Update no.355

Update from the Heartland
No.355
29.9.08 – 5.10.08
Blog version: http://heartlandupdate.blogspot.com/

To all,
The follow-up news items:
-- You may recall the suspicious fire aboard RMS Cutty Sark, 16 months ago [285]. The Metropolitan Police and London Fire Brigade completed their investigation of the fire and concluded there was no evidence of arson or nefarious activity. The cause was an industrial vacuum cleaner that had been left switched on all weekend, overheated, and burst into flame. Fortunately, the restoration will repair the damage and return the magnificent ship to full glory. The process will just take a little longer and cost more than planned.
-- Hikers near Mammoth Lakes, California, discovered the wreckage of a small plane, near the 10,000 foot level of steep, jagged peaks. Recovered evidence indicates the crash site was that of famous adventurer James Stephen ‘Steve’ Fossett [169, 300], who went missing on a personal reconnaissance flight a year ago. A limited amount of human remains were reportedly recovered as well, and will be analyzed to determine identity. The NTSB has deployed an investigation team to determine the cause of the event.

While we were in California this week, advertisements both for and against Proposition 8 [345] ran in various local Media. For those who may not know, California Proposition 8 is a state constitutional amendment initiative placed before the voting residents this coming November.
The ballot description reads:
“ELIMINATES RIGHT OF SAME-SEX COUPLES TO MARRY. INITIATIVE CONSTITUTIONAL AMENDMENT.
“Changes the California Constitution to eliminate the right of same-sex couples to marry in California. Provides that only marriage between a man and a woman is valid or recognized in California. Fiscal Impact: Over next few years, potential revenue loss, mainly sales taxes, totaling in the several tens of millions of dollars, to state and local governments. In the long run, likely little fiscal impact on state and local governments.”
Proposition 8 reads:
“Only marriage between a man and a woman is valid or recognized in California.”
The television advertisement against Proposition 8 features an older couple who say they treated all their children equally and want their lesbian daughter treated equally under the law. Then, on the other side, we have a male spokesman claiming that if Proposition 8 is not passed by the residents of California, churches will be sued, religion attacked, and the moral fiber of the community will disintegrate. The contrast between the two approaches in the light of reality gives us a stark example of deflecting, fear-mongering, distracting, subtle bigotry at its finest. The argument offered is not about the proper state interests that a constitutional amendment discriminating against and segregating a small portion of our society is warranted. Rather, the argument in favor of such an extreme action hangs upon playing to the emotions of personal preference when making constitutional law – an extraordinarily dangerous precedent. This proposition is not about marriage; it is about legalizing discrimination. I trust California residents will do the correct thing.

We arrived home from our California journey, just in time to watch the Biden-Palin debate live, as it happened. First, I have a hard time calling the event a debate. It was more like a joint press conference with only one journalist. I winced an equal number of times; by that measure, I suppose they both did about the same. I was not impressed with either candidate’s responses on policy issues. I was impressed with Joe’s restraint in dealing with Sarah. And, I was also impressed by Sarah’s folksy, charismatic style; she does have a way of connecting with folks. There is no question Joe has more Washington experience than Sarah, but that is not necessarily a good thing these days. Leadership at that level is about picking the best lieutenants and communicating. Neither stumbled; they both passed.

Reuters-London reported, “British commander says war in Afghanistan cannot be won.” Brigadier Mark Carleton-Smith, commander of 16 Air Assault Brigade and Task Force Helmand in southern Afghanistan, said in an interview, “We're not going to win this war. It’s about reducing it to a manageable level of insurgency that’s not a strategic threat and can be managed by the Afghan army.” The headline title does not quite match Brigadier Carleton-Smith’s statement, but that is the sensationalism of journalism, I suppose. I am disappointed that a British Army brigadier general would state things quite that way, but I certainly understand.

