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AMERICANS enter the New Year in a strange new role:
financial lunatics. We’ve been viewed by the wider world with mistrust
and suspicion on other matters, but on the subject of money even our
harshest critics have been inclined to believe that we knew what we were
doing. They watched our investment bankers and emulated them: for a long
time now half the planet’s college graduates seemed to want nothing more
out of life than a job on Wall Street. January 4, 2009 financial
lunatics
This is one reason the collapse of our financial system has inspired not
merely a national but a global crisis of confidence. Good God, the world
seems to be saying, if they don’t know what they are doing with money,
who does?
Incredibly, intelligent people the world over remain willing to lend us
money and even listen to our advice; they appear not to have realized
the full extent of our madness. We have at least a brief chance to cure
ourselves. But first we need to ask: of what?
To that end consider the strange story of Harry Markopolos. Mr.
Markopolos is the former investment officer with Rampart Investment
Management in Boston who, for nine years, tried to explain to the
Securities and Exchange Commission that Bernard L. Madoff couldn’t be
anything other than a fraud. Mr. Madoff’s investment performance, given
his stated strategy, was not merely improbable but mathematically
impossible. And so, Mr. Markopolos reasoned, Bernard Madoff must be
doing something other than what he said he was doing.
In his devastatingly persuasive 17-page letter to the S.E.C., Mr.
Markopolos saw two possible scenarios. In the “Unlikely” scenario: Mr.
Madoff, who acted as a broker as well as an investor, was
“front-running” his brokerage customers. A customer might submit an
order to Madoff Securities to buy shares in I.B.M. at a certain price,
for example, and Madoff Securities instantly would buy I.B.M. shares for
its own portfolio ahead of the customer order. If I.B.M.’s shares rose,
Mr. Madoff kept them; if they fell he fobbed them off onto the poor
customer.
In the “Highly Likely” scenario, wrote Mr. Markopolos, “Madoff
Securities is the world’s largest Ponzi Scheme.” Which, as we now know,
it was.
Harry Markopolos sent his report to the S.E.C. on Nov. 7, 2005 — more
than three years before Mr. Madoff was finally exposed — but he had been
trying to explain the fraud to them since 1999. He had no direct
financial interest in exposing Mr. Madoff — he wasn’t an unhappy
investor or a disgruntled employee. There was no way to short shares in
Madoff Securities, and so Mr. Markopolos could not have made money
directly from Mr. Madoff’s failure. To judge from his letter, Harry
Markopolos anticipated mainly downsides for himself: he declined to put
his name on it for fear of what might happen to him and his family if
anyone found out he had written it. And yet the S.E.C.’s cursory
investigation of Mr. Madoff pronounced him free of fraud.
What’s interesting about the Madoff scandal, in retrospect, is how
little interest anyone inside the financial system had in exposing it.
It wasn’t just Harry Markopolos who smelled a rat. As Mr. Markopolos
explained in his letter, Goldman Sachs was refusing to do business with
Mr. Madoff; many others doubted Mr. Madoff’s profits or assumed he was
front-running his customers and steered clear of him. Between the lines,
Mr. Markopolos hinted that even some of Mr. Madoff’s investors may have
suspected that they were the beneficiaries of a scam. After all, it
wasn’t all that hard to see that the profits were too good to be true.
Some of Mr. Madoff’s investors may have reasoned that the worst that
could happen to them, if the authorities put a stop to the
front-running, was that a good thing would come to an end.
The Madoff scandal echoes a deeper absence inside our financial system,
which has been undermined not merely by bad behavior but by the lack of
checks and balances to discourage it. “Greed” doesn’t cut it as a
satisfying explanation for the current financial crisis. Greed was
necessary but insufficient; in any case, we are as likely to eliminate
greed from our national character as we are lust and envy. The fixable
problem isn’t the greed of the few but the misaligned interests of the
many.
A lot has been said and written, for instance, about the corrupting
effects on Wall Street of gigantic bonuses. What happened inside the
major Wall Street firms, though, was more deeply unsettling than greedy
people lusting for big checks: leaders of public corporations,
especially financial corporations, are as good as required to lead for
the short term.
Richard Fuld, the former chief executive of Lehman Brothers, E. Stanley
O’Neal, the former chief executive of Merrill Lynch, and Charles O.
Prince III, Citigroup’s chief executive, may have paid themselves
humongous sums of money at the end of each year, as a result of the bond
market bonanza. But if any one of them had set himself up as a
whistleblower — had stood up and said “this business is irresponsible
and we are not going to participate in it” — he would probably have been
fired. Not immediately, perhaps. But a few quarters of earnings that
lagged behind those of every other Wall Street firm would invite outrage
from subordinates, who would flee for other, less responsible firms, and
from shareholders, who would call for his resignation. Eventually he’d
be replaced by someone willing to make money from the credit bubble.
OUR financial catastrophe, like Bernard Madoff’s pyramid scheme,
required all sorts of important, plugged-in people to sacrifice our
collective long-term interests for short-term gain. The pressure to do
this in today’s financial markets is immense. Obviously the greater the
market pressure to excel in the short term, the greater the need for
pressure from outside the market to consider the longer term. But that’s
the problem: there is no longer any serious pressure from outside the
market. The tyranny of the short term has extended itself with
frightening ease into the entities that were meant to, one way or
another, discipline Wall Street, and force it to consider its
enlightened self-interest.
The credit-rating agencies, for instance.
financial lunatics
Everyone now knows that Moody’s and Standard & Poor’s botched their
analyses of bonds backed by home mortgages. But their most costly
mistake — one that deserves a lot more attention than it has received —
lies in their area of putative expertise: measuring corporate risk.
Over the last 20 years American financial institutions have taken on
more and more risk, with the blessing of regulators, with hardly a word
from the rating agencies, which, incidentally, are paid by the issuers
of the bonds they rate. Seldom if ever did Moody’s or Standard & Poor’s
say, “If you put one more risky asset on your balance sheet, you will
face a serious downgrade.”
The American International Group, Fannie Mae, Freddie Mac, General
Electric and the municipal bond guarantors Ambac Financial and MBIA all
had triple-A ratings. (G.E. still does!) Large investment banks like
Lehman and Merrill Lynch all had solid investment grade ratings. It’s
almost as if the higher the rating of a financial institution, the more
likely it was to contribute to financial catastrophe. But of course all
these big financial companies fueled the creation of the credit products
that in turn fueled the revenues of Moody’s and Standard & Poor’s.
These oligopolies, which are actually sanctioned by the S.E.C., didn’t
merely do their jobs badly. They didn’t simply miss a few calls here and
there. In pursuit of their own short-term earnings, they did exactly the
opposite of what they were meant to do: rather than expose financial
risk they systematically disguised it.
This is a subject that might be profitably explored in Washington. There
are many questions an enterprising United States senator might want to
ask the credit-rating agencies. Here is one: Why did you allow MBIA to
keep its triple-A rating for so long? In 1990 MBIA was in the relatively
simple business of insuring municipal bonds. It had $931 million in
equity and only $200 million of debt — and a plausible triple-A rating.
financial_lunatics
By 2006 MBIA had plunged into the much riskier business of guaranteeing
collateralized debt obligations, or C.D.O.’s. But by then it had $7.2
billion in equity against an astounding $26.2 billion in debt. That is,
even as it insured ever-greater risks in its business, it also took
greater risks on its balance sheet.
Yet the rating agencies didn’t so much as blink. On Wall Street the
problem was hardly a secret: many people understood that MBIA didn’t
deserve to be rated triple-A. As far back as 2002, a hedge fund called
Gotham Partners published a persuasive report, widely circulated,
entitled: “Is MBIA Triple A?” (The answer was obviously no.)
At the same time, almost everyone believed that the rating agencies
would never downgrade MBIA, because doing so was not in their short-term
financial interest. A downgrade of MBIA would force the rating agencies
to go through the costly and cumbersome process of re-rating tens of
thousands of credits that bore triple-A ratings simply by virtue of
MBIA’s guarantee. It would stick a wrench in the machine that enriched
them. (In June, finally, the rating agencies downgraded MBIA, after
MBIA’s failure became such an open secret that nobody any longer cared
about its formal credit rating.)
The S.E.C. now promises modest new measures to contain the damage that
the rating agencies can do — measures that fail to address the central
problem: that the raters are paid by the issuers.
