Mid-Life MBA: The Art of Business

The Securities and Exchange Comission has announced a temporary rule on short selling of investment bank stocks as well as the stock of Fannie Mae and Freddie Mac.  The rule will require brokers to actually pre-borrow the shares before shorting a stock.  Currently many short sellers could short a single stock based on the same shares; the new rule will require a broker to cover shorts, share for share by removing shares from the market once a stock has been shorted.  The SEC will consider extending this rule to the broader market.  To me this is kind of a “duh,” or, self evident principle that should have led to reform years ago.

Payrolls shrank again in June for the sixth consecutive month, this time, by about another 62000 jobs.  Couple that with the market now entering official “Bear” territory and looks like we’re in for some real dog days this summer.  Is it all doom and gloom?  That depends on who’s talking.  In the short term it most certainly is though the Fed is expected to be more bullish about prospects going into the new year (not to mention a new presidency).

In a recent Duke University survey of CFO’s the highest priority worries were 1) consumer demand; 2) cost of labor; 3) cost of fuel; 4) interest rates; 5) cost of health care.  Interestingly, European and Asian business leaders were much more optimistic.

A CNN Money article states that Federal funds futures on the Chicago Board of Trade show that investors are betting 100% on the likelihood of a half point rate cut on March 18th and, 88% on a three quarter point rate cut.  They then, on the basis of the growing opinion among some economists that we don’t, ask “do we really need another rate cut?”

“The problems the markets are facing are not due to interest rates being too high. It’s a lack of confidence,” said Barry Ritholtz, the CEO and director of equity research for Fusion IQ.  Ritholtz and others argue that the rate cuts are only worsening the pain through devaluation of the dollar and amped up demand for commodities such as gold and oil.  If additional rate cuts are not going to increase either consumer confidence or trust among lenders, do we really need one?

What do current proposals for an economic stimulus package propose? I’ve heard estimates of $600 - $800 for average American families. This “windfall,” in theory, will revitalize our consumer-based economy by filling malls with customers who are eager to spend, spend, spend. Perhaps the hope is that this “priming of the pump,” will once again get the streams of cash flow, flowing, and keep them flowing. This kind of stimulus measure however, clearly cannot keep consumers spending for long and it is reasonable to question how many will start spending at all. $800.00 after all, at least makes a dent in whatever astronomical figure the average American has for an outstanding credit card balance.

To really really get the economy going, how about not only a larger windfall to families, but an incentive for actually spending the money on new consumer goods. What if the government say, offered a matching tax credit to consumers of $1.00 for every $1.00 spent on soft goods and perhaps double that amount for durable goods? Wouldn’t that be sweet?

My gosh, why stop even there, why not actually pay people to go shopping? Can you imagine the amount of consumer spending that could be stimulated if the government would just pay us all to shop! They of course could not keep this up forever, maybe just for a year or two until we get over the hump and the bear goes back into hibernation.

Seriously though, what about something really radical like ending the drain on the economy by ending the war that has so far created over $40,000 in debt for every American family? What about some real leadership from our elected leaders to help transform this nation into a nation of savers instead of spenders, a nation of thoughtful investors rather than reckless consumers, and a nation of well-rounded, productive people rather than amusement junkies? A one-shot, injection of liquidity may have psychological value but it won’t change the fundamentals, a long term plan and real leadership is needed for that.

Angry Bear phrased it well, “we must think further than just giving the junkie one more–maybe his last–shot in the arm. In short, merely priming the consumer for one more run at the punch bowl is a bit short-sighted.”

Read the Intelligence Daily, article here

Executive Summary:

Bernanke, in his testimony before congress today, admits that the economy has worsened since August in the wake of sub-prime loan defaults which would increase over coming months.  He also hinted that the present credit crisis could become a fully blown recession.

Internationally, China has suggested it may react by diversifying its $1.43 trillion in foreign exchange reserves into stronger currencies, and French President Sarkozy said that America’s ”monetary disorder risked turning into economic war” as American exports cheapened and European exports were becoming more expensive.

Bernanke’s appearance before congress was opened with a statement from New York Senator Charles Schumer, the chairman of the Joint Economic Committee. 

