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Cookie Monster On The Economy – Me Like… Recovery!!!


He Who Sees No Bubbles – That Not Good, Keemosabee


And: Goldman Apologizes.  Goldman Gives Back.  Goldman Cancels Christmas Party. 

The Shape Of Things To Come

This week Sesame Street celebrated its 40th anniversary.  Jim Henson, creator of the Muppets, is no longer with us, but he lived to see his handiwork change the world in ways television’s earliest proponents dreamed of.  Odd though it may seem now, television’s pioneers were of mixed emotions regarding the new medium.

Edward R. Murrow, the father of broadcast journalism, crossed over from radio to television with trepidation, fearing that the medium would stifle the imagination.  Still, early visionaries saw this invention as a tool that would educate the world.  CBS producer George Crothers created the weekly program Lamp Unto My Feet which, through its dramatizations and scholarly discussions, promoted religious understanding and tolerance.  The year was 1948, and tolerance was in short supply.  The next year Paul Tripp launched Mr. I. Magination, a weekly show that encouraged children to use their imagination and learn about the world.

Now we honor Sesame Street, a spiritual descendant of Tripp’s efforts to use television to stimulate children intellectually.  Sesame Street exemplifies all that is best about television.  It has taught generations of kids to spell and count, and has helped them to encounter a diverse world without sacrificing their own unique identity.

Speaking of the letters of the alphabet, here’s a group of people that could use an education.

We continue to be barraged by an alphabet soup of economic forecasts.  First there was the V-shaped recovery.  Then the concern of a double-dip recession led to the W-shaped recovery.  Some economists think the trough will last longer and the recovery lead off slower, leading to a U-shaped graph.  Others – not forecasting a double-dip, but less sanguine about the strength of the recovery – think the recovery will be L-shaped.

Into this mix, we would like to introduce the letter that says it all.  Today’s economic crisis is brought to you by the letter Q.  Indeed, we are calling for a Q-shaped recovery, in which the markets get pulled back into the endless cycle of boom, bust and Ponzification, while wealth keeps escaping out the tail, being siphoned off to the Usual Suspects. 

The average investor – which is most people in the world with cash in their bank account and a roof over their head – will be buffeted by the ups and downs of the market, spurred on by the self-dealing of the professionals who exhort them to buy each new investment product.

National governments will rush clunking down the corridors of power like knights in thousand-pound suits of chain mail, swinging the crushing mace of excess regulation at the marketplace, a weapon that lands with devastating force, though always wide of the mark.  Within three to five years after the consensus of Wall Street, Washington and the press announce themselves satisfied that the situation is under control (think “Mission Accomplished”) fresh bubbles will burst worldwide, sowing civil unrest and massive economic hardship.

It may pay to meditate on that next bubble – which neither governments nor financial pundits will successfully predict.  We do not yet know where it will originate, but the world it roils will be changed substantially from the world we saw trampled as we entered into the current bubble a mere two years ago.

By the time the next bubble pops, China will have reached an accommodation for its massive holdings in US Treasury debt.  This may take the form of forcing the US to establish a floor valuation for the dollar.  Secretary Geithner recently came out swinging – rhetorically, if not actually – in favor of a strong dollar, and his single biggest customer may decide it’s time for him to put up or shut up.  Our currency is, to use an unfortunate turn of phrase, no longer worth the paper it is printed on.  This is lost on no one.  Indeed, the more one’s wealth is tied up in dollars, the more painfully one recognizes this.  We foresaw the Fed sitting on its hands while other nations rushed in to prop up the dollar, for fear their own currencies would appreciate into crisis, and this has been happening everywhere but China. 

China and the US are locked in a Mexican standoff over the value of the yuan.  The Chinese will not stand down and have called us out on the obvious fact that the US has engineered the mother of all carry trades with our combination of a weak dollar and negative interest rates.  The Financial Times reports (20 November, “Short-Term US Interest Rates Turn Negative”) this week’s Treasury issue saw bidders pay a premium, meaning the buyers will actually give money back to the Treasury when these bills mature in January.  The inevitable result of this is that the Fed is beggaring-thy-neighbor into a global round of forcing everyone else to bail us out.