But this should come as no surprise, for the S.E.C. itself is plagued by
similarly wacky incentives. Indeed, one of the great social benefits of
the Madoff scandal may be to finally reveal the S.E.C. for what it has
become.
Created to protect investors from financial predators, the commission
has somehow evolved into a mechanism for protecting financial predators
with political clout from investors. (The task it has performed most
diligently during this crisis has been to question, intimidate and
impose rules on short-sellers — the only market players who have a
financial incentive to expose fraud and abuse.)
The instinct to avoid short-term political heat is part of the problem;
anything the S.E.C. does to roil the markets, or reduce the share price
of any given company, also roils the careers of the people who run the
S.E.C. Thus it seldom penalizes serious corporate and management
malfeasance — out of some misguided notion that to do so would cause
stock prices to fall, shareholders to suffer and confidence to be
undermined. Preserving confidence, even when that confidence is false,
has been near the top of the S.E.C.’s agenda. financial_lunatics
IT’S not hard to see why the S.E.C. behaves as it does. If you work for
the enforcement division of the S.E.C. you probably know in the back of
your mind, and in the front too, that if you maintain good relations
with Wall Street you might soon be paid huge sums of money to be
employed by it.
The commission’s most recent director of enforcement is the general
counsel at JPMorgan Chase; the enforcement chief before him became
general counsel at Deutsche Bank; and one of his predecessors became a
managing director for Credit Suisse before moving on to Morgan Stanley.
A casual observer could be forgiven for thinking that the whole point of
landing the job as the S.E.C.’s director of enforcement is to position
oneself for the better paying one on Wall Street.
At the back of the version of Harry Markopolos’s brave paper currently
making the rounds is a copy of an e-mail message, dated April 2, 2008,
from Mr. Markopolos to Jonathan S. Sokobin. Mr. Sokobin was then the new
head of the commission’s office of risk assessment, a job that had been
vacant for more than a year after its previous occupant had left to —
you guessed it — take a higher-paying job on Wall Street.
At any rate, Mr. Markopolos clearly hoped that a new face might mean a
new ear — one that might be receptive to the truth. He phoned Mr.
Sokobin and then sent him his paper. “Attached is a submission I’ve made
to the S.E.C. three times in Boston,” he wrote. “Each time Boston sent
this to New York. Meagan Cheung, branch chief, in New York actually
investigated this but with no result that I am aware of. In my
conversations with her, I did not believe that she had the derivatives
or mathematical background to understand the violations.”
How does this happen? How can the person in charge of assessing Wall
Street firms not have the tools to understand them? Is the S.E.C. that
inept? Perhaps, but the problem inside the commission is far worse —
because inept people can be replaced. The problem is systemic. The new
director of risk assessment was no more likely to grasp the risk of
Bernard Madoff than the old director of risk assessment because the new
guy’s thoughts and beliefs were guided by the same incentives: the need
to curry favor with the politically influential and the desire to keep
sweet the Wall Street elite.
And here’s the most incredible thing of all: 18 months into the most
spectacular man-made financial calamity in modern experience, nothing
has been done to change that, or any of the other bad incentives that
led us here in the first place.
SAY what you will about our government’s approach to the financial
crisis, you cannot accuse it of wasting its energy being consistent or
trying to win over the masses. In the past year there have been at least
seven different bailouts, and six different strategies. And none of them
seem to have pleased anyone except a handful of financiers.
When Bear Stearns failed, the government induced JPMorgan Chase to buy
it by offering a knockdown price and guaranteeing Bear Stearns’s
shakiest assets. Bear Stearns bondholders were made whole and its
stockholders lost most of their money. financial_lunatics
Then came the collapse of the government-sponsored entities, Fannie Mae
and Freddie Mac, both promptly nationalized. Management was replaced,
shareholders badly diluted, creditors left intact but with some
uncertainty. Next came Lehman Brothers, which was, of course, allowed to
go bankrupt. At first, the Treasury and the Federal Reserve claimed they
had allowed Lehman to fail in order to signal that recklessly managed
Wall Street firms did not all come with government guarantees; but then,
when chaos ensued, and people started saying that letting Lehman fail
was a dumb thing to have done, they changed their story and claimed they
lacked the legal authority to rescue the firm.
But then a few days later A.I.G. failed, or tried to, yet was given the
gift of life with enormous government loans. Washington Mutual and
Wachovia promptly followed: the first was unceremoniously seized by the
Treasury, wiping out both its creditors and shareholders; the second was
batted around for a bit. Initially, the Treasury tried to persuade
Citigroup to buy it — again at a knockdown price and with a guarantee of
the bad assets. (The Bear Stearns model.) Eventually, Wachovia went to
Wells Fargo, after the Internal Revenue Service jumped in and sweetened
the pot with a tax subsidy.
In the middle of all this, Treasury Secretary Henry M. Paulson Jr.
persuaded Congress that he needed $700 billion to buy distressed assets
from banks — telling the senators and representatives that if they
didn’t give him the money the stock market would collapse. Once handed
the money, he abandoned his promised strategy, and instead of buying
assets at market prices, began to overpay for preferred stocks in the
banks themselves. Which is to say that he essentially began giving away
billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs and a
few others unnaturally selected for survival. The stock market fell
anyway.
It’s hard to know what Mr. Paulson was thinking as he never really had
to explain himself, at least not in public. But the general idea appears
to be that if you give the banks capital they will in turn use it to
make loans in order to stimulate the economy. Never mind that if you
want banks to make smart, prudent loans, you probably shouldn’t give
money to bankers who sunk themselves by making a lot of stupid,
imprudent ones. If you want banks to re-lend the money, you need to
provide them not with preferred stock, which is essentially a loan, but
with tangible common equity — so that they might write off their losses,
resolve their troubled assets and then begin to make new loans,
something they won’t be able to do until they’re confident in their own
balance sheets. But as it happened, the banks took the taxpayer money
and just sat on it.
Continued at "How to Repair a Broken Financial World."
financial_lunatics
Mr. Paulson must have had some reason for doing what he
did. No doubt he still believes that without all this frantic activity
we’d be far worse off than we are now. All we know for sure, however, is
that the Treasury’s heroic deal-making has had little effect on what it
claims is the problem at hand: the collapse of confidence in the
companies atop our financial system.
Weeks after receiving its first $25 billion taxpayer investment,
Citigroup returned to the Treasury to confess that — lo! — the markets
still didn’t trust Citigroup to survive. In response, on Nov. 24, the
Treasury handed Citigroup another $20 billion from the Troubled Assets
Relief Program, and then simply guaranteed $306 billion of Citigroup’s
assets. The Treasury didn’t ask for its fair share of the action, or
management changes, or for that matter anything much at all beyond a
teaspoon of warrants and a sliver of preferred stock. The $306 billion
guarantee was an undisguised gift. The Treasury didn’t even bother to
explain what the crisis was, just that the action was taken in response
to Citigroup’s “declining stock price.”
Three hundred billion dollars is still a lot of money. It’s almost 2
percent of gross domestic product, and about what we spend annually on
the departments of Agriculture, Education, Energy, Homeland Security,
Housing and Urban Development and Transportation combined. Had Mr.
Paulson executed his initial plan, and bought Citigroup’s pile of
troubled assets at market prices, there would have been a limit to our
exposure, as the money would have counted against the $700 billion Mr.
Paulson had been given to dispense. Instead, he in effect granted
himself the power to dispense unlimited sums of money without
Congressional oversight. Now we don’t even know the nature of the assets
that the Treasury is standing behind. Under TARP, these would have been
disclosed.
THERE are other things the Treasury might do when a major financial firm
assumed to be “too big to fail” comes knocking, asking for free money.
Here’s one: Let it fail.
Not as chaotically as Lehman Brothers was allowed to fail. If a failing
firm is deemed “too big” for that honor, then it should be explicitly
nationalized, both to limit its effect on other firms and to protect the
guts of the system. Its shareholders should be wiped out, and its
management replaced. Its valuable parts should be sold off as
functioning businesses to the highest bidders — perhaps to some bank
that was not swept up in the credit bubble. The rest should be
liquidated, in calm markets. Do this and, for everyone except the firms
that invented the mess, the pain will likely subside.