He said that in the aftermath of the “seizing up of the credit markets” in the summer, “there is now a lack of confidence in credit-worthiness throughout the market… However, while we did weather that summer storm, I’m very concerned that there may be a bigger storm on the horizon. Quite frankly, I think we are at a moment of economic crisis stemming from four key areas: falling housing prices, lack of confidence in credit-worthiness, the weak dollar and high oil prices. Each of these problems alone would be enough of a threat to our economic well-being. But taken together, they are essentially the four horsemen of economic crisis…

“Even our bedrock assumptions are being put into doubt. As housing prices decline, there are real fears that we won’t be able to depend on consumers, the engine of our economy over the past few years, to keep spending. And now we hear that foreign investors may no longer be confident in the dollar as the global currency of choice. I’m not surprised to hear experts, such as your predecessor Alan Greenspan, warn about the threat of recession. I’ve begun to worry about worse.

“In particular, as I watch bank after bank write down bad investments tied to baroque financial instruments that even sophisticated investors don’t understand, I fear for the stability of our financial system.”

The Wall Street Journal noted today how the current market volatility is raising the stock of a little-known economist whose views have suddenly become very popular–Hyman Minsky.

The WSJ says that, “Minsky, who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.”

“Today, his views are reverberating from New York to Hong Kong as economists and traders try to understand what’s happening in the markets. The Levy Economics Institute of Bard College, where Mr. Minsky worked for the last six years of his life, is planning to reprint two books by the economist — one on John Maynard Keynes, the other on unstable economies. The latter book was being offered on the Internet for thousands of dollars.  Christopher Wood, a widely read Hong Kong-based analyst for CLSA Group, told his clients that recent cash injections by central banks designed “to prevent, or at least delay, a ‘Minsky moment,’ is evidence of market failure.”"

The “Minsky moment” has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.

Wikipedia says:

“Hyman Minsky has proposed a simplified explanation that is most applicable to a closed economy. He theorized that financial fragility is a typical feature of any capitalist economy. High fragility leads to a higher risk of a financial crisis. To facilitate his analysis Minsky defines three types of financing firms choose according to their tolerance of risk. They are hedge finance, speculative finance and Ponzi finance. Ponzi finance leads to the most fragility.

Financial fragility levels move together with the business cycle. After a recession firms have lost much financing and choose only hedge, the safest. As the economy grows, and expected profits rise, firms tend to believe that they can allow themselves to take on speculative financing. In this case they know that profits will not cover all the interest all the time. Firms, however, believe that profits will rise and the loans will eventually be repaid without much trouble. More loans lead to more investment and the economy grows further. Then lenders also start believing that they will get back all the money they lend. Therefore they are ready to lend to firms without full guarantees of success. Lenders know that such firms will have problems repaying. Still, they believe these firms will refinance from elsewhere as their expected profits rise. This is Ponzi financing. In this way the economy has taken on much risky credit. Now it is only a question of time before some big firm actually defaults. Lenders understand the actual risks in the economy and stop giving credit so easily. Refinancing becomes impossible for many and more firms default. If no new money comes into the economy to allow the refinancing process, a real economic crisis begins. During the recession firms start to hedge again and the cycle is closed.”

Major Works of Hyman P. Minsky

• “Central Banking and Money Market Changes”, 1957,
• “Can “It” Happen Again?”, 1963, in Carson, editor, Banking and Monetary Studies.
• “Longer Waves in Financial Relations: Financial factors in more severe depressions”, 1964, AER.
• “The Modeling of Financial Instability: An introduction”, 1974, Modelling and Simulation.
• John Maynard Keynes, 1975.
• “The Financial Instability Hypothesis: A restatement”, 1978, Thames Papers on Political Economy.
• Can “It” Happen Again? Essays on instability and finance, 1982.
• “The Financial-Instability Hypothesis: Capitalist processes and the behavior of the economy”, 1982, in Kindleberger and Laffargue, editors, Financial Crises.
• “Beginnings”, 1985, BNLQR.
• Stabilizing an Unstable Economy, 1986.
• “The Global Consequences of Financial Deregulation”, 1986, Marcus Wallenberg Papers on International Finance.
• “Sraffa and Keynes: Effective demand in the long-run”, 1988
• “The Macroeconomic Safety Net: Does it need to be improved?”, 1989, in H.P. Gray, editor, Modern International Environment.
• “Schumpeter: Finance and evolution”, 1990, in Heertje et al, editors, Evolving Technology and Market Structure.
• “Financial Crises: Systemic or Idiosyncratic?”, 1991
• “Market Processes and Thwarting Systems” with Piero Ferri, 1991 
• “The Transition to a Market Economy: Financial Options”, 1991
• “Reconstituting the United States’ Financial Structure: Some Fundamental Issues”, 1991
• “The Capitalist Development of the Economy and the Structure of Financial Institutions”
• “The Financial Instability Hypothesis: A clarification”, 1991, in Feldstein, editor, Risk of Financial Crisis.
• “Financial Instability Hypothesis”, 1993, in Arestis and Sawyer, Handbook of Radical Political Economy
• “Finance and Stability: The Limits of Capitalism”, 1993
• “Business Cycles in Capitalist Economies”, 1994, MIJCF.