By the time the next global crisis strikes, the Chinese will have resolved this disequilibrium.  This may be as simple as forcing the US back onto the gold standard, or by making us acknowledge the dollar to be a Basket Case, and having the dollar pegged to a basket that includes the Yuan, the Euro, the Brazilian Real, and IMF Special Drawing Rights.  The consensus today appears to be that the dollar will not remain the world’s source of liquidity forever, but also that it is in no imminent danger of losing its place.  We think a transitional arrangement might evolve.  Clearly, the Chinese would push for one that will give them increased leverage as they continue to hold onto their Treasurys, meanwhile closing out those other pesky currencies like the Yen and the Ruble.

There is also the possibility of serious civil unrest in China, as those dissatisfied with their government’s policies grow bolder.  The error the West made in its analysis of Tiananmen Square was the self-satisfied notion that the Chinese wanted to be like us –where what they really wanted was the freedom to be like themselves.    

A Wall Street Journal Opinion piece (20 November, “The China President Obama Didn’t See”) claims there may be over 100 million Chinese practicing a secret form of Christianity, driven underground by their refusal to hew to the official policy that prohibits evangelizing and, of course, protest.  Christianity may be one of the most important hotbeds of a nascent protest movement.  The Journal piece says that “dissident intellectuals have been attracted to Christianity” as more and more “well-educated city dwellers turn away from Communist Party atheism.”

While we believe this will act as a destabilizing force in Chinese society, we caution against anyone thinking the embrace of a Western faith will draw its Chinese adherents any closer to our way of life.  Rather, this is likely to be a uniquely Chinese form of Christianity that has little truck with the west.  What, after all, have we done for them lately?

Religion forced underground has always been a catalyst for social upheaval.  While the façade of government might is incredibly sturdy, once it cracks even a little, the ensuing flood can be cataclysmic.  We have a scary vision of China, either returning to the harsh repression of Tiananmen, or falling victim to social revolution on a scale to dwarf what we have witnessed in Iran.  

Speaking of Iran, there will be another game-changer as well.  By the time the next financial crisis strikes, Iran will have nuclear weapons. 

Looking for a safe place to invest that battered 401K?  As you peruse those endless lists of mutual funds that all look mind-numbingly the same, don’t forget to factor in the precarious state of the dollar, the ascendancy of the Chinese-Brazilian economic and political axis, a billion unhappy Chinese, and a re-armed Hezbollah, implicitly backed by tactical nuclear weapons. 

To the cycle of Boom and Bust, now add Blam!!!

As you feel yourself being sucked into the vortex, remember that the politicians and bankers who doggedly persist in keeping us locked in this endless cycle will always continue to pay themselves.  This is a Zero Sum Game: they get Some, and we get Zero.  See that little curl at the bottom of the letter?  Underneath the endless cycle is that squiggly little tail where the money just keeps draining out and draining out…

Today’s economic forecast was brought to you by the letter Q, and by the numbers All, and None.

Unreservedly Fed Up

Philip Booth, editorial director of the Institute of Economic Affairs, writes in the Financial Times (13 November, “Ethics Alone Will Not Prevent Financial Crises”) “when the government signals that some banks are too big to fail… banks grow big.”  The “unintended” consequence of government meddling in the private sector is that it promotes the very activities it seeks to hinder.   Dead on the money, Mr. Booth.  In the old days, Capitalism used to mean that anyone could succeed – and that anyone could fail.  By coining the phrase “too big to fail”, the government de facto created a new category.  Is it any wonder that firms rushed to sign up?

The giant financial institutions’ problems were solved with the stroke of a pen.  They are all squealing with delight at the announcement that they are Too Big To Fail, like Moliere’s M. Jourdain, who is thrilled to learn that he has been speaking in prose all his life.

“Once governments interfere to the extent they have,” Booth observes, ‘we do not know what behaviour creates wealth and what behaviour feeds the boom.” 

The government does not merely tolerate this behavior, it actively fosters it.  The Wall Street Journal reports (19 November, “Pimco’s New Job Raises Concerns”) that the National Association of Insurance Commissioners has hired Pimco to “estimate losses in insurers’ holdings of residential-mortgage bonds, estimates regulators will use to determine for 2009 the capital insurers must hold to back these bonds up.”  Last week we learned the NAIC was planning to take this job away from the ratings agencies for fear of conflicts of interest, as insurance companies resorted to the old practice of shopping for the best rating for the distressed instruments languishing in their portfolios.

