisms have worked well in past crises. Now is the time to take a similarly forceful step.

The American economy still has enormous underlying strengths. What we need, and in part are proposing, is a road map to financial stability.

Mr. Brady was U.S. Treasury secretary from 1988-1993. Mr. Ludwig was U.S. comptroller of the currency from 1993 to 1998. Mr. Volcker was chairman of the Federal Reserve from 1979-1987.

The Wall Street Journal
OPINION
SEPTEMBER 16, 2008

The Resilience of American Finance

By JEREMY J. SIEGEL

The turmoil in the financial markets will reorganize the financial landscape. But this does not mean the financial industry will shrink dramatically. In fact the current crisis could well lead to an increase in the demand for financial services, as the world grapples with the need for new financial instruments, new risk management techniques, and the increasing complexity of the financial world.

Getty Images

There is no doubt that some of the most hallowed names in the industry, such as Bear Stearns, Merrill, Lehman and others will disappear as separate entities. Their demise was caused by bad risk management, and a failure to understand the high risks of an overheated real-estate market, the root cause of our current problems.

We can argue about who was responsible for the overleveraging of the financial industry and the poor to nonexistent credit standards that prevailed in real estate. Certainly the regulatory agencies, including the Federal Reserve, should have sounded a warning. But the lion's share of the blame must go to the heads of the financial firms that issued and held these flawed credit instruments and then, in many cases, "doubled down" by buying more when their price was falling.

Overleveraging has been the cause of many past financial crises, and will undoubtedly be the cause of those in the future. It was the cause of the 1998 blowup of Long Term Capital Management, where the Fed also intervened to prevent a crisis. Then two years later the tech and Internet boom burst. If banks would have been allowed to buy on leverage these stocks during the bubble, they would have been in even more trouble than now.

But few were willing to admit that subprime real-estate loans could be as risky as stocks. It was just too profitable to issue these mortgages. So eyes were closed and the money kept pouring in. Groupthink prevailed. To paraphrase John Maynard Keynes, it is much easier for a man to fail conventionally than to stand against the crowd and speak the truth.

There is no doubt in my mind that if we didn't have a proactive Federal Reserve and deposit insurance, we would have been following the same course as we did in the 1930s, when the bursting of the stock bubble and fear of loan defaults led to thousands of bank failures and ushered in the Great Depression.

That will not happen this time. The rapid provisions of liquidity by the Fed will prevent any full scale downturn. In fact, I take it as a mark of confidence in our financial system that the Fed did not feel compelled to bail out Lehman Brothers as they did last March when they folded Bear Stearns into J.P. Morgan. Certainly politics played a role in this election year, as critics (and some Congressmen) criticized the government for bailing out the big boys, while letting homeowners twist in the wind.

Despite the recent turmoil, there is good evidence that the worst is over, especially for the commercial banks with access to Federal Reserve credit. Despite yesterday's severe sell-off, most are significantly higher than their July 15 low, and some such as Wells Fargo and UBS are up over 50%.

Nevertheless, the current crisis will change the financial landscape. Certainly Bear, Merrill, Lehman and others will disappear as separate corporate entitles. But other institutions, specifically the commercial banks that absorb these firms, and who have direct access to Federal Reserve credit, will become larger.

The demand for financial services will in no way disappear as the automobile pushed out the horse and buggy a century ago. Although unemployment on Wall Street will undoubtedly rise, many workers will be reabsorbed elsewhere in the industry. The current financial crisis calls out for new products and services as well as more, not less, information about what is safe and profitable in the future environment.

It is easy to be pessimistic about the future of financial services in the current climate. But objective facts indicate that the future demand for these services will be high. Looking beyond past losses, the demand for financial services, especially internationally, has been strong. The growth of the developing countries, combined with the aging in the developed countries, will lead to huge international capital flows that will be facilitated by new and existing financial intermediaries.

It is shocking that firms that withstood the Great Depression are now failing in what economists might not even call a recession. But their failure was not caused by lack of demand for their services. It was caused by management's unwillingness to understand and face the risks of the investments they made. The names of the players will change, but the future growth of the financial services industry is assured.

Mr. Siegel, a professor of finance at the University of Pennsylvania's Wharton School, is the author of "Stocks for the Long Run," now in its 4th edition from McGraw-Hill.