This is more plausible than it may sound. Sweden, of all places, did it
successfully in 1992. And remember, the Federal Reserve and the Treasury
have already accepted, on behalf of the taxpayer, just about all of the
downside risk of owning the bigger financial firms. The Treasury and the
Federal Reserve would both no doubt argue that if you don’t prop up
these banks you risk an enormous credit contraction — if they aren’t in
business who will be left to lend money? But something like the reverse
seems more true: propping up failed banks and extending them huge
amounts of credit has made business more difficult for the people and
companies that had nothing to do with creating the mess. Perfectly
solvent companies are being squeezed out of business by their creditors
precisely because they are not in the Treasury’s fold. With so much
lending effectively federally guaranteed, lenders are fleeing anything
that is not.
Rather than tackle the source of the problem, the people running the
bailout desperately want to reinflate the credit bubble, prop up the
stock market and head off a recession. Their efforts are clearly
failing: 2008 was a historically bad year for the stock market, and
we’ll be in recession for some time to come. Our leaders have framed the
problem as a “crisis of confidence” but what they actually seem to mean
is “please pay no attention to the problems we are failing to address.”
In its latest push to compel confidence, for instance, the authorities
are placing enormous pressure on the Financial Accounting Standards
Board to suspend “mark-to-market” accounting. Basically, this means that
the banks will not have to account for the actual value of the assets on
their books but can claim instead that they are worth whatever they paid
for them.
This will have the double effect of reducing transparency and increasing
self-delusion (gorge yourself for months, but refuse to step on a scale,
and maybe no one will realize you gained weight). And it will fool no
one. When you shout at people “be confident,” you shouldn’t expect them
to be anything but terrified.
If we are going to spend trillions of dollars of taxpayer money, it
makes more sense to focus less on the failed institutions at the top of
the financial system and more on the individuals at the bottom. Instead
of buying dodgy assets and guaranteeing deals that should never have
been made in the first place, we should use our money to A) repair the
social safety net, now badly rent in ways that cause perfectly rational
people to be terrified; and B) transform the bailout of the banks into a
rescue of homeowners.
We should begin by breaking the cycle of deteriorating housing values
and resulting foreclosures. Many homeowners realize that it doesn’t make
sense to make payments on a mortgage that exceeds the value of their
house. As many as 20 million families face the decision of whether to
make the payments or turn in the keys. Congress seems to have understood
this problem, which is why last year it created a program under the
Federal Housing Authority to issue homeowners new government loans based
on the current appraised value of their homes.
And yet the program, called Hope Now, seems to have become one more
excellent example of the unhappy political influence of Wall Street. As
it now stands, banks must initiate any new loan; and they are loath to
do so because it requires them to recognize an immediate loss. They
prefer to “work with borrowers” through loan modifications and payment
plans that present fewer accounting and earnings problems but fail to
resolve and, thereby, prolong the underlying issues. It appears that the
banking lobby also somehow inserted into the law the dubious requirement
that troubled homeowners repay all home equity loans before qualifying.
The result: very few loans will be issued through this program.
THIS could be fixed. Congress might grant qualifying homeowners the
ability to get new government loans based on the current appraised
values without requiring their bank’s consent. When a corporation gets
into trouble, its lenders often accept a partial payment in return for
some share in any future recovery. Similarly, homeowners should be
permitted to satisfy current first mortgages with a combination of the
proceeds of the new government loan and a share in any future recovery
from the future sale or refinancing of their homes. Lenders who issued
second mortgages should be forced to release their claims on property.
The important point is that homeowners, not lenders, be granted the
right to obtain new government loans. To work, the program needs to be
universal and should not require homeowners to file for bankruptcy.
There are also a handful of other perfectly obvious changes in the
financial system to be made, to prevent some version of what has
happened from happening all over again. A short list:
Stop making big regulatory decisions with long-term consequences based
on their short-term effect on stock prices. Stock prices go up and down:
let them. An absurd number of the official crises have been negotiated
and resolved over weekends so that they may be presented as a fait
accompli “before the Asian markets open.” The hasty crisis-to-crisis
policy decision-making lacks coherence for the obvious reason that it is
more or less driven by a desire to please the stock market. The
Treasury, the Federal Reserve and the S.E.C. all seem to view propping
up stock prices as a critical part of their mission — indeed, the
Federal Reserve sometimes seems more concerned than the average Wall
Street trader with the market’s day-to-day movements. If the policies
are sound, the stock market will eventually learn to take care of
itself.
End the official status of the rating agencies. Given their performance
it’s hard to believe credit rating agencies are still around. There’s no
question that the world is worse off for the existence of companies like
Moody’s and Standard & Poor’s. There should be a rule against issuers
paying for ratings. Either investors should pay for them privately or,
if public ratings are deemed essential, they should be publicly
provided.
Regulate credit-default swaps. There are now tens of trillions of
dollars in these contracts between big financial firms. An awful lot of
the bad stuff that has happened to our financial system has happened
because it was never explained in plain, simple language. Financial
innovators were able to create new products and markets without anyone
thinking too much about their broader financial consequences — and
without regulators knowing very much about them at all. It doesn’t
matter how transparent financial markets are if no one can understand
what’s inside them. Until very recently, companies haven’t had to
provide even cursory disclosure of credit-default swaps in their
financial statements.
Credit-default swaps may not be Exhibit No. 1 in the case against
financial complexity, but they are useful evidence. Whatever credit
defaults are in theory, in practice they have become mainly side bets on
whether some company, or some subprime mortgage-backed bond, some
municipality, or even the United States government will go bust. In the
extreme case, subprime mortgage bonds were created so that smart
investors, using credit-default swaps, could bet against them. Call it
insurance if you like, but it’s not the insurance most people know. It’s
more like buying fire insurance on your neighbor’s house, possibly for
many times the value of that house — from a company that probably
doesn’t have any real ability to pay you if someone sets fire to the
whole neighborhood. The most critical role for regulation is to make
sure that the sellers of risk have the capital to support their bets.
Impose new capital requirements on banks. The new international standard
now being adopted by American banks is known in the trade as Basel II.
Basel II is premised on the belief that banks do a better job than
regulators of measuring their own risks — because the banks have the
greater interest in not failing. Back in 2004, the S.E.C. put in place
its own version of this standard for investment banks. We know how that
turned out. A better idea would be to require banks to hold less capital
in bad times and more capital in good times. Now that we have seen how
too-big-to-fail financial institutions behave, it is clear that
relieving them of stringent requirements is not the way to go.
Another good solution to the too-big-to-fail problem is to break up any
institution that becomes too big to fail.
Close the revolving door between the S.E.C. and Wall Street. At every
turn we keep coming back to an enormous barrier to reform: Wall Street’s
political influence. Its influence over the S.E.C. is further
compromised by its ability to enrich the people who work for it.
Realistically, there is only so much that can be done to fix the
problem, but one measure is obvious: forbid regulators, for some
meaningful amount of time after they have left the S.E.C., from
accepting high-paying jobs with Wall Street firms.
But keep the door open the other way. If the S.E.C. is to restore its
credibility as an investor protection agency, it should have some
experienced, respected investors (which is not the same thing as
investment bankers) as commissioners. President-elect Barack Obama
should nominate at least one with a notable career investing capital,
and another with experience uncovering corporate misconduct. As it
happens, the most critical job, chief of enforcement, now has a perfect
candidate, a civic-minded former investor with firsthand experience of
the S.E.C.’s ineptitude: Harry Markopolos.
The funny thing is, there’s nothing all that radical about most of these
changes. A disinterested person would probably wonder why many of them
had not been made long ago. A committee of people whose financial
interests are somehow bound up with Wall Street is a different matter.
Doheny & Nesbitt, a favorite watering hole of Dublin’s
political and business elite, and the property tycoon Sean Dunne stoops
to retrieve a penny from the pub’s grimy floor.
One would think that Mr. Dunne, Ireland’s best-known building developer,
would be in bed at this hour. It’s a weeknight, after all, and he has
meetings that begin before first light.
What’s more, the Irish economy, pummeled by the most severe housing bust
in Europe, has collapsed. And the gossip around town is that Mr. Dunne,
whose brazen deal-making and Donald Trump-like lifestyle epitomized the
country’s euphoric boom, might be going bankrupt.
But, no matter, a penny is a penny.
“I am never, never too proud to pick a penny up from the floor,” Mr.