This week, the NAIC has hit upon the capital idea of taking one of the largest players in the world of money – a firm that manages funds for both insurance companies and state pensions – and making them the arbiter of credit worthiness. 

Pimco, needless to say, is tickled.  They have expressed themselves as being “extremely honored to have been selected by NAIC for this important assignment.”  Their rigid internal controls notwithstanding – they have assured the world their information barriers will prevent conflicts – it should be patently obvious that this has the potential to lead to trouble.

Pimco already works for the federal government.  It managed the emergency commercial paper program, and currently purchases mortgages for the Fed.  We do not question Pimco’s abilities, nor their integrity in forthrightly handling the new responsibilities.  But by asking Pimco to take on a job which creates such obvious potential for conflict, the NAIC is setting them up to be next on the list of firms to become a target of public ire, and Congressional investigation.  Pimco is clearly well suited for this task, and will no doubt execute with integrity.  But there are countless other shoes to drop in the asset-backed portfolios, and Pimco risks being vilified down the road for taking on what will, in retrospect, be called an unavoidable conflict.

Just in passing, we don’t for a moment believe the NAIC could be motivated by a desire to protect the industry they oversee.  We only mention this in light of the clearly unrelated item (WSJ, 16 November, “Banks’ Safety Net Fraying”) that reports on an apparent act of contrition by the major ratings agencies.  It seems that Standard & Poor’s has decided to treat banks that received government assistance much in the way baseball views players who have admitted to using steroids.  In awarding their asterisks, S&P may well be rocking a very large boat.  Says the Journal, “S&P gives Citigroup a single-A rating, but adds that it would be rated triple-B-minus, four notches lower, with no assistance.”  The article goes on to report that, thanks to government funding, “Morgan Stanley and Bank of America get a three-notch lift.  Even Goldman Sachs Group enjoys a two-notch benefit.”  Should such granular scrutiny be turned to the insurers’ portfolios, there’s no telling where it might lead.

Secretary Geithner was outed this week by none other than the SIGTARP – the Special Inspector General of TARP – who announced the bizarre finding that the Fed did not believe AIG’s tottering CDS posed a systemic risk.  What, then, was the rationale for paying them off in full, and not requiring the banks on the other side of those transactions to take a substantial haircut – or, indeed, to lose out altogether?

Congress’ response is, increasingly, to insist that Geithner must go, and many urge throwing in Larry Summers for good measure.  Secretary Geithner’s response is that it is very easy to criticize after the fact.  We accept that, but somewhere in the midst of all this, we keep coming back to the fact that AIG got $180 billion of our money, and that a lot of that was handed over to Goldman et al without asking for anything in return.  Oh well, we guess you had to be there…

While we are on the subject of government stoking conflict in the financial sector, we caught banking analyst Meredith Whitney on Bloomberg Radio this week.  She said the Fed’s balance sheet is now up to about one-third Fannie and Freddie-type paper – mortgage-backed securities that would be worthless but for the Mark To Market Of Last Resort.  At the same time, she says major bank balance sheets average some twenty percent holdings of just this type of paper which are counted in their capital.  To this we add our own Broad Street Irregulars who report seeing the same Cusip numbers of new Treasury issues appearing in less than thirty days of issue on the books of the Fed.  The nation’s entire financial system looks like a cycle of auto-Ponzification. 

Banking institutions classed as TBTF are sustained only by a Fed that stands willing to take their worthless paper onto its books at an artificial price.  If our Broad Street Irregulars are accurate, and the Government is buying back substantial chunks of its own newly-issued debt, then what percentage of the Fed’s own balance sheet has any actual market value?

Fed Chairman Bernanke gave a speech last Monday in which he remarked “It’s not obvious to me in any case that there’s any large misalignments currently in the US financial system.”

Will someone please show this man how to get to Sesame Street?

The Goldman, The Badman, And The Uglyman

I like big fat men like you.  When they fall they make more noise.