The Wall Street Journal
SEPTEMBER 16, 2008

Surviving the Panic

We're happy to report that the world didn't end yesterday, though sometimes it was hard to tell. A major Wall Street banking house filed for bankruptcy, the taxpayers didn't come to the rescue, and financial markets lurched but didn't crash. Amid the current panic, this is a salutary lesson that our fate is in our own hands and that a deeper downturn is far from inevitable.

The immediate priority is to calm markets and prevent a crash, and to do so it helps to recall how we got here. We are not living through some "crisis of capitalism," unless policy blunders make it so. Nor is this largely the fault of the Bush Administration, as Barack Obama claims, or of some lack of regulation, as John McCain asserts. These politically convenient riffs do nothing to reassure the public.

The current panic is the ugly aftermath of the credit mania that took flight in the middle years of this decade. As students of economic historian Charles Kindleberger know ("Panics, Manias, and Crashes"), financial manias throughout history have shared one trait: the excessive expansion of credit. This bubble was no different.

The Federal Reserve kept interest rates too low for too long, creating a subsidy for debt and a global commodity price spike. The excess liquidity and capital flows this spurred became the fuel for the wizards on Wall Street and in mortgage-finance who created new financial instruments that in turn fueled the housing bubble. As long as it lasted, nearly everyone inhaled the euphoria of rising asset prices and soaring profits. Normal risk assessment gave way to the excesses that always attend manias.

Enter the panic stage, or the great deleveraging that began some 13 months ago. Fear now trumps greed, while the short-seller and cash are kings. The core of our financial problem, as Treasury Secretary Hank Paulson said yesterday, is that these mortgage instruments are underpinned by real-estate assets whose value keeps declining. Until home prices stabilize, no one knows how large the losses will be. Thus no one is sure which financial companies are truly endangered, or how many.

Amid this turmoil and uncertainty, the challenge for policy makers is twofold: Protect the overall financial system from the fallout of individual bank failures, and protect the larger economy from recession caused by financial distress. They each require different policy levers.

On the finance side, there has already been much progress, albeit not enough. The banking system is reforming itself right before our eyes, without the advice of Congress or new regulation. The days of banks running with leverage at 30 or 40 to 1 are over. The companies that took those risks have either failed (Bear Stearns, Lehman) or been absorbed by others (Merrill Lynch, Countrywide). The SIVs, CDOs and other exotic creatures have been put back on balance sheets, losses have been taken, and new capital has been raised to absorb those losses. We are moving to a sturdier system.

On that score, Lehman's bankruptcy filing is another sign of progress. The Treasury and Fed have signaled they can say no. While Lehman's failure has spooked markets, the lesson that a storied investment house can fail without a federal rescue is its own crash course in risk management. The weekend decision by a group of major banks to establish a common fund to borrow against is also hopeful. The banks, which each anted up $7 billion to be part of this private lending fund, realize that acting in concert can serve their self-interest -- a lesson that J.P. Morgan would have applauded in the Panic of 1907.

Paul Volcker

And yet the financial system will remain fragile as long as asset values keep declining. More major bank failures are a certainty, including some very large ones. That means more Sunday soap operas like this month's, with all of the anxiety that inspires among the public. The longer these melodramas continue, the greater the risk of a recession.

Which leads us to suggest another Resolution Trust Corp. as one more tool to calm financial markets. The first RTC helped to buy, stabilize and liquidate troubled assets amid the savings and loan mess of the late 1980s. Then it blessedly went out of business. Former Fed Chairman Paul Volcker endorsed an RTC II yesterday in a speech in Naples, Florida, and we suspect the idea will gain more traction. He said he "reluctantly" embraced the idea for "dealing with the market breakdown, breaking the logjam of mortgages and other assets of uncertain value [and] restoring a sense of reasonable valuation and market confidence."

Yes, this would require a Congressional appropriation, and in that sense it would cost taxpayers. But by now it should be clear that some taxpayer money is going to be needed, if only to pay off insured depositors at failing banks. The Federal Deposit Insurance Corp. has already said it may need to borrow from its Treasury line of credit, and that's based on what could be optimistic estimates about home prices.