Dunne said. He is on perhaps his fifth pint of Guinness, capping a
rollicking night of Champagne cocktails, followed by a wine-soaked
dinner — yet his thick brogue is clear of even the faintest slurring.
“I grew up with nothing and I know the value of money,” he adds. “The
Celtic Tiger may be dead and if the banking crisis continues I could be
considered insolvent. But the one thing that I have is my wife and
children — that they can’t take away from me.”
It is not known whether Mr. Dunne will fall victim to today’s world
financial catastrophe, but there is no doubt that his country has.
Everything, it seems, has grown worse here. The recession started
earlier and its bite has been deeper. Housing prices have fallen by as
much as 50 percent. Bank shares have plummeted by more than 90 percent.
Unemployment is approaching 10 percent.
The roots of Ireland’s fall date to more than 20 years ago, when a
clutch of economists, politicians and civil servants put their heads
together in this very pub and planted the philosophical seeds for the
Irish economic miracle.
Known widely as the “Doheny & Nesbitt School of Economics,” these beery
musings soon became government policy that chopped taxes in half,
sharply reduced import duties and embraced foreign investment — a
radical transformation that gave birth to the Celtic Tiger and perhaps
the most open and vibrant economy in Europe.
But beyond the glow of this sudden efflorescence that made Ireland the
fourth most-affluent country in the Organization for Economic
Cooperation and Development, a housing bubble had begun to form. Low
interest rates, a wave of inward immigration and a bank lending spree
drove housing’s share of the economy to 14 percent, the highest in
Europe, from 5 percent, according to research done by Finfacts, a
financial Web site that analyzes the Irish economy.
Developers like Mr. Dunne became multimillionaires and — much like the
hedge fund and private-equity elite in America — became visible public
and cultural figures. They were living large in a country just coming to
grips with its ability to show a little swagger.
Ireland’s policy makers, like their counterparts in the United States
and Britain, were seduced by record tax inflows and a full-employment
economy. They paid little heed to the lonely voices that warned of the
crash that finally came over the summer, when interest rates in Europe
began to rise. Banks that had steered more than 60 percent of their
loans toward property stopped lending, and asset values plummeted.
“We have repeatedly warned that the government’s housing policy was
extremely dangerous,” said John Fitz Gerald, an economist at the
Economic and Social Research Institute, a leading policy center in
Dublin, who has long urged that the government stanch housing demand by
raising taxes. “You will now see unemployment going to 10 percent and we
will experience a sharp drop in output.”
He shakes his head and sighs: “This was predictable, but the government
just did not deal with it.”
BY wide consensus here, two events have come to define — both culturally
and financially — the sweep and excess of the Irish property boom. Both
revolve around Sean Dunne.
In July 2005, Mr. Dunne paid 379 million euros for a seven-acre plot in
the exclusive Ballsbridge neighborhood of Dublin and promptly announced
that he would tear down the two luxury hotels on the site to build a
high-end commercial and residential development.
That deal amounted to 54 million euros an acre, one of the highest
amounts ever paid for land in Europe. His subsequent architectural plan
featured a soaring Dubai-like office tower cut in the shape of a diamond
that anchored a futuristic community of expensive houses and glamorous
shops, and the price tag of one billion euros shocked Dubliners with its
gall and ambition.
Hobbled by delays and vocal neighborhood opposition, the project sits
before a local planning board that on Jan. 30 will either approve or
scrap the plan.
The second moment occurred in 2004 when Mr. Dunne, who is now 54,
celebrated his second marriage, to Gayle Killilea, a former gossip
columnist 20 years his junior, by inviting 44 of his friends on a
two-week Mediterranean wedding cruise on the yacht Christina O, on which
Aristotle Onassis and Jacqueline Kennedy married.
Much as the $3 million birthday party for Stephen A. Schwarzman, the
Blackstone Group founder, came to be seen as a crass display of private
equity’s manifold riches, the Dunne wedding was viewed similarly in
Ireland: as a conspicuous and garish expression of the man and his
business.
That a billion euro property plan and a gaudy wedding celebration should
be held up as cautionary exemplars of Ireland’s pursuit of money angers
Mr. Dunne. In his view, it speaks to what some call the Irish disease.
“Jealousy and begrudgery are still alive and well in Ireland, and
whoever eradicates them should be prime minister for life,” he says as
he tucks into a heaping plate of gravy-drenched turkey and mashed
potatoes in the restaurant of one of the two hotels he owns — and is
hoping to raze. “It’s part of the Irish psyche and it is the result of
800 years of being controlled by other people, of watching everything
the master or landlord is doing.”
Mr. Dunne’s compact paunch, reddish cheeks and mischievous grin — which
he occasionally deploys with a wink of his eye — can give him the air of
a department store Santa. But his business methods are far from jolly:
he is notorious for taking legal action against all who cross him, from
local newspapers to rival property developers.
He defends his purchase of the Ballsbridge site as responsible, not
reckless, as his critics have deemed it. He points out, too, that his
winning bid was just slightly more than the second-highest offer and
that subsequent property sales had far exceeded his submission of 54
million euros an acre.
Still, he recognizes that times have changed. Just recently, he pruned
staff at his development company, and some of his senior executives
agreed to take 50 percent pay cuts.
Asked where he will find the 600 million euros that he needs to tear
down the two hotels, dig a massive hole in the ground and erect his
vision of a new Dublin, he ruefully remarks: “It is fair to say that
there is not a queue of bankers lining up to lend to me right now.”
But he says the project will be completed, assuming that it wins
approval of the planning board. “If anyone wants to bet I can’t do this,
I will take that bet,” he says, citing, without specifics, talks with
Asian banks and a sovereign wealth fund. “You have to have steel in a
certain part of your body to do this job, and as one of my bankers
recently said to me, ‘Sean, the only thing that will take you out is a
stray bullet.’ ”
IN many ways, the ups and downs of Mr. Dunne’s life and career mirror
the Irish economy’s own rise and fall. Born into a house without
electricity or running water in the small provincial town of Tullow,
outside Dublin, Mr. Dunne studied construction economics at a technical
college in the 1970s.
Along with many of his countrymen, he forsook the stagnant Irish economy
— in his case, choosing bartending in New York City and working on an
oil rig in Canada.
With the Irish economy still afflicted by an unemployment rate of about
20 percent in the 1980s, and a punitive overall tax rate, he began his
real estate career in London. He moved back to Ireland in 1990 and began
a string of property deals.
He initially focused on government-sponsored housing projects. But as
the Irish economy began its true take-off, demand came from the growing
corps of newly wealthy Irish, many of whom were returning to Ireland
from abroad. They were joined by a wave of foreign workers.
After years of emigration and economic stagnation, Ireland’s housing
stock was depleted, precipitating a housing euphoria. Capital gains
taxes were low, as were interest rates. Banks stood ready to lend,
offering mortgages with no money down to a house-hungry population.
The projects of Mr. Dunne and a small circle of developers grew in size
and scope until the skyline of Dublin, never known for its tall
buildings, began to fill with cranes and great shiny towers.
Signs of a bubble were everywhere: a family home in Dublin cost as much
as a similar abode in Beverly Hills; house prices more than doubled over
a 10-year period; and household debt as a percentage of G.D.P. jumped to
160 percent from 60 percent during the same period.
Irish banks, unlike those in the United States, didn’t dole out that
many subprime loans. Rather, they lent furiously to big property
developers who themselves were liberated to build pell-mell by
government-imposed tax breaks.
Mr. Dunne, who says he put 35 percent cash down — or about 125 million
euros — for the Ballsbridge project, says that even with the drop in
asset values, he still has hope that the project can be completed.
“This is the way God made me, with heavy shoulders and an ability to
carry a great load,” he says, forcefully rejecting the rumors of his
financial demise buzzing around Dublin. (One of the more fantastic
claims was that his financial troubles had forced him to take a month’s
recuperation in a mental institution.)
“Failure is not an option for me,” he says. But others aren’t so sure.
The Irish government recently announced a $7.5 billion bank bailout and
took majority stakes in the country’s largest banks, a move that
followed the government’s earlier promise to guarantee all bank
deposits.
Analysts are uncertain that the government will allow the banks to
continue to support the type of high-risk, high-reward projects that
have become the bane of their financial existence.
