Creative Class

I know most of you voted for Obama. In the process, you were hoping and praying for change. Unlike many of you, I had far less faith, but much hope. On January 18, I posted this about Obama. I would like to revisit this earlier post, as my fears are being confirmed. In it the deepest insight was that Obama was ratifying Bush’s failed policies and taking ownership of them. By choosing not be truthful with the American people, Obama is now rapidly on the way to failure. This is despite the fact that Michael Wells and others have argued that he has just been in office for four weeks, give him a chance.

The trouble is that the market and foreign policy are not giving him time and he is continuing nearly all of the failed policies of the past using advisors that are the architects of this failure.

On the economy, there is no reason to list the architects of failure he has appointed, but it is important to note that it is not only the top appointments, but also the lower-level appointments including an ex-lobbyist for Goldman Sachs, a new head of the SEC who formerly was the head of the securities industry self-regulatory (an oxymoron) organization, which did an excellent (snark) job with Messrs. Madoff and Stanford.) An aside, in my experience when one finds one large mother cockroach  [i.e., an enormous Ponzi scheme] under the refrigerator, much less two, be prepared for many baby cockroaches, small Ponzi schemes and frauds, and, God forbid, even larger ones to be exposed soon. The big ones are the signs of the infestation. In a similar vein, appointing a hedge fund manager to help with the automobile industry bailout, where the hedge funds have been involved in bankrupting not only the manufacturers, but also the parts suppliers, seems particularly tone deaf. Instead of change, Obama has taken ownership of the failed policies of the past and seems bound and determined to continue them.

In terms of the military adventures, he is going down a parallel path. He has not unilaterally declared that we will be completely out of Iraq in 16 months. In Afghanistan, he is taking the Lyndon Johnson path of only approving half of what the generals want. He has continued Bush’s policies on rendition, put the CIA dungeons in Afghanistan off limits to human rights rules, and not yet closed Guantanamo. Folks, let us be serious. These wars are not going to be won. Dungeons are not moral and cannot be defended. But, more important, we and Obama need to face the fact we CANNOT afford these wars and dungeons.

What is the biggest “tell” that Obama may not be serious about change? He is discouraging Congressional investigations of the Bush Administration and serious investigations as to the causes of and responsibilities for the financial meltdown. He is not demanding that the SEC prosecute CEOs lying about the financial condition of their firms, has not told his press secretary to stop attacking reporters who say things that he doesn’t like, or demanded that his cabinet officers including Geithner stop lying about the fact that our banks are insolvent.

If he represents change, then he needs to stop the lies, sleights to hand, and doubletalk. He needs to stop the surreptitious transfer of public funds to private firms. The bloggers, the stock market, and the economy will expose the corruption regardless. And, unfortunately for all of us, Obama will be discredited. Trust is so valuable for someone trying to change the system, once lies are exposed it is over. It is not too late, but it is very late. Yes, only four weeks into a new presidency and it is late. To begin with so much promise and so quickly plant the seeds of a collapsed Presidency is a tragedy for all of  us.

Those who voted for Obama need to contact him and your Congresspersons every day saying you want something different. We did not vote for four more years of a more personable George Bush. Obama must be something different. He does not need to take ownership of the Bush Catastrophe.

This Monday, the world’s governments took a final plunge on fixing this crisis by basically assuming the debts of the world’s important banks. In the U.S., the politics of who receives the bailout and who doesn’t will be interesting. In my mind this gamble poses two questions:

1)  Will it be enough to prevent a collapse of the financial system?

This is a difficult question to answer.  I have my doubts.

If this extreme program operates as many think it might, it would guarantee that a certain set of banks would not collapse. The reasoning seems to be that these guarantees will unfreeze credit markets. For this the governments of the world will take hundreds of billions of bad bank loans, default swaps, structured investment vehicles, and all manner of so-called assets (probably worth zero or close to zero) onto their books. The sheer scale of what is being proposed can be seen by the aftermath of the Lehman Brothers bankruptcy. We now know it had worthless loans and assets of, at least, $100 billion. Some Europeans are saying that Lehman’s collapse cost them about $300 billion. We also know that almost always in such bankruptcies the true cost is greater than what is initially reported. Let us extrapolate from this and assume (because to take on all of them would be unimaginable) that when the Treasury/Fed say they will bail out banks, they only mean a few key banks and leave the rest to their own devices (there is evidence for this suspicion as the large regional banks such as Sun Trust and Zion did not participate in the huge rally on Monday). So, which banks will be bailed out? My guess is Goldman Sachs (Paulson and Robert Rubin’s ex-employer), Citi, JPMorgan Chase, Bank of America, and a few others (did Wells Fargo buy Wachovia so that it could enter this charmed circle?).  P.S. – We now have confirmation of which firms are being bailed out: JPMorgan, Goldman, Citi, BoA, Wells Fargo, Merrill Lynch, Morgan Stanley, State Street Bank [thank you Barney Frank], Bank of NY Mellon [thank you Hillary and Schumer].