The taxpayer is also currently at risk through the Fed, which has become ever more creative with its use of the discount window. Its new lending facilities have been necessary amid this crisis, but they have also meant that the Fed is accepting ever-dodgier paper as collateral. Over the weekend it agreed to take non-investment grade paper. The danger is that all of this will put the Fed's own balance sheet at risk -- which would mean even bigger trouble. Better to put this bad mortgage paper on the Treasury side of the federal balance sheet.

Meanwhile, a new RTC would provide a buyer for securities for which there is no market, set a floor under the market, hold the securities until markets stabilize, and liquidate them in an orderly fashion, perhaps at a profit. Failed institutions and managers would not be bailed out. There's always a risk that the politicians will meddle, which is one reason for the Bush Administration to do this now so it can insist on enough political insulation.

As for the larger economy, the last 13 months are a guide to what not to do. The Fed recklessly cut interest rates, while Congress and the White House dropped "rebate" checks from helicopters. The rate cuts ignited another oil and commodity spike that walloped middle-class consumers, while the rebates did nothing to change incentives or lift investment.

We hope the Fed heeds this lesson and holds firm on rates today. Yesterday it injected $70 billion in liquidity to stabilize the fed fund rate at its peg of 2%, as it should in a crisis. But that money can be withdrawn over time as the crisis eases. Meanwhile, a more cautious monetary policy overall will help the dollar, which in turn will mean lower oil prices and more capital flows to the U.S.

What the economy really needs is a big pro-growth tax cut, the kind that will restore confidence and risk-taking. This is an opportunity for both candidates, but especially for Mr. McCain. Instead of focusing on an extension of the Bush tax cuts, the Arizonan should offer his own tax cut to revive capital markets and prevent a recession. Democrats will claim he's helping "the rich," but our guess is that every American who owns a 401(k) will figure he's one of those "rich."

One great lesson of past panics is that they needn't become crashes, if policy makers make the right decisions. Thirteen months into this crisis, the best choices are the same as they were last August: energetic emergency plumbing to protect the financial system, steady monetary policy to defend the dollar, and a tax cut to spur growth. It's also the kind of agenda -- and leadership -- that could win an election.

Hurricane Ike: Get Ready For Soaring Gasoline Prices

Hurricane Ike: Get Ready For Soaring Gasoline Prices

Posted By Keith Johnson On September 12, 2008 @ 12:51 pm In Gulf of Mexico, Gasoline, Refining | 24 Comments

Hurricane Ike is bearing down on the Texas coast like an eerie reminder of the deadly 1900 storm that mauled Galveston, and represents a perfect-storm scenario of possible damage to vulnerable refining, chemical, and shipping industries.

As Ike’s Category-2 winds start pounding one-quarter of America’s oil-refining capacity, what’s the likely outcome in terms of gasoline prices and shortages? Reuters quotes one breathless meteorologist:

“Hurricane Ike is a gigantic Category 2 monster and is likely to generate a massive and particularly destructive storm surge at key refinery centers,” said Jim Rouiller, meteorologist with private weather forecaster Planalytics. “Close to 20 percent of the U.S. refining capability could be lost for a long period of time.”

But what’s a “long period of time”? The folks at The Oil Drum have been trying to divine how Ike’s storm surges and inland flooding could affect Texas’ refining capacity. In a nutshell, it doesn’t look good—with some outages potentially lasting the rest of the year:

The key question is refinery damage…Current models are showing that there will be at least 1 MMBBL offline for 30 days, with the potential for 5 MMBBL offline at 30 days and 4 MMBBL at 60 days, 1 to 2 MMBBL out through the end of the year. That would certainly cause
significant shortages of refined products (eg gasoline).

You don’t have to tell Houston drivers. On their way out of town, many have already run into long gasoline lines—and some service stations have already run out of fuel, thanks to the early refinery shutdowns prompted by Ike’s arrival.

If Americans thought $99 oil meant the end of $4 gasoline, Ike might just make them think again.

Plan Skirts Housing's Biggest Troubles

Rescue Won't Fix Falling Home Prices, Rising Foreclosures

By MICHAEL CORKERY
September 8, 2008; Page A14

The government takeover of Fannie Mae and Freddie Mac likely will help ease mortgage rates for home buyers, say economists, home builders and housing experts. But it won't cure the housing market's biggest ailments: falling home prices and rising foreclosures.