“The banks in Ireland did not lend recklessly to individuals; they lent
recklessly to developers,” says Ronan Lyons, an economist at Daft,
Ireland’s largest property Web site. As for the Ballsbridge project, he
may well take Mr. Dunne’s bet.
“I would be surprised if it gets built,” Mr. Lyons says. “The migrants
are going home, there is a surplus of properties for sale, and even
though this is a landmark project there is just not an appetite for
large projects now.”
WHILE the pain is acute in Dublin, at least the city has the small
comfort of having enjoyed the full benefit of the boom.
Such is not the case in the city of Limerick. Traditionally one of
Ireland’s more depressed cities, Limerick was a latecomer to the
property party. While there were some good times, the downturn has had a
more wrenching effect there, with unemployment over 14 percent — among
the highest rates in Ireland.
The layoffs have picked up speed around Limerick in the last month, as
construction companies have stopped work, seemingly on a dime, sending
such a procession of jobless to seek assistance that the local
unemployment office became the second busiest in the country.
The waiting room in the office is dank and gloomy, and Dale McNamara,
20, wonders how a professional life once so charmed came to be so
hopeless. Since graduating from high school as an electrician,
flourishing building work in the area kept him more than busy and flush
enough to buy a new car, start a family and consider buying a house.
Then, without warning on Dec. 5, he was told that it would be his last
day of work, just six months before he would have received his
certificate as an independent electrician.
Since then, he has been frantically knocking on doors, but to no avail.
Now, as rent, heating bills and car payments pile up, he is beginning to
feel desperate, unable to afford a night out or a Christmas present for
his 20-month-old baby.
“If I don’t get a job in the next two weeks, I am worried about losing
my house,” he says. “We have no money.”
He looks at his number in the unemployment lines and grimaces — he has
been waiting four hours now and his name has still not been called.
“My grandfather says this reminds him of the 1930s when everyone left
for America and Australia,” he adds. “There is just no work here.”
More dire, however, is the condition of the permanently unemployed in
Limerick’s festering ghettoes, where experts say the unemployment rate
touches 70 percent. During the early years of the economic revival, the
government did its best to spread money to such areas, which are a
feature of urban life all over Ireland.
IN fact, it was through social housing projects like these that Mr.
Dunne got his start as a developer. But as the investment returns in the
private sector became quite obviously more lucrative, the attention paid
to so-called social estates like Moyross, on the northern outskirts of
Limerick, wavered.
Crime, gangland disputes and a sense of anomie flourished as Moyross and
other similar projects evolved as cocoons of poverty and hopelessness
amid the riches and celebration of the Irish miracle.
“This place missed out entirely on the moment,” says Stephen Kinsella,
an economist at the University of Limerick. “There has been no
accumulation of wealth here.”
Walking through the garbage-strewn, empty roads on a cold, misty
afternoon, Mr. Kinsella points to the shuttered houses and the mothers
still dressed in pajamas taking their children home from school. Social
workers in Moyross refer to the “pajama index”: the more men and women
one sees who do not take the time and care to dress for the day, the
worse the economic situation tends to be.
The Irish government has recently begun a regeneration project in
Moyross that would result in large new investments in housing and
infrastructure, but the going so far has been slow.
For Brother Shawn O’Connor, a Franciscan monk who has been living and
working with the poor in Moyross for more than a year now, the
vicissitudes of the Irish property market are a notion as distant as is
his hometown, Red Hook, a village in the Hudson Valley of New York.
Brother O’Connor is the local superior of the community of Franciscan
Friars, who do their work in some of the world’s most destitute
communities. He and his fellow monks extend day-care assistance and
spiritual counseling to the needy. They survive themselves on four hours
of daily prayer and food handouts from neighbors — as Franciscans, they
take a vow of chastity, poverty and obedience and thus do not spend
money on any personal items, including food.
He recognizes that the deprivation of his community is severe, but
suggests that it may be an easier hardship than the experiences of many
Irish who have seen their riches disappear.
“There was this one story of a guy who shot his wife, son and daughter,”
he says. “He had overextended himself. There is this desperation for
wealth and people go after it — only to find out that it is not enough.”
Waterford Wedgwood PLC, the maker of classic china and
crystal, filed for bankruptcy protection on Monday after attempts to
restructure the struggling business or find a buyer failed.
Four administrators from business advisory firm Deloitte were appointed
to run the company's businesses in Britain and Northern Ireland, while a
Deloitte partner in the Irish Republic was appointed as receiver of
Waterford Wedgwood PLC, the ultimate parent of the U.K. companies, and
other Irish subsidiaries.
The U.K. joint administrators said they intended to continue to run the
business as they seek a buyer. Trading in the company's shares was
suspended on the Irish Stock Exchange where they languished at just
one-tenth of a euro cent and the company's directors — including Anthony
O'Reilly, the Irish publishing magnate who along with his brother-in-law
Peter Goulandris owns more than half of all Waterford Wedgwood shares —
handed in their resignations.
"Waterford, Wedgwood and Royal Doulton are quintessentially classic
brands that represent a high quality product which is steeped in
history," the administrators said in a statement. "The administration
team will be working closely with management, customers and suppliers
during this time to ensure operations continue whilst a sale of the
business is sought."
Waterford Wedgwood, which employs around 7,700 worldwide, is the latest
in a burgeoning list of iconic British companies to succumb to the
global economic slowdown and credit squeeze. Department store veteran
Woolworths, the queen's tailor Hardy Amies, tea and coffee merchant
Whittard of Chelsea and fellow ceramics stalwart Royal Worcester and
Spode have all filed for bankruptcy protection in recent months.
Wedgwood has been an iconic name in British pottery for 250 years, after
its founder Josiah Wedgwood opened the first factory in Stoke-on-Trent,
central England, in 1759. It began making bone china in the 19th
century.
Waterford Crystal traces its lineage to a factory opened in Waterford,
southeast Ireland in 1783, although that business failed in the 1850s.
The brand was revived by Czech immigrant Miroslav Havel in 1947.
Under O'Reilly's watch, Waterford acquired Wedgwood in 1986 to form the
present company, listing on the stock exchange and expanding overseas in
the 1990s before buying fellow Stoke-on-Trent ceramics maker Royal
Doulton in 2005.
Much of the business has now shifted offshore, where it employs 5,800
people, including 1,500 people at a plant in Jakarta, Indonesia, which
produces most of the company's ceramics. The majority of its crystal
production has been handed to Eastern European subcontractors.
The company employs a work force just a third of that size at 1,900 in
Britain, including around 600 in Stoke-on-Trent and 800 in Waterford.
Waterford Mayor Jack Walsh said the closure of the crystal factory would
deal a cultural and psychological blow to all of Ireland, noting that
the crystal plant was one of the country's top tourist attractions and
the product "one of only a handful of iconic Irish brands.'
"Given this, it is of major strategic importance that this company not
be allowed to slip into oblivion," Walsh said.
In Stoke on Trent, Margaret Kilford was close to tears as she described
how important Waterford Wedgwood was to the town.
"It's part of Staffordshire. It's a very sad day," she said. "I've
always bought Wedgwood. Nothing else will do. If it goes, that's it."
The Deloitte administrators said the company has "benefited from
significant shareholder support" in recent years as the management team
tried to restructure the business. O'Reilly and Goulandris have pumped
more than 400 million pounds of their own money into the business since
2002.
"However, as trading conditions deteriorated, it became apparent that a
restructuring of the businesses could not be achieved in an acceptable
timescale," they said in a statement.
A subsequent alternative strategy to find a buyer also failed, they
added.
Waterford Wedgwood chief executive officer David Sculley said he was
"disappointed" about the bankruptcy filing, but remained confident a
buyer could be found.
Under the administration process, administrators are appointed to
salvage as much of the company as possible for the benefit of its
creditors. While they may do so by selling the company as a going
concern, they can revert to a break-up to recoup as much money as
possible from assets if a buyer for the whole business cannot be found.
The receivership process in Ireland follows a similar path.
Waterford Wedgwood announced last month that it had been forced to ask
its chief creditors for "forbearance" because the company could no
longer pay its loans on time or in full. It also revealed falling sales
and increasing first-half losses, and said its survival depended on
securing new investment.
In 2008, we certainly learned why some folks shouldn't
try to make predictions about the economy.
Let's take a look at what some of our "in-charge" people had to say last
year -- and how we've all learned that we can't always trust what we
hear.