Not to beat it to death since the early news has already been out for a couple of weeks or more but the economy has shown definite slowing in the 1st quarter with GDP increasing only by an annualized 1.3 percent according to the Bureau of Economic Analysis.  This is in comparison to the 4th quarter of 2006 where real GDP increased by 2.5 percent. The bureau cautions however that 1st quarter numbers are subject to revision and that the official, preliminary numbers will not be realeased until May 31st.

First quarter increases mainly reflected personal consumption expenditures (PCE) as well as state and local government spending.  These numbers were undermined however by the negative contributions from residential fixed investment, private inventory investment, and federal government spending.  The report also points out that imports, which are a subtraction in the calculation of GDP, increased.

The report summarizes…

“The deceleration in real GDP growth in the first quarter primarily reflected a downturn in exports, an upturn in imports, a deceleration in PCE for nondurable goods, and a downturn in federal government spending that were partly offset by a smaller decrease in private inventory investment, an upturn in equipment and software, a smaller decrease in residential fixed investment, and an acceleration in PCE for durable goods.”

A continued possibility of rising inflation may be responsible for some of the overall lack of direction in the market. The Federal Reserve Board’s release of minutes from a March meeting of the Federal Open Market Committee said the “predominant policy concern” is that future inflation won’t moderate. For the week, the S&P 500 Index rose 0.6% to 1,453, and the yield of the 10-year U.S. Treasury note rose 1 basis point to 4.76%.

Producer prices are up with the Producer Price Index (PPI) rising 1% over the last month. This is the 4th large increase in the past 5 months and is largely due to increased food and energy costs.

The trade gap however, continues to narrow and has narrowed for every month since August 2006 with the exception of December. Many analysts had expected the gap to widen in February. The gap was a record 68.9 billion dollars in August of last year but was 54.8 billion in February.

In the week ahead we look forward to a Consumer Price Index update on Tuesday as well as updates on industrial production and residential construction that same day.  On Thursday the Conference Board will release a report on leading economic indicators.

‘Tis the season for customary, post-Christmas, stock market gains and today’s figures show a market up-tick on news of increased consumer spending and consumer confidence.

Spending in November increased by 0.5% from 0.3% in the month previous. Analysts see a possibility of interest rate cuts by policy makers in the new year. This is all around, good news to an economy where two thirds of GDP is dependent on consumer spending.

Factory orders for big-ticket items such as appliances rose 1.9% in November after an 8.2% tumble in October.

On the first Friday after thanksgiving 140,000,000 shoppers spent slightly more than $360 each, up by 18.9% from last year. The first Friday after Thanksgiving is known as Black Friday because as the official kick off to the Christmas, shopping season, it marks the point in the year when traditionally, retailers’ balance sheets move into the black.
“Each year, consumers have greater expectations for doorbuster specials, forcing retailers to raise the bar,” said NRF President and CEO Tracy Mullin in a statement. “This year, stores did not disappoint.”

The NRF survey said that one-third of shoppers had hit the stores by 6 a.m. and that more than half had visited at least one store by 9 a.m.

The NRF anticipates holiday sales will grow 5 percent to $457.4 billion, slower than last year’s 6.1 percent increase.

The WSJ reports concerns on the part of economists however, that increased sales may represent only deep discounts instead of fundamental strengths (see WSJ Why the Economy Needs Consumers to shop), particularly in light of consumers’ decreasing wealth in a softening real estate market.