Economic history continued:
-- At the urging of the USG, Wachovia Bank was acquired by Citigroup. We are headed toward fewer and even more massive banks – Bank of America, Citigroup, and J.P. Morgan Chase – closer to a centralized bank. Wait, wait! Before this week’s Update could be released, Wells Fargo made a better offer (US$15B) with their money rather than the USG guarantee Citigroup was relying upon.
-- The contagion of financial panic is spreading. The British government nationalized Bradford & Bingley – one of the UK’s biggest mortgage lenders. The Belgium, Luxembourg, and Dutch governments took over Fortis Group – a 200-year-old, Dutch-Belgian bank – to save it from collapse.
-- Japanese conglomerate Mitsubishi bought a 21% stake in Morgan Stanley for US$9B.
-- The House rejected the first pass at the Emergency Economic Stabilization Act of 2008 [H.R. 3997; House: 205-228-0-1(1)]. There was just not enough pork attached to the bill to buy the votes of enough members, I suppose.
-- The big sell off! Monday, the Dow Jones Industrial Average dropped -778 points (-7%) [US$1.2T in market value, and the largest point drop in history], after the news of the House vote failure spread. For the record, we have not sold. The market will recover, just as it has after 9/11, 17.9.2001 [-685 pts (-7%)]; 19.10.1987 [-508 pts (-23%)]; 29.10.1929 [-38 pts (-13%)]; and all the other weak moments in U.S. financial history. Let us keep things in perspective. This too shall pass. -- The big surge followed the big plunge. Tuesday, the Dow Jones Industrial Average rose +485 points (+4.7%); then, another big drop again on Thursday [-348.22 points (-3.2%)] as well as an additional -157 points on Friday, after the bad-debt absorption plan was passed by Congress.
-- It seems Warren Buffet remains in high demand in these troubled times. Less than a week after his deal with Goldman Sachs [354], Berkshire Hathaway bought US$3B in General Electric, three-year callable, preferred stock with a 10% dividend and a 10% premium if called after three years. GE also intends to sell US$12B in common stock to the public.
-- The Senate figured they would do better than the House by adding unrelated attachments and pork barrel spending to a quickly revised older bill. In the Senate’s version, the Paul Wellstone Mental Health and Addiction Equity Act of 2007 [H.R. 1424; Senate: 74-25-0-1(0)] indeed did much better. So, now the House will try to sufficiently pork-up the Senate bill to buy enough votes for passage. This is such a disgusting process.
-- President Sarkozy proposed a €300B ((£237B, US$414B) European Union fund to rescue troubled banks in Europe.
-- California Governor Arnold Schwarzenegger fired a warning shot across the bow of the Federal government with a letter to the Treasury Secretary that his state will need an emergency US$7B loan, if the credit market is not freed up soon.
-- The USG announced 159,000 jobs lost in September – the 9th straight month of employment constriction. The unemployment rate remained at 6.1% -- not good, but not bad either. How many more signs do we need?
-- Citigroup executives are reportedly considering legal action against Wells Fargo and Wachovia for allegedly reneging on the sale of Wachovia – shades of the 1984 Texaco-Getty Oil-Pennzoil contract dispute, decided by the Supreme Court in 1987; Pennzoil Co. v. Texaco Inc., [481 U.S. 1 (1987)].
-- Then, to top another historic week, on Friday, after 90 minutes of floor debate, the House passed H.R. 1424 that includes:
• Emergency Economic Stabilization Act of 2008
• Energy Improvement and Extension Act of 2008
• Heartland Disaster Tax Relief Act of 2008
• Paul Wellstone and Pete Domenici Mental Health Parity and Addiction Equity Act of 2008 [the bill that became the skeleton for the bad-debt absorption plan, upon which the rescue plan plus all the myriad of pork-barrel projects were hung to get the plan passed, began 18 months earlier – the piranhas at the public trough.]
• Tax Extenders and Alternative Minimum Tax Relief Act of 2008
[H.R. 1424; House: 263-171-0-0(1)]
The President signed the bill less than two hours after the new law was passed by the House. Apparently, the President was not particularly embarrassed by the US$110B (that is a ‘B’ for billion, not an ‘M’ or a ‘K’ – a ‘B’) in add-on pork that had absolutely nothing to do with the current bad-debt, credit crisis. We are talking about trauma surgery to stop the bleeding, and we have a bunch of bloody politicians picking the patient’s pockets while he’s on the surgery table in the operating room. Can anyone think of a more disgusting analogy for these pork-mad politicians, in this latest example of how mutated our Federal government has become? I wonder if these bozos think we are not paying attention to their largesse with public treasury. My apologies . . . I get all riled up with this stuff.

OK. Now, the USG has taken an unprecedented step authorizing the Executive to intercede in the financial market to absorb the mountain of bad-debt that has choked off credit between banks, for business, for citizens, for the economy. The Executive must now transform the authority into direct action. Plenty of folks predict this scheme will not work. Some even suggest it will make the situation worse. The current crisis began decades ago, not three weeks ago. The Press, talking heads, political pundits, and numerous networks, journals, blogs and eMail threads pressed the debate of whether the USG’s action plan is the correct thing to do, or even needed at all, or even whether the crisis is real. I am an ordinary, common citizen who knows very little about the world of national and international capital markets and finance, so my opinion and judgment must be questioned. However, the collateral damage done to the U.S. and World economies by these out-of-control, greed-manic, money launders remains my greatest worry. These money men have done far more damage than al-Qaeda, Islamo-fascist terrorists, jihadistanis, and even the domestic crazies we endure from time to time. I can only hope the perpetrators suffer an appropriate punishment for the destruction they have wrought.