"This is another marginal step in the right direction," says Richard DeKaser, an economist at National City Corp., a large Cleveland bank. "But it doesn't resolve the glut of homes on the market or remove pressure on prices."

The housing market is stuck in a vicious cycle. It started with an oversupply of homes that eventually caused prices to plummet. Falling prices led to waves of foreclosures, as homeowners ran into problems refinancing their mortgages or selling their houses. Banks are reluctant to lend when home values keep sinking and defaults are rising, curbing housing demand further and fueling more price drops and defaults.

Investors and economists feared that a collapse of Fannie and Freddie would greatly exacerbate the downward spiral by essentially freezing the mortgage market. "The government's move takes that serious disruption to the financial market off the table," says Mark Zandi, chief economist at Moody's Economy.com.

Mr. Zandi says that while the takeover of the mortgage giants won't immediately stop the home-price slide, it should limit price declines to 5% to 10% over the next year, rather than the doomsday scenario of additional declines of 15% to 20% that some economists were predicting if Fannie and Freddie failed or pulled back dramatically....

Mounting Woes Left Officials With Little Room to Maneuver

By DEBORAH SOLOMON, SUDEEP REDDY and SUSANNE CRAIG
September 8, 2008; Page A1

WASHINGTON -- In the end, Fannie Mae and Freddie Mac had no choice.

Summoned to separate meetings on Friday with Treasury Secretary Henry Paulson and other top officials, the two mortgage giants were told they could either agree to a government takeover or one would be foisted upon them.

"We have the grounds to do this on an involuntary basis, and we will go that course if needed," Mr. Paulson told senior executives at the two companies, who had little idea such a move was coming, according to three people familiar with the meetings.

There was no dramatic trigger, nor was there fear of imminent collapse. Instead, the sweeping government intervention stemmed from a growing realization by Treasury and Federal Reserve officials that the two companies couldn't survive in their present forms, and that any collapse would be devastating to the economy.

The decision was hashed out over weeks of meetings. They included a conclave of Federal Reserve officials during their annual retreat at Jackson Hole, Wyo.; a mid-August polling of bond-market players by Morgan Stanley bankers advising Treasury; and a marathon session over the Labor Day weekend, fueled in part by Diet Coke and Coke Zero.

Dozens of bankers and lawyers were involved in the process. One junior banker joked that the round-the-clock schedule was tougher than prison -- at least there, you got three square meals a day.

In the end, Mr. Paulson, Federal Reserve Chairman Ben Bernanke and James Lockhart, head of the companies' regulator, the Federal Housing Finance Agency, concluded that the two companies had lost the confidence of the markets and couldn't survive as currently structured. No one could say how much money from the Treasury, either via a loan or an equity investment, would be enough to get them through the housing mess. Hence, the need for the government to step in and stabilize what has become a vital cog for the housing and mortgage market.

This account of the government's dramatic decision is based on interviews with government, Wall Street and company officials and others.....

U.S. Seizes Mortgage Giants

U.S. Seizes Mortgage Giants
Government Ousts CEOs of Fannie, Freddie; Promises Up to $200 Billion in Capital
By JAMES R. HAGERTY, RUTH SIMON and DAMIAN PALETTA
September 8, 2008;

In its most dramatic market intervention in years, the U.S. government seized two of the nation's largest financial companies, taking direct responsibility for firms that provide funding for around three-quarters of new home mortgages.

Treasury Secretary Henry Paulson announced plans Sunday to take control of troubled mortgage giants Fannie Mae and Freddie Mac and replace the companies' chief executives....

With that, the U.S. mortgage crisis entered a new and uncharted phase, potentially saddling American taxpayers with billions of dollars in losses from home loans made by the private sector. Bush administration officials argued that the cost of doing nothing would be far greater because of the toll on the economy of falling home prices and defaults in the $11 trillion U.S. mortgage market....

By taking this action, the government has seized control of the vast bulk of the secondary market for home mortgages and will have a more direct responsibility than ever for solving the housing crisis. The intervention also marks the failure of the public-private experiment that was created to boost home ownership among Americans. Fannie and Freddie were created by Congress to help prop up the housing market, and investors have long believed the government would bail the companies out in a crisis. But the companies have long been owned by private shareholders seeking to maximize profits.


The move is also likely to nudge down mortgage rates for consumers, who are facing the worst housing bust since the 1930s. Despite steep interest-rate cuts by the Federal Reserve, the cost of a typical 30-year fixed-rate mortgage has remained well over 6% for most of the past year....