          - Tuco in “The Good, the Bad and the Ugly”


Realizing that they are now damned if they do, and damned if they don’t, Goldman Sachs has decided to do.  They are preparing to pay out record compensation to their employees, in recognition of a record year.

Suddenly they are getting flak from a most unexpected quarter: their own shareholders.  An as-yet anonymous group of Goldman investors have contacted Blankfein & Co urging them to exercise restraint.  We are not privy to their identity, but clearly they are important enough to make the front pages.  In fact, there is no better group to urge this.  Government, you may be shocked to learn, has neither the ability nor (harrumph!) the standing to legislate morality to Wall Street, or to anyone.  Like Rumpelstiltskin, Goldman has an uncanny ability to spin gold out of straw.  It is a given in their business model that profits are shared with those who generated them.  Indeed, Goldman is one of the few financial firms that fosters any kind of team spirit.  In an industry notorious for Lone Wolves, Goldman pays bonuses based on the overall performance of the firm.  For those who have never worked in the belly of the beast of Wall Street, it is not immediately obvious how unusual this is. 

Yes, Goldman is noted for ruthlessness, for obsessive pursuit of profits, for people whose entire lives mean nothing but the pursuit of money – and later, of power.  But let’s not put too fine a point on it.  Practically everyone who works on Wall Street wishes they could work for Goldman Sachs.  Goldman is hated, more than anything, because they consistently personify the pinnacle of success in the industry. 

Blankfein has been accused of having a tin ear where public sentiment is concerned.  But in fact there is nothing he can say to win approval.  By Wall Street standards, Goldman runs an ethical business.  They do not break the law, they do not purposely send widows and orphans to the poor house.  But they do capitalize on every advantage, and do not stop to weep if their competitors suffer.

It is not the job of Lloyd Blankfein to put a stop to this.  If anything, the shareholders are the proper agents of this transformation.  They actually own the company, and they are the ones both responsible for, and capable of demanding accountability on the part of management.  If they don’t complain to their CEO, who are we to kvetch?

If we can fault Blankfein for anything, it is his efforts to smooth things over.  As reported, for example, by the Financial Times (18 November, “Goldman Apologises For Crisis And Pledges $500m To Small Business”) the firm is taking steps calculated to burnish its public image.

To put it in perspective: $500 million over five years is not a lot of money for Goldman Sachs.  The stated target of these funds is “small business” – Main Street.  Goldman’s $500 million is small beer in context, both of its own finances, and of the magnitude of the problems facing America.  It is a major step, however, if other financial institutions fall in line.  We applaud Goldman for showing leadership, and we wonder whether any other firms will follow.  Goldman is already being taken to task for the paucity of its offer.  The FT article starts off by observing that the amount is “about 2.3 per cent of its estimated bonus and salary pool for 2009”.  They just can’t win.  And they won’t unless it becomes a movement.  We wonder whether the shareholders of any other banks will pressure them to follow Goldman’s lead.  With no other takers, Goldman’s gesture will be seen as cynical and criticized as too little, too late.

Oh, and a final word to Mr. Blankfein.  Forget the apology.  Apologizing went out of fashion earlier this year.  No one is listening.  You can beat your breast all you want, but you can’t hold a candle to the Apologizers’ Gallery that paraded across our television screens earlier this year.

In the month of February alone, John Thain apologized to Maria Bartiromo for his wastebasket; William Ackman apologized to his investors for Target; the heads of Royal Bank of Scotland and of England’s HBOS bank apologized to Parliament for their banks’ rotten judgment – the standout was Fred “The Shred” Goodwin of RBS who offered up this heartfelt plea: “I apologized in full and I’m happy to do so again.”

And of course, Mr. Blankfein, let us not forget the Apologizer-In-Chief who, after being caught with his Presidential trousers around his ankles over the succession of tax cheats he tried to name to his cabinet, bravely told the American people “I take full responsibility”.  Let’s face it, apologizing is done.  You can’t even win on that score.

What’s a Blankfein to do?

For our money, Mr. Blankfein, we think you just keep on doing what you are doing.  Cynical as we are – and knowing full well that, in the dirty, nepotistic and conflicted world of Washington and Wall Street, Timothy Geithner will probably be working for you by the end of President Obama’s first term –we think you are doing just fine.

Moshe Silver

Chief Compliance Officer