The best analogy I can muster up for our present predicament is a aviation one. The object of flying fixed wing aircraft is to balance all of the various performance variables: weight, thrust, airspeed, altitude and direction. Many bad things can happen to upset the balance. The pilot responds to the imbalance with the controls he has available. One of the worst conditions for an airplane is a flat spin. We do not need to analyze the physics of a flat spin. Let it suffice to say, it is not good. The object of flying is to avoid conditions necessary for the aircraft to enter a spin. Yet, if you find yourself in a spin, you do not have time to read the Aircraft Flight Manual or Pilot’s Operating Manual. You have to do what you were taught. And, when the correct actions do not work, you have to try the wrong things or the illogical actions . . . anything to shift the aircraft just enough for the control surfaces to find a bite of air, allowing proper anti-spin control inputs to work. So it is today with the credit crisis. The time to avoid the crisis was four to ten years ago. We chose not to respond. We are in an economic flat spin, and we do not have time to read the book or study the root cause. We must react. Whether the Paulson Plan is the proper, correct action, history shall tell the tale. The new law gives extraordinary latitude to the Secretary of the Treasury, which means it can be adjusted and tweaked as necessary. A truly free market is a seductive philosophical and ideological, utopian concept and the ultimate in capitalist objectives, just as much as the opposite end of the spectrum – true, Marxian communism – is a utopian ideal. Neither extreme serves us common folk very well. We, the People, created and maintain a republican governance system ostensibly to protect our freedom to live our lives as we choose, without interference from others, either individually, in groups or via the instruments of State. A genuinely free market does not serve that purpose any more than communism, or dictatorship, or Papal or Crown dicta serve us. Conversely, rules for proper behavior – to respect the equal rights of fellow citizens – must regulate the market to a sufficient level to prevent or minimum harm to innocent, uninvolved citizens. If I choose to take risks in the marketplace, then I benefit from the rewards and suffer the consequences. If I choose not to take those risks, I should not suffer the downside as I have no opportunity for the upside. Today, we have a grotesque imbalance in that equation. In 1929, the Federal government took a laissez-faire approach to the loss of market confidence, and virtually every citizen suffered. Fortunately, the USG did not stand idly by in 1987 or 2008. History shall judge those who hold the reins today. Lastly, just as every one of the last five presidential administrations should feel genuine and profound remorse for allowing Islamic Fascism to become the threat it is today, so too at least, the last four administrations should feel bone-shaking embarrassment that proper intervention was not taken when the price of such action would have been substantially less.

New York City Mayor Michael Rubens Bloomberg wants to repeal the two-term limit law that stands in his way for a third, or perhaps in perpetuity, term as mayor. I trust the voting residents of New York City will see this for what it is and do the correct thing. In my most humble opinion, every single elected political office from local to Federal, from legislative to judicial and executive office, should have term limits and preferably only two, period. I eagerly include all leaders – great or weak, important or inconsequential – Abraham Lincoln to Sir Winston Churchill – ALL! I am quite attracted to the model set for us by Lucius Quinctius Cincinnatus, nearly 2.500 years ago. The audacity, arrogance and egocentrism of guys like Bloomberg worry me more than a little. If Mike wants to remain a politician, let him find another position from which to serve. Better yet, he should return to private business and let someone else have at public service as mayor.

Comments and contributions from Update no.354:
“Unfortunately, today my warning came true (i.e., "if we can find someone smart and wise enough to know what to do), given the bill failed. The players would rather have a food fight instead of act like adults and solve the nation’s ills. Seems others are confused as well. It is hard to accept the donkey blaming the elephant when the donkey owns most of the votes. On the other hand, the elephant is stuck in the morass of complexity along with everyone else. If reports are true, 400 economists including 3 nobel prize winners advised to wait and find the causes first. Like you, we know the causes came decade or more ago. What to do now is the question. I'm still looking for someone smart and wise enough to solve it.
“I keep hearing the words of Adam Smith ‘...the invisible hand...’ We need it or something now.”
My response:
What we witnessed in Washington yesterday was disgusting – a collective Nero fiddling as the Nation burned.
I do not agree with the economists including Nobel laureates. When you are in a spin, it is not time to get the checklist out and consider what to do. Intellectually, determination of root cause is always the best choice to arrive at the proper corrective action. Unfortunately, the time to determine root cause and take proper corrective action was four years ago.
‘Invisible hand’ indeed!