Without government support for the mortgage market, home prices would fall much further, exposing the country as a whole to greater economic strain...

Fiscal Conservatism Helped Louisiana Beat Katrina By BOBBY JINDAL

August 29, 2008; Page A17

Baton Rouge, La.

Three years ago today, Hurricane Katrina battered New Orleans and southeast Louisiana. A few weeks later, Hurricane Rita hit southwest Louisiana, completely demolishing some of our coastal communities. These terrible storms destroyed thousands of small businesses, displaced hundreds of thousands of residents, killed over a thousand people, and caused tens of billions of dollars in property damage.

At the time, many experts predicted Louisiana's economy would never be the same. That's true, though not the way the experts thought: It's getting better.

These storms forced us to rethink our aspirations as a state. We are not just rebuilding the failed institutions of the past -- we are rebuilding smarter.

We streamlined our state recovery processes, cutting red tape, and are pushing federal recovery dollars to local governments to rebuild critical infrastructure, all without forfeiting transparency and accountability. And we continue to focus on helping our hardest-hit communities complete their recovery efforts.

We also moved quickly to increase Louisiana's overall economic competitiveness. Shortly after my inauguration in January, we worked with the state legislature to adopt the strongest governmental ethics laws in the country. Next we eliminated unorthodox business taxes. We also adopted a comprehensive workforce-development reform plan to improve the effectiveness of our community and technical colleges, provide turnkey workforce solutions to expanding and relocating businesses, and ensure that our workforce programs are driven by real business needs.

For the first time in our history, Louisiana has become a hotbed for education innovation. In New Orleans, state and local education leaders are working with national nonprofits and foundations to implement a variety of promising reform efforts, including charter schools and school choice for disadvantaged kids.

While we need to retain and grow our traditional industries, the state also needs to diversify our economy through new, high-growth sectors.

Louisiana is now among the top three states in the country for film productions. We are seeking to match that success in the digital media sector, starting with Electronic Arts -- the world's leading interactive entertainment software company -- which last week announced it will launch its global quality assurance center in partnership with Louisiana State University (LSU).

We are becoming a national leader in the coming global nuclear-energy resurgence, as well. On Tuesday, The Shaw Group and Westinghouse announced that they chose Louisiana for the first manufacturing facility in the U.S. focused on building modular components for new and modified nuclear reactors.

Louisiana is attracting significant investment in mature industry sectors, as well. Albemarle, a Fortune 1,000 specialty chemicals company, recently moved its corporate headquarters to Baton Rouge from Virginia. Edison Chouest Offshore, one of the world's most technologically advanced offshore vessel service companies, recently announced plans to construct a 1,000-job shipyard in Port of Terrebonne, in south Louisiana.

We also have implemented conservative fiscal management practices. For example, a state hiring freeze saved $39 million and led to the elimination of nearly 1,000 state jobs. I vetoed 258 line items in the recently passed state budget, which is more than double the number of vetoes in the past 12 budgets combined. And we ended our state's long-held habit of using one-time revenues to cover recurring expenditures. These efforts helped us to implement the largest personal income tax cut in state history, while freeing up new funds to invest in higher education, transportation, research, health care and coastal restoration.

Thanks in large part to these reforms and our aggressive efforts to attract new business investment, our economy today is strong. Compared to the nation as a whole, Louisiana's economy is growing substantially faster, and our state has considerably lower unemployment levels.

The rest of the country is starting to take notice. Citing strong fiscal management, three major credit-rating agencies -- Moody's, Standard & Poor's, and Fitch -- recently upgraded Louisiana's bond ratings. The Center for Public Integrity noted that Louisiana's new governmental ethics laws regarding legislative disclosure will increase our ranking to first in the country, from 44th. For the first time, U.S. News & World Report ranked LSU in the top tier of its list of America's Best Colleges. And Forbes magazine increased its growth-prospects ranking for Louisiana to 17th from 45th.

Our state has long had a special charm that draws visitors from around the world. Significant policy reforms, conservative fiscal management and targeted investments are now steadily transforming Louisiana into the next great American state for business investment, quality of life and economic opportunity.

Mr. Jindal, a Republican, is the governor of Louisiana.

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