1. Barney Frank. In July, the chairman of the House Financial Services
Committee said: "I think this is a case where Fannie Mae and Freddie Mac
are fundamentally sound. They're not in danger of going under.... I
think they are in good shape going forward."
Well, for another two months, anyway.
At least he followed up those comments with: "We made a mistake as a
society in promoting home ownership as a universal achievable goal." I
like it when people admit mistakes. We need more of that.
2. George W. Bush. In March, the president said the "market is still in
the process of correcting itself."
No kidding! This is one of the grand understatements of the year. In
about as much of an about-face as we can expect from Bush, his position
changed to "Wall Street got drunk, and now it's got a hangover." If he
were still commenting on the topic, I'm guessing Bush would say Wall
Street is now passed out next to the porcelain throne.
3. John McCain. The Republican presidential nominee told us in April and
again in September that "the fundamentals of our economy are still
strong."
Perhaps he was trying to spin positive the sinking of the Titanic. But
statements like this are likely why November's election turned out the
way it did.
4. Oil prices to hit $200? I'm not sure I've seen anything rise and fall
as fast as the price of oil this year. And of course, as oil was going
up, and much of the demand seemed to be "made in China," forecasting
ever higher prices became fashionable.
Oil industry guru T. Boone Pickens forecast $150 a barrel by the end of
this year (it almost got there, but it's now hovering at about $48). The
normally reserved Goldman Sachs pegged it at $200 in the "not too
distant future" with a supply disruption. And naturally those forecasts
drove increases -- apparently much more than the fundamentals did.
I should note, in Goldman's defense, they predicted a possible drop to
$60 if "normalized" trends returned to the marketplace. Guess things got
more normal than they expected.
5. Bernie Madoff. In late 2007, Madoff said: "In today's environment, it
is virtually impossible to violate rules."
Apparently, he figured out a way to do just that.
Trust your instincts
So what does it all mean? A few chuckles, yes. And much to wonder about
in the folks in charge and the best and the brightest they hire. But it
also brings this thought to mind: Most of the time, you're your own best
judge of the facts. Others can help, and some will be right on. But as
chief executive of your own finances and your own destiny, act on what
you see and what you know. Trust your instincts when it comes to your
investments. If you find a product that works great for you, look into
whether the company that makes it is publicly traded. If you can buy
shares, maybe you should check it out.
"Recession-Plagued Nation Demands New Bubble to Invest
In:" Yes, and that gets my vote as the best faux news story, from The
Onion last summer.
We all know humorists turn out to be better prognosticators than all of
Wall Street's self-interested happy-talking hustlers. Why? Because
comedians, satirists and jesters just tell the truth; they're painfully
funny and they're usually right. That was mid-July -- before the big
crash, before Washington's mega-billion-dollar bailout giveaways to
their screw-up buddies on Wall Street.
The Onion added, rather prophetically we must warn you: "Congress is
currently considering an emergency economic-stimulus measure,
tentatively called the Bubble Act." Of course the White House
incidentally changed the name from "Bubble Act" to TARP, but the faux
prophecy clearly exposes a classic truth:
"The U.S. economy cannot survive on sound investments alone ... Perhaps
the new bubble could have something to do with watching movies on cell
phones ... Or, say, medicine or shipping. Or clouds." But note, the
"manner of bubble isn't important, just as long as it creates a hugely
overvalued market based on nothing more than whimsical fantasy and
saddled with the potential for a long-term accrual of debts that will
never be paid back, thereby unleashing a ripple effect that will take
nearly a decade to correct."
In short, no matter how destructive to America, Wall Street wants,
needs, demands and, yes, has a passionate love affair with blowing
bubbles. It's in their blood. Wall Street is the ultimate bubble-blower,
will be for all eternity, in bear markets and bulls, world without end.
Flash forward: Today Wall Street is desperately hyping a new bubble
A recent USA Today report headlined: "5 Stock Experts Foresee 2009
Rebound" proves this fundamental principle: "Nearly all expect
double-digit percentage gains, despite another year of sharp swings. The
most bullish projections call for a 24% gain from current levels." Yes,
a 24% rally for 2009. Yikes, sounds more like another report in The
Onion, not something in USA Today.
But look closely at who's hyping those "predictions." You guessed it:
Economists, pundits and strategists on the payrolls of the same Wall
Street banks (J.P. Morgan Chase, Citigroup and my old firm, Morgan
Stanley) that our clueless Washington politicos gave tens of billions of
our taxpayers dollars after those banks failed America's investors with
their excessive greed, arrogance and incompetence.
Worse yet, last January those same banks "were also bullish heading into
2008." Folks, you'd be a fool to believe them. Yet they keep conning us
because they know many Americans will buy into the scam again.
USA Today even added a quote from S&P's highly respected chief
investment strategist, Sam Stovall: "When this bear market ends, be
prepared for a fast and furious partial recovery ... Historically, the
S&P 500 has recouped, on average, 33% of its bear-market losses 40 days
after a bottom." Fortunately, USA Today was also quick to remind us that
"the S&P 500 fell 15.2% in 1932 after its record 1931 decline."
Flashback: Wall Street sang the old bubble song back in 2000-2002
All this nonsense reminded me of the earlier media happy-talk back
during the 2000-2002 bear-recession. For 30 months the best and
brightest minds on Wall Street were all over the media hustling us:
"Market's hit bottom," "recovery's started," "jump back in now!"
Meanwhile "Mr. Market" sank deeper, laughing at their absurd hype, while
Wall Street lost $8 trillion of investors' capitalization.
So before you let Wall Street con you again, quickly peruse the
following 15 bullish "predictions" made during the last bear-recession.
They're an amazing bit of financial history from a 2003 bestseller:
"Bull! 144 Stupid Statements from the Market's Fallen Prophets."
The specific facts are different today, but the motivation driving Wall
Street is the same as when the Dow peaked at 11,722 in January 2000 and
took 30 agonizing months to hit bottom in October 2002 at 7,286.
We selected 15 of the best quotes out of the 144 put together by Greg
Eckler and L.M. Mac Donald, the authors of "Bull!" So listen closely for
the consistent leitmotif that drives Wall Street's bubble-blowing greed.
Listen especially for the echoes that make today's markets just like all
prior historic cycles, just another sequel to an old song that's again
being hyped in the media.
Why? Because nothing even really changes in Wall Street's bubble-blowing
brain:
1.
October 1999: James Glassman, author "Dow 36,000." "What is dangerous is
for Americans not to be in the market. We're going to reach a point
where stocks are correctly priced, and we think that's 36,000 ... It's
not a bubble. Far from it. The stock market is undervalued." (Fact:
dot-com PE's were astronomical, most over 40)
2.
December 1999: Joseph Battipaglia, market analyst. "Some fear a burst
Internet bubble, but our analysis shows that Internet companies account
for only 7% of the overall Nasdaq market cap but carry expected
long-term growth rates twice those of other rapidly growing segments
within tech." (Fact: Internet Index lost two-thirds within six months.)
3.
December 1999: Larry Wachtel, Prudential. "Most of these stocks are
reasonably priced. There's no reason for them to correct violently in
the year 2000." (Fact: Nasdaq lost 50% in 2000.)
4.
December 1999: Ralph Acampora, Prudential Securities. "I'm not saying
this is a straight line up. I'm not saying you can't have pauses. I'm
saying any kind of declines, buy them!" (Fact: He also predicted a
14,000 Dow by year-end 2000, and an 11-year bull.)
5.
February 2000: Larry Kudlow, CNBC host. "This correction will run its
course until the middle of the year. Then things will pick up again,
because not even Greenspan can stop the Internet economy." (Fact: This
faux economist is still hosting a cable show.)
6.
April 2000: Myron Kandel, CNN. "The bottom line is, before the end of
the year, the Nasdaq and Dow will be at new record highs." (Fact: In
September he even predicted a rally to 12,000 by election day 2000.)
7.
September 2000: Jim Cramer, Mad Money host. "SUNW probably has the best
near-term outlook of any company I know." (Fact: Within four months Sun
Microsystems dropped from $60 to $30. Down to $10 in a year. Below $3 in
two years.)
8.
November 2000: Louis Rukeyser on CNN. "Over the next year or two" the
stock market "will be higher, and I know over the next five to 10 years
it will be higher." (Fact: The market continued sinking, we fell into a
recession, and tech lost 70% within two years.)
9.
December 2000: Jeffrey Applegate, Lehman Strategist. "The bulk of the
correction is behind us, so now is the time to be offensive, not
defensive." (Fact: A sucker's rally.)
10.
December 2000: Alan Greenspan. "The three- to five-year earnings
projections of more than a thousand analysts, though exhibiting some
signs of flattening in recent months, have generally held firm. Such
expectations, should they persist, bode well for continued capital
deepening and sustained growth." (Fact: In 2008 he admitted he misled
America.)
11.
January 2001: Suze Orman, financial guru. "In the low 60s here, I think
the QQQ, they're a buy. They may go down, but if you dollar-cost
average, where you put money every single month into them, I think, in
the long run, it's the way to play the Nasdaq." (Fact: You lose -- the
QQQ lost 60% more by October 2002.)
12.
March 2001: Maria Bartiromo, CNBC anchor. "The individual out there is
actually not throwing money at things that they do not understand, and
is actually using the news and using the information out there to make
smart decisions." (Fact: Maria sounds more like a writer for The Onion.)
13.
April 2001: Abby Joseph Cohen, Goldman Sachs. "The time to be nervous
was a year ago. The S&P then was overvalued, it's now undervalued."
(Fact: The markets continued down for another 18 months.).
14.
August 2001: Lou Dobbs, CNN. "Let me make it very clear. I'm a bull, on
the market, on the economy. And let me repeat, I am a bull." (Fact: The
market was actually in bear territory for another year as the Dow and
Nasdaq lost another third.).
15.
June 2002: Larry Kudlow, CNBC host. "The shock therapy of a decisive war
will elevate the stock market by a couple thousand points." (Fact: For
Larry, war is just another "economic stimulus program." He also said the
Dow would hit 35,000 by 2010.)
Yes folks, in spite of all this happy-talk nonsense (laced with enticing
yet lethal rhetoric about "Climbing a Wall-of-Worry," "Suckers Rallies,"
"Dead-Cat Bounces," "Bottom-Feeding" and "Buy-on-Dips" opportunities)
please be patient. Remember, it took 30 months to hit the last bottom as
the Dow fell about 40% from 11,722 in early 2000 to 7,286 in October
2002.
Expect more of the same today, because "BS" is still Wall Street's
official language. In both bear and bull markets the lure is the same,
to get you to drink the Kool-Aid, to feed a new bubble and to make them
(not you) rich
The promise of the incoming Obama administration has
thrown a new light on certain sectors of the stock market, and on the
exchange-traded funds that track them.
Building and materials stocks were crushed in 2008 by the global
economic slowdown. But some investment professionals see new long-term
opportunities in construction-related industries as the U.S. prepares to
invest heavily in infrastructure improvement.
Focus on funds, ETFs
complete coverage of mutual funds and exchange-traded funds.
Investor interest has grown since President-elect Barack Obama in a Dec.
6 radio address outlined a plan to create millions of jobs in the U.S.
by "making the single largest new investment in our national
infrastructure since the creation of the federal highway system in the
1950s." Obama, who takes office on Jan. 20, pledged to invest in roads
and bridges, make public buildings more energy-efficient, modernize
schools and improve Internet-based communication and its availability.
And that's just part of an expected global surge in infrastructure
spending. "Governments around the world are making plans to jump-start
their economies by throwing hundreds of billions of dollars at
infrastructure projects," notes Robert Markman, portfolio manager of the
Markman Global Build-Out Fund (MGBOX
markman multifund tr gbl build out
MGBOX) , a conventional mutual fund that opened for business in
September.
That spending could boost infrastructure-related ETFs launched in recent
years in anticipation of a long-term global infrastructure boom driven
by emerging-markets countries. Those ETFs -- which invest in industries
including construction, engineering, utilities, building materials,
industrial equipment and metals -- have been battered by worries about a
near-term slump in private-sector construction spending.
"There are buying opportunities in many infrastructure ETFs," says Matt
McCall, president of investment adviser Penn Financial Group LLC in
Ridgewood, N.J.
Obama also has promised to focus on the development of alternative
energy sources, another global trend, so investors may want to keep an
eye out for further developments on that front. But his infrastructure
plans appear far more advanced and so are likely to have a more
immediate impact on stocks.
'Megatrend' seen in place
To be sure, infrastructure-related ETFs, like other narrowly focused
funds, are unsuitable as core portfolio holdings. The S&P Global
Infrastructure Index lost 41% in 2008, close to the 42% loss for the S&P
Global 1200 Index, according to Standard & Poor's.
Losses among ETFs included a 32% decline by the SPDR FTSE/Macquarie
Global Infrastructure 100 ETF (GII
GII
GII) and a drop of 39% by the iShares S&P Global Infrastructure Index
Fund (IGF
IGF
IGF) . Another fund, PowerShares Emerging Infrastructure Portfolio (PXR
PXR
PXR) , opened for business in October.
Chart of GII
But McCall says he still believes in the infrastructure "megatrend"
toward higher global spending. And engineering and construction stocks
got a boost late last year after Obama outlined his infrastructure
plans.
Choosing an infrastructure ETF presents its own challenges, though. For
one, McCall and others say some infrastructure funds are too heavily
invested in utility stocks, which many analysts believe aren't poised to
gain as much from infrastructure spending as other sectors, like
construction and engineering.
For example, the SPDR FTSE/Macquarie Global Infrastructure 100 ETF had
more than 90% of its holdings in the utilities sector as of
mid-December, according to State Street Global Advisors. Jim Ross,
senior managing director at State Street Global Advisors, says he
expects growth in the sector as countries add utilities to areas that
don't have them.
The iShares S&P Global Infrastructure Index Fund had more than 40% of
its assets in utilities. A spokeswoman for Barclays Global Investors,
which manages the ETF, notes that its holdings reflect the composition
of the index it tracks.
ETFs that are more focused on other infrastructure-related sectors
include the First Trust ISE Global Engineering & Construction Index Fund
(FLM
FLM
FLM) , PowerShares Dynamic Building & Construction Portfolio (PKB
PKB
PKB) , Market Vectors Steel ETF (SLX
SLX
SLX) and Materials Select Sector SPDR Fund (XLB
XLB
XLB) .
Tough to focus on U.S.
For investors looking to focus on the expected infrastructure boom in
the U.S., none of the ETFs that are currently available are a perfect
play, says Matthew Hougan, an editor at IndexUniverse.com who follows
ETFs.
For instance, he favors the First Trust ISE Global Engineering &
Construction Index Fund because it is invested in the kinds of stocks
that stand to benefit most from a building boom: The ETF tracks a share
index that includes only companies engaged mostly in large public and
private-sector infrastructure projects.
Recently, the First Trust fund's largest holdings were Vinci SA (VCISF
VCISF
VCISF) , Bouygues SA (BOUY.Y
BOUY.Y
BOUY.Y) , Actividades de Construccion & Servicios SA (ACSAF
ACSAF
ACSAF) , Leighton Holdings Ltd. (LGTHF
LGTHF
LGTHF) and Jacobs Engineering Group Inc. (JEC
JEC
JEC) But the ETF has only about a quarter of its assets in U.S. stocks.
Hougan points out that another fund he favors, the PowerShares Dynamic
Building & Construction Portfolio, invests only in U.S. stocks. But
recently about a quarter of its assets were invested in consumer-reliant
stocks like flooring company Mohawk Industries Inc., (MHK
MHK
MHK) home retailers Lowe's Cos. (LOW
LOW
LOW) and Home Depot Inc. (HD
HD
HD) , home builder NVR Inc. (NVR
NVR
NVR) and Tractor Supply Co. (TSCO
TSCO
TSCO)
About 70% of the ETF's assets were invested in industrial names such as
Caterpillar Inc. (CAT
CAT
CAT) and Fluor Corp. (FLR
FLR
FLR) , and the rest were in materials companies.
Hougan says another ETF worth considering -- one that investors could be
overlooking as an infrastructure play -- is the Market Vectors Steel ETF,
which invests in international steel companies. After a strong run since
it was launched in late 2006, the fund fell sharply in the second half
of 2008 on global economic worries and a slump in auto sales.
Investment researcher Morningstar Inc. warns, though, in its latest
report on the fund that steel "has historically been a volatile
commodity" and that any investor looking to buy this ETF "should be
prepared for a bumpy ride."
Energy alternatives
Meanwhile, other companies may eventually benefit from another pledge
made by Obama -- to encourage the development of renewable sources of
energy. And alternative energy is another area that's been embraced by
the ETF business.
A couple of caveats, though: Investors' enthusiasm for the sector has
been tempered by the plunge in oil prices in the past few months,
because growth in the use of alternative energy sources depends largely
on their ability to compete with oil-based products on price. And the
new administration doesn't appear poised to act as quickly on this
front.
"Alternative energy is another theme," in addition to infrastructure, to
consider as Obama takes office, says Hougan, but "spending on roads and
bridges would be more immediate."
Should the alternative-energy sector turn around, there are plenty of
ETFs available that invest in particular types of energy or a variety of
alternative-energy stocks, or that track various energy indexes. They
include the Market Vectors Solar Energy ETF (KWT
KWT
KWT) , Claymore/MAC Global Solar Energy Index ETF (TAN
TAN
TAN) , PowerShares WilderHill Clean Energy Portfolio (PBW
PBW
PBW) , iShares S&P Global Clean Energy Index Fund (ICLN
ICLN
ICLN) and First Trust ISE Global Wind Energy ETF (FAN
FAN
FAN)
Delivering his inaugural speech eight years ago after a
nerve-wracking election, George W. Bush brimmed with millennial
inspiration.
America's faith in freedom and democracy, he said, turned from a "rock
in a raging sea" during the Cold War into "a seed upon the wind, taking
root in many nations."
Now, though, it's unclear just what has taken root -- the seed or the
wind. While many nations have embraced freedom, some in the Middle East
remain defiant and pose a strategic threat to the new world order.
That's how Bush came to see it after he stared down Ground Zero's
smoldering remains and concluded the Middle East's surplus of violence
was linked to its deficit of liberty.
As Bush retires and Arab leaders convene an unprecedented economic
summit, the outgoing president's Middle Eastern imprint -- as he
presented it last month in a speech at the Brookings Institution's Saban
Forum in Washington -- is largely political, namely the democratic
beachhead he built in Iraq.
Bush is leaving his successor contradictory forces of mercantilism and
entrenchment that Barack Obama would do well to reconcile and thus help
dry the region's festering social swamps.
Construction whirlwind
The Middle East did see economic action during the Bush years, and in
some parts of the region, that action was the most hectic in the world.
In Dubai, for instance, more offices were built than anywhere else. A
$20 billion luxury real-estate project crowned by the world's tallest
structure sprouted opposite an artificial archipelago, while more than
$200 billion has been invested in local tourism projects.
Further north, in Bahrain, a forest of skyscrapers was built to house
battalions of insurers and bankers. And across the Arabian Peninsula,
the Saudis laid the cornerstone for King Abdullah Economic City, a $27
billion project on the Red Sea coast.
This celebration of steel, concrete, glass and cash reflected both the
high oil prices that financed it and the American friendship that
welcomed it. What's more, it included vestiges of progress like American
academic outlets in Qatar, where several thousand Arab students were
exposed to Western thought.
As the Gulf joins the global meltdown, though, questions arise
concerning this boom's financial costs and pan-Arab benefits.
The extravagant opening last month of Dubai's $1.5 billion Atlantis
resort with Michael Jordan and Robert De Niro in tow came with a
fireworks spectacle said to have been visible from outer space. The
development, however, later came crashing back to Earth. Prices around
the glitzy resort plunged 50%, making the party feel more like a requiem
to several years of wasted bounty that are now giving way to a
major-league bust.
That bust is being felt throughout the Arab world. Mortgages that sold
cheap in Dubai fed the real-estate bubble that now is bursting as did
America's overheated housing market, and just as stock markets from
Cairo to Riyadh have nosedived along with Wall Street, London and Tokyo.
Economic gaps
A closer look at the Gulf's recent economic commotion unveils a
spendthrift psychosis that is the flip side of the rest of the Arab
world's poverty -- and also is the potential key to a new American
policy for the Middle East.
Did Emirates Airlines, for instance, really need to order a $37 billion
fleet of new airplanes? Does Saudi Arabia's defense spending have to
equal Russia's? Does Dubai need a 20% stake in the London Stock
Exchange? How can Abu Dhabi's $1 trillion sovereign wealth fund be
reconciled with Egypt's entire GDP being a mere $128 billion, smaller
than New Zealand's?
Evidently, the petrodollar economies' historic refusal to fuel a Middle
East industrial revolution remained unchanged even when America set out
to reinvent the region and while Washington counted the oil-rich
countries among its allies.
While Gulf money has been buying toys like carmaker Ferrari and London's
Madame Tussauds wax museum, a series of United Nations-sponsored reports
on Arab human development was written by regional scholars.
They found the region's combined GDP was smaller than that of Spain,
that Arab women comprised the smallest share of any workforce in the
world, that all aspects of freedom remained low by any standard, and
that translations into Arabic were as infrequent as translations into
Greek. Greek is spoken by less than 5% of the number of Arabic speakers
worldwide.
These reports both expressed and inspired a realization across the
Middle East that economic gaps with the rest of the world must be
narrowed or the Arab world will be condemned to indefinite squalor and
wrath.
It was enough to spur Egypt to simplify access to its economy. That
nation consequently saw direct foreign investment soar from $500 million
in 2001 to $11.3 billion in 2007. It's also why Syria finally will
launch the Damascus stock exchange next month that its government had
promised in 1990, and why the country is now encouraging investments in
modern malls and new tourism resorts.
It's also what's made the Arab League sponsor -- for the first time
since it was established in 1946 -- an economic summit to be held Jan.
19 and 20 in Kuwait. There, finance ministers and central bankers
representing 22 Arab governments plan to get together with private
investors and seek ways to reinvent the pan-Arab economy.
This conclave could well generate little action, but it still could mark
a mental turning point that -- even if its sponsors will not admit it --
is in the spirit of the Bush quest to pacify the Middle East.
An opening for Obama
This is also where Obama can step in, offering Arab leaders American
help to reboot the Middle East's economy. It's a thought that at least
some of them are likely to welcome, rather than to reinvent its
politics, an attitude that all of them resented.
The Arab economic summit's vision, as presented by Arab League
Secretary-General Amr Moussa, is not new. The linking of regional
electricity grids, construction of interstate railways, and
simplification of Customs regulations have all been part of the New
Middle East vision that accompanied the Casablanca economic conference
of 1994.
At the time, the sponsors thought that the vision that gave rise to the
European Union and NAFTA would also appeal to Arab leaders. That proved
naive. In reality, the projects never left the drawing board and Arab
wealth remained cool to its own poverty.
Microstates like the United Arab Emirates, where 4.3 million Arabs enjoy
a per-capita product of $37,000, spent billions building castles in the
Gulf and buying assets in America and Europe. Meanwhile, Egypt's 75
million people, whose per-capita product is 15% that of their brethren
in the UAE, saw bread riots after the government was compelled to slash
subsidies.
Not only does the Gulf's surplus capital generally avoid the poorer Arab
world, surplus labor is prevented from easing the Gulf's chronic labor
shortage. In Dubai, the 1 million foreigners who live alongside the
200,000 local citizens are mostly non-Arab. In Saudi Arabia, Asian
workers are preferred even over the local unskilled workforce.
As he inherits the ever-troubled Middle East, Obama would do well to
help close the gap between Arab slums and labor markets, and between the
region's mineral riches and its under-development. Bush's attempt to
impose democracy on Arab regimes may have been premature, but America is
surely in a position to tell its oil-producing allies that it expects
them to treat nearby economies at least the way the U.S. treats Mexico
through the NAFTA treaty.
If the Gulf's capital can be made to meet the surplus labor in Egypt,
Syria, Morocco and Algeria, migratory pressures on Europe will gradually
decline and cultural friction between Islam and the West will subside.
And if the Gulf's leaders are prodded to build the hospitals,
universities, vocational schools, highways, railways and sewage systems
that most Arabs so glaringly lack, then the region's fuming clerics will
see their audiences shrink by the day.
As he makes this case, the president-elect may well add to his Arab
interlocutors that if it is up to his stimulus plans, oil will
eventually give way to alternative energies, and thus change their
petrodollars' status from misused to useless, or -- to use Bush's
inaugural imagery - from seed to wind.
financial lunatics
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