Another contribution:
“I know I can be very opinionated (and a bit emotional) in some of my posts. I realize I’ve been that way on this bailout. I suppose many folks are allowing their emotions to run very high, even much higher than mine. I appreciate you tempering your opinions as you do continued research. This toxic debt problem is serious, and I’m afraid it appears to be spreading to other global markets, and I do fear the systemic loss of both liquidity and velocity could continue to present greater problems. Troubling too was our own governor, Arnold, saying our state will be out of money by the end of October and we need $7 billion. I am nervous this is starting a trend. I would love to be positive about it all, but right now it seems like we are just now getting into the storm and there is tremendous uncertainty whether the bailout will be effective, and where the bottom (flight out of the thunderstorm) is going to be. Last week I read that FDIC may be running low on cash and need more money, if that word were to spread we might have a serious loss of confidence leading to withdrawal of deposits. Some have told me there has been a silent run at Wachovia, and the same may have happened at Washington Mutual. I would imagine this should soon be verifiable. Late Saturday, I heard a judge blocked the sale of Wachovia to Wells Fargo. I believe Citi must have hired good counsel and got the representation because they were calling fowl Friday, about Wells Fargo.”
My reply:
I continued to be enormously thankful that I have been able to connect with folks like you, who have the confidence, knowledge, and energy to express their opinions on common as well as highly sensitive topics. I hope you will continue to express yourself as freely as you feel comfortable. The broader, vigorous, public debate is absolutely vital to this Grand Republic and our vision of a free and open democracy.
The Paulson Plan approved Friday is an embarrassment and potentially ‘too little too late.’ The Powers That Be saw this coming years ago, just as they did the generic attacks of 12/7 and 9/11, and chose to hope the threat would go away. Well, it didn’t. Wishful thinking rare works. I do not know if the Paulson Plan is going to work, but I do believe it is a bona fide attempt to ‘unclog’ the capital and credit markets. We shall see.

This is part of a thread with a friend and contributor in the banking business regarding the current credit crisis that began with an article titled:
“Let Risk-Taking Financial Institutions Fail”
To which I replied:
Every business takes risks. Can we let all businesses fail?
. . . round two:
“Rest assured they won't all fail... just the ones that need to as with Wachovia, the customers won't see a change but for the sign on the front.
“The market works just as well on the downside as on the upside.”
. . . my replied to round two:
True. No debate. I truly believe the marketplace can sort this mess out. The only question is, how much pain are you and me willing to endure to as the marketplace works it out? A lot of innocent people are being harmed, and the longer this recovery takes the more innocent people will be harmed. If only the guilty were harmed, I'd say let 'em suffer. Alas, that is not the case.
. . . round three:
“Agreed, we must respond to this problem. I just don't think the answer is to buy illiquid assets from reckless investors who can't even say what their assets are.”
. . . my replied to round three:
1. What would [the] bank do if demands absorbed the bank's liquid assets and there was no money available from other banks?
2. Where does a local bank turn for bridge funds to weather a demand storm?
3. How [does the bank] loan funds to farmers, builders, small businesses when the bank's liquid assets drop below thresholds?
4. Hopefully, the local banks did not get sucked up in the sub-prime mortgage mess. How does the bank adjust its liquid asset threshold as bad-debt quantities increase?
It is the collateral impact I worry about. When capital markets start to dry up, dominoes begin to fall. If it's too much, just say so.
. . . round four:
“Well, it's all academic now that the bill has been signed. I would have preferred a different approach, but in the end, we had to do something. Let's hope this is effective.
“Rural Ag banks are odd ducks compared to most. We loan locally deposited money primarily to farmers. This time of year we are in a borrow position and have to go outside for money. But the farmers have started selling grain and paying down their operating loans, so we will be under-loaned again before year end. It’s an annual cycle that we plan for.
“Regarding getting money outside, we've not had any trouble. First we are well capitalized. When we run worst case scenarios, we have commitments for about 3 times the money we might need. One of the reasons that banks don't want to loan money to other banks is that they don't trust them (they don't trust the investments they've made). The banks that have made commitments to us know we have zero investments in sub-prime mortgage backed securities, a conservative portfolio, and a readily identifiable and loyal customer base. The fall back position is selling securities. We maintain a diverse portfolio of conservative investments, so that would help.
“I think that when they blurred the lines between commercial banks and investment companies or ‘banks’ (Gramm-Leach-Bliley Act of 1999), we let that aggressive, risk-taking mentality into banks when the two institutions serve different purposes in the financial system. I also don't think the banks that got involved with the more exotic instruments, credit default swaps, derivatives, etc. understood them at all. I'm not sure anyone does. They certainly are having trouble identifying them and determining their value.
“Interestingly, Wal-Mart has been lobbying Congress to allow them to form a bank to put in their stores. Hopefully the odds of Congress allowing retail and banking to mix are reduced after what we've learned here.
“Really, I think the answer for banking is keeping it simple. That almost sounds regressive when I type it, but in an overly complex environment one can convince oneself of about anything. That might have a place in the wild and woolly world of venture capital and investments, but not in core banking where we need to pay the school teacher's salary.”

My very best wishes to all. Take care of yourselves and each other.
Cheers,
Cap :-)