Will this unfreeze credit markets? I think it is unlikely for two reasons: One, if you are an unprotected bank, then why would you lend at all? If you are one of the protected, then banks why on earth would you lend to any organization outside the circle of protected banks? The assumption appears to be that the actors in the system will now assume everything is fine and begin lending. If as everyone expects a recession is coming and most firms are highly leveraged, lending would be very risky. What type of collateral for a loan could you receive that would be worth as much in a bankruptcy tomorrow. Of course, one could have loans or investments a la Warren Buffett in Goldman Sachs or GE, which charge nearly usurious penalty interest rates of 10 percent and radically dilute the common stock holder, i.e., our pension funds and 401Ks.

The world’s governments have taken what appears to be a final step by assuming on the debt of their largest and privileged banks, they are committing future taxpayers to valorize today’s debt. They are not yet willing to admit openly that the taxpayers are buying garbage and moving it from the banks to themselves. Governments appear to hope that by moving some portion of the garbage to the taxpayer the problems will go away. This is similar to the belief among Bear Stearns, Lehman, and AIG executives that hiding garbage debt inside their firms and then lying about it to the public would make the garbage disappear.

So will this newest plan unfreeze credit markets and encourage banks to loan again? Unlikely, but no one has a crystal ball.

2) The second question is this: Is the financial system telling us something far more profound about the underlying economic situation?

Why is this the most important question? If this is a profound crisis in the core of the economic system, then these approaches are merely treating symptoms and are destined to fail (sort of like treating metastasized cancer by surgically removing parts of the body). Remember, Ben Bernanke has been called the “foremost expert on the Great Depression” by his fellow mainstream economists. Bernanke essentially lays the problems of the Great Depression on bad financial policy by the Federal Reserve and other fiscal and monetary mistakes. This belief says that government fiscal and monetary policies, if well administered, can circumvent capitalist economic crises. Marxists and Schumpeterians are not so sanguine. Particularly Marxists argue that the Great Depression was the expression of fundamental discontinuities in the underlying economy and, if this is the case, then attempts to patch the current system up are bound to fail – and probably in the process waste resources and time.

Let me play out the reasons that we may be in a more profound crisis and, if this the case, why the current ever more panicked efforts by governments to swallow private sector debts cannot provide a basis for a sustainable recovery.

a) The forces of globalization are still underway and, as many of have been saying, they are putting downward pressure on incomes in the developed nations, which, of course, are the consumers of the products of the developing nations. A small telltale of this, IBM announced dramatically increased profits on only slightly higher sales. My guess is that these profits were made by substituting low-cost developing world service providers for their high-cost developing nation employees. This dynamic will continue putting pressure on wages in the developed nations and contributing to a deflationary dynamic.

b) Real wages have stagnated in the U.S. since 2000 for all but the wealthy.

c) Income inequality has increased globally and, as a result, the vast majority find themselves less and less capable to consume.

d) The technological revolution of digitization has changed the central source of value creation from the assembly line to the designer/engineer.

e) The entire credit complex that was built up after World War II that Vance Packard decried and the cult classic The Hidden Persuaders may be at its endpoint. This would mean a deleveraging on a scale never before seen in human history. Is it possible that we can no longer borrow from the future because the future is now?

If our situation is, as I suspect, more profound, then the newest bailout will fail, and this will be clear soon.

I am not an economist. I do not know the techniques, standards, and theories of behavioral economics. That said, I know that actions speak louder than words.

There has been a lot written about the ‘collapse’ of the U.S. financial system due to the current credit crisis – with pundits, economists, politicians, and others pointing fingers and claiming their ideologies and policy explain why the U.S. is ‘bankrupt’ and doomed. There has been a lot of ink and electricity spent pushing these theories.

Regardless of all the talk and prose, Warren Buffet, the greatest capitalist of all time, put down $5 billion today on the U.S. financial system when he invested in Goldman Sachs. He also has the right to put down another $5 billion over the next five years at today’s prices.

Yes, his deal is a sweetheart deal, but investors like Buffet build wealth and strengthen the economy in times like these. GS, the best brand in the financial world, is paying a big price for Buffet’s brand and knowledge, but it sends a clear signal: the smartest institutions and people are moving forward as hot air blows from Capitol Hill, newsrooms, blogs, and press conferences.

Yes, these times are difficult and there is pain to be doled out, but panics and bailouts are part and parcel of the great engine of economic and social change known as capitalism and have been a regular occurrence in the U.S. since Hamilton’s time. There will be regulatory and institutional tweaks in the coming months and years, but that is how the system functions.

The warrant portion of the Buffet-GS deal shows that the Oracle of Omaha views five years as long-term. How long do you think it will take for this mess to sort itself out? Or are you part of the ‘end of the world’